In an “unofficial kick-off of the budget season,” East Lansing’s Acting Finance Director Audrey Kincade presented a five-year financial forecast to the City Council at its meeting Tuesday, Feb. 21.
The presentation provided a window into how and why the city is struggling to meet its pension debt, what a difference it’s making to have the state helping East Lansing more with the cost of providing firefighting and paramedic services to Michigan State University, how badly the city could be hurt if it loses its appeal in one particular court case, and a lot more.
In this special ELi report, we bring you key takeaways from the 40-page report and discussion at Council.
Kincade likes what she’s seeing.
The forecast specifically looked at the city’s general fund, which Kincade described as “the main operating fund of the city.” It’s hardly the sum of the city’s finances, but it is the fund into which most of the city’s property taxes and income tax flow, along with funding from the state. And it’s the fund out of which the city pays for most staffing, including emergency services and the people who run day-to-day municipal operations.
All in all, Kincade called this “the most positive forecast I’ve seen in my time at the city.”
Compared to the last fiscal year, revenue at the end of this fiscal year is expected to be up 5.9%. Expenditures are expected to be up 10.6%. The large expenditure increase is due in part to Council’s decision to put an extra $2 million towards the pensions and the use of $500,000 in American Rescue Plan Act (ARPA) funds for sidewalk repairs.
That increase of expenditures is about what finance staff expected, but revenue has come in much higher than expected. This means the city is pulling less out of the general fund’s savings (called the “fund balance”) than it expected for this fiscal year.
Projections for the next fiscal year show the city expects to be back in the black, adding money to the fund balance.
Kincade presented a chart that showed what she called a “revenue gap” since the 2008 recession. The top line shows the trend of inflation from Fiscal Year (FY) 2007 to 2023. It rose at an average annual rate of 2.25%.
But, Kincade noted, the city’s general fund struggled for years to keep up with inflation. Now, it’s doing better, getting closer to closing the gap, thanks largely to the income tax that started being levied on Jan. 1, 2019. The BWL franchise fee has also helped substantially, but that may be disappearing soon. More on that in a bit.
If you’re looking at that chart and wondering what happened to the property tax revenue that made it suddenly dip starting in FY20, note that voters approved the 12-year income tax with the stipulation the property tax rate would drop as long as the income tax is in effect. Hence the drop.
The income tax automatically reimburses the general fund for the drop in property taxes before the remaining income tax revenue gets split up to the pensions (60%), emergency services (20%), and parks and infrastructure (20%).
Property tax revenue is increasing substantially. But the general fund isn’t seeing the full benefit.
East Lansing tax assessor David Lee told Council property tax revenues are up by unusually large amounts. This is thanks largely to the fact “the real estate market is very strong” and big new developments are coming online. This is resulting in a “huge growth in the tax base.”
For the next fiscal year, property tax revenues to the general fund are expected to go up 5.9%, or almost a million dollars.
Big projects that are coming online include the Falcon Pointe West development (adding $1.15 million in taxable value), Provision Living senior housing on Chandler Road ($5.4 million), and the new TechSmith building on Harrison Road ($4.15 million).
But the general fund will not benefit from a major new property tax generator downtown: the new MSUFCU office building at the corner of Abbot Road and Albert Avenue. ELi recently provided a special report explaining that about $1 million in new property taxes downtown from the MSUFCU building, The Abbot Apartments and The Graduate Hotel will be diverted away from local taxing authorities, including the City of East Lansing.
The tax money from those three buildings will instead go to the coffers of East Lansing’s Downtown Development Authority.
Lee told Council he wasn’t going to talk about the diversions happening under the DDA’s tax increment financing (TIF) tax-diversion scheme nor the diversions happening via over a dozen other TIF plans, “because the city won’t see tax growth from those properties in the near term.”
Councilmember Dana Watson, who asked the most questions during this presentation, indicated she wants to hear about the tax diversion to the DDA at some point.
City staff are hoping the DDA will use some of the diverted taxes to help the city with staffing, including paying for two new full-time downtown maintenance workers. The city also looks to use the DDA’s budget for infrastructure, like security cameras and public art projects.
