Reading's Proposition 2 1/2 Override - Part 2

This is the second in a series of letters to the Editor whose goal is to give Reading voters some background on our Town finances, explain the financial challenges we have faced, and outline the reasons why we are bringing a Proposition 2 ½ Override question to the voters in a special election on October 18.

In my last letter I explained how Proposition 2 ½ limits our property taxes, what an override accomplishes, and how tax classification works. I described how additions to the tax base (New Growth) factor positively into the tax base. In this letter I will explain the way Reading performs its annual revenue and spending projections and how a recurring structural imbalance has developed between the two. I will also explain the proactive measures Reading has taken over the last decade to address this imbalance and delay the need to ask the taxpayers for additional tax revenues via an Override. (Additional information can be found on the Town of Reading website at http://www.readingma.gov/finance-department/assessment/pages/override-in...).

Sources of Income

After Prop 2 1/2 was first instituted, revenue growth of 5% was common throughout the state, although figures in the past several years are closer to 4%. Let's take another look back at historical sources of revenues for Reading. Below is a table that shows FY03 & FY04 and FY16 & FY17 sources of revenue in Reading for comparison. Note that FY03 & FY04 are chosen to show the context surrounding the last operating override of Proposition 2 1/2:

FY17 FY16 FY04 FY03

Property Taxes 72.5% 72.2% 68% 62%

Local Charges 7.5% 7.5% 9% 9%

State Aid 15.6% 16.0% 19% 24%

Other 4.4% 4.3% 4% 5%

Reading has been increasingly reliant on local sources of revenues because inflation adjusted state aid has declined by about 50% since the last operating override. For FY17 the Governor's budget showed a meager 1.6% increase in state aid for Reading. Annual state aid would need to increase by over $2 million from predicted levels in order to fund 9% of Reading's budget as it did after the last override.

The Town Manager has explicitly cautioned for the past few years, that balancing the budget with increasing amounts of Free Cash (the Town’s “savings account”, funded by higher than expected revenues plus lower than expected expenses) is not a good or sustainable practice. The town is now at a crossroads, and must decide how to balance the financial resources available with the demand forservices.

Where is the Money Spent?

On the spending side, Reading looks a lot like our Peer Communities (see detailed information on Town website). Because of the high residential tax base, Reading has a larger student population. Using 2014-15 MA Department of Education data, Reading has 17.4% of the population of the town in the public school system, compared to 15.8% among Peers (the range is from 22.1% in Westford to 10.7% in Stoneham). Thus, while the town spends slightly more than average of the budget allocation on Schools, we also spend a low per-pupil amount. Due to highway proximity and commuter ‘cut- through’ traffic, the town also spends a bit more in Public Works and Public Safety. Because we offer Advanced Life Support, about $800,000 in ambulances fees flow to the general fund each year to be used by the Town and School budgets. This revenue more than offsets the above average spending in Public Safety. Finally, the town spends less on Town Hall staffing, and on fixed and other costs.

Here is a chart showing the Spending comparison:

% of Budget Spending Reading Peers Difference

Education 39.3% 39.1% +0.2%

Fixed Costs & Debt 17.7% 17.8% -0.1%

Public Safety 9.2% 8.7% +0.5%

Public Works 5.1% 4.9% +0.2%

General Gov’t 3.6% 4.3% -0.7%

Culture & Rec & Human Svc2.7% 2.4% +0.3%

Other (incl. Ent. Funds) 22.4% 22.8% -0.4%

What Cost-Saving Measures Have Been Taken?

Over the last decade, Reading has been increasingly creative in getting maximum value out of every dollar spent. These measures successfully put off the day when additional tax revenues would be needed:

• Spend money to save money: Performance contracting (competitive bidding of energy efficiency improvements); some out-of-district Special Education (SPED) brought in-district; employee payments to opt-out of Health Insurance
• Spend money to generate revenues: Ambulance revenues from Fire Department Advanced Life Support
• Operational efficiencies: capital spending; rubbish/recycling; technology
• Restructuring large departments and single positions
• Financial planning emphasized
• Fees & Revolving Funds increased

  Note also that the town has taken several short-term steps in order to steer funds to the operating budgets, such as using rainy day Free Cash and cutting capital investments. These are signs of caution, when repeated over the years, that we are in effect living above our means.

