City of Palo Alto
GENERAL FUND RESERVE POLICY
As revised XXXrXX, 2008
Reserve Level Discussion
Determination of the appropriate level of General Fund reserves is a policy decision. Some general guidelines have been suggested by the literature in the government finance field. The Government Finance Officers of America (GFOA) recommend that reserve levels be directly related to the degree of uncertainty the local government faces: the greater the uncertainty, the greater the financial resources necessary. Past experience should be used as a guide, with particular attention being paid to the following:
· Diversity of revenue base
· Volatility of revenue structure
· Volatility of political environment
· Consistent operating surpluses/occasional or frequent operation deficits
· Uneven cash flows, requiring short-term borrowing
Diversity of Revenue Base: Palo Alto has a comparatively diverse revenue base: in the 2009 Adopted Budget, almost half of the $146.6 million in General Fund revenues came from non-tax sources. This means that in periods of economic recessions, Palo Alto is somewhat more resilient to revenue reductions than cities in which tax revenue makes up the overwhelming majority of their revenue base. (In contrast, for all cities in California of Palo Alto’s size, taxes make up roughly two-thirds of total General Fund revenue.)
Volatility of Revenue Structure: Tax revenues show the most volatility in terms of growth, although Palo Alto’s revenues have been relatively more stable than other cities in Santa Clara County or the Bay Area in general. Sales tax is spread broadly across consumer retail, business-to-business sales, and other sales (transportation, food products, and miscellaneous); they are less able to withstand political vagaries, however.
Political Volatility: While Palo Alto’s revenues have shown strength and resilience in relation to the general economy, considerable volatility has been introduced by the inability of the State government to deal with its own budget problems. In 1990-91, the State gave counties authority, through SB 2557, to charge cities for the cost of booking prisoners and for property tax administration; this action cost Palo Alto approximately half a million dollars on an annual basis. In 1991-92, the State shifted 47 percent of cities’ cigarette tax away to fund trial courts. In addition, the State took half of all non-parking fines and forfeitures attributable to cities. From 1992-94, the State reduced cities’ property tax revenues by almost 15 percent, eliminated the balance of cigarette tax revenues, and extended the definition of booking fees so that counties may potentially double or triple the charges they assess. In November 1996, voters passed Proposition 218, the Right to Vote on Taxes initiative. It further limits the City’s ability to raise new funds.
The State has further targeted property tax revenues as an offset to its 2004 and 2005 budget balancing activities. Approximately $1.5 million (10 percent) in Palo Alto property tax revenues were targeted for inclusion in the Educational Revenue Augmentation Fund (ERAF) in 2004-05.
Of all the factors to be considered in setting reserve levels, none appears more critical than political volatility in the current economic environment.
Operating Surplus/Operating Deficit: The City continues its philosophy of “pay as you go” as its preferred approach to operations. This requires a balanced budget and operating result at yearend, along with not funding operating deficits with reserves.
Uneven Cash Flow: General Fund reserves are invested as part of a pool, which includes idle cash in all City funds, including the Enterprise and the Special Revenue Funds. At June 30, 2008, the City’s cash and investment portfolio (excluding funds under the management of third party trustees) totaled $370 million. Cash flow projections for the portfolio reflect no need for short-term borrowing, and the City has not experienced this need in the past.
Budget Stabilization Reserve (BSR)
The General Fund requires a BSR to serve as a repository for unspent operating funds at yearend, as well pay for one-time unexpected needs that arise outside of the regular budget planning process. The BSR is not meant to fund ongoing operating expense. A reserve range of 15 to 20 percent of General Fund operating expenditures, with a target of 18.5 percent, shall be maintained. Any reserve level below 15% shall be approved by the Council. At the discretion of the City Manager, reserve balance above 18.5% may be transferred to the Infrastructure Reserve within the Capital Fund.
Reserve for Equity Transfer Stabilization
The Reserve for Equity Transfer Stabilization in the General Fund is designated to replace the equity transfer in the event that the Gas and Electric Funds are unable to make the required annual equity transfer to the General Fund. This reserve is funded at the end of each fiscal year by the Gas and Electric Funds based on a Council approved formula. The transfer is dependent on the positive operating results and reserve balances of the funds. Funding of this reserve will cease when Reserve for Equity Transfer Stabilization reaches 30% of the combined required annual equity transfer of the current year.
City of Palo Alto
CAPITAL FUND RESERVE POLICY
Infrastructure Reserve (IR)
The Infrastructure Reserve (IR) was originally created as a mechanism to accumulate funding required to complete a 10 year, $100 million infrastructure rehabilitation program that would repair or renovate existing buildings and facilities, streets and sidewalks, parks and open space and transportation systems. Because of the need to maintain infrastructure on a systematic basis, it was recognized that the IR would of necessity never be exhausted but would act in perpetuity as the source of funding for General Fund infrastructure.
From time to time, the Council has used the IR to fund new capital projects. However, the Council has not changed the original policy, adopted when the Infrastructure Management Plan was approved, to prioritize the care and maintenance of existing infrastructure over the acquisition of new infrastructure.
The reserve would therefore be used primarily to fund the projects identified in the original Infrastructure Master Plan, or any other projects not identified in the plan but which are critical to the maintenance of existing infrastructure. Secondarily, should Council choose, the IR may be used for major capital projects involving the acquisition or renovation of infrastructure not previously included in the IMP.
Because this reserve is to be used for priority capital projects that will be reviewed by the Council, no maximum reserve level is recommended. Conversely, because of the discretionary nature of this reserve, no minimum balance is required.
Unspent monies from IMP projects will be returned to the IR and retained within the Capital Fund. Investment income from this reserve will also be retained within the IR to fund future capital project needs.
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