Manager’s Budget Report Today Confirms $65-100 Million Deficit Faces San Diego City

City to Increase Budget by Whopping 11% While Masking True Size of City’s Budget Deficit

“For weeks officials at City Hall have downplayed the city’s financial problems, but when you add up the City Manager’s own numbers the real story emerges of a city government either in complete denial or trying to keep important facts from the public,” commented Performance Institute President Carl DeMaio who conducted the analysis. “Admitting you have a problem is the first step to any recovery. The City’s budget forecast reveals not only a huge budget deficit, but transparency and accountability deficits as well. It is time for the Mayor and Council to become actively engaged in this process and demand better and more accurate information from the City Manager and his replacement.”

The Institute’s analysis makes several conclusions using the City Manager’s own data:

City Plans to Increase Spending by a Whopping 11 Percent!

Even if the Mayor and the Council agree to Manager’s suggested reductions of $24 million for the coming year, the city plans to spend a whopping 11% more from its General Fund in FY 2005 than in FY 2004. This is well above a more healthy increase to match population growth and inflation—which is an accepted benchmark other governments are using. While the Manager’s report intentionally does not add up all expenditures planned for FY 2005, the Institute did add the number up and discloses it to the public.

“We were shocked to see how much the city wants to increase spending by. Rule one when you are in a hole: stop digging.” DeMaio noted. “Instead of rethinking the city’s budget priorities and transforming city management, today’s briefing is solely based on how much more the City wants to spend, followed by a search for revenues to finance that 11 percent increase in spending.”

Deficit Figure: $8.5 Million for Current Year; $65-100 Million “Shortfall” for Budget Year

On March 18, 2004 the Performance Institute provided analysis as part of its work for the San Diego Citizen’s Budget that demonstrated that the City’s budget shortfall for FY 2005 would be in the $80-100 million range. This initial analysis was based on the city’s own financial data and projections using FY ’04 data rather than the fresh data provided in Uberuaga’s report today. The Institute stated at the time that once the Manager released his forecast, an updated figure would be provided.

“You have to look real hard and know a lot about public sector budgeting to add it all up properly, but when you do the true size of the city’s deficit emerges,” commented DeMaio. Using the City Manager’s OWN financial projections, the Institute has confirmed its original range by making the following categorizations of the Manager’s own data:

DeMaio recommends that a number of other adjustments should be considered by the Mayor and City Council as they deliberate over the budget. They include:

* Manager is banking on getting federal homeland security grants to cover PSCP funding. As a result, his forecast includes NO General Fund monies for this vital project.
**See attached Chart (in PDF) summarizing full analysis of Manager’s forecast and justification for each adjustment.

“City Hall continues to say that they don’t have a ‘deficit,’ and instead are hiding behind bureaucrat speak that they have a ‘shortfall.’ No matter what you call it, the city is in a financial hole!” DeMaio lamented—noting that the current deficit does not include the long-term pension liability of $1 billion.

“Once all the gimmicks are removed, I still would peg the city’s deficit at between $80-100 million, but we are willing to go as far as accepting the Manager’s rosy revenue estimates should he be able to justify them.” Should the Manager justify the revenue estimates, the Institute announced that it would recommend to the San Diego Citizens’ Budget Project that it use at least the $65 million deficit number as its starting point for the construction of a balanced budget to be presented to the Mayor and City Council in May.

Accounting Gimmicks and Fund Transfers Used to Mask Deficit

While the Manager is claiming a $2.5 million surplus for the FY 2004 budget, according to the analysis the city currently has at least a $8.5 million deficit for the current budget year. DeMaio faults the City for using one accounting gimmick—dubbed in the Manager’s report as “Sales Tax Accrual”—to generate $10,000,000 in “phantom” revenue in FY 2004.

This amounts to an accounting change on paper—where the city is claiming revenue in FY 2004 even though no actual increased revenue is collected by the City. The City will count sales taxes paid by consumers for purchases in FY 2004 as “revenue” even though these funds are not received by the city from the state until as much as 90 days into FY 2005. While limited and prudent use of accrual policies are allowed under government accounting rules, the use of changes in accrual policies to mask a deficit is NOT accepted as a legitimate financial management practice.

Another practice employed by the City to mask its deficit is the raiding of funds from Special Funds and Enterprise Funds—which are for restricted uses. The City has come under criticism in recent years for its use of this practice—most notably charging water and sewer funds a “Right-of-Way” fee for running lines under City streets. Water and sewer fees have just recently been hiked for the past three successive years—with the promise that all funds would go to improving our water and sewer system. In other cases, the City uses its “Internal Services Fund” to raid these restricted use funds—using Memorandum of Agreements, Service Level Agreements, and Form “292s” to transfer funds with little or no transparency nor accountability. Moreover, to accommodate current year budget reductions, General Fund staff have been transferred to Special or Enterprise Fund positions even though their duties remain unchanged.

While the extent of the inappropriate transfer of funds into the General Fund using the Internal Services Fund is not yet known for FY 2005 (this number will be revealed in May), the Manager’s budget projection calls for direct Fund Transfers amounting to $8 million. The City also proposes to reduce the $10 million in funding to the Regional Park Fund and Mission Bay Improvement Fund and reduce the City’s reserve by $3 million.

