Budgeting in an ever-swirling environment

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The closing of the massive IRS data-processing center late last year created both a financial hit and an opportunity.

Pandemic, other pressures made complex task even more so 

(EDITOR’S NOTE: This is the second of two releases on the City of Covington’s 2020-21 budget. This release focuses on context for the budget.)
 
COVINGTON, Ky. - It made one’s head whirl.
 
As Covington officials labored over the last four or five months to craft the City’s budget for the fiscal year that begins July 1, they were confronted with a series of challenges, pressures, unforeseen circumstances, opportunities, unexpected emergencies, and ongoing trends that would drastically increase the difficulty of an already complex task.
 
The financial impact of some of those factors could be expected to be negative. Others would be positive. And the impact of some - even after the passage of the budget Tuesday night - remains to be seen.
 
“A budget is no more than a snapshot in time - an educated prediction of the revenues expected to come in during the coming one-year period, as well as a measure of the services that will be necessary to meet the needs of the City and its citizens,” Finance Director Muhammed Owusu said. “This year, both of those projections proved particularly difficult in Covington, given events out of our control around the world and here in Kentucky. It was a nightmare.”
 
Or as City Manager David Johnston said, “these are interesting times in which to craft a budget.”
 
Among the factors that Covington officials had to account for:
 
The pandemic: Efforts to slow the spread of the highly contagious coronavirus COVID-19 forced many businesses to shutter their doors, drastically increased unemployment throughout the state, and raised fears of budget deficits among local governments. Small businesses in Covington, including many restaurants and bars, were particularly hard hit, and many furloughed or laid off employees.
 
But the diversity of Covington’s economy so far has shielded its budget - for which payroll tax revenue makes up roughly half of the General Fund - from the worst of the impact, Finance officials say. That’s because not a single one of the City’s 33 largest employers - who contribute 63 percent of payroll tax revenue - reported plans to lay off employees.
 
However, much could change in the coming months as the pandemic continues to play out.
 
Consequently, Covington officials took a very cautious approach on projecting revenue. Rather than project a 3 percent growth in revenue from the City’s four primary tax revenue streams, as it likely would have done in a normal year, it based its budget on a projected 1.25 percent reduction.
 
Public pensions: The Kentucky General Assembly and Gov. Andy Beshear threw the City the equivalent of a $1 million lifeline with the passage of Senate Bill 249, which froze for one year the rising employer contribution rates billed to local governments. The rates had been increasing by 12 percent a year, and - barring another intervention - that 12 percent increase is scheduled to kick in again during the next fiscal year.
 
The IRS closure: The Internal Revenue Service’s tax-processing facility shut down in September 2019 after a three-year warning. The loss in payroll tax revenue to the City’s budget in the coming fiscal year - the first full year since the closure - is thought to be about $1.2 million, based on average years’ revenues.
 
Job growth: Conversely, aggressive efforts by City economic development officials and corporate decision-making have led to an explosion of project announcements in the last year that will add over 1,000 jobs to Covington’s economy. These projects include an addition to Hotel Covington; the redevelopment of Latonia Plaza II shopping center into a modern workspace for computer firms ReGadget and Blair Technology Group; an expansion of Fidelity Investments, the arrival of Northern Kentucky’s largest law firm, DBL Law; and the move of company headquarters for Gentis Solutions, Hilltop Basic Resources, and STEP CG to RiverCenter office towers.
 
But the timing of these new jobs is staggered over many months. Many of those projects are just now getting under way, and thus the growth in payroll tax revenue will not be immediately realized in the budget.
 
IRS site development: At the same time, the departure of the IRS also created a rare opportunity. Having spent nearly $500,000 in the previous two years to create a conceptual master plan for the site and navigate the federal government’s extension surplus land process, the City finalized an agreement earlier this year to purchase the site for $20.5 million.
 
Demolition of the sprawling facility and site work to prepare it for the market is expected to take three years or so.
 
As Mayor Joe Meyer said previously, “It would be difficult to exaggerate the magnitude of this opportunity. The size and value of this site and its potential for development awards Covington the chance to reshape the very identity and economics of the city long into its future.”

Diversion of growth revenue: An explosion of growth in the urban core has brought increased energy and a more robust economy to Covington. But the financial impact of that growth is largely not being reflected in the City’s General Fund, which is used to fund operations.
 
To date, much of that growth revenue is rebated to developers or is reserved by law for specific uses outside the General Fund: The creation of a Tax Increment Financing (TIF) district in 2013, previous decisions to use Industrial Revenue Bond incentives in unusual ways, and other incentive programs have created a “gap” between gross and net tax revenue of almost $4 million, according to finance documents.
 
That “gap” has a big impact on how the budget is put together.
 
New City Hall: When the City of Covington moved most of its administrative offices into the converted department store at 20 West Pike St. in 2013, the move was supposed to be temporary. But the five-year lease was later extended by four years in a building that is wholly inadequate for what the City needs and complicates the business of City Hall on a daily basis. With that lease extension drawing to a close, officials must begin finding a long-term solution to what has been a nomadic existence for five decades.
 
Credit rating: The onset of the 2007-08 recession, the conviction in 2014 of a previous Finance Director for embezzlement, and large bond issues for capital projects around that same time drastically lowered the City’s credit rating. But - citing conservative budgeting practices, strong fiscal policies, tax base growth, and enhanced expenditure controls over the last few years - Moody’s Investors Service in April raised Covington’s rating for the second time in two years. The decision has a practical impact - it will save taxpayers millions of dollars in borrowing costs going forward.
 
Money management: The Finance Department under Owusu and Accounting Manager Jerome Heist in June 2018 implemented an expanded investments strategy designed to use the City’s cash flow for maximum benefit to taxpayers. Mostly through strategic, short-term investments, the Department has earned almost $404,000 in interest so far this fiscal year, plus an additional $46,000 in credit card rebates. It’s indicative of a “no stone uncovered” approach to budgeting that adds another piece to be factored into the puzzle, officials said.
  
Budget processes: One thing the City has done to inspire confidence by Moody’s and other Wall Street analysts is to add sophistication to its budgeting. Last year, the Finance Department under Owusu began compiling five-year budget models in addition to its annual forecasts and budgeting.
 
As suggested, the modeling helps elected officials and staff understand the impact of short-term budget decisions on the City’s financial picture long-term, leading to greater awareness and strategic planning.
 
In the coming year, the City likewise hopes to begin moving toward “priority-based budgeting,” an innovative approach that helps match available resources to programs and services that best meet community needs, leading to better-formed decisions and more meaningful public engagement. Many cities across the nation use this took, and Covington set aside money this cycle to begin that transformation.
 
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As the City weighs investments in the years ahead in things like roads, streets, housing, parking, and job creation, Johnston said awareness of challenges and issues like those faced this year provide important context for decision-making.
 
“City budgeting is a lot more complicated than managing a checkbook,” Johnston said. “You have to pay attention to dynamics happening around you that are beyond your control. You have to make strategic decisions that affect the City in the long term. And, unlike the federal budget, the City’s budget must be balanced. With all this aside, I am pleased to say that we are not cutting services next year. Our cautious approach should benefit our citizens for years to come.”
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