Watson asked Lee if he had the property tax forecast from five years ago, so Council can see whether the previous forecast had panned out as expected. Lee said he would get that information for Council.
The city is now using the equivalent of all of the general fund’s property tax revenue just to pay for the pensions.
Property taxes are the largest single source of general fund revenue, and the city is planning this fiscal year to use the equivalent of all of that money (about $15 million) plus another $1 million to try to close the gap on the pension debt.
The city is still awarding 100% defined benefit pensions, which guarantee a certain retirement payout, to its police officers and firefighter-paramedics. Defined benefit pensions are much more difficult to cost-control than defined contribution retirement savings programs because they promise a certain level of pay-out regardless of what the market does. Defined contribution programs put the burden of market downturns on retirees, not the city.
At the meeting this week, Interim City Manager Randy Talifarro, former fire chief for East Lansing, indicated he thought the city was providing police and fire employees hybrid pension plans, which combine defined benefit pensions and defined contribution retirement saving plans. But Kincade explained that isn’t the case; they are receiving 100% defined benefit pensions.
By comparison to East Lansing, Michigan State University’s police officers are awarded no pensions, instead having 100% defined contribution retirement saving plans. These consist of an employee contribution of 5% of base salary and a university matching contribution of 10% of base salary.
Prior to the passage of East Lansing’s income tax, this difference in approach to police retirement benefits became a point of contention between then-mayor Mark Meadows and then-MSU president Louanna Simon, who was fighting the income tax idea. Simon noted that MSU had shifted its employees to defined contribution plans decades before.
Here is a graph produced by ELi showing the pension fund debt (liability) and assets (value of the funds in the system) from 2006 to 2021. A great deal of the reason the city has struggled to close the gap is because it is continuing to provide defined benefit pensions.
The state’s Community Financial Dashboard ranks East Lansing’s pension health as 219 out of 247 municipalities. East Lansing is in the lowest 11th percentile for pension health.
This fiscal year, the City of East Lansing will pay almost $8 million into the defined benefits program, plus about $600,000 for defined contribution and hybrid plans. In addition, the city plans to make $7.4 million in supplemental contributions.
This puts the total payment into the retirement system at almost $16 million this year, or about 36% of the total expenditures of the general fund.
At this week’s meeting, Kincade showed a chart showing the debt (liability) of the city’s pension fund compared to the assets (“pension net position”) currently in the system.
She said the gap between the liability and assets has been narrowing. But she did not mention that the value of the pension fund’s assets is expected to see a dip when the next valuation comes out, because of market downturns in 2022, as ELi previously reported.
That’s expected to again widen the gap between liability and assets. The city almost certainly lost ground again in 2022. Continuing to add more employees with defined benefit pensions, as is the plan, is going to make funding the pension system still harder.
Kincade told Council that if the city keeps making an extra $5 million supplemental payment into the pensions each year, “future required contributions are expected to level out and then decrease.”
In other words, the city is, at the moment, still facing increasingly large required annual contributions from MERS (the Municipal Employees’ Retirement System of Michigan), despite the implementation of the income tax in 2019. It’s still struggling.
The income tax is set to sunset in 2032 unless renewed by voters. It has definitely been bringing in substantial revenue.
Kincade told Council, “We seem to be doing better year after year” on the income tax. In fact, the city has gone back this year to collect unpaid taxes from 2019. Using state records, the city was able to identify people who should have paid income tax for that year and didn’t.
But the income tax has been highly unpredictable, particularly with the two-year COVID disruption caused by many MSU employees working from home in other municipalities. Nonresidents only owe tax to East Lansing if they are physically working in the city limits.
Now, Kincade said, many people are back to working at their employers’ locations. The city has managed to make a total of almost $16 million in supplemental payments to the pensions from the income tax since the income tax started. Without it, the pension system would certainly be worse off.
East Lansing’s drop in population will impact how much money the state sends in support.
The politicians in charge of the state’s budget decide how much money will go from the state to cities in “revenue sharing” and Kincade noted, “There is always uncertainty surrounding this amount, as this could be reduced or increased by the State.”
