Fourteen Dollars

Yesterday, I explained why Scranton’s 2014 budget is broken.  Today, I am going to offer a potential solution.

There’s a whole truck load of disclaimers here:

• Yes, the Union contracts are good through 2017 and I am contemplating altering them before that date.  But one of Courtright’s biggest campaign promises was that the Unions would negotiate with him.
• No, you can’t unilaterally restructure debt.  And the Evans/Hughes 2012 debt issue may be the hardest of all with its “guaranteed interest” clause.
• Yes, there may some questions about the tax status of the restructured debt.  But the necessary changes to State rules should be easier than getting approval for a $2.3B tax hike.
• No, I don’t think the tax payer gets out of this unscathed.  But this proposal does “spread the pain around” as much as possible.

With all of that out-of-the-way, here it is:

And here’s what it all means:

Union Concessions: Courtright promised the Unions would work with him and only him.  Here’s the chance.  This “restructure” has three prongs.  First, implement pay freezes beginning in 2015 (they’ll come back by 2018).  Second, replace 20 police officers (via retirement over three years) with lower cost new hires.  Third, increase employee contribution to healthcare by 10% (phased in at 3% per year beginning in 2015).

Pension Savings: By capping the maximum payable benefit and capturing the savings from the 20 new “lower cost” officers, Scranton can save about $1.5 million  Revised terms would cap pension benefits at 60% of average salary (based on the last five years of service) or $35,000.  In exchange for the concession, Scranton will make an “pre-fund” pension contributions through 2017.

Debt Service Savings: restructure the debt.  A big part of Scranton’s problem is it’s lumpy debt service schedule.  By spreading out the principal repayment schedule and reducing interest rates (from 8.5% to 7% – hopefully), the city should be able to reduce their annual debt service by 40%.

Wage Tax Increase: Increase wage tax from 2.4% to 2.75%.  I’m sorry.  But this equates to roughly $75 on average.

Real Estate Tax Increase: 10%.  Possibly 7.5% if we can get our realization rate up.

It’s important to keep future real estate rate increases to a minimum.  Beyond the issue with collecting the current balance, tax hikes impact real estate values.  With household incomes stagnating around $37,000, most households have a monthly maximum mortgage payment of about $850.  If Scranton’s tax – which currently totals $65 per month – increases by 15%, the “monthly” escrow in your mortgage payment increases by about $10.   Since wages aren’t increasing, that means other portions of the mortgage payment have to give.  Reducing the Principal and Interest component of the monthly payment by just $10 decreases the “purchasing power” by $2,000.

Let me phrase that another way: for every 15% increase in the city’s real estate tax, home values decline by $2,000 (if wages do not increase).

Scranton’s 2014 Budget looks a lot like its 2013 Budget

Scranton’s 2014 budget will fail and 2015 will require a 50%+ tax hike.

It’s simple math: the city is cash flow negative.  This problem existed in 2013, and they rolled it into 2014 by ignoring the fact that revenue does not equate to cash flow.  Let’s look at the city’s problem using small numbers – sometimes the zeros make things confusing (first, a picture.  Then the detailed boring stuff):

“Revenue” is a misleading term:

Realization rates impact the collections of budgeted items.  Think of it like this: the City budgets $73 in cash and fee income, but only $64 shows up at City Hall.  That’s a $9 reduction due to realization impact.

Tax anticipation notes must be repaid using that year’s cash flow.  The City borrows $16 from the bank and promises to use it’s first $16 of income to pay the bank back.  That means that the $131 of total revenue needs to be deflated by $16.  This is basically like a taxpayer counting their credit card limit as income… which, no.  Just no.

Debt Issuance isn’t cash flow when it’s earmarked for a specific cost.  The City can’t use the $32 of planned debt issuance for anything other than paying the court award.  So, again, knock the $131 by $32.  Think of it like this: when you bought a house and got a mortgage, you didn’t count the mortgage amount as income, right?  That’s what Scranton is trying to do here.

Finally, Interfund Transfers are the equivalent of make a withdrawal from a Savings Account to pay your bills.  Is it cash?  Yes.  But it is not revenue, and at some point that kitty will be empty.  Reduce the $131 by $3.

This leaves Scranton with a total of $70 in cash “inflows”.

Expenses exceed cash “inflows”

The City’s total expenses of $130 include about $29 related to the court award.  When you remove that cost, they have scheduled cash outlays of $101.

And, to be fair, the TAN repayment included in the $130 is a wash, since we already reduced revenue for it.  This means they plan to have “outlays” (of $84) exceed “inflows”.

The bottom line: even with the 2014 tax hike, there is still a $14 shortage.

