City’s Financial Forecast Contains Uncertainty and Some Good News
Finance Director Jill Feldpausch’s five-year financial forecast for East Lansing contains more uncertainty than usual – but also unusually good news, she told City Council last week.
The City income tax that went into effect on January 1, 2019, is the most significant new factor in the City’s finances, but there is some other noteworthy news, as well.
Here are some highlights from the Fiscal Year 2020-24 report presented to the City Council on February 19. Feldpausch will continue to update and refine the document as the Council looks toward developing the FY (Fiscal Year) 2020 budget this Spring.
The bottom line of the five-year projection:
The Council listened to an hour of rapid-fire, detailed information about anticipated revenues and expenditures before learning the bottom line. (See the slide presentation here.) We are putting it right up front in these selected highlights.
Feldpausch concluded her report to Council on a positive note. “This year was pretty tough, with all the changes – a lot more uncertainty than I’m used to seeing,” she said. “But I will say, this is about the prettiest forecast I’ve see as far as the bottom line. You don’t have a negative fund balance at the end of the five years.”
Feldpausch said that, in her thirteen years working for the City, this is the first time she has seen a forecast that did not have a negative fund balance at the end.
Last year’s forecast projected that, by FY 2023, the City would have $3.3 million less in revenue than in expenditures, and, before then, the City would have already emptied its fund balance. Indeed, FY 2023 would show a hypothetical fund balance of -8.3% of operating expenditures. This scenario is impossible, however, because local governments must have a balanced budget. The implication of that forecast was that expenditures would have to be cut significantly by then.
This year’s projection is notably different. Instead of a -$3.3 million balance at the end of five years, the report the Council received last week shows a positive fund balance of $4.1 million five years from now (FY 2024), equivalent to a cushion of 9.9% of operating expenditures.
What the income tax means for the City’s revenue:
Not surprisingly, the largest cause of the change in the City’s projected bottom line comes from increased revenue, especially from the new income tax.
In August 2018, City voters adopted an income tax to bring in more revenue. City residents will now owe a 1% tax on qualified income (excluding some forms of retirement income), and non-residents who work in East Lansing owe a 0.5% income tax. The new income tax is limited to 12 years, and the City’s property tax will be reduced by 5 mills in any year there is an income tax.
The idea is that this will mitigate local tax liability for East Lansing residents while broadening the City’s tax base to include non-residents who work here, including employees on Michigan State University’s main campus.
There is not yet any real-world data generated in East Lansing to project revenue from the income tax. For now, the City is using an estimate of $10 million in revenue from the income tax (net of administrative costs), taken from the Income Tax Feasibility Study conducted by Plante Moran in 2016 for the Financial Heath Review Team. The City expects a reduction of $5 million as a result of reducing the property tax millage, so the net increase in tax revenue is expected to be $5 million.
(If you haven’t looked into how the tax will affect you individually, you can view information provided by the City here. For individuals who may be required to make quarterly payments, the first payment is due on April 30, 2019.)
Fire protection payment from the State may increase:
During the lame duck session at the end of 2018, the Michigan Legislature voted to authorize full funding for PA-289, a law that calls for the State to reimburse local governments for fire protection services they provide to tax-exempt, State-funded institutions, such as MSU. There is still uncertainty about what increased funding might result, however, because the State legislature has not yet appropriated funds to pay for this.
Feldpausch is projecting a possible increase of $1.6 million in PA-289 funds and recommends that this amount be used for a supplemental payment toward the City’s unfunded pension liabilities. If the legislature appropriates less money, that would mean lowering the supplemental pension payments.
Other revenue sources:
The forecast document and Feldpausch’s slide presentation to Council estimate changes in many other sources of revenue into the General Fund, include State revenue-sharing, building permits related to downtown development, housing rental licenses, fines for parking and other ordinance violations, court and ambulance fees, and Board of Water and Light (BWL) franchise fees. With a few exceptions, revenue from these sources is expected to increase between 0% and 3% annually.
Personnel cost increases:
Personnel account for 75% of General Fund expenditures. The Finance Director’s projections are for a 2.0% cost of living adjustment (COLA) increase each year plus anticipated merit increases averaging 1%.
Personnel costs are also expected to rise because of reinstating four positions – two police officers and two firefighter / paramedics – that were cut in the FY 2019 budget before residents approved the new income tax. A new housing inspector is also expected to be hired. Other personnel changes in various departments will be discussed when the Council considers the FY 2020 budget.
All seven unions representing various groups of City employees will negotiate new contracts with the City this spring.
Pension payments and unfunded liabilities:
The City will be able to increase payments into the employee pension plan as a result of the income tax. Indeed, the law adopted by East Lansing voters in 2018 requires that 60% of net income tax revenues be used to make supplemental payments for unfunded pension liabilities for retired city employees.
Feldpausch gave Council the news that the State of Michigan now requires that all financial statement reporting of pension systems must assume an annual investment rate of return of 7.0%. By contrast, the Municipal Retirees Employment System (MERS) which administers East Lansing’s pension funds, currently assumes a 7.75% investment rate of return.
Mayor Mark Meadows commented that the State’s assumed annual rate of investment return of 7% is probably more realistic that MERS’ more optimistic assumption.
Implementing a lower rate of return assumption means that larger contributions will need to be made into the system in order to meet estimated pension payments to retirees. If you expect lower investment earnings, larger amounts must be paid in to reach the same estimated amount needed to fund future pension payments.
Feldpausch told the Council that she wanted them to be prepared to see the City’s pension funding percentage go down because of this new reporting requirement, despite the City’s making additional payments into the fund. Had there not been a change in assumptions, she had hoped to see the City’s funding percentage go up.
The current funding ratio is about 54%, Lahanas reported. Now, Feldpausch expects the funding ratio to go down into the high 40s.
From a practical point of view, Feldpausch explained that the change in this assumption means we now expect a “huge jump” in the City’s required pension payments starting in FY 2021. Her forecast shows the following required pension payments in the next five years: $6.04 million (FY 2020), $6.26 million (FY 2021), $6.41 million (FY 2022), $6.53 million (FY 2023), and $6.67 million (FY 2024).
In her forecast, Feldpausch reduced anticipated supplemental pension payments from $2 million to $1 million starting in FY 2022 because of the higher required payments that will be due.
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