Measuring New York City’s Budgetary Cushion: How Much is Needed to Weather the Next Fiscal Storm?
In determining the strength of New York City’s fiscal position, it is critical to assess the resiliency of its budget and fiscal outlook. In addition to how readily the budget can be adapted to raise revenues or cut expenditures when necessary, this resiliency is determined in part by the level of cushion available to cover unexpected revenue shortfalls or expenditure shocks without greatly disrupting City services. Forecasting revenues are the most volatile element of budgeting because revenues fluctuate with the economy. Having adequate resources in reserve is necessary to weather times of fiscal stress. A strong cushion is an indicator of a strong fiscal position. This report will examine how the City has structured and utilized its fiscal cushion in recent years.
The fiscal cushion of most state and local governments takes the form of an unreserved fund balance, or a rainy day fund, which is established with surplus resources from revenues that come in above expenditures for use in a future year when revenues are short, or to mitigate the impact of expense shocks. New York City however, is required to balance its operating budget according to generally accepted accounting principles (GAAP) which mandates that revenues in a given year must equal or exceed expenditures in the General Fund in that year.
The balanced budget requirement stems from the Financial Emergency Act (FEA) of 1975, which was enacted after New York City almost defaulted on its obligations during the financial crisis. The provisions of the FEA, most of which were codified in the New York City Charter in 2005, also require the City to have a fouryear financial plan and to maintain a General Reserve of at least $100 million at the beginning of the fiscal year. The FEA precludes the City from funding operating costs with capital dollars. The GAAP-balanced budget requirement mandated by State law and the City Charter explicitly prohibits the City from using surpluses accumulated in prior years in future years.
While all governments in the country practice GAAP accounting, New York City is the only major government in the country subject to GAAP budgeting. In applying this standard as a bulwark for New York City’s budget, the State’s intention was to put an end to the City practice of funding operating expenses with capital funds and obscuring operating deficits as it was doing under cash accounting in the 1970s. The discipline instilled by the FEA is evidenced by New York City passing a balanced budget each year, by no longer borrowing from the operating budget and by maintaining access to capital markets.
As successful as it has been in achieving budget balance and eliminating the financing of large operating deficits, GAAP budgeting has its limitations. A consequence of a balance requirement is that each year’s adopted budget condition appears the same as the last. The continuous balanced condition is of limited value when comparing years. It does not reveal the differences between a boon year and a challenging year.
A more helpful bellwether of the City’s financial condition is the outyear budget gaps in the financial plan. That measure has its limitations as well. While one year in the plan may look better or worse than another, the projections are only accurate to the degree to which the City can predict a future downturn. The outyear gaps can vary greatly depending on revenue projection models and certain expenditure levels, only some of which are at the discretion of the City. Any change in revenues, which are volatile by nature, distorts the entire four or fiveyear plan. Even though the City often forecasts revenues conservatively, when a recession occurs, revenues can drop below projections. A single year’s recession affects all subsequent years of the financial plan since each outyear is trended off a base year.
“Rolling” Resources
Another challenge of the GAAP budgeting requirement is the unintended consequence of potentially incentivizing spending unanticipated revenues within the fiscal year they are generated because these resources cannot be used for future expenses. Fortunately, instead of immediately spending rather than forfeiting these additional revenues, the City has developed several budget relief mechanisms. The first and oldest tool the City has is the “rolling” of prior year resources.
That “roll” is the amount paid in the concluding fiscal year to reduce the need for certain payments in the upcoming year. This is done by using current year additional resources to pre-pay debt service and advance subsidies to entities whose budgets are outside of the City’s General Fund such as city libraries, the Health and Hospitals Corporation (HHC) and the Metropolitan Transportation Authority (MTA). 2 Beginning in FY 2003, the roll also included discretionary transfers to the New York City Transition Finance Authority (TFA) to pay for future TFA debt service. Even though these prepayments and subsidies reduce the City’s need to provide funds in future fiscal years, GAAP recognizes them as expenditures in the year they are made. This has enabled the City to roll prior-year resources into future fiscal years for budget relief while adhering to GAAP budgeting.
When looking back at history, a continuous pattern emerges showing that when prior-year resources rolled into a year are not used within that year, they are subsequently rolled again. Essentially, during good times, the City has typically added to the roll, resulting in a higher roll-out at the end of the fiscal year. In bad years the City has partially depleted it. However, the recurring nature of the roll is not generally apparent when viewing individual financial plans on their own. That is because the City normally budgets for the roll to be depleted in the next fiscal year. Since the City balances its budget using conservative revenue forecasts and expenditure projections, each year, it assumes that the roll is depleted. As the year progresses, if all of those resources were not in fact needed, the roll appears again to help balance the next year’s budget.
Chart 1 shows the size of the rolls since FY 2000. The chart shows that in most years the City adds to the roll, but following 9/11 and the Great Recession the City drew down upon it. When the roll was the only mechanism to use prior year resources for future years, its size provided an indication of the City’s overall fiscal health. A roll that was growing meant the City had an operating surplus and a roll that was diminishing indicated an operating deficit. The roll’s ability to provide a cushion was gauged not just by whether it was growing but also by its size.