Tapping Cash Reserve: Risky Tactic for L.A.

By HOWARD FINE

Staff Reporter

Whatever happened to last fall’s gloom and doom reports projecting that the city of Los Angeles would show a budget shortfall of $100 million?

It’s all in the reserves.

If L.A. officials follow the recommendation of City Administrative Officer Bill Fujioka, $133 million of the $175 million socked away in reserve funds will go towards reducing the projected deficit to a mere $22 million.

The problem is that without reserves, L.A. would be in the hole by a whopping $155 million. And unexpectedly large drops in retail sales or other revenue sources could widen that hole.

While reserves are meant for times of fiscal crisis, tapping into them so heavily to help balance this fiscal year’s budget (which expires on June 30) is a risky strategy, one that counts on the economy turning around in time to boost revenues for next year’s budget.

“This is a real one-shot gamble that they would be taking,” said Steve Frates, senior fellow at the Rose Institute of State and Local Government. “If the economy doesn’t return, they are going to have a really acute problem next year.”

Frates added that if reserves are drained, the city would lose a substantial amount of interest income from them.

There could be another consequence: the bond rating could be jeopardized. Currently, reserves are at about 6 percent of the city’s $3 billion budget, a healthy level, thanks to several years of surpluses. Taking $133 million out of reserves would put the level at about 1.5 percent, dangerously close to thresholds at which bond rating agencies begin downgrading debt.

“My very great concern is using so much of the reserve to balance this year’s budget,” said City Controller Laura Chick. “We need to increase revenues, improve collections and reduce inefficiencies in government before we tap so much into our reserves.”

Better than the ’90s

To be sure, this year’s budget is in better shape than those of the early 1990s, in the midst of the last recession. At that time, annual deficits approached $300 million.

There also has been some improvement in the fiscal outlook over the last three months and not just in Los Angeles. Cities like Burbank and Long Beach are reporting that revenues have not plunged as steeply as feared just three months ago.

In L.A. itself, the unexpected strength of the residential real estate market led to a 4 percent boost in a relatively new tax on real estate transactions. The city had previously projected revenues from this tax to fall 5 percent.

Also, Los Angeles International Airport officials reimbursed the city’s general fund for extra security precautions at LAX more quickly than expected. As a result, Fujioka projected the revenue shortfall at $59 million, not the $71 million he projected back in October.

But even Fujioka concedes it’s hard to project out these revenue trends for future quarters. And there may be more unpleasant surprises on the horizon.

“We will see the full impact of Sept. 11 in the fall quarter (sales) receipts, which will be available in mid-March,” Fujioka said in the report.

Of course, it’s also possible that the sales tax may not take a huge hit. All the huge discounting and “zero-percent financing” going on at local shopping and auto malls last fall may have kept sales volumes stable. And it’s sales volumes, not prices, that are the key indicator for sales taxes.

Meanwhile, on the expenditure side, Chick and other city officials note some progress has been made in slowing down spending as departments have implemented a November order from Mayor James Hahn to freeze hiring and look at cutting expenses.

These savings particularly $17.4 million in salaries and equipment in the Los Angeles Police Department have helped close the budget gap, according to the Fujioka report.

But at the same time these cuts were being made, the City Council recently approved a new City Attorney program for neighborhood prosecutors. Also, last week, Hahn announced his intention to seek $42 million in next year’s budget to augment the Affordable Housing Trust Fund.

While council budget committee vice chair Eric Garcetti said these programs were not being funded with general fund dollars, they illustrate what one city official said is a serious fiscal threat.

“There is a tendency for newly elected officials to want to spend money on new programs to establish profiles for themselves,” said the official. “And right now, we have the most newly elected officials in city history, so it’s extra hard to put a clamp on new spending.”

Still looking to cut

For now, Garcetti said the emphasis remains on cost-cutting within city departments. The newly elected councilman said that at last week’s budget committee meeting, department heads were warned not to slack off in their budget cutting efforts for the current fiscal year.

At the same time these department heads are scrutinizing current budgets, they also are drawing up budgets for the 2002-03 fiscal year, which begins July 1. Hahn, who will release his 2002-03 budget in April, said he intends to keep the lid on spending, though has kept private details of next year’s budget.

“Our top priority this year was to make sure we get through this budget cycle with no cuts in services,” said Matt Middlebrook, a Hahn spokesman. “Thanks to the hiring freeze and the request to each department to find 10 percent in savings, we think we will be able to accomplish that goal.”

Middlebrook said the imperative not to cut services outweighed the need to maintain reserve levels as high as 6 percent, at least for the current budget year.

As for next year, “We are now evaluating the revenue picture for next year and adjusting our budget projections accordingly,” Middlebrook said.

Whatever budget does emerge, the choices may be starker next year. “The city right now is engaged in deficit spending,” said economic development consultant Larry Kosmont. “And you can’t do it on this scale for two years in a row. If revenues don’t improve, very serious budget cuts will have to be made.”