Taxpayers Have Not Been Informed of the Financial Details & Enormous Risks Involved
By John Lemoine. Mr Lemoine has worked as an economist at the Federal Reserve Bank and the International Monetary Fund.
Background and context
The City Council and School Board have sponsored numerous Town Halls to inform citizens and receive input on a range of issues related to the long discussed project for building a new high school. The most recent such event, on June 10, provided a detailed and comprehensive view of various proposed architectural plans, expected construction time frames and estimated costs for a new GMHS presented by the Perkins Eastman, the architectural firm contracted by the City. The presentation addressed in considerable detail the site layout of various architectural configurations and took into account the setting aside of space for hoped for future economic development permitted in conjunction with the agreement with Fairfax County that incorporated the GMHS/MEHMS campus into the City/s jurisdiction.
In contrast with the information and analysis of the physical aspects of the GMHS project, City leaders have provided only the sketchiest of information on critical financial aspects, although as admitted by the City Manager, going forward with the GMHS project represents the greatest financial challenge to the City in its history. In particular, the financing of this project and new debt required will impose huge short and long term strains on and risks to the City’s finances and would violate City financial policies, which were recently updated and approved by the City Council just a few months ago. Specifically, adding the estimated $120 million cost of the GMHS project to existing and projected debt increases for other projects in the CIP (capital improvements program) already approved would produce a total City debt of nearly $170 million and a debt service to expenditure ratio of 17%, substantially above the 12% ceiling incorporated in existing financial policies. The project is projected to raise the real estate rate up to 20 cents on top of the existing $1.305, or an additional annual increase in real estate taxes of about $1,600 for the median homeowner.
Despite the large expected increase in total City debt and annual debt service, almost no information has been provided to taxpayers regarding the proposed phasing of the school project’s financing. This phasing should also include the expected time frame and phasing of revenues from economic development on the site, which are expected to eventually offset part of the cost of building the new school. Although City staff has estimated that the sale or lease of land on the site for economic development could produce $40 million some of which could become available as early as 2021, the staff has not presented any basis for the reliability of such estimates nor has it given any indication of concrete interest by credible developers. Even less is known about the nature of such development (e.g., how much commercial vs. residential) and its longer term impact on the City’s finances and overall character. In fact, the City Manager has proposed that issues regarding the nature of development would not be decided until after the referendum in November. Discussion of the financial issues at the Council’s working session on June 19 suggests that the Council itself does not have a good grasp of the financial issues and risks involved.
Issues arising from the recent City Council Work Session
On July 19, City Council and staff explored different alternatives for attempting to partially mitigate the stress that the GMHS project would place on the City finances. Some of these alternatives involve tradeoffs that some citizens may find undesirable, questionable assumptions and dubious financial maneuvers. For example, the Council, in conjunction with the 1st and 2nd reading of an ordinance to approve the referendum, plans to modify the CIP by postponing for lengthy periods the implementation of a significant number of projects already approved, most notably the renovation of the public library and a contemplated (but not yet approved) expansion of Thomas Jefferson School. Most notably, if the referendum were to be approved, bonds to finance the construction would be issued for 30 years, rather than for 20 years, the normal practice for capital projects. This lengthening of conventional city bond maturities by 10 years would by itself substantially increase the total interest to be paid on the GMHS debt and, in addition, because of the longer maturities of the bonds the market would demand a significantly higher interest rate than on bonds of 20 year maturity. Both effects would raise significantly the overall cost of the school project beyond the face value of $120 million. Staff also contemplates using $10 million in capital reserves, reducing capital reserves to a mere $3 million, as part of the financing package. One Council member suggested the possibility of drawing down part of the operating budget’s fund balance, a move that almost surely would raise further the interest rate that the market would demand for a successful issue of bonds.