And here’s the kicker: $14 is about half of the $28 budgeted for real estate taxes in 2014.  I see another 50% hike in 2015 if the city is serious about issuing debt…

I am going to dig back in time and end this post with a FUN FACT: Earlier this summer, PEL said Scranton needed a 117% take hike to close the budget deficit.  In 2014, the City is budgeting for roughly a 50% hike.  If they do the same in 2015, like I suspect they will, that means that actual real estate taxes will have increased by 125%.  Witness:

 

Remember: point to the doll’s wallet when they ask where the city touched you.

Fiscal Infarction strikes Scranton, PA

History books shall forever read that September 19, 2013 was when Scranton suffered a Fiscal Infarction brought on by advanced Blue City Disease.  OK, that may be a stretch, but seriously… shit got deeper with a recent court judgement that apparently authorizes the city’s unions to seize public assets for resale to raise the $22M in bonus court ordered back pay

Let’s recap:

October 2011: Scranton loses appeal at the State Supreme Court.  Unions awarded more than $30M

July 2012: Scranton’s coffers run dry, salary cut to minimum wage

August 2012: Scranton borrows more than $6M from union-owned Amalgamated Bank

December 2012: City levies 47% tax hike to pay for new debt

July 2013: Deadline for payment passes.  City rings in first in a series of interest charges ($110,000 per month)

August 2014: city rings in second interest charge of $110,000

September 2014: Unions ask for, and receive, judgement for more than $22.2M

So, what’s that do?  According to nearly every lawyer quoted in the article, the Judgement gives the unions the right to begin seizing city assets with the intention of re-selling those assets.  The money they raise will go to pay down that stupendous court award – nearly $60,000 per employee.

Keep in mind, these are the same public servants who currently start at more than $60,000.  They need your money.

I keep having this image in my head: a 20’s era gangster wearing a police badge busts into city hall proclaiming “This all belongs to me now, see!”  Then he begins selling the contents for cheap (and people cart them off in their smokey old stake body pickup with wooden wheels, because 1920’s).

Unfortunately for Scranton, this might actually happen.

 

Presented without Comment:

IZA After Dark: Everyone Wins When No One Walks Away Happy

Rather than bore you with thousands of words, I am going to try to linking to everything.  Be sure to click through for a lot of the details.

I hate taxes.  One of the taxes I hate the most is the “non-resident earned income tax”.  I’ve worked to stop the commuter tax in Scranton and I recently wrote a piece about why the commuter tax is a bad deal for the tax payer.

It’s no secret, though, that PA’s cities are beginning to sag under the weight of Blue City Disease.  Attempting to fix this problem by throwing money at it looks – to me-  a lot like working harder and not smarter.  I will concede that a well rounded solution is necessary and that means both expense reductions and responsible revenue enhancements (aka “tax hikes”).

Let’s look at what that might look like, starting with some revenue enhancements:

State-wide 1% “county sales tax”: raise the state’s sales tax from 6% to 7% [1].  Allow counties to “opt out” (via voter referendum).  All revenue from increase will be split among the county’s municipalities.

Reduce the 1% sales tax remittance to .5%: PA allows businesses reporting sales tax revenue to keep 1% – like a “processing fee” (or implicit subsidy).  Have businesses remit 5.5% sales tax and earmark that .5% increase in total collections for assisting municipal budgets.

Total New Revenue: 1.5% of the new 7% sales tax would be distributed to cities.

Assuming Pittsburgh (Allegheny county) and Philadelphia (Philadelphia count) opted out of the sales tax hike, this could mean as much as $2.7M in revenue for Scranton (and nearly $1.9M for Harrisburg) [2].

In the interest of fairness, here’s an Expense side solution:

Enable Act-47 Cities to selectively void sections of union contracts: specifically the compensation, healthcare and pension portions.  If this would enable a 10% reduction in total union costs, cities like Scranton and Harrisburg would see an immediate decrease in expenses of approximately $2.5M per year.

Ready for the bottom line of this “both sides of the equation” approach: In Scranton, an extra $5.2M.  Harriburg: $4.4M.

Unfortunately, “share the pain!” isn’t a very good campaign platform.  But the truth of it is: you know you have a good deal when both sides walk away disappointed.

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[1] Does this suck?  Yeah.  It does.  I hate taxes.  But a nearly imperceptable increase of 1.5% [3] in what you spend on sales tax is a better deal than a $500+ per year increase in your real estate tax bill.

[2] PA collected about $3B a year in sales tax.  Assuming Philly and Pittsburgh account for half of that, the addition 1.5% (a whopping 30% increase) would be on a $1.5B base.  Total increase would be $450M.  Splitting pro-rata by population means cities would receive $35 of assistance for every resident.

