Policy on Management of Surplus

Transcription

1 Policy on Management of Surplus (City Council at its regular meeting held on October 3, 4 and 5, 2000, and its Special Meetings held on October 6, 2000, October 10 and 11, 2000, and October 12, 2000, amended this Clause to provide that a target level for the funding of reserves not be established until the 2001 Operating Budget process.) The Policy and Finance Committee recommends that the policy outlined in the following report (August 31, 2000) from the Chief Financial Officer and Treasurer, be approved and implementation thereof be referred to the 2001 Budget process: Purpose: This report presents the rationale and strategy for allocating year-end operating budget surplus so that contributions can be authorized by the Chief Financial Officer and Treasurer to any tax supported reserve or reserve fund, to off-set borrowing for capital purposes and where it is not contrary to law, to reduce or eliminate unanticipated changes in future years tax rates. Financial Implications and Impact Statement: The 2000 Operating Budget has a budgeted surplus carried forward from 1999 of $41.3 million and contemplates a surplus carried forward into 2001 of $30million which will create a $11 million pressure for the 2001 Operating Budget. This report is recommending that by 2004 the surplus carried forward be zero which will create an Operating Budget pressure of an additional $41 million over the next three years. Recommendations: It is recommended that: (1) the surplus carried forward be zero by the 2004 fiscal year and that this be accomplished by reducing the surplus carried toward in 2001 to a target level of $30 million, in 2002 to $20 million and 2003 to $10 million; (2) a Tax Rate Stabilization Reserve Fund be established for the purpose of funding any operating deficit and to which any operating surplus would be applied with a target level of 1 percent of property taxes by 2004; (3) By-Law No (reserves and reserve funds by-law) be amended by adding the Tax Rate Stabilization Reserve Fund to Schedule C; (4) the Chief Financial Officer and Treasurer be authorized, consistent with Recommendation No. 1 and No. 3 above, to apply any additional surplus, in priority order to:

2 (a) (b) (c) fund the Tax Rate Stabilization Reserve Fund ( if below its target); Capital Financing Reserve Fund (at least 10 percent of the additional surplus); and the remainder to fund any unfunded liabilities, or otherwise proven inadequacy in a reserve or reserve fund on the basis of highest risk of immediate property tax impact as determined by the Chief Financial Officer and Treasurer; (5) the Chief Financial Officer and Treasurer shall report such contributions as per Recommendation No. 4 to the Budget Advisory Committee no later than four weeks following the closing of the accounts for the prior year; and (6) the appropriate City Officials be authorized and directed to take the necessary action to give effect thereto. Background: At its meeting of February 29, March 1, and 2, 2000 Council adopted the report (February 7, 2000) from the Chief Financial Officer and Treasurer entitled Administration of Reserves and Reserve Funds. Among other things, the report recommended that the Chief Financial Officer and Treasurer shall be authorized to make contributions to any tax supported reserve or reserve fund, where it is not contrary to law, to reduce or eliminate unanticipated changes in future years tax rates that would otherwise occur based on changes in the surplus from year to year, subject to the Chief Financial Officer and Treasurer reporting on a surplus management policy, or to fund unfunded reserve and reserve funds in accordance with Council approved policies for addressing such under-funding. Such contributions to be reported to the Budget Advisory Committee no later than four weeks following the closing of the accounts for the prior year. This report outlines the rationale for a surplus management policy - the explicit policy requested in the recommendation. Discussion: A surplus arises in the Operating Budget (operating fund) when there is an excess of revenues over expenditures (a deficit would arise if the reverse were true). Year-end surpluses generally arise from two occurrences higher than budgeted revenues including one-time only revenues, and lower than budgeted expenditures. The Municipal Act requires municipalities to bring the prior year s surplus forward into the next year as a revenue source for the Operating Budget. On the one hand this might be deemed to be a positive action because the surplus partially off-sets any need for an increase in the tax rate in the subsequent year. However, on the other hand, the downside

3 of this requirement is that once a surplus has been carried forward in this way, it must be maintained because the reduction or elimination of it will create a pressure in the following year s Operating Budget. Where municipalities have had surpluses, there is a need to maintain consistency from one budget year to the next to avoid significant budget pressures, or unsustainable revenue increases. (A) Municipal Practice: A survey of municipalities (mostly in Ontario and including the former Toronto municipalities) concerning surplus management policies, summarized in Appendix A, indicates that for the most part municipalities did not have formal policies in this regard. Municipalities recognized the need to maintain consistency from one year to the next in the amount of surplus carried forward. The majority of municipalities allocate any additional surplus (above that required to maintain consistency) to one or a combination of the following: by placing funds in a tax rate stabilization reserve or by applying funds to the following year s capital program and/or by applying funds to other unfunded liabilities and reserve/reserve funds. Generally, a surplus position is not identified until year-end and so allocations cannot be budgeted for in advance. Hence, it would be useful to staff if there was a surplus management policy from Council to guide in these allocations. (B) City s History: Table No. 1 indicates the pattern of surpluses carried forward for the former municipalities amalgamated into the new City of Toronto since Table No.1 History of Surpluses Carried Forward (est.)* $114.2 m. $101.5 m. $84.7 m. $52.8 m. $43.6 m. $41.3 m. $13.0 m. * 2000 Operating Budget documents This table clearly indicates the pressure that has been placed on the Operating Budget since 1995 as a consequence of the reduction in surpluses. Over these years the major contributors to the surplus have been over achievement of revenue budgets especially interest earnings and tax related revenues and less than budgeted expenditures especially welfare costs and unexpended contingency funds. (C) Policy:

4 If the surplus carried forward every year is zero, then the budget in each subsequent year is truly balanced (expected revenues generated in that year equal expected expenditures for that year). If this were the surplus approach, then each year would stand on its own and any potential surplus or deficit in a year would need to be resolved through year-end adjustments. It is being proposed in this report that Council adopt the policy that there be no surplus carried forward in future and that the Chief Financial Officer and Treasurer be authorized to allocate funds as indicated below to reduce the surplus carried forward to zero or to transfer funds from the Tax Rate Stabilization Reserve to make up any deficit in the operating fund. Given the size of the current surplus carried forward namely $41.3 million, it is not practical to absorb the consequences of this in one year. Therefore, it is being recommended that the surplus carried forward be reduced in equal installments so that by the budget year 2004, the surplus carried forward is zero and remains such from then onwards. Thus, the projected surplus carried forward for 2001 would be $30 million, for 2002 $20 million, for 2003 $10 million and for 2004 $0. If Council adopts this policy, then two problems potentially arise what if there is a deficit in any year and what if there is a surplus. A surplus, in the case of the City, would be created in one of three ways excess of revenues over expenditures in the operation of an Agency, Board or Commission (ABC), special circumstances such as one time only revenues, and/or excess of revenues over expenditures for its core operations. In the case of surpluses generated from ABC s, since they are supposed to be self-sufficient, and would have no capacity to deal with a deficit, then it has been prudent to place the surplus funds in a stabilization reserve fund to off-set any subsequent deficits. Council has already subscribed to this approach in that it has created four stabilization reserve funds for the major self-sustaining, or largely self-sustaining, ABC s Toronto Zoo, Hummingbird Centre for the Performing, Toronto Centre for the Arts (formerly the North York Performing Arts Centre), and the Toronto Transit Commission. As well it has created two additional ones for Water/Wastewater program. The Chief Financial Officer and Treasurer already has the authority to make the necessary year-end adjustments to net these operations to zero by either transferring funds into or out of their respective reserve funds depending on whether the ABC would otherwise have a surplus or deficit in its operations. An example of a special circumstance is Council s action with respect to surpluses generated by underspending in the social assistance program. As part of Council s plan to mitigate the impact of the next recession on the welfare roles and that impact on the property tax rates, it was decided to create the Social Assistance Stabilization Reserve Fund and to fund it in two ways. The first way is to make a direct payment to the reserve fund as part of the Operating Budget.

5 The second way is to transfer any surplus that results from underspending directly attributable to social assistance caseloads to the reserve fund. A second special circumstance is the situation where the City receives one-time only funds for a special purpose and the expenditure stream related to it is expected to proceed over several years. The funds are placed in a reserve fund rather than being attributed as income in the year of receipt where they would be a contributor to surplus. An illustration of this would be the National Child Benefit Support Reserve Fund. It is being recommended that the surplus management policy have three components, creation of a tax rate stabilization reserve fund, a contribution to the Capital Financing Reserve Fund and contributions based on the Chief Financial Officer and Treasurer s judgement as to which liability or deficiency in a reserve or reserve fund is most likely to have an immediate impact on the tax rate. (D) Tax Rate Stabilization Reserve Fund: Similar to the major self-sustaining ABC s, the City should have a tax rate stabilization reserve fund to be funded from surpluses to be applied against any subsequent deficits. This reserve fund would have exactly the same purpose for the City as a whole, as it currently does for the self-sustaining ABC s. The reserve fund would accumulate in the good years and would off-set deficits in the years in which they occur. The question arises as to the target level that such a reserve fund ought to have. The larger this target the greater the protection the City has from unexpected financial shocks. On the other hand, since it would be recommended that any surplus funds be applied to this purpose first, if the target is too large other worthy applications of surplus funds might be unduly deprived of resources. A review of the surplus reductions since 1995 (see Table #1 above) would indicate that, if the surplus carried forward target had been zero in the past, then a target of 1 percent of one year s property taxes ($25.8 million) would be in the order of magnitude of the largest reduction. Given that it is being recommended that the surplus carried forward be phased over three years to mitigate the impact of the pressure on the tax rate, it is recommended that a tax rate stabilization reserve fund be established for the purpose of funding any operating deficit and to which any operating surplus would be applied with the target level of 1 percent of property taxes being achieved by If funds were available, a likely scenario of contributions would be $5 million in 2001, $10 million in 2002 and $10 million in 2003 to a total of $25 million by (E) Capital Financing Reserve Fund:

6 If the tax rate stabilization reserve fund were set at 1 percent and the target were reached (schedule as per above in the early years), then any policy would need to prescribe the application of additional surplus funds, if available. As noted above, other municipalities have applied their surpluses to capital financing and/or unfunded liabilities/reserve and reserve funds. Applying the funds to capital financing would reduce the City s debt service requirements and thus have a positive impact on the operating budget. This would have the direct impact of supporting the existing tax rate. At first blush, this would appear to be the best application of any surplus in terms of the bang for the buck. Surplus funds would be used the next year by placing them exclusively in a reserve fund for capital financing to reduce borrowing and thereby reduce debt service costs in the long run. The current debt policy is that capital financing ought not to not be to more than 10 percent of property taxes. The current projections are that Council will be hard pressed to maintain debt service costs within this range in the near run. Therefore, it is being recommended that, should there be sufficient funds, the next application of funds after contributing to the Tax Rate Stabilization Reserve Fund would be a contribution of at least 10 percent of the surplus to the Capital Financing Reserve Fund. (F) Liabilities/Reserves/Reserve Funds: However, as indicated in the report (February 7, 2000) from the Chief Financial Officer and Treasurer entitled Longer Term Reserve and Reserve Fund Adequacy and Funding Strategies, significant inadequacies in reserve/reserve fund balances have already been identified and as other accounts are reviewed in the course of next year or so further inadequacies will be identified. A long term strategy must be put in place to deal with these inadequacies. The ideal response to this situation would be to fund the shortfalls directly from the Operating Budget on an appropriate schedule which would bring the accounts to the target on a time-line consistent with risk they are intended to mitigate. The City s current financial circumstances preclude this approach. The fallback position is the one currently in use for the Social Assistance Stabilization Reserve Fund whereby the City is making a modest contribution in the Operating Budget and applying any surplus that results from underspending directly attributable to social assistance caseloads to the reserve fund. This strategy ensures that annually the deficiency is dealt with and provides for an acceleration of the mitigation should circumstances allow. Table No. 2 indicates the inadequacies identified to date from the report noted above. Table No. 2 Adequacy of Reserves and Reserve Funds

