1 M E M O R A N D U M
DATE: August 24, 2023
TO: Mayor and the City Council
FROM: Alan Alton, Chief Financial Officer
Maraskeshia Smith, City Manager
SUBJECT: General Fund Status
Executive Summary
The City’s Ge ne ra l Fund is in a d e ficit which is projected to grow over the foreseeable future. The d e ficit will grow la rge r whe n the City e nte rs into ne w a gre e me nts with a ll the City’s la b or group s when they expire on June 30, 2024. There is a brief period where the City can use Fiscal Stabil ity Reserves assigned in the General Fund, which was established to preserve General Fund reserves, al l owi ng ti me to devel op, and put i n pl ace, ex pendi ture reducti on and revenue enhancement measures. Failure to do so will result in unsustainable General Fund operations.
General Fund Forecasting Methodology
The guiding principal used when budgeting in the General Fund is to develop a balanced budget.
The City uses a long- range financial forecast as a tool to gauge the condition of the General Fund, id e ntify potential surpluses or deficits for the Fund, and understand the causes of imbalance. The f orecast covers a f i ve -year period showing known revenues, expenditures, and transfers in and out of the Fund. Leading up to and including the COV I D -19 pandemic, the City took a conservative approach to forecasting, resulting in forecasted deficits, but year -end resul ts end ed in surpluses.
This was exacerbated during the Pandemic as the City took an ultra -conservati ve approach to e s timating re ve nue s a nd ins titute d a hiring fre e ze . This re s ulte d in s ignific a ntly highe r than expected revenues, especi al l y Sal es T ax revenue, and higher than normal unspent salary and benefit appropriations from unfille d va c a ncie s.
After the Pandemic, the City adopted a less conservative approach to forecasting General Fund revenues, beginning with a mid -year revenue adjustment of over $9 million in early 2022. This adj ustment reset our revenue esti mates to be more ref l ecti ve of actual revenue the Ci ty was receiving and provided a more realistic base from which to make future estimates. Beginning in Fi scal Y ear (FY) 2022- 23, the City adopted a l ess conservative posture for forecasting General Fund revenues, estimating a “most likely” amount.
While expenditure forecasting has always been based on the best -known data, beginning in 2022, the City increased its vacancy credit to account for the unp recedented vacancy rates the Ci ty was
2 experiencing. These changes in budgeting and forecasting are intended to provide more resources for program budgeting and minimizing the amount of revenue exceeding estimates and unspent appropriations returning to the General Fund reserves. T he F Y 2022- 23 General Fund budget was passed as bal anced f or the f i rst ti me i n nearl y a decade.
Status of the General Fund
The General Fund balanced budget for FY 2022 -23 was short -lived, and the FY 2023- 24 was presented to Counc il with a $2.5 million d e ficit a nd a d opte d with a $3.3 million d e ficit. The initia l deficit was a result of revenues easing off from higher prior year growth combined with adding key positions to round out the City’ s organizational structure. The deficit i ncreased at budget adoption when approximately $800,000 worth of ongoing positions were added to the budget.
While the economic condition of Santa Rosa continues to be positive, we are seeing an easing of past growth l evel s i n Sal es Tax and a decl i ne in revenue from Real Property Transfer Tax (RPTT).
T hese changes have been expected as the Federal and State sti mul us packages i n response to th e C O VID-19 Pandemic have been spent in the local economy. Also, while home prices have not declined, the volume of sales has, thus the decline in RPTT revenue. Finance staff closely monitors these revenues as the General Fund budget is programmed based on less conservative revenue esti mates.
The General Fund deficit is an ongoing, budgetary structural deficit. This means that even though we are bei ng more re alis tic with our revenue esti mates to prov i de the highest level of resources as possible, our operating expenditures still outpace those revenues. Operating transfers, where funds are transferred out of the General Fund to fund projects and programs, contribute significantly to the ongoing deficit.
The current year deficit of $3.3 million grows to $9.9 million by FY 2027 -28, without factoring impacts relating to changes in labor contracts . The d e fic it grows la rge ly d ue to tra ns fe rs from the General Fund without an offsetting revenue source. These include transfers to miscellaneous program including funds for free bus fare for V eterans ($30,000) ; funds to subsidize the Bennett V alley Golf Course (BV GC) ($229,000); Courthouse Square debt service ($729,000); and transfers to the Capital I mprovement Program (CI P) for ADA facility projects ($1.2 million). Transfers to the CI P for Roseland Pavement ($662,000) and the Parking Fund for parking enforcem ent servi ces ($1.3 million) are offset entirely by revenue from Sonoma County and parking fines, respectively.
I n addition, the City transfers approximately $4 million to $5 million per year to support Homeless Programs and Services and Affordable Housing Production. Council Polic y 000- 48, “Policy to Designate General Funding for Homeless and Affordable Housing Production,” mandates this transfer from the General Fund, and the amount of the transfer is tied to Real Property Transfer Tax (RPTT) revenue . As such, this transfer takes revenue supporting General Fund operations and redi rects i t to f und speci f i c homel ess servi ces and programs, a s we ll a s a fford a ble hous ing production. In 2018, the City Council amended th is Council Polic y to increase inc re me nta lly the mandated transfer amount until an amount equivalent to 100% of annual RPT T revenue i s transferred from the General Fund to support those programs. Due to the e xpansion of the programs in recent years, the amount transferred from the General Fund to support these programs al ready exceeds the total RPT T revenue recei ved annual l y.
The City was able to use ARPA funding to pay for homeless programs and services beg inning in FY 2022-23, which in turn allowed all the General Funds transferred as mandated by Council 3 Policy 000- 48 to go to affordable housing production. Beginning in FY 2024- 25, when the ARPA p e riod of p e rforma nc e ends, those homeless programs and s e rvic e s will onc e a ga in b e fund e d by the General Fund and therefore reduce the amount funded for Affordable Housing production.
Othe r ARP A-f unded p rogra ms , including S a fe Pa rking a nd inRES PONS E, will als o funding afte r D ecember 202 4, and t he Council will need to decide whether to continue those programs by funding them in the General Fund. I f the programs are to continue in the General Fund, the cost to operate the programs will take funding away from other General Fund operations.
T he Ci ty establ i shed a Fi scal Stabi l i ty Reserve wi thi n the General Fund usi ng PG& E settl ement funds resulting from the 2017 Tubbs Fire. These funds were assigned in the General Fund, meaning they could only be used for a specific purpose and with approval from the City Council.
Specifically, these funds are designed to provide time for the City to correct the General Fund structural deficit, through revenue enhancements, or expenditure reductions, or both, while preserving unassigned General Fund reserves . U nassi gned reserves must be preserved f or several reasons. Should another significant natural disaster occur, these funds will be drawn down to provide resources to respond to the disaster. T he 2017 Tubbs Fire showed that rei mbursement f rom the f edera l gove rnme nt ta ke s ye a rs . Ad d itiona lly, the re a re c ritic a l fa cility infrastructure needs. These one -time project costs should be paid for with some of the funds in excess of the Council 17% reserve policy.
Prior to adopting the FY 2023- 24 budget, the Fiscal Stability Reserves had a balance of $27.3 million. Using $3.3 million of those funds to offset the FY 2023- 24 budget def i ci t reduced the balance to $24 million. Using our base forecast, and not accounti ng for labor contracts in FY 2024- 25, the Fi scal Stabi l i ty Reserves is p roje c te d to be exhausted with the FY 2026- 27 budget, with only a s ma ll re ma ind e r a va ila ble FY 2027-28. At that point, the unassigned General Fund reserves woul d be used to of f set the d e ficit going forwa rd , as shown on the Base Forecast below.
At this writing, s ta ff is c omp le ting the ye a r-e nd c los e p roc e s s a nd finalizing fina ncia l s ta te me nts f or audi t revi ew. T hi s rev i ew typi cal l y starts at the end of September. Final fis c al ye a r-en d (FYE) 2022 unassigned reserves totaled $53.9 million, or 27.4% of operating expenditures, which is L ong Range Financial Forecast
Base Forecast
4 about $20.4 million over the Council policy amount of 17% of operating expenditures . However, since FY E 2022, the reserves were reduced for various projects by about $5.5 million. These reductions in reserves, and the results of the year -end close of FY 2022- 23, will change the unassigned reserve amounts. Preliminary FY E 2023 unassigned reserve amounts should be a va ilab le in Oc tob e r.
The Path Forward
The General Fund has a budgetary structural deficit, which will require reduced expenditures, increased revenue, or a combination of the two to bring it into balance, and the City needs to imple me nt s ound fis c al s tra te gy imme d ia te ly. S taff has mod el ed l abor contract costs based on various scenarios, including a contract approved by Sonoma County for SEI U, and it shows that the Fis c a l S tab ility Re s e rve s will b e s ignific a ntly re d uc e d with the projected FY 2024- 25 d e ficit a nd fully e xha us te d the followi ng year. T he Ci ty must preserve unassi gned General Fund reserves for emergency use, or high priority one -ti me needs. The following are short and long- term strategies to bring the General Fund into balance and be fiscally stable going forward.
Budget Pr ioritie s
• The City can no longer add general fund resources without a corresponding increase in revenue or reduction in expenditures to offset the increased cost to the General Fund.
Furthermore, this offset must be immediate; not resulting from a potential revenue enhancement due to ballot measure or improved economic base in the future. • Any new project or program must be analyzed to account for the potential of ongoing operations and maintenance costs associated with that project, whether those costs ar e di rect or i ndi rect. Thi s i ncl udes real estate purchases. • One -time funding must be used to address City facility infrastructure needs. The amount ne e d e d to fully a dd re s s fa c ility infra s tructure is too muc h to a d d re s s holis tic a lly. Ins te ad , the City is forced to “triage” the worst problems, and take any general funds turned back a s a s ourc e to fix thos e c ritic al ne e d s .
