Staff Report. REVIEW OF FYs FINANCIAL PLAN. July 19, 2016 NEW YORK STATE FINANCIAL CONTROL BOARD

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1 Staff Report REVIEW OF FYs FINANCIAL PLAN July 19, 2016 NEW YORK STATE FINANCIAL CONTROL BOARD

2 STAFF OF THE NEW YORK STATE FINANCIAL CONTROL BOARD ACTING EXECUTIVE DIRECTOR Jeffrey L. Sommer SENIOR STAFF Barbara Marin Administration Steven A. Bollon - Acting Expenditure and Covered Organization Analysis Martin Fischman - Acting Economic and Revenue Analysis Jewel A. Douglas Finance and Capital Analysis ANALYTIC STAFF Sew-Lian Ang Iwona Matusiak Michelle McManus Jean L. Schwartz Edward C. Thurston ADMINISTRATIVE AND SUPPORT STAFF Saundra L. Truell

3 TABLE OF CONTENTS PAGE l. Overview... 1 II. Balancing the FY 2017 Budget... 6 City Funds Edge up $172 Million as FY 2016 Comes to a Close... 6 Taxes Improve by $1.5 Billion in FY 2017 but City Funds Increase Only $273 Million... 7 Expenditure Highlights... 8 FY 2016 Surplus Funds... 9 III. The FYs Financial Plan The Outlook for Revenue Growth Property Tax Growth Nonproperty Taxes Miscellaneous Revenue Sources of Expenditure Growth over the Financial Plan The Capital Program Continues to Grow Commitments Have Increased in All Areas of the Capital Program Debt Service Is Projected to Be Affordable IV. Glossary of Acronyms i

4 LIST OF TABLES PAGE 1. JUNE FINANCIAL PLAN: THE CITY'S OPERATING PROJECTIONS FOR FISCAL YEARS CHANGES TO THE CITY'S OPERATING PROJECTIONS FOR FISