Everything you should know about Providence’s improving-but-still-shaky finances

PROVIDENCE, R.I. (WPRI) – Mayor Jorge Elorza used part of his State of the City address this week to tout progress on Providence’s short-term finances but also warn that the city still needs to address its massive unfunded liabilities for retirees. And he wasn’t just being cute with his words.

So how is it possible report budget surpluses while also staring down billions of dollars in long-term problems?

Here’s a cheat sheet that might help explain things.

A new budget is approved every year.
Let’s start with the very basics. Real people think of a year as starting on Jan. 1 and ending on Dec. 31. But governments (and plenty of other entities) operate on fiscal years. In Providence’s case, the year begins July 1 and ends June 30. Every year, the mayor is required to propose his budget for the next fiscal year by May 1. The budget is proposed to the City Council as a package of ordinances – or municipal laws – and is based on educated assumptions of how much revenue the city will generate through taxes, state aid, permitting fees, and fines (like tickets from red light and speed cameras) as well as how much it expects to spend on everything from salaries and pensions to road repairs and retirement cakes during the fiscal year. The City Council then vets the proposal, tinkers with parts of it and, if all goes well, approves it in early June so that first-quarter tax bills can be paid by July 24. The current year’s total budget is $736.7 million, with a little more than half of that money set aside for the school department.

Providence has run operating surpluses two years in a row.
When the politicians talk about budget surpluses, they are only talking about the government’s performance during that one fiscal year. Think of it like a person making $50,000 a year who ends the calendar year with $1,000 in the bank – that $1,000 is still yours even if you have credit card debt and a mortgage to pay. In Providence’s case, an independent auditing firm determined the city had a $10.3 million surplus during the 2015-16 fiscal year and a $5.4 million surplus during the 2016-17 fiscal year. This is good news, but it doesn’t mean the city has stuffed away an extra $15.7 million in its coffers over the last two years. That’s because the city also started the 2015-16 fiscal year with a $13.4-million cumulative deficit, which was the combination of all previous annual shortfalls the city incurred dating back to 2011. (The city didn’t actually owe anyone $13.4 million, but state law requires communities that run deficits to come up with plans to run surpluses in the future in order to offset the earlier red ink.) When you take $15.7 million and subtract $13.4 million, you get $2.3 million. There’s your rainy day fund.

The rainy day fund is meant for… rainy days.
To understand the importance of having cash reserves – a.k.a. a rainy day fund – flash back to July 1, 2009. On the first day of that new fiscal year, the city had $17.3 million stockpiled away in reserves compiled from surpluses in previous years. But that year was devastating for Rhode Island cities and towns, thanks to the Great Recession as well as massive cuts in state aid (mostly from changes to car tax reimbursements). Providence ended that fiscal year with an operating deficit of nearly $14 million, but a healthy rainy day fund gave the city some breathing room, almost like a savings account. The real trouble came a few years later when Providence didn’t have enough in reserves to absorb its operating shortfalls, which led to downgrades in its credit rating and talk of bankruptcy. All of that is a long way of explaining that rainy day funds are generally meant to be used for emergency situations as opposed to new spending proposals. Even today, having $2.3 million in reserves is nice, but the city still has little margin for error in its budget – that amount would cover just 0.3% of this year’s budget. The goal is to build the rainy day fund to above $20 million over the next five years by posting smaller operating surpluses each year.

The city has plenty of money to pay its bills.
Here’s the good news for active city employees and vendors who have contracts with Providence: cash flow is not one of the city’s problems right now. Between all revenue sources, the city brings in anywhere between $12 million and $139 million a month. In December, for example, the city ended the month with about $40 million after paying all of its immediate bills – like salaries, health care, transfers to the school department and other operating expenses. With the exception of July, the city will spend between $32.7 million and $53.3 million a month during the current fiscal year. (July 2017 was closer to $100 million because that’s when the city receives the most tax revenue and state aid, and also when it makes a much larger payment to its pension fund.)

Providence’s pension system remains its biggest challenge.
If Providence is running surpluses, has a rainy day fund and can pay its bills, how does it also have an unfunded pension liability that exceeds $1 billion? The very basic answer is that it’s possible for all of those facts to be true at the same time. Providence’s pension system was just 25.8% funded as of June 30, 2017, with an unfunded liability of about $1.2 billion, but the vast majority of that money is not due to retirees this year. The city pays out about $7 million a month to retirees, an amount that has remained fairly steady for several years. But in order to raise that 25.8% funding level, the city needs to continue making large annual contributions to the pension system and hope that the fund’s investments can earn an average return of 8% a year over the next several decades. The city’s current plan call for taxpayers to gradually increase their annual pension contribution from $78 million in the current fiscal year all the way to $172 million by 2040. But Mayor Elorza has warned that there will come a time in the not-too-distant future that Providence will be unable to make its yearly payment to the fund without deep cuts elsewhere in the budget that would affect the quality of life in the city.