• T he Ci ty needs a vi abl e, ongoi ng revenue stream to address i ts i nf rastructure needs. While the City ha s d e b t c ap a city a nd looks for financing opportunities to fund infrastructure projects, currently there is no ability to pay the debt service . • Preserv ing existing General Fund revenue sources is a must. W a iving and def erri ng f ees or re -directing General Fund revenue sources away from existing services with grow short - te rm d e fic its . S ta ff mus t a na lyze the p ote ntia l long-te rm b e ne fits b y d e fining the like lihood of occurrence, fiscal benefit, and weigh those against current operational i mpact.
Expenditure Reductions
• All d e p a rtme nts , and General Fund departments in particular, must look for ways to reduce ongoing expenditures. Priority needs to be placed on reduced costs based on an analytical approach to reducing the budget progr ammati cal l y, i nstead of arbi trary percentage -based cuts.
• Departments must identify true core services and build a budget around those; anything less than a core service should be available for reduction.
5 R evenue E nhancement
Give n the p ote ntial s ize of the d e ficit within a five-year period of the General Fund forecast, the City cannot address the imbalance with expenditure reductions alone. The City needs to update its various tax ordinances to make them more equitable in the community and generate additional revenue. Bel ow are exampl es of these types of updates.
• Transient Occupancy Tax (TOT). Santa Rosa has a TOT rate of 9% which is the lowest in Sonoma County. I n addition to TOT, Santa Rosa has two tourism business impr ovement assessments (BI A): the Santa Rosa Tourism BI A which charges 3%, and the Sonoma County Tourism BI A which charges 2%. Taken together, the combined TOT and BI As paid by a lodger staying in Santa Rosa is 14%; however, only the revenue generated by the 9% TOT goes to the General Fund. The SRTBI A is split between the City’ s Economic D evel opment fund (30%) and Santa Rosa Tourism (70%). All the SCT BI A revenue goes to Sonoma County Tourism. While Santa Rosa’ s TOT rate is the lowest in the county, the combined TOT and BI A rate of 14% is third highest, behind Healdsburg (16%) and Sonoma (15%). Petaluma and Cloverdale have the lowe s t combined rate of 12%. The potential revenue from increasing the C ity’s TO T rate by 1% is approximately $600,000. • Utility Use rs Tax (UUT). The City is one of a s ma ll numb e r of c itie s in Ca lifornia tha t d oe s not have a modern UUT ordinance, in that the Telephone UUT does not apply to mobile devices. The City could expand the revenue base for this tax by modernizing the ordinance to include mobile devices. This was tried in 2014 but was defeated by a significant “NO” campaign. While we’ re still analyzing the revenue potential of this change, it c ould b e s ignific a ntly b e tte r than the $955,000 we currently receive and create more equity amongst taxpayers .
• Business Tax. The City charges a tax based on business group with a cap of $3,000, re ga rd le s s of s ize of b us ine s s . City s ta ff a nd the City’s Bus ine s s Ta x Ad minis tra tor (Hd L) is currently analyzing the impact of removing the cap. Any change would be strategic to not harm existing small or mid -sized businesses but allow for larger businesses to pay a f ai rer share based on thei r revenues . Based on that analysis, we could even expl ore lowering the rate for certain businesses while still removing the cap for all business groups.
I n addition, the ballot measure would close the loophole that allows residential property rental operators with less than four units to be exempt from paying Busi ness Tax.
The other significant revenue source is sales tax. The City has a current rate of 9.25%, with .75% coming from two transaction and use taxes: a quarter -cent publ i c saf ety speci al tax; and a hal f - cent general tax. The half -cent general tax generates about $23 million - $25 million per year and is due to expire on June 30, 2031. The City cannot sustain its current General Fund operations without the extension of that tax. I n addition, depending on the amount of additional revenue generated by updates to Business Tax, TOT, and UUT, the City could explore raising the existing ha lf-cent tax. The increase in the sales tax is necessary for long- term sustai nabi l i ty to address increasing employee labor costs, and potential debt service for needed infrastructure projects.
Conclusion
The City’s Ge ne ral Fund s truc tura l d e fic it is a re a lity a nd mus t b e a dd re s s e d imme d iate ly. The City has taken a “most likely” stance on revenue estimating to increase resources to General Fund operations , on ly to find tha t the re a re s till not s ufficie nt re s ourc e s to support those operations. In addition, labor contract increases necessary to retain the City’ s workforce and ARPA funded 6 programs returning to the General Fund will exacerbate the General Fund’ s imbalance in the near term. The City must prioritize fiscal stability, utilizing the approaches outlined above, otherwise Ge ne ra l Fund op e ra tions will c e a s e to b e s us tainab le .