Receive a presentation on the FY 2020-2021 proposed budget and provide direction to staff

Receive a presentation on the FY 2020-2021 proposed budget and provide direction to staff.

Fiscal Year 2020-2021 Budget Development and Framework

On February 4, 2020, City Council adopted the Fiscal Year 2020-2021 (“FY 20-21”) budget calendar and staff began working on the development of the budget for the upcoming year. At this same meeting, staff presented a mid-year review of the current fiscal year (Fiscal Year 2019-2020) budget to Council. Revenues received to date indicated that property, sales and use and transient occupancy taxes were on track to meet budget projections.  Departmental expenditures aligned with budget expectation, with some specific expenses anticipated to be slightly over budget offset by salary and benefit savings from vacant positions.  The City was anticipated to end the fiscal year positively, on track with the budget expectation, but with little additional savings or surplus.

However, the economic forecast quickly began to change as news surrounding the coronavirus (“COVID-19”) emerged.  While the initial news focused on the spread of the virus internationally, the associated economic effects were already beginning to materialize locally.  First, the local hotel establishments experienced an immediate decline in occupancy due to travel restrictions,  followed by a loss of visitors due to a cancellation of a conference at the Sunset Center, then a near shut down with a shelter in place (“SIP”) order issued by Monterey County on March 17, 2020 followed by a statewide SIP issued by Governor Newsom on March 19, 2020.  In addition to the hotels, inns and other lodging providers, restaurants and other eating establishments and retail experienced economic distress due to social distancing protocols and the overall loss of customers, despite efforts by many restaurateurs to offer “to go” services.  The economic reality of COVID-19 required staff to revise expectations regarding the current fiscal year as well as change the guiding framework for developing the FY 20-21 budget.

Fiscal Year 2019-2020 Estimated Performance

The FY 19-20 budget is based on strong performance by the City’s three leading revenues. While property tax revenue will finish the fiscal year on budget, sales and use tax and transient occupancy tax (TOT) will fall far short of the budget, especially as the timing of COVID-19 coincides with the spring and start of summer, which are typically strong in terms of economic performance. In addition, the City charges fees for certain services, such as planning and building permits. These revenues were anticipated to be less than budgeted prior to COVID-I19, and are projected to continue to decline, although the true magnitude of the loss is contingent on customer demand and the City’s ability to provide these services within any SIP restrictions. As such, the revenue projections have been revised downward compared to the February 4, 2020 expectations as illustrated below in “Table 1: FY 19-20 Estimated Actuals by Major Revenue Source”.

Table 1: FY 19-20 Estimated Actuals by Major Revenue Source

In order to mitigate the anticipated loss of revenue, the City immediately initiated efforts to curtail spending such as implementing a hiring freeze for vacant positions, deferring capital projects and reducing spending in professional services, materials and supplies. Even with these efforts, the City is projected to have a deficit of $1.4 million after accounting for General Fund operational expenses, debt service and capital outlays due to the loss of revenue.  At fiscal year-end, staff will make necessary adjustments to balance the General Fund and use savings, or fund balance, within the Hostelry Fund to close the budget gap.

Fiscal Year 2020-2021 Budget Framework and Revenue Projections

The FY 19-20 Adopted Budget assumed $24.2 million in revenue and is likely to end with $20.4 million in new revenue instead.  Staff anticipates continued revenue decline due to COVID -19 for FY 20-21 and the following fiscal years.  Proposed revenues for FY 20-21 total $18.5 million, a decrease of $5.7 million, or 24%, over the FY 19-20 Adopted Budget.

The economic magnitude of COVID 19 is unprecedented and uncertain, although economists and other industry experts believe the fiscal outcome to be far worse than the Great Recession and 911.  Factors like stock market losses and volatility and high unemployment contribute to decreased consumer confidence and spending, resulting in less sales taxes.  Ongoing social distancing protocols are likely to limit the seating room capacity of the City’s spatially constrained restaurants and other establishments, impacting food and beverage sales. The extent to which tourism rebounds is unknown.  Tourism is influenced by local businesses being able to provide services as many of the Village’s businesses are currently closed; the lifting of shelter in place orders and travel restrictions; social gathering protocols for public events; and the desire and economic ability of individuals to travel.  The latter is particularly important as TOT is based upon both occupancy and the room rate charged.

Therefore, the proposed FY 20-21 budget takes an ultra conservative approach to revenue generation as shown in “Table 3: FY 20-21 Proposed Revenues by Source” below.  Staff budgeted a 3% growth in property tax over FY 19-20 for a total budget of $6.8 million.  Sales taxes are projected to continue to decline, and the FY 20-21 budget of $1.9 million reflects a 12% decrease over the FY 19-20 Estimated Actual. Local sales tax, bolstered by an additional 0.5% increase on July 1, 2020, is expected to increase $546,000 over the FY 19-20 Estimated Actual, to $3.1 million. Yet, this is only a 1% increase when compared to the FY 19-20 Adopted Budget. Staff researched data from tourism industries, consulted with the City’s auditor and other jurisdictions, and mapped scenarios similar to 911 in an effort to try to predict the immediate future for transient occupancy tax revenue.  However, the economic recovery is extremely difficult to predict, especially with shelter in place restrictions still in effect, State directives regarding prohibiting large social gathering through the summer months and the possibility of another spread of the virus in the autumn.  The City received approximately $3 million in TOT revenue last year from July to October and thus a forecast that assumes little to no revenue during this timeframe, assumes no Car Week, and incremental revenue for November to June is bleak.  The FY 20-21 revenue projection of $2.5 million for TOT reflects a 34% decrease over the FY 19-20 Estimated Actual and a 64% decrease over the FY 19-20 Adopted Budget.