You can’t solve the pension problem through existing union contracts.
Only a fraction of the money Providence allocates toward its pension system each year goes toward the future pensions of its current employees. In the current fiscal year, $9.8 million of the city’s $78 million contribution is meant for the pensions of current city workers; the rest goes toward the pensions of people who have already retired. While the mayor could attempt to negotiate with his unions and make pension changes for current employees, the unions do not have the ability to negotiate on behalf of retirees. The mayor could lobby the City Council to make changes to retiree pensions, although any cuts would almost certainly end up in court. He could also attempt to convene retirees and reach some type of agreement, like Mayor Angel Taveras did several years ago.

The mayor thinks the city’s water supply is an answer to the pension issue.
If this were easy, it would have happened 20 years ago. There are legal questions about who actually owns the Providence Water Supply Board – Providence, the ratepayers or multiple cities and towns? – and fears in other communities that any effort to monetize water will leader to an increase in water rates. But if Providence can find a way to navigate its way through the roadblocks, Mayor Elorza has said believes the city could receive more than $300 million for the sale or lease of the system. (The mayor has repeatedly said he opposes the privatization of the water system, but he hasn’t shied away from suggesting Rhode Island’s current water rates are “artificially low” and probably need to be increased. A one-time infusion of $300 million wouldn’t necessarily fix the entire pension system, but the fund would be healthier. And if the fund’s investments could earn 8% a year over the long term while the city continues to make its annual payments, the mayor believes any talk of bankruptcy would be off the table for good.

Don’t forget about retiree health care.
It still doesn’t get the same attention as pensions, but retiree health care costs continue to be a concern for Providence, too. The city currently spends about $25 million a year on health benefits for about 3,800 former employees and, unlike with pensions, doesn’t have money saved to help cover those costs. Instead, it basically pays for retirees on a pay-as-you-go basis, a practice that remains common but is increasingly frowned upon by many financial experts. The good news: a few years ago, the city started requiring retirees to enroll in Medicare after they turn 65, which will save the city hundreds of millions of dollars in the future. Still, the city’s actuarial accrued liability for healthcare was $955 million as of July 1, 2016.

Providence is heavily reliant on property taxes.
This is common in many communities around the state, but property taxes total about 72% of all of the revenue Providence generates each year. One of the challenges this creates: the city can’t afford to significantly reduce taxes in the short term even if doing so might pay off in the long run. Use the commercial rate as an example. Unless they have a tax break from the city, commercial property owners pay $36.70 per $1,000 of assessed value. One study that looks at taxes in the largest cities nationwide ranks Providence’s as the fifth-highest commercial rate in the country. Let’s pretend the mayor’s next budget cut the commercial rate by $10 to bring it closer to the middle of the pack with Baltimore or Newark, New Jersey. That would lower city revenue by more than $30 million next year. Even if those lower rates led to a boom in construction over the next decade, the city would not have a way of replacing the immediate revenue it needs to run the government. That’s one of the reasons city officials prefer tax breaks rather than tax cuts.

The school department may soon have money problems.
We treat the city budget as though it’s one large spreadsheet of all the money coming in and out of Providence in a given year. But it’s not quite as simple as that – especially when it comes to the city’s schools. The Providence school budget really functions separately from the city side, except that it is approved by the City Council and if the school department runs a deficit, the city has to cover it. The current school budget is about $382 million and it comes from two main sources: the state, which is providing about $247 million this fiscal year, and the city, which gives $128.5 million. The school department’s finances are fine in the current fiscal year, but with expenses projected to grow by between $6 million and $10 million a year over the next five years, large deficits are looming. In 2020, for example, the district is projecting a $12 million shortfall.

School funding is beginning to dry up.
There are only two ways to address projected shortfalls in the school department: increase revenue or make cuts. For years Providence has been relying on large annual increases in state aid based on the new education funding formula that lawmakers approved in 2010, but those increases are starting to taper off. Now, rather than getting increases of more than $10 million a year, the city is projecting the state will only provide $2 million or $3 million extra. At the same time, city officials are always hesitant to provide extra money to the school department because the state’s maintenance of effort policy essentially prohibits the city from cutting its allocation to the school department later. (In other words, Mayor Elorza cannot say he only wants to give the school department $100 million next year instead of the $128.5 million it is getting in the current fiscal year.) When it comes to trimming expenses, cuts are easier said than done. Nearly all of the school department’s money is tied up in salaries, benefits and service provider contracts. It may be possible to cut a few jobs here and there, but it’s not as though there are hundreds of do-nothing positions on the school side. Is it possible to cut programs or technology purchases? Maybe, but advocates say it would come at the expense of kids.

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Dan McGowan (dmcgowan@wpri.com) covers politics, education and the city of Providence for WPRI.com. Follow him on Facebook and Twitter: @danmcgowan