[3] My footnotes have footnotes.  The IRS estimates that the average PA resident making between $50 and $60,000 per year pays about $580 in sales tax.  This is due primarily to the 6% sales tax rate.  Bump this rate to 7% and it would cause you pay about $675 per year, an increase of roughly $95.

The Cost of Incompetence: Seven Million Dollars?

The municipal credit market is very active.  With more than 80,000 municipalities and municipal authorities in the US, it should be.  In fact, there has been about $250,000,000,000 (that’s billion – two hundred and fifty billion) of municipal debt issued through 8/31/2013.

Average deal size?  $27,700,000.  This is skewed high, though, because a few mega-cities and some states that have floated billion dollar deals in 2013.  The actual average deal size, accounting for these outliers, is just under $10,000,000.  That’s a whole lot of your money being pledged to finance some local pols hopes and dreams of higher office.  According to my research, the average coupon, or interest rate, on this newly issued debt is about 3.3%.

READY FOR SOME TERRIFYING MATH?  Roughly $8.25B will be spent on interest payments for just the new issuance alone.  Assuming the existing two trillion dollars (just for effect: $2,000,000,000,000), also carries a similar interest rate, that means about $75B tax dollars are being spent on interest alone.  That’s roughly $250 for every man, woman and child.  And it is more than $500 for every working US citizen.

That, my friends, is one hell of a vig.

Allow me to quantify that amount for you: with the average worker earning about $21 per hour, that $500 is roughly equivalent to one week of salary after you pay federal, state,  FICA, FUTA, SUTA, medicare and social security taxes (via withholding, because heaven knows our governments can’t trust you with your money).

But this is actually the good news.   Want to know why?   Because cities,  just like people,  can slip into the “subprime” market.  And that means higher interest and tougher bond terms.  Stick with me here, it’s about to get technical but I promise the pay off is worth it.

A healthy city (like Austin or Seattle), which can achieve a AAA rating on their debt issuance, pays between a 2 and 3% interest rate on General Obligation debt. General Obligation – or GO debt – is the least trustworthy of municipal debt.   It’s backed by nothing more than a promise to pay (the “full faith, credit and taxing authority” of a city).

If the same city were to issue “anticipation” debt or special purpose debt backed by a specific stream of tax revenue, that interest rate drops to less than 1%.  That is what you call free money, and good financial planning.

But, when a city starts to struggle – like Scranton, Detroit, Stockton, etc – that interest rate rises (Scranton no longer bothers to have their debt rated.  Probably because “HAHAHAHA” is not a bond rating).  And that higher rate, the “cost of incompetence,” can be truly staggering.

In Scranton’s case, all new debt issuance which is approved by the Court (because, you know, the City is distressed and they need a second layer of rubber stamping for their bad decisions) usually has a specific tax hike attached to it.  All new revenue from that hike is earmarked for debt repayment.  It’s like promising the first paycheck per month to the bank in order to cover your mortgage.

But the interest rate is still more than double the market average.  When the city issued about $26M in debt in late 2012 and early 2013, this debt carried coupons of between 7.25% and 8.5%.  That’s a big difference from the 3.3% average, right?  It is between 4% and 5% extra just because of Scranton’s financial condition.

But, here’s the ugly truth in whole dollars: Scranton’s fiscal woes are costing you, the taxpayer, an extra $7,000,000 over the next 10 years.  Just in extra interest.

Being broke sure is expensive.

Blue City Disease

A version of this op-ed appears on Public Sector Inc as my contributions to their on-going series entitled “The GOP and The Cities”.  You can read the whole series over at Public Sector’s website.  I’d encourage you to check it out.

American Cities from coast to coast are dying on their feet.  Fiscal Distress has taken hold and – egged on by reckless spending –  has emerged as the Heart Disease of these once-vibrant communities.  Serving as the equivalent, for cities, of the greasy cheeseburgers and Marlboro Reds are bond offerings for boondoggles and lucrative union contracts.

Democrats have long been politically-dominant in America’s distressed cities. Up until recently, Republican calls for greater fiscal responsibility have generally been ignored or dismissed as hysterical claims that the “sky is falling”. But the fiscal crisis that has finally arrived cannot help but to alter urban America’s political landscape.

Let’s consider the visible symptoms: Detroit is bankrupt.  Harrisburg is in receivership.  My hometown of Scranton once cut public sector workers to minimum wage.  In California, Stockton, San Bernardino and Mammoth Lakes have all sought court protection.  Countless other bastions of Democratic control are showing the telltale signs of distress.

