By Thomas J. Hastie, Jr.
As our calendars turn to April, your municipality has prepared and introduced its 2023 budget and begun the adoption process. During this time, municipal finance officials became adept at using the concept of a penny to help explain the impact of tax increases on property owners and anticipated revenue through the municipality. Simply put, a penny on a dollar is the amount of additional revenue a municipality would realize if it increased its municipal tax rate by one penny. Depending on the size of the tax base of your town (total assessed value), a penny could equal $100,000 or $280,000 or $600,000. The actual amount is not material. What is material is that the penny becomes THE unit of measurement to describe the amount of increased spending required, and by extension, the amount of tax increase necessary to fund that spending. State pension increases are described as up XXX thousand dollars or a penny and a half. Rather than an analysis on actual dollars up or dollars down on a program-by-program basis or discretionary versus non-discretionary spending, the penny analysis keeps the focus on the overall impact of the new budget on the taxpayers. If your municipality is on track and has gotten to the budget approval process, congratulations on a job well done. The next step is drafting capital ordinances and beginning to place orders; and that’s where municipalities will start to notice the impact of inflation and higher interest rates. What should you do if your new budget is no longer enough?
Unfavorable economic conditions, including rising interest rates and project costs, could cause the capital elements of these budgets to be inadequate. Let’s first take a look at interest rates hikes. In 2019, a good estimate for the cost of financing a capital improvement project of $1,000,000 over a twenty-year period was approximately $61,000 a year given the lower interest rates available at that time. In 2022, an estimate for the same $1,000,000 project was $72,000 per year over twenty years. And it’s not just the cost of money that has increased. Project and material costs have also soared. We can expect that a project that costs $1,000,000 in 2019 would cost about $1,250,000 in 2023. When you factor in more principle to pay off and higher interest rates, that twenty-year cost of capital on the same $1,000,000 project from 2019 can be expected to cost $89,000 per year in 2023 which is an astonishing increase of 46%! So how do you respond to these new dynamics?
Option 1 is to prioritize the capital requests and order only what is absolutely required to replace vehicles and equipment that are on their last leg.
Option 2 is to spend the money on the equipment that can get in the door fastest, so buy the vactor truck and the dump truck but pass on the SUVs because none are available.
Option 3 is to resize the capital requests and go back to the governing body with a supplemental bond ordinance or plan to do an additional bond ordinance in the fall so that all the hard-to-find light duty vehicles can be ordered at the end of this calendar year (avoid the 2024 price increase) with delivery in the first quarter of 2024.
Your plan of action may be a combination of Options 1, 2 and 3 depending on the particular circumstances and projects impacted.
With rising interest rates, cash flow management becomes important again. When your Bond Anticipation Note comes due in August, you will rollover what needs to be rolled. But do you hold off on adding the 2023 ordinance until you have more certainty on when the money will actually be needed? With short term money now costing 3.5% or more, do you add just enough to fund the deposits on the big-ticket items with a long lead time and fund the rest when the items are scheduled for delivery? Maybe you will consider an additional note sale in November because it may actually be cheaper than borrowing it all in August.
And finally, be prepared to educate your governing body and the public. In calculating the new cost of doing business, it will be helpful to have a new metric. Rather than a penny, the new go to metric should be cost per year outlined above. Take a five-million-dollar capital project: In 2019, that project would be about $305,000 per year in additional debt service. In 2023, the costs are likely to approach $450,000 per year. That is an extra $145,000 per year in debt service, or you know, half a penny.
Local government finance officials can anticipate some unique challenges in 2023. Using some of the options detailed above, municipalities can minimize the impact of high interest rates and project costs. The public finance attorneys at Malamut & Associates can help devise strategic plans to help public entities stay on track and on budget. Contact Tom Hastie at thastie@malamutlaw.com or visit our website at MalamutLaw.com.
The content of this post should not be construed as legal advice. You should consult a lawyer concerning your particular situation and any specific legal question you may have.
