JULY 15, 1998

Last month’s debate over adoption of the city’s budget for fiscal year 1999 in all likelihood confused all but the most ardent budget observers. One end of City Hall characterized the adopted budget as an irresponsible action that will severely exacerbate already large projected out-year budget gaps, while the other end championed the budget as one of the best the city has ever seen. As you might expect, the truth is somewhere in between¾ I’ll leave it up to you to decide who is closer to the truth based on an analysis of the budget recently completed by the Independent Budget Office.

First, I would like to discuss the revenues, expenditures, and reserve funds that make up the city’s budget for 1999.

Revenues. IBO’s forecasts the city will collect about $400 million more in tax revenues than was assumed by the Mayor and the City Council in adopting the 1999 budget. Although our tax revenue estimates have historically been in the same ballpark as those prepared by the Mayor’s Office of Management and Budget, our forecast for 1999 is substantially higher than OMB’s. Much of the difference results from the fact that tax revenue projections, which in prior years were routinely updated after issuance of the executive budget to reflect new information gleaned from April income tax collections, were left essentially unchanged by the Mayor’s budget office this year. As you know, the Council was forced to use most of the Mayor’s revenue estimates in crafting the budget because the Charter requires that non-property tax revenues be estimated by the Mayor.

The extra revenues we are projecting result primarily from three reestimates: personal income taxes¾ $341 million higher than assumed in the budget; business income taxes¾ $203 million higher; in contrast, property taxes are forecast to be $165 million lower.

Spending. IBO’s projections of spending are, in aggregate, very similar to the estimates used in adopting the budget. Although we have repriced a number of expense budget items, they tend to offset each other resulting in a change of only about $15 million from the budget’s assumptions.

Notable spending reestimates include: lower Board of Education costs ($173 million) resulting in part from a rollover of unspent 1998 funds; higher costs for public assistance ($22 million) and Medicaid ($28 million) from higher caseload and inpatient utilization assumptions; additional overtime at uniformed and social services agencies ($43 million); and new expenses for pension supplementation of city retirees ($125 million).

Surplus or Gap? Accordingly, IBO’s revenue estimates ($400 million higher than assumed in the budget) and spending projections ($15 million higher) lead us to forecast an operating surplus of $385 million for the current fiscal year. That surplus estimate, however, does not include the effect of any reserve funds that were provided in the budget.

Reserves. The budget contains two pools of reserve funds, $300 million set aside in a budget stabilization account and $200 million earmarked as a general reserve. As with past years, much of the general reserve fund could be needed during the course of the year to cover unanticipated costs. Given our expectation of continued local economic growth and a substantial operating surplus, however, we do not foresee the need to spend any of the budget stabilization account for current year expenses. Accordingly, the full budget stabilization account needs to be taken into account when calculating the city’s total surplus for the current year.

Surplus Estimate for 1999. Combining an operating surplus (revenues minus expenditures) of $385 million with excess reserves of $300 million results in a total surplus of $685 million for the current fiscal year.

Budget Projections Beyond 1999. Clearly, the city is in good fiscal shape for the time being, but we continue to be concerned about the size of projected out-year gaps. Assuming continuation of current spending policies and tax laws, the city faces deficits of $1.6 billion in 2000, $2.0 billion in 2001, and $1.5 billion in 2002.

Those out-year deficits are likely to be somewhat larger, however. A number of tax reduction proposals—including tax credits for child care and Subchapter S corporations, cuts in sales taxes on clothing under $110, and extension of co-op and condo tax abatements—enjoy widespread support from the Council and the Administration. Taken together, those probable tax reductions would widen the gaps by nearly $400 million in 2000 and roughly $500 million in 2001 and 2002.

While the strength of the local economy is helping the city solve many of its near-term budget problems, persistently large projected out-year gaps at this point in the business cycle could be an omen of difficult times ahead. If the city follows its recent practice and uses the lion's share of its 1999 operating surplus to prepay debt service scheduled for 2000¾ which would reduce the 2000 gap to $1.2 billion¾ the projected gap looking two years ahead would be at its lowest level (5.0 percent of city funds) since the 1992 executive budget. However, the projected gaps for 2001 and 2002 (8.0 percent and 5.8 percent of city funds—excluding yet to be negotiated collective bargaining pay raises and any additional tax cuts) remain much larger than the comparable out-year gaps of the mid- and late-1980s, the city's previous period of sustained economic growth. In fact, the 1988 and 1990 executive budgets actually projected surpluses at the end of the respective plan periods.

Those projected surpluses, of course, were rapidly transformed into large deficits by the steep recession of the early 1990s. But the city's fiscal situation would have been even more dire had it entered that period of rapidly declining revenues and rising spending needs with significant out-year budget shortfalls. The danger facing the city today is that even a modest slackening of the still-robust growth forecast for the next four years could quickly push projected out-year budget gap percentages back up to the double-digit levels of the early 1990s. Spreading surplus 1999 funds over the entire financial plan period and beyond by reducing the city's outstanding debt would help fortify the city's long-term fiscal position. The decision to include $165 million in the 1999 budget for long-term debt retirement was an important step in the right direction.

Finally, it should be emphasized that the city’s fiscal future is, however, continuing to improve. Our current services gap estimate for 2001 has fallen by $800 million since we issued our Fiscal Outlook report in January. Moreover, simply continuing current year spending policies and tax laws as specified in the adopted budget would result in lower out-year gaps than if the Mayor’s executive budget had been adopted in its entirety. The challenge for the city in the years ahead is to bring spending and revenue growth rates more in line with each other, thereby helping to ensure balanced budgets for the long run.