DeMaio reserved his strongest criticism of the city for the use of these tactics: “Accounting gimmicks and raids on special funds were tools used by Gray Davis and the California Legislature for years to mask the true size of the state’s budget woes. Voters sent a clear signal during the Recall election that they wanted those kinds of budget gimmicks banned in government. Apparently that message has not yet been heard in San Diego’s City Hall.”

Intentional “Under-Funding” of City Departments Evident

The City Manager’s report reveals that City Departments overspent their budget allocations by $15,675,000 in FY 2004—not including $6.3 million spent in response to the Cedar Fire. “This level of busting the budget demonstrates that the FY 2004 budget as adopted balanced only on paper from the beginning,” noted DeMaio. Analysis of individual city department budgets reveals no funding in the FY 2004 budget for overtime and woefully inadequate funding for workers compensation claims. Police and Fire Departments were responsible for the lionshare of overspending in 2004. Positions in the Police Department are budgeted for the public’s peace of mind but intentionally left vacant to save money. Nevertheless, the Police Department is then forced to pay overtime to its limited officer corps at a higher pay rate—questioning the wisdom of leaving positions vacant for cost saving purposes.

DeMaio praised the Manager for mid-year spending adjustments, noting the Manager reduced the current operating budget deficit by making $10,722,000 in cuts. For FY 2005, the Manager already is suggesting $24 million in reductions to Department spending requests.

“We need to watch how the Manager implements these reductions. The practice of intentional underfunding of some city departments such as Police and Fire just to balance the budget on paper has to stop. There’s now a perverse expectation that many city agencies will bust their budgets from day one of the fiscal year.” DeMaio cautioned.

Good and Bad News on City Revenues

The analysis demonstrates that city revenues are improving as the economy in San Diego improves. FY 2004 revenues are up by a healthy $10,500,000 over budgeted amounts—which is good news for the city. Moreover, in FY 2005, economic indicators point to continued recovery in San Diego’s economy. However, the revenue forecasts provided the City were $15,000,000 higher than “High” expectation in revenues projected by the Performance Institute for FY 2005 in its March 18 analysis. This “rosy” scenario outlined by the City Manager’s forecast might not come to fruition. Mayor and the Council should plan accordingly and be conservative in revenue forecasts. Another flaw in the City Manager’s forecast is the ignoring of the anticipated loss of $14,750,000 in state property tax and state booking fee revenues.

Small “Downpayment” for Public Safety Investment Made

After years of under funding public safety investments, the City Manager takes a positive step by allocating $13 million in funding for public safety investments in deferred maintenance, new vehicles and equipment purchases, and four new police academies. However, this number is but a small downpayment on a larger investment need. On March 12, the Police and Fire Departments released a full accounting of key public safety infrastructure investments needed over the next five years—totaling $478 million. This includes $159 million for the Fire Department, $186 million for the Police Department, and $133 million for a joint Public Safety Communications Project (PSCP).

One other cautionary issue is raised on public safety: instead of securing funding for an estimated $6 million in PSCP expenditures in FY 2004, the City Manager zeroes out the General Fund portion of this project in hopes of winning homeland security grants from the federal government. While these grants might come through, there is no assurance that the City will receive any funding from this source.

The Unresolved Challenge: Rising Employee Costs!

The Manager’s budget report reveals the true driver in the city’s budget problem: rising employee salaries and benefits. In its March 18 analysis, the Institute noted that since 1994 the city’s budget has increased 20%, but during the same time employee costs have risen by 118%. Moreover, in the past five years, city employees have seen a 35% increase while the average increase in CA personal income is up by only 24%.

The level of increases for salaries and benefits alone in FY 2005 is startling—totaling $75,000,000. The lionshare of the city’s deficit comes from these rising labor costs. With these increases, a whopping 80% of the General Fund now is dedicated to cost of labor—with the remaining 20% available for library books, police cruisers, supplies, services, etc.

The good news is for the first year since 1996, the City will make a full payment to its Pension Plan in the amount of $130,000,000. However, the structural underfunding and long-term liability has not yet been addressed. Under a recently-announced lawsuit settlement, the City will start making its “back payments” on July 1, 2005—after this coming fiscal year. DeMaio comments: “While city employees themselves are NOT the problem, rising cost of labor is a ‘center of gravity’ that must be overcome if the City is to address its financial woes.”

Conclusion: Immediate Engagement Needed by Mayor and Council

DeMaio concludes his analysis with a call to action: “City Hall is not leveling with the public. The Mayor and City Council should demand a full and transparent disclosure of the city’s finances to the public. Before we can begin to work on solutions to the city’s budget deficit, we must know how great the problem is. Based on the magnitude of the problems revealed in the Manager’s budget report today, the City can no longer tinker around the edges. It is time for a fundamental overhaul and transformation of San Diego city government operations.”

Based here in San Diego, the Institute is a national government reform think tank that promotes the principles of performance, transparency, competition and accountability in government. It is conducting a “performance audit” of the entire City of San Diego and will release a plan in May for balancing the city’s budget through fundamental reforms, streamlining and reorganization in each city Department.

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