The big elephant in the room, however, is, as noted above, the basis for the estimated $40 million in revenues from sale or lease of land on the school site for economic development and when such revenues might possibly begin to be generated. These questions have not been considered in any meaningful way by the Council. Even if this $40 million figure were to be eventually realized, it does not take into account infrastructure expenditures (e.g., streets and/or other traffic enhancements) that the City might have to make in order to make the site attractive to prospective developers. If such infrastructure outlays were to require an additional bond referendum, it would likely delay the projected earliest date that the school site would be available for economic development. Several years would be involved in the building of the new school, the demolition of the existing school, and the approval, financing and putting in place any new infrastructure that might be required by developers. As currently projected by City staff, without any underlying substantive basis, the magic figure of $40 would become available in 2021. However, the increased likelihood of an economic recession poses a strong risk that any prospective developer interest could rapidly fade by the time the site were to become available. The reader should be aware that the current US economic expansion, the 3rd longest since 1854, in 2 more years (2019, or 2 years before development revenues are projected to become available) would become the longest ever since 1854.
Short and long run financial issues: Questionable assumptions and unanswered questions
Because the City effectively projects budgetary finances only one year at a time (the CIP is nominally projected out for 5 years, but often revised substantially prior to final approval of each year’s budget), the City Staff and Council have almost no idea concerning the longer run financial implications that would flow from the approval of the GMHS project. Some questions and issues to contemplate:
- What are the risks of significant cost overruns before a new GMHS would become built and fully operational, what additional amounts could be expected and how could these overruns be dealt with? Readers should recall that delays in the Fairfax County Planning Commission’s approval of the expansion of Mount Daniel resulted in a substantially more costly, yet smaller facility than originally contemplated. More recently, the publicized estimated costs of the modernization of City Hall increased by about 50 percent in the space of 4-5 months, resulting in the need to substantially cut back the scope of this project to remain within the originally approved amount.
- What would be the operating costs of the new, expanded high school compared with current GMHS costs and how would these costs be financed? Readers should understand that the proposed GMHS project is expected to accommodate twice the number of currently enrolled students.
- What are the estimates for future operating and capital costs for expansion of feeder schools for the new, expanded high school?
- How much will the vastly increased debt service arising from the GMHS project crowd out the ability to meet future nonschool and school operating expenditures, not to mention future capital needs? Citizens must be aware of the budgetary struggles in recent years to meet the pressures on City revenues imposed by rapidly increasing school enrollment. These pressures in turn have resulted in a steady decline in operating expenditures spent per citizen on nonschool City services, including public safety, transportation needs, library, parks, etc. The constraints on size of City staff have also adversely impacted the delivery of service such as permitting, licensing, etc. and have led to delays in implementing badly needed projects. The perennial shortage of staff in the City’s Finance Department, which violates best practices, is flagged every year by our outside auditors. Neither the Council nor the City Manager seems to have any interest in addressing this issue. In fact, one can infer that inadequate resources for budgetary analysis, both short term and long term, has contributed to so much poor financial decision making by the Council at taxpayers’ expense.
- Is it realistic to assume that tax revenues will continue to grow in the future at the same rate as in the past? Because the City is required to maintain a balanced operating budget and expenditures are constrained by the growth in revenues, most importantly tax revenues generated by the real estate tax. (Capital projects are largely financed by debt, but debt service, i.e, repayment of principal and interest, are included in operating expenditures.) Because tax revenues have grown on average about 2 ½ percent annual over the last 10 years, City staff have made the dubious assumption that this rate of growth will continue over the next 10 years. It should be noted that even this relatively slow rate of revenue growth has incorporated a real estate tax increase of about 30% (30.5 cents on assessed real estate values) and a high percentage of the growth in real estate tax valuation in recent years has come from new economic development projects.
- Will taxpayers continue to accept such a rapidly rising rate of tax increases, or alternatively, where is the growth in new assessed values expected to come from? Taxpayers should understand that new development projects, especially those involving apartments and condos, also will require additional demands for City services by the growth in population and students, and will intensify the pressures to meet already inadequate capital infrastructure.
Despite the ambiguities, large uncertainties and high risks involved, the Council seems poised in its next regular session on June 26 to approve the first ordinance to approve a November referendum that would have to pass before the GMHS project could go forward, with final approval set for July 24. Given the high downside risks associated with this project and intensification of longer term pressures on the City’s finances flowing from the related decisions, citizens should demand answers to the vast array of associated financial questions, including through one or more town hall meetings, BEFORE any decision on holding a referendum is taken.