Budget Modeling

Reading uses a model, introduced ten years ago, that has brought increased transparency and stability to the town’s finances. Part of the transparency is the ability to look ahead – and what we see is not encouraging. The model starts with Revenues as projected by the Town Accountant, an independent position that reports directly to the Board of Selectmen. From that figure, so-called Accommodated Costs (benefits, capital, debt, energy, financial, vocational education, out of district SPED, and some miscellaneous items) are subtracted, and what remains are the funds available to split between the town and school operating budgets, which is currently done on a 36%/64% basis.

The rationale for the Accommodated Costs category was that some items, such as out of district SPED, energy and healthcare costs, are well beyond local control and used to lead to volatility (and in some cases hostility among town and school departments) in the annual budget process. In the current FY17, with Revenues at $90.2 million and Accommodated Costs at $33.2 million, the town and school operating budgets have been allocated $57M, an increase of +3.4% over FY16.

The first assumption was to ascertain the right target for an annual operating budget increase for the Town and Schools. Since the last Override that figure has been about 3.2%, but we also know in recent years that increases of 3.6% have required staffing reductions. We settled on 3.5% as a reasonable long-term target. Prudent annual financial management should allow the Town and Schools to add new services as needed within that framework, and minimize budget reductions.

The next set of assumptions involved our expected Revenues and Accommodated Costs. All estimates were done line-by-line by the Town Accountant (Revenues) and Town Manager (Costs) in a bottom-up fashion, though only the summary results are describedbelow.

Revenues - Property taxes ($61 million) are straightforward at +2.5% annually plus New Growth. The latter is conservatively estimated at $500,000/year from FY18 through FY21, below the recent $830,000 three-year average. This New Growth figure is then increased to $1,000,000/year gradually by FY24, given staff ground work being done in the commercial development sector. Other revenues came in around +2.5% annually, although State Aid has not recently hit that target.

In general, aside from Free Cash usage, Revenues are projected to increase by between 3.2% and 3.5% using this approach for the foreseeable future.

Accommodated Costs - Health Insurance as a driver at +7.5% leads benefits forecast at +6.4% annually. Other costs were forecast between 3% and 5% - much lower but still a challenge when compared to estimated revenue growth.

In general, Accommodated Costs are forecast to increase at about 5.4% annually, after a first year increase closer to 7% to allow for a stepped up increase in Pension contributions.

Funding Gap - At the same time the revenue outlook remains very constrained, accommodated costs are experiencing their second year of 'above revenue growth' rate increases after a period of low growth for a few years prior to that. When accommodated costs grow at a rate above revenues, both the Town and School operating budgets are squeezed, unless free cash is used to ameliorate this situation.

Our modeling predicts that the squeeze will be on the Operating Budgets for the foreseeable future as Revenue growth (3.2% to 3.5%) is not expected to keep pace with Accommodated Costs (5.4%). That Funding Gap translates to an annual $660,000 budget shortfall – and the effect is cumulative.

For FY18, given the assumptions above, a structural deficit of $3 million exists ($1.925 million Schools and $1.075 million Town), in order to fund +3.5% Operating budgets. An additional $3 million will be needed to close this structural deficit over the next 8 fiscal years.

In my next letter I will discuss why the Town is seeking $7.5 million in the Override, what a YES vote will mean for town finances, the effect on the average household’s taxes, and the impacts of a NO vote as determined by the Town Manager and Superintendent of Schools.

Daniel Ensminger, 6 Oakland Road, Reading, Member & Former Chair, Reading Board of Selectmen