Table 3: FY 20-21 Proposed Revenues by Source

Fiscal Year 20-21 Expenditures

The FY 19-20 Adopted Budget assumed $24.2 million in revenue to support General Fund operations ($21.2 million), debt service ($1.3 million) and capital ($1.7 million).  The original FY 20-21 budget forecast developed prior to COVID-19 assumed $22.2 million for General Fund expenditures. Operational costs were forecasted to increase due to factors such as negotiated salary and step increases; health insurance; pension costs; general liability, property and workers compensation insurance premiums and inflationary increases to services and supplies.

In addition, the FY 20-21 budget forecast included funding for debt service. This amount is the required debt service for the NGEN Radio project, Sunset Center and pension obligation bonds.  Based upon revenue projections and the anticipated increase in local sales tax, the expenditure forecast proposed to fund capital projects, set aside funding for pension mitigation and increase the City’s reserves.  The preliminary expenditure forecast is depicted in Table 4: FY 20-21 Preliminary Expenditure Forecast below.

Table 4: FY 20-21 Preliminary Expenditure Forecast

However, at that time, revenues were projected to generate sufficient revenue to pay for these expenses.  As a result of COVID-19, the FY 20-21 anticipated revenues have been significantly reduced.  With $18.5 million in FY 20-21 expected revenue, Citywide expenditures must be curtailed to balance the budget.

Strategies to Address the Budget Shortfall

In light of the economic reality imposed by COVID-19, staff does not anticipate being able to increase reserves or set aside funds for pension mitigation.  In addition, Council held two public meetings on the capital improvement program and provided direction to staff to eliminate any planned spending on capital projects for FY 20-21.  Debt service is required to be paid, which means that after deducting the $1.2 million expense from the anticipated $18.5 million in revenue, there is $17.3 million remaining to pay for operations.  

Similar to debt service, the City is required to pay pension costs, which include retirement benefits and the annual contribution to the City’s unfunded actuarial liability (“UAL”).  For FY 20-21, the City is required to pay $1.6 million toward the UAL. From the proposed $17.3 million in available funding, an additional $1.6 million must be set-aside for the UAL, now leaving $15.7 million to fund General Fund operations. As shown in Table 4 above, General Fund Operations were projected to be $21.7 million in FY 20-21.

In order to help mitigate the loss of revenue, department directors were instructed to prepare budget submittals reflecting a minimum reduction of 20% to their respective services and supplies budgets without impeding critical public health and safety services or any federal or state mandated program or function. This resulted in a services and supplies budget of $7.2 million, which reflects a $1 million reduction, or 14% decrease, over the FY 19-20 Adopted Budget.  The budget workshop will include a presentation on the proposed reductions by department with an emphasis on the impacts to service delivery.

Even if the services and supplies budget was further reduced, or, although infeasible, eliminated entirely, it would not generate sufficient funding to pay the FY 20-21 projected cost of personnel.  Salaries and benefits account for 48% of the FY 19-20 budget, and this percentage is within the range of expenditures spent on personnel by local governments given the nature of services governments provide to their respective communities.  Due to the budget deficit and the current Governor’s order for essential services, the City will be reducing salaries and benefits that may include layoffs, reductions, salary freeze, and other solutions to reduce the projected budget shortfall for this year and to mitigate the ongoing structural deficit the City is projected to face over the next several years.  For FY 20-21, this approach includes a combination of keeping the existing vacant positions unfilled and a reduction of approximately 30% of the existing workforce.   This results in a projected salary and benefit cost of $9.5 million as compared to $11.6 million.  

Although the City is proposing to make dramatic reductions to the budget, there is still a projected shortfall for FY 20-21 due to the diminished revenue expectations as illustrated below in Table 5: FY 20-21 Proposed Budget at a Glance. This will require the use of fund balance, further cuts, or a combination of these two strategies to balance the FY 20-21 budget as required by State law. The one-time use of fund balance in FY 20-21 will further decrease the amount of fund balance available to balance the budget in future years.  

Table 5: FY 20-21 Proposed Budget at a Glance

Financial Forecast and Structural Deficit

While the ongoing fiscal impacts associated with COVID-19 is truly unknown, economic forecasts assume it will take several years to fully rebound economically.  In terms of the City’s long-term forecast, staff assumes stability in property taxes, an incremental uptick in sales tax and a gradual phasing in of transient occupancy tax, starting with 75% of FY 18-19 revenue in FY 20-21.  

Although revenue projections are difficult to predict, there is some certainty that the Citywide expenditures are still likely to increase over the next few years. The UAL is expected to grow each year, projected at $2.4 million in FY 24-25, without factoring in any adjustments related to COVID-19 economic loss.  The maturity of the pension obligation bond on June 1, 2023 will afford economic relief of approximately $700,000, although the Sunset Center bond obligation of $500,000 will remain until 2031.  While capital spending has been postponed for FY 20-21, it is anticipated that the City will need to budget expenditures for capital and vehicle equipment to perform essential deferred facility maintenance, critical infrastructure repair and/or replace aging public safety vehicles.  Based on increased operational costs, debt service and minimum capital investment, staff anticipates an ongoing structural deficit of $1-2 million a year for the next four years, unless there is a dramatic economic recovery or further cuts are made.  A high level financial forecast will be presented at the budget workshop.  Also, staff plans to conduct regular budget updates to Council next fiscal year. 

The FY 19-20 Proposed Budget totals $19.6 million and requires the use of approximately $1 million in prior year's savings ("fund balance") in order to balance unless additional reductions are made.

Council received presentations regarding the capital improvement program on April 7 and May 5, 2020 respectively.