Municipal Distress has three common drivers: excessive debt (and related debt service), unfunded pension and healthcare liabilities and overly generous compensation contracts with police, fire and clerical unions.  In Scranton, debt service and pension liabilities consume nearly one-quarter of city revenue.  Compensation soaks up another 90 percent, and actual operating expenses –like the utility bills for City Hall – come in at about 15% of revenue.  That means the city is left with a structural deficit – which it covers by borrowing – of approximately 30% of cash receipts.  And the numbers from around the country are equally as dismal: Harrisburg’s pre-2013 metrics are nearly identical to Scranton.  Detroit and Stockton each ran deficits in excess of 20% of budget.  

The solution to this problem, locally elected Democrats will tell you, is to raise taxes.  Witness Philadelphia’s stifling wage tax and 8% sales tax, or Scranton’s proposed 117% property tax hike in 2014.  Meanwhile, Detroit’s average property tax bill is more than double the 50-city average.  This is a prescription that doesn’t cure the ill.  At best, it’s methadone treatment.  At worst, its more burgers and smokes.

Sky high taxes push businesses out of cities, driving down tax revenue.  People then follow their employers, depressing home values, encouraging neighborhood blight and further straining already-tight budgets.  Once cities max out their credit limits, they must cut crucial services, leading to spikes in crime and more flight. During the 1970s, when NYC almost went bankrupt, nearly one million people left town. It took until the mid-90’s for New York to recover the population loss, an extraordinary accomplishment which, unfortunately, few other cities are likely to repeat.  After all, there is a draw to NYC – not every city has Wall Street.

In some cases, Republicans grasp the problem and have taken real, tangible steps to deal with fiscal distress.  In Harrisburg, Governor Tom Corbett appointed a receiver.  The receiver’s revised recovery plan cuts unions compensation by roughly 10% per year, restructures the crippling incinerator debt and leaves the city on the path towards stability by 2016.  In Detroit, Governor Rick Snyder appointed Kevyn Orr, an experienced bankruptcy professional.  Orr has proposed major haircuts for much of Detroit’s debt, including for pensions and retiree healthcare.

The Republican actions, though varied in approach, have a common focus in mind: sustainable cost structures matched to a sustainable tax policy.  This is something Democrats could never achieve, beholden as they are to unionized labor, patronage[1] and entitlements.  And this could also be a major advantage for Republicans in urban areas.

Republicans should capitalize on their proven track record of aggressively managing government cost structures at the state level.  They are the Cardiologists with the right experience to manage the recent spate of Fiscal Infarctions caused by “Blue City Disease”. 

Households are deleveraging and dealing with declining actual wages and stagnant unemployment.  Municipalities, on the other hand, are tapping credit markets to ensure public sector unions – their main voting bloc in many cities – remain insulated from the downturn.  In Scranton, police and firemen earn salaries between 250-300% of the median wage and in Detroit, employees are eligible for retirement at 55.  A simple question – “Why are you paying for perks you don’t get for yourself” – could trigger a debate that plays to Republican strengths.

Voters understand direct costs and they are acutely aware of their precarious financial position.  They write checks for property taxes and they see withholdings reduce their take-home pay.  When faced with cold hard facts – borrowing 30% per year adds $75 to your annual tax bill for the next twenty years; or city employees who support the Democratic administration earn twice what you do – they would err on the side of conservative fiscal policy. 

This is a message that may also allow in-roads with the minority and immigrant communities.  It is no secret that immigrants take great pride in building small businesses and earning a living.  They may not be able to articulate fiscal policy, but they intuitively understand cash flow and “business thinking” far better than most local Democratic officials.

Let’s hope Republican leaders see the value in a policy focused more on “your wallet” than on “your morals”.  Voters sure do.

[1] Witness Bob Lesh (D), Scranton School Board, on 7/7/2013: “They’re all patronage jobs.  Everybody on the board gets a pick.” http://thetimes-tribune.com/news/scranton-school-director-board-gives-patronage-jobs-1.1516674

Also consider Kwame Kilpatrick’s (D) entire administration as Detroit Mayor.  

IZA After Dark: Robbing Peter to pay… Peter? Or: the true story of “sale lease-back” transactions

Politicians and their campaign donors friends in finance like to use big,  scary terms to foster a sense that municipal finance is too complex for mere voters to understand.  I think that is horseshit.  “You wouldn’t understand” is just another way of saying “don’t look behind the curtain.”

In honor of this spirit of openness, tonight’s IZA After Dark will be exploring the shady world of “sale leaseback” transactions – or SLBs. Enjoy.