7 Reserve 5 Year Operating Impact Total Inadequacy Vehicle and Equipment Replacement $21 m. $21 m. * TTC $49 m. $210 m. Staff Benefits $13 m. $725 m. Weather $10 m. $20 m. Social Service * $67 m. $326 m. Building Maintenance $17 m. $1,600 m. TOTAL $177 m. $2,902 m. * already reported to Council On this basis, it is being recommended that, once funds have been contributed to the Tax Rate Stabilization Reserve Fund (if below its target) and once at least 10 percent of surplus available has been contributed to Capital Financing Reserve Fund, the Chief Financial Officer and Treasurer contribute the remainder of the surplus to any unfunded liability, or otherwise proven inadequacy in a reserve or reserve fund, on the basis of highest risk of immediate property tax impact. (G) Recommended Policy: Therefore, the recommended surplus management policy would be that the Chief Financial Officer and Treasurer be authorized to apply any additional surplus, in priority order to: (a) fund the Tax Rate Stabilization Reserve Fund ( if below its target); (b) Capital Financing Reserve Fund (at least 10 percent of the additional surplus); and (c) the remainder to fund any unfunded liabilities, or otherwise proven inadequacy in a reserve or reserve fund on the basis of highest risk of immediate property tax impact as determined by the Chief Financial Officer and Treasurer. Table No. 3 outlines a scenario of how this policy might play out in practice on the assumption that the conditions that caused there to be a $41.3 million surplus carried forward into 2000 would generally obtain through 2004 and assuming any ABC surpluses and special circumstance generated surpluses were already transferred to their respective reserve funds. Table No. 3 Application of Surplus Management Policy

8 Budget Year Prior Year Surplus before Provisions Provisions to: Tax Rate Stabilization R. F Capital Financing R. F Underfunded Reserve Funds Prior Year Surplus Applied to Budget Conclusion: Council, in adopting the Administration of Reserve and Reserve Fund By-law, requested that there be a surplus management policy. It is being recommended that the City work towards a corporate surplus target with the goal of zero funds carried forward for the 2004 Operating Budget. If there are excess funds from the current year-end results over and above the annual surplus target, then the Chief Financial Officer and Treasurer be authorized to apply them first to a new Tax Rate Stabilization Reserve Fund if not at the target, then at least 10 percent of the additional funds to the Capital Financing Reserve Fund, and finally, any remaining funds to unfunded liabilities and otherwise proven inadequacies in reserves and reserve funds based on mitigating the highest risk of immediate impact on property taxes. As per Council s request, such year-end activity would be reported to the Budget Advisory Committee no later than four weeks following the closing of the accounts for the prior year. Contact: N. Donald E. Altman, Manager, Financial Planning, Phone: (416) , Fax: (416) ; daltman@city.toronto.on.ca Len Brittain, Director, Treasury and Financial Services, Phone: (416) , Fax: (416) ; lbrittai@city.toronto.on.ca Former Municipalities: East York : No information available Appendix A Survey of Municipal Practice re: Allocation of Surplus

