OCTOBER 20, 1999

The Independent Budget Office appreciates the opportunity to testify at this hearing regarding the proposed changes to the city's charter, which will appear on ballot November 2nd. We have analyzed the three changes proposed in the area of budget process and presented our findings in our Inside the Budget news-fax. Since you have included our analysis as Exhibit G in your report, I will just briefly touch on a few of its main points and then I will be happy to answer any questions.

Before addressing the three changes, please allow me to say that the Independent Budget Office does not advocate a particular vote on the referendum. However, we present this analysis because the proposed changes could significantly affect the management of the city's finances and their impacts are not necessarily apparent from the brief synopses that will appear on the ballot.

The first proposed change would limit city-funded spending increases in the executive and adopted budgets to the rate of inflation, as measured by increases in the regional consumer price index (CPI). This proposal is best understood by examining its likely impact on spending.

The cap would not force the city to keep spending growth below the rate of inflation. The Mayor and Council could easily override the cap.

Also, the cap could be circumvented by creative accounting devices because the proposal does not control for the city's method of rolling surpluses or include items moved "off budget." In fact, this year's budget would have fit under the cap even though-once the surplus roll and off budget items are controlled for-city funded spending grows 7.4 percent, or five times the rate of inflation.

Thus, the cap's real impact would be the result of the incentives it creates. It would provide an incentive to control spending by providing a benchmark against which the public and the press would measure spending growth. But it also would provide an incentive to hide spending so that any growth would be less apparent. There would be more of an incentive to move spending off budget or to defer spending increases to budget modifications, since the cap applies only to the executive and adopted budgets.

Our analysis also considered the choice of the CPI as the benchmark for spending growth. The CPI is used as a proxy for the increase in the cost of items that make up city spending, so theoretically the city budget could maintain the same purchasing power year to year. It is not a measure of what the city can afford. If the objective were to tie spending to what the economy could support, then an appropriate cap would be some measure of economic growth. Or, there could be a charter requirement for a balanced budget, which would limit expenditure growth to revenue growth.

In sum, the proposed spending cap may have little impact on spending growth and would provide an incentive to obscure the presentation of city expenditures.

The second change proposed would require the city to deposit at least 50 percent of "net surplus revenues" into a budget stabilization and emergency fund to prepay debt service. Up to 10 percent of these funds could be used for pay-as-you-go capital financing.

It is crucial to understand that this would not create a rainy day fund. A rainy day fund would save surpluses for use only when needed to address a short term emergency, such as an economic downturn. Instead, this mechanism would just use surpluses to support spending in the following year, whether or not the economy is expanding or contracting.

In general, this proposal simply would codify something akin to the city's current practice. For the past 19 years, the city has used nearly 100 percent of any surplus to prepay future expenditures, primarily debt service. This mechanism effectively rolls surplus funds into the subsequent year. This practice developed because state law requires the city to balance its budget in accordance with generally accepted accounting principles (GAAP). If the city did not use this mechanism to roll the surplus, the funds could not be spent.

The proposal also appears to create a new limit of 10 percent of the portion of the surplus that could be used for pay-as-you-go financing of capital projects. This could reduce the city's ability to use surpluses in a manner that is prudent. However, the provision allowing funds to be transferred out of the budget stabilization and emergency fund effectively may circumvent this limit.

In sum, although prudent use of budget surpluses is an important aspect of managing the city's finances, the proposal would do little to help the city fortify its long-term fiscal condition.

This third proposed change would require a two-thirds majority of the City Council to impose a new tax or increase an existing tax, and it would require a vote of four-fifths of the Council to override a mayoral veto of a new tax or tax increase. These supermajorities would not apply to the property tax.

When the city is facing fiscal difficulties, elected officials often are forced to choose between cutting spending and/or raising taxes in order to balance the budget. This proposal would move the bias toward spending cuts and property tax increases. Moreover, it would empower a small minority in the Council-11 members-to block the override of a Mayoral veto.

Thank you for the opportunity to testify on this matter. I would be happy to answer any questions.