In PA, cities have some arbitrary debt ceilings.  General obligation debt,  thats the stuff they promise to repay with your taxes,  is generaaly limited to 250% of the “borrowing base”.  The base is a simple average of the last three years of tax revenue.  In Scranton, thats about $55M.  So their debt limit its about $135M.

But! The state wrote a loophole into this law.  If the city issues debt through an authority , the limit rises by an additional 100% of borrowing base.   In Scranton’s case, that increases the total by another $55M, for a total debt limit of $190M.

Politicians love borrowing through their authorities.  Usually this debt is “self liquidating” – meening they use it to build something that generates cash which is then used to pay of the debt.   Everyone wins, right? The city gets some new… thing that people can talk about,  the politician gets his or her ugly my in the paper and a talking point on the campaign trail for higher office.   And you, the tax payer,  get off without your taxes going up.

But there is an ugly side to Authority Debt: the dreaded SLB.  In an SLB, the city sells an asset -like its DPW garage or Police HQ – to an authority who then mortgages the asset and gives the city the money. 

“Wait a minute!”, you may find yourself thinking.  “That sounds normal.  In fact,  when I bought my house I did something similar.”

Well, not quite.  See, when you bought your house, you had to have a enough income to pay the mortgage.   In a SLB, the city – which “sold” the asset – promises to continue to use the asset, only now they get to pay rent for the right to do so. The authority, which bought the asset, has to promise to give these rent payments to the bondholders.

In regular accounting,  this is called an “off balance sheet” transaction.  That might sound familiar.  Know why?  These are what sunk Enron.  But, I digress…

WHO WANTS A RECAP?  I hope you do. Because I drew you a picture!

So… there’s a couple problems here. First: Scranton is pursuing an SLB because they dont have enough credit left without their authorities. Second: this is deficit borrowing. It is not being used to better the city, it is going straigh into the pockets of our local unions. Third: what the hell are we going to do next year? Wheres the $3.6M they need for debt service going to come from?

I think the single biggest issue I have with this transaction is the blatant end run around the county court. See, if the city were somehow able to finance this themself, they would have to go and ask the court for permission. But because it is the authority issuing the debt, they avoid this inconvenient hoop (and the court order for a 25% tax hike to repay it). It’s infuriating and disgusting and dishonest and… political.

Sure looks like they are painting the next mayor into a corner. Good luck. You’ll need it.

Scranton’s Million Dollar Question

Scranton has a problem.  A very big problem.   As part of the Supreme Court ruling in favor of the city’s unions, the administration needs to figure out how to pay off our current and former employees.  The total award was somewhere in the $30M neighborhood, but the unions graciously cut the amount in half (in exchange for an average 4% raise per year for the next three years).  The city budgeted $17M for the award in 2013.

Then the fuzzy math kicked in: the award rose to $21M by July of 2013.  Nearly thirty days after the deadline to pay, the city was still guessing at the cost, and accruing interest at 6%, or roughly $100,000 per month.

Our fearless Mayor assured the city that the award would be paid once the amount was finalized by an actuary (why this was not done during the 2013 budget process is another story).  The money, to be obtained via a sale-leaseback, would sure be available to us.

Well, friends, here we are.   It is now September 2 and a bond offering, if it is even possible, has disappeared from the news.  A redline – a preliminary document filed prior to closing – has not been made public and City Hall had grown suspiciously quiet.  

I think the reason for the radio silence is the cost.   See, we also need to finance a $5.1M pension obligation.   That means the total amount to be borrowed is about $26.5M.

BUT WAIT THERE’S MORE (I am so sorry for the Cities property owners): we usually have to offer a 3-4% discount and, of course, Boyd Hughes and his ilk need their pound of flesh (which usually totals about a million bucks; nice work if you can get it).  That means total principal will be about $28M.

Want to know the minimum Cost of that?  At 8%, it’s about $2.5M per year, plus some amount for principal reduction.  $3.5 is safe bet.

Keep in mind, this is in addition to our $15-20M deficit in 2014. 

Would you make that loan?  I wouldn’t.   Not without a 150% tax hike.

Remember: point to the doll’s wallet when they ask where the city touched you.

“That’s my money!”

Pensions are a touchy issue.  Because employees do contribute to the pension fund, the common refrain of city employees when pension reform comes up is “that’s my money! I paid for that.”

Well… yes and no.  Did they contribute something?  Absolutely. Usually about 3.5% of salary (fun fact: I set aside 15% of salary for retirement.  Sounds like someones trying to underfund…).  But the largest portion of the money by far comes from theemployer contribution.  Usually that amount is several times more than the employee contribution. 

Dont believe me?  Here’s a picture: