Budgeting for the Unexpected

by Nicolas Heidorn

Nicolas Heidorn is a board member nominee of Make Oakland Better Now!  A Rainy Day Fund proposal will be on the agenda at the joint Make Oakland Better Now! East Bay Young Democrats meeting on Sunday, February 20, 2011, 2:00 p.m.  at Lakeshore Avenue Baptist Church, 3534 Lakeshore Avenue (directions).  All are welcome.

The issue

In recent years, Oakland has been facing budget crisis after crisis. In the 20 months leading up to the 2010-2011 fiscal year (FY 10-11) the City was forced to painfully bridge $170 million in budgetary shortfalls, largely through furloughs, service reductions,  layoffs, and bookkeeping maneuvers. The shortfall results mostly from runaway costs (which the City imprudently committed to in good times) and plummeting tax revenues in the wake of the housing bust. While the recession was beyond City control, much of the fiscal hardship could have been avoided by adopting long-term policies setting aside money for future economic downturns.

Current Policy: The General Purpose Fund (GPF) Reserve

The City has historically attempted to handle fiscal uncertainty through use of a General Purpose Fund Reserve. The General Purpose Fund (GPF) is the City’s largest fund and the source of most of its discretionary spending. Libraries,  Police, Fire, and many other services are funded by the GPF. The current Reserve Policy requires that the City keep in reserve (i.e. commit to not spend) 7.5% of annual GPF appropriations. The reserve may only be tapped to “fund unusual, unanticipated and seemingly insurmountable events of hardship of the City, and only upon declaration of fiscal emergency” by the City’s elected leadership.

Oakland met its Reserve Policy up until 2009 when the City, faced with a looming budget deficit, chose to reduce its reserve to $10 million, the equivalent of only 2% of GPF appropriations. That amount was projected to remain constant over the next three years, despite even greater budget cuts appearing on the horizon.

There are several reasons why the Reserve has not been more helpful in the present budget crisis. First, because a Reserve is an annual allocation and does not grow year –to year, it is inadequate to mitigate against a steep revenue decline.

Second, it is bad policy for a City to fully tap its Reserve. The Reserve is a cushion against unexpected revenue shortfall within a fiscal year. If the Reserve is spent at the start of the year to cover a projected deficit and revenues decline even further the City has nothing to fall back on. Entirely spending the reserve could also have an adverse impact on the City’s bond rating and its ability to cover deficits in other funds.

Proposal: A Rainy Day Fund (RDF)

Many cities have supplemented their reserve policies with  separate budget stabilization funds, colloquially known as  Rainy Day Funds (RDFs). Unlike a GPF Reserve, which sets aside a fixed percentage of GPF appropriations each year independent of previous allocations, a Rainy Day Fund is a separate, cumulative fund that is only paid into during good times (when it grows) and can be drawn from in bad times (when it shrinks). Here’s an example of the difference: Over a ten year period Oakland is presently expected to keep a constant 7.5% of GPF appropriations in reserve. In contrast, an RDF starts with no money in the first year, requires (assuming revenue growth) annual contributions perhaps equivalent to 1 to 2% of GPF in subsequent years, and in ten years may grow to a cushion equivalent to 30% of the GPF.

The chief advantage of an RDF is that it can be used for long-term revenue smoothing by leveling off revenue peaks to fill in subsequent revenue troughs. In sustained high-growth periods the City would be able to set aside substantial money that could then be used to weather a multi-year recession. Moreover, by taking money off the top for an RDF in good times, the City has less money to spend at the peak of a revenue cycle and so is less likely to commit to potentially unsustainable new expenditures. In essence RDFs propose a tradeoff: reduced spending in the short-term is exchanged for longer-term stability.

The effects of a RDF over the long-term are dramatic. A 2005 study of states with rulebound RDFs found that they effectively reduced expenditure volatility (the jagged up and downswings of government spending) by 20 percent. The Oakland Budget Advisory Committee (BAC) has recommended that when the City’s revenue grows by more than 3% over the previous year half of the excess be paid into a RDF. Using Budget Office data the BAC estimates that, had the City adopted this policy in the 1990s, it could have entirely backfilled the past three fiscal years (FY 07-08 through 09-10) of revenue loss by dipping into its reserves.

Make Oakland Better Now! (MOBN!) Recommendation

MOBN! endorses the creation of a Rainy Day Fund. The present recession is sad evidence of the pitfalls of not having a long-term fiscal policy that accounts for cyclic economic downswings. There are many ways RDFs can be structured, but at minimum a RDF should:

  • have mechanical rules governing when and how much money is deposited into the RDF in periods of revenue growth;
  • allow the City Council to withdraw money from the RDF by majority vote when revenues decline but require a supermajority vote and declaration of fiscal emergency in all other situations; and
  • be amended into the City Charter to protect the policy from falling victim to shortsighted politics.

Given the present recession it may not yet be feasible for the City to make contributions into an RDF.  Still, the City should adopt a RDF charter amendment that is triggered when the GPF reaches a given threshold. Even a properly-structured RDF adopted now could not bail the City out of its present fiscal crisis; however, it would go a long way to preventing the next one.

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10 responses to “Budgeting for the Unexpected

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