9 Etobicoke: No written policy. Surplus got carried automatically forward to the next year to reduce taxes. Special items had to be pre-approved by Council before the end of the fiscal year. Metro: No formal policy. Use all or part of surplus to reduce next year's mill rate; transfer any additional surplus to reserve/reserve fund deemed appropriate by Council. North York: No written policy. Senior management had discretion. Managed the amount brought forward to next year to maintain it at a consistent level. Balance used to top up reserves/reserve funds at senior management's discretion for financing future liabilities, e.g. employee benefits Scarborough: Written policy. 2 to 2.5 mills transferred to Corporate Capital Levy Reserve Fund; any additional balance was carried to next year's budget. In the last few years, set surplus budget level every year and smoothed out fluctuations from year to year Toronto: No formal policy. Council reviewed surplus at the end of year and decided where it should go. Treasurer managed the amount brought forward to next year to maintain it at a consistent level. York: No formal policy. Practice - 1st call - for surplus went to Water Stabilization Fund and City Stabilization Fund; balance went towards stabilizing next year's mill rate. Other Municipalities: Brampton: No written policy. Informal guidelines only - transfer of surplus, based on forecasts to a reserve for infrastructure maintenance as determined by Council. Durham: No written policy. Informal guidelines only - general tax surplus set aside as Rate Stabilization Reserve funds applied for future year capital expenditures or to stabilize property tax rate. Surplus from Water/Wastewater use rates will be set aside as

10 Water/Wastewater Stabilization Rate Reserve fund applied for services and capital expenditures as determined by Council. Edmonton: Formal policy: 50 percent of an annual operating surplus placed in the Financial Stabilization Reserve to a target of 7 percent of current general government operating expenditures. The Financial Stabilization Reserve is an uncommitted reserve account established for the purpose of providing a resource which can be used in circumstances involving financial emergencies and in protecting the City against unforeseen operating costs that will cause the City to incur an operating deficit. The goal is to maintain stable taxes and other revenue sources, as well as the orderly provision of services to residents. The reserve is not intended to be used to stabilize future mill rate increases. The policy was adopted by Edmonton's City Council on May 20, 1997, as policy # C213. Haldimond-Norfolk: Formal policies: Allocation of surplus based on year-end review to Contingency Reserve and Capital Reserve as approved by Council; and Stabilization Social Reserve established from the excess of the budget amount of the Social Service Program. Halton: No written policy. Informal guidelines only - through annual year-end review - 90 percent applied to capital expenditure and the remaining balance applied to the least adequate reserve/reserve fund or unfunded liabilities. Hamilton-Wentworth: No formal policy. Surplus transferred to Tax Stabilization Reserve Fund to offset extra items outside of the operating budget as directed by Council. Markham: No written policy. Informal guidelines only - funds set aside to Corporate Rate Stabilization Reserve otherwise directed by Council. Mississauga: Informal policy: Amount - if less than or equal $2.5 M, the Surplus carried forward to next year as general revenue; if over $2.5 M set aside as reserve funds toward least adequate reserve/reserve fund as decided by Council.

11 Niagara: No written policy. Informal guidelines only - funds applied to a reserve fund when the fund is inadequate or to fund future year capital expenditures or other areas as directed by Council, e.g. last year, their surplus was used to reduce mill rate. Oakville: Formal policy: First $500, shall be applied to reduce next year s mill rate. If any excess remains, it shall be contributed to the Tax Rate Stabilization Reserve to the extent necessary to maintain the balance of the reserve at $2,000, Any remaining surplus shall be contributed to the Capital Financing Reserve to fund future year capital expenditures. Ottawa-Carleton: No written Policy. All current year operating surplus is applied to the following year capital expenditures. Peel: No guidelines or policies. Sudbury: Formal policy: Any surplus for the current year will be set aside to Capital Financing Reserve Fund to finance future year capital expenditures. A by-law was established for this reserve fund, By-law No F, Feb. 25, Vaughan: Formal policy: 50 percent go to "Working Capital Reserve" and 50 percent go to "Mill Rate Stabilization Reserve" Waterloo: Formal policy: Amount of $600, carried forward to next year to reduce tax levy of that year. The balance is allocated 50/50 to Working Fund Reserve and Tax Stabilization Reserve Fund. York: Formal policy: Surplus applied to General Capital Reserve for capital financing.