Ill-advised Financial Practices

Jointly, cities have over one-hundred years of experience managing public finances. Given all this experience, why are local governments still getting into financial trouble in 2003? Much of the problem deals with the time it takes for a problem to manifest itself. Most ill advised financial decisions are made during good financial times. Since the agency has sufficient revenues and adequate balances, decisions are made to spend money. Perhaps it’s for a healthy salary increase, an enhanced retirement benefit, a new social program or a combination of several of these items.

The full cost impact of these decisions may not show up until two or more years later. By then a new city council, that has little knowledge of the previous decisions, may be in office. At first, these councilmembers may try to ignore the problem, hoping that things will get better. At some point it becomes apparent that a real problem exists. Since it is virtually impossible to undo the decisions that caused the financial imbalance, they look for painless ways to carry on as before. The following four expedient behaviors actually exacerbate a financial crisis and if unchecked can result in fiscal meltdown.

1. Raid Fund Balance
Fund balance serves many purposes. It is used for cash flow, internal loans and a source of monies to deal with natural disasters, lawsuits and insurance claims. It is sometimes used as a temporary hedge against the loss of volatile revenues. Most importantly, it generates interest income for the general fund. Fund balance is one of the first sources agencies access during periods of fiscal stress. Using fund balance for temporary relief until a financial plan is developed is an appropriate remedy. Depleting fund balance as a technique to avoid cuts or tax increases is not sound financial management.

2. Spend Windfall Revenues
Windfall revenues result from several sources including sharp increases in building activity, interest rates, retail sales or utility prices. When unexpected revenues are received by the city, officials appropriate the monies for new programs. In many cases money is committed before the agency determines whether this money is ongoing or one-time. This failure to exercise restraint increases the base budget. If the windfall revenues are one-time, ongoing revenues must be found to pay for the new programs.

A variation of this occurs when surplus funds are used for new ongoing programs. Surplus funds may occur from conservative revenue projections, liberal expenditure estimates or failure to implement adopted programs. Before these monies are used, the agency needs to determine whether the money is ongoing or one-time. Surplus funds that are one-time should be used for reducing debt, increasing fund balance or capital projects.

3. Pursue Grants That Are Not Affordable
There is tremendous pressure to acquire federal and state grants. It is very difficult to say no when a US Senator is on the airport tarmac with a check in hand. Yet grants can create more problems than they solve. They create a clientele that exerts public pressure to preserve and enhance the grant established program. Grants may reorder priorities and require upfront matching funds. Most have provisions that require the agency to pick up one hundred percent of the cost after a fixed period of years. Before a grant is pursued the agency should make sure that the grant implements an agency goal and is affordable.

4. Adopt Structurally Unbalanced Budgets
Having a balanced budget is no guarantee against insolvency. The question is: “How is the budget balanced?” A structurally unbalanced budget results when recurring expenditures exceed recurring revenues. Failure to right this imbalance results in the gap getting bigger and more painful to close.

During times of fiscal stress, the budget may be structurally unbalanced by design. The agency may make a conscious decision to use one-time funds to get through the difficult period. If this approach is used, a fall back position (such as budget cutbacks) is needed if the fiscal climate does not improve. It is also a good practice to alert the community that the budget is structurally out of balance.

Some governing bodies have adopted financial policies that limit or prohibit these practices. A balanced budget policy may read as follows: “A structurally balanced general fund budget, in which recurring revenues exceed recurring expenditures by one percent, will be submitted to the city council.” A surplus policy might read: “General fund surpluses will be used for capital projects, increasing fund balance or debt reduction rather than new or enhanced operating programs.” Publishing these polices in the budget and requiring staff to publicly report on each policy provides an open public forum on the city’s financial condition and helps guard against inappropriate fiscal practices.