That said, we know “the City will see a minor decrease due to a small reduction in our census count.” (Read more about what the 2020 census showed in this ELi report.) This year, the city expects to obtain about $7 million in revenue-sharing from the state.
The state is also helping East Lansing make up for the cost of providing emergency services to MSU.
MSU pays no property taxes but the City of East Lansing is expected to provide its emergency fire and paramedic services to the entire East Lansing campus. To help with this huge burden, Michigan’s Public Act 289 says the state will provide funding. But only recently has the state started paying the full cost.
“In December 2018,” Kincade wrote in her report, “the State of Michigan enacted legislation calling for additional funding for the fire protection under PA289. Historically, this funding was approximately 50% funded based on the formula, and this new legislation requires full funding.”
This has been a big deal for the general fund’s bottom line. Just this year, PA289 funding will bring in about $3.3 million.
In his comments on this, Talifarro noted that if the state had been paying the full cost all along, this would have made a big difference for East Lansing’s financial health. (MSU helped with some payments but East Lansing was still left in the red on this service.) “This community is still paying a price” for those years of inadequate funding support, he said. He said he wanted to emphasize that the financial problems are “not due to mismanagement or inattention.”
Staffing is way down in the city, but the cost of staffing is not.
“We are experiencing savings due to vacancies for a significant portion of the year for positions in the Communications, Finance, Fire, HR [Human Resources], Planning & Zoning, and Police Departments,” Kincade wrote in her report. “However, there are significant costs related to leave payouts resulting from these unplanned retirements or resignations.”
The result of this was a net increase in “personnel services costs” this year.
Kincade also reported that, for the next year, employees are generally expected to receive a 3% cost of living increase.
The city’s recent wave of resignations and retirements is definitely impacting operations. Kincade said it was challenging for many department heads to estimate revenue and expenses, as many are interim or acting heads.
She herself has been acting finance director since last summer, and she asked Council’s forgiveness and understanding “as I am still catching up.”
Asked by Watson what it’s been like taking over this job when no one has replaced her in her own job, Kincade admitted, “It’s been tough.” She thanked Budget Analyst Justin Guigar who she said has been functioning as her right-hand man.
The forecast for this coming year includes the expectation of adding an election coordinator and a communications specialist, retaining a second fire inspector, reinstating a school resource officer, a patrol officer, a part-time jail officer and a part-time PACE officer.
Councilmember Noel Garcia asked when the expectation was the city would be providing a school resource officer (SRO) to the East Lansing Public Schools. He was told the assumption was July 1 of this year.
Revenue from fines and forfeitures is down.
“The City has transitioned to a new way of policing and enforcement, inherently decreasing the amount of fees charged,” Kincade explained to Council. “FY22 results [for income from fines] were approximately half of that from five years ago.”
Kincade said revenue from ordinance fines are now about 15% of what it was a decade ago.
Expect more decisions about how to use ARPA funds.
The city was awarded about $12.2 million in ARPA funds and, so far, Council has only designated use for about $5.8 million of that. All of the funds have to be “obligated” by Dec. 31, 2024, and all of the funds have to be spent by Dec. 31, 2026.
In 2022, about $300,000 from ARPA was used to award hazard pay to employees who worked through COVID and for a basement sewer water backup prevention program.
If the city loses its appeal in the BWL franchise fee case, the cost will be big.
The city has been collecting a franchise fee since 2017, essentially a 5% surcharge on the bills of BWL customers in the City of East Lansing. The fee had brought in about $7 million in total up to this year, according to Kincade. This year, it is expected to bring in about $1.5 million to the city’s general fund.
But in March 2022, Ingham County Judge Wanda Stokes ruled that the fee constitutes an illegal tax. Kincade said the city is appealing the ruling, but if it loses, the hit could be big.
Not only would it mean the loss of $1.5 million or more per year, the city could be required to pay back the fees collected.
Kincade told Council that if the city has to pay back $7 million this fiscal year, it has no plan for how it would manage this. The city currently has less than two months of operating expenses in the general fund’s fund balance.