Cause of Erie's Budget Crisis— IT Cut Taxes, Then Increased Spending and Used One-Shots to Close the Gaps
Comptroller Calls for Erie County Control Board
Erie County faces a 2005 budget gap of $118.4 million and projected gaps in future years that grow from $131 million in 2006 to $279 million in 2010 and as a result is running out of cash to pay its bills, according to a report on the County budget issued today by New York State Comptroller Alan G. Hevesi.
“Erie County is facing a fiscal crisis, a cash crisis and a crisis of confidence. The ongoing strategy of cutting taxes without cutting spending and using gimmicks to cover up the deficits set the stage for this fiscal crisis years ago. I am recommending that the Governor and Legislature establish a control board to force Erie County to solve its financial problems. The people of Erie County deserve no less,” Hevesi said.
The review of Erie County’s finances found:
Erie cut property tax rates 35 percent in 2000 and 2001, but did not cut spending to match its revenues, thus throwing its budgets out of balance. Spending increased by 3.1 percent a year from 2000 to 2003, while revenues grew only 1.1 percent a year. The financial books are not yet closed on 2004, but the County had an estimated operating deficit of $107 million that year.
To cover its overspending, the County has used $346.6 million in one-shots since 2000, including $202 million from its now depleted fund balance, which is the accumulated surpluses from past years, $85 million from the sale of the County medical center and $59.6 million from tobacco funds.
The overspending has created a cash crisis. From 1999 to 2001, Erie did no short-term cash borrowing. In 2004, it borrowed $82.5 million. In 2005, it plans to borrow $260 million in short-term debt to fund operations, without a clear financial plan for the future.
Misleading and inaccurate budget numbers made the situation worse.
In 2004, the County planned for an operating deficit of $35 million, but because of inaccurate estimates of spending and revenues, the actual operating deficit was $107.3 million, forcing the County to use all of its remaining fund balance.
The 2005 budget includes inaccurate estimates and unrealistic savings for some of the budget cuts. For example, the County’s current budget includes $32.5 million in spending to be taken from reserves that do not exist. In part, that’s why the $108 million in cuts passed by the County Legislature are not enough to close the gap.
“Erie County decided to use its $202 million in prior year surpluses to cut taxes, but also rapidly increased spending, only a portion from State mandates. It may have made sense to use some of the $202 million in reserves to keep taxes lower, but it was imprudent to use up every penny of the reserves leaving the County with no cushion. And it was irresponsible to cut taxes and not cut spending, creating unbalanced budgets and huge deficits that threaten the County with insolvency,” Hevesi said. “Erie County can no longer spend more than it takes in. The purpose of a control board will be to force County officials to make difficult decisions to resolve the crisis, including most significantly requiring accurate financial reporting.”
In December 2004, the County adopted a 2005 budget of $960 million, which included a one percentage point sales tax increase (from 8.25 percent to 9.25 percent). In February 2005, the County Legislature refused to pass the sales tax increase, leaving a $108 million gap in the budget. Instead, County Legislators amended the budget by eliminating more than 1,500 full- and part-time County employees and reducing funding for many County services.
Since February, there has been an ongoing dispute regarding the size of the budget gap. On March 14, 2005, the Erie County Legislature passed a unanimous and bi-partisan resolution requesting that the State Comptroller perform a comprehensive financial review of Erie County to ascertain the County’s financial position.
That review has found a remaining projected 2005 budget gap of $118.4 million:
The current budget includes a non-existent $32.5 million from the empty fund balance. All reserve funds were used to close the 2004 deficit and the fund balance had disappeared by the time the County Legislature voted to enact the County Executive’s budget in December 2004 and then voted on a budget modification in February 2005.
The estimate of 9 percent growth in sales tax revenues in 2005 is unrealistic. Sales tax revenues have grown on average 1.85 percent a year from 2000 to 2004. Thus, sales tax revenues are likely to be about $17 million less than projected.
Personal services spending – salaries and other costs of County employees – is underestimated by $21.5 million. For example, severance costs for laid off workers will cost an additional $3 million and jail overtime is underfunded by $6 million.
Fringe benefits costs are underestimated by $36.1 million. Fringe benefit costs were more than $70 million in 2004, but only $45.9 million was appropriated for 2005. Actual costs are likely to reach $82 million.
The County overestimated miscellaneous revenues and underestimated miscellaneous expenses by $3.8 million. For example, the County has already spent all the money in the budget for fuel, though the year is not even half over.
The budget includes $7.5 million in prior commitments to spend money, but no funding to cover this expense.
The County currently does not have sufficient funds to deal with the risk from higher than expected gaps. It no longer has any fund balance. The 2005 budget includes only $1.2 million for contingencies. (Rating agencies recommend a five percent reserve, which would be about $40 million for Erie.)
“Even if County officials had passed the sales tax increase, the County would still have a significant budget deficit because the adopted 2005 budget is based on exaggerated revenue estimates for sales tax, substantially underestimated personal service and fringe benefits costs, and the appropriation of nonexistent reserves,” Hevesi said. “The first rule of fiscal discipline and integrity in government is honest budget numbers presented in a clear way. Without this there is no trust, people lose confidence in their government, and as we see in Erie County, government becomes paralyzed.”
2004 Budget Deficit
In 2004, the County had unexpected additional costs and revenue shortfalls of $70.3 million, which resulted in a total operating deficit of $107 million. The 2004 budget gap resulted from over or underestimation of many of the same items contributing to the 2005 gap, such as:
Sales tax revenues were overestimated. Actual revenues were $10.2 million less than expected.
Penalties and interest revenues on real property taxes were $13.2 million less than budgeted.
Personal services spending was $38.4 million more than budgeted.
Fringe benefit costs exceeded budgeted levels by $16.5 million.
The Erie County Comptroller has consistently issued warnings concerning the depletion of the County fund balance. Prudent management would have used that information to produce mid-course budget corrections to close this growing budget gap. Instead, the County chose to ignore its fiscal problems and exhausted all of its reserves.
From Surplus to Deficits
From 1996 through 1999, Erie County had average annual surpluses of $28.4 million a year. When the new County Executive took office in 2000, he inherited an accumulated fund balance of $202 million. The County cut property taxes in the 2000 and 2001 a total of 35 percent. As a result, County revenues were reduced by about $70 million a year starting in 2001.
However, the County did not reduce its spending. In fact, spending increased more than average for all New York counties outside New York City. From 1999 to 2003, the latest final data available for all counties, Erie increased spending in areas other than Medicaid and other mandates – the spending over which the County has the most control – by 21.4 percent, compared to an average of 12.5 percent for the other counties (outside New York City). Both personal services and capital spending grew more in Erie County than statewide: personal services spending in Erie County grew 14.2 percent, compared to 9.4 percent for all other counties statewide, and equipment and capital outlays declined slightly statewide (2 percent), but more than tripled in Erie County (up 234 percent). As a result, the County has had increasing operating deficits, rising from $10 million in 2001, $39.9 million in 2002, $44.1 million in 2003, an estimated $107.3 million in 2004 and a projected $118.4 million in 2005.
These continuing deficits have forced the County to increase short-term borrowing for cash to fund operations. From 1999 to 2001, thanks to its years of surpluses, the County did not need to do any cash borrowing. In 2004, Erie borrowed $82.5 million to cover operations. This year, the County plans to borrow $260 million: it issued $80 million in revenue anticipation notes (RANs) in March, and plans to issue another $80 in RANs in July and $100 million in tax anticipation notes (TANs) in December. “Absent immediate budget actions and a sound long-term plan, it is unclear how Erie County will repay these notes,” Hevesi said.
As a result of its budget practices, the two major credit rating agencies that rate Erie have downgraded its debt. Moody’s Investor’s Services has twice downgraded the County’s credit rating since July 2004. From July 2004 to present, its rating has dropped from “A2” to “Baa1,” and Moody’s issued a “negative outlook” warning. Moody’s consistently cited the County’s structural imbalance, diminishing fund balance, use of one-shot revenues, and depletion of reserve funds as contributing factors for these downgrades. For the same reasons, Fitch downgraded Erie three times from AA- to A+ in July 2004, to A- in February 2005 and to BBB on March 2005.
The County Executive projects a general fund budget of $889.3 million in 2006, which increases to $1.02 billion in 2010, representing an average annual increase of 3 percent. The projections show potential budget gaps of $53.1 million in 2006, which is 6 percent of the budget. That increases to $71.5 million in 2007, $95.6 million in 2008 and $120.7 million in 2009. In 2010, the County projects a gap of $146.8 million, which is 16.8 percent of that year’s revenues. Projected gaps that exceed 10 percent of budget estimates are red flags that indicate severe fiscal stress.
The Comptroller’s Office rejects the County Executive’s out-year estimates. The Comptroller’s Office projects gaps of $131.2 million in 2006, $178.2 million in 2007, $209.7 million in 2008, $242.4 million in 2009 and $278.9 million in 2010. The projected 2010 gap would be 34 percent of that year’s revenues. These gaps are so large that they will be very difficult to close if action is not taken promptly.
Role of Medicaid
The County Executive has declared that Erie County’s budget problems were caused almost exclusively by growing Medicaid and pension costs. The review found that from 1999 to 2003:
Medicaid spending has increased much less than average in Erie, up six percent annually compared to 8.6 percent annually for all other counties (outside New York City).
Erie increased spending in areas other than Medicaid and other mandates – the spending over which it has the most control – by 21.4 percent, compared to an average of 12.5 percent for the other counties (outside New York City).
After a decade of very low pension costs due mainly to exceptionally strong financial markets, the stock market declined in 2001 and 2002, requiring a return to normal pension costs. All local governments faced the same increase. The County’s total employee benefit costs (of which pensions is one part) increased from $39.2 million in 1996 to $70.7 million in 2004, representing an average annual increase of 7.7 percent. When measured as a share of general fund expenditures, employee benefits grew from 4.8 percent in 1996 to 6.8 percent in 2004.
“Increasing costs of Medicaid and pensions are a serious problem for all counties, but only Erie County has such a severe budget crisis. That’s because of the rapid increase in spending over which Erie County does have control,” Hevesi said. “As I have said many times, it is essential that New York State control rising Medicaid costs, which have created very serious problems for all counties. But Erie County’s leadership may have actually hurt the reform effort by not controlling its own spending and then trying to blame Medicaid costs for the problems it created for itself.”
“Erie County has suffered through many years of structurally imbalanced budgets, underestimated expenses and overestimated revenues; the chronic use of one-shot funding sources; the use of the entire fund balance leaving no reserve or contingency; and the use of debt to pay for operating expenses. In sum, Erie County has been systematically violating the fundamental rules of responsible financial management. That has left the County with limited options for fixing its fiscal mess. At this point, the problem is so big and it is so late in the year, that it will require every possible measure to deal with the problem this year and to close the huge future gaps. That means more budget cuts, tax increases such as the County Executive has already proposed, and deficit financing. Deficit financing and other assistance will require State action. And it is clear that it would be irresponsible to give the current Erie County government more resources unless there is a control board to ensure that those resources are used properly. However, County government should not wait until a control board is in place. With half the fiscal year gone, further delay would add substantially to the pain. The County Executive and the Legislature must immediately develop an emergency financial plan for this year and for the future, ready for approval by the Governor, the State Legislature and, ultimately, the new control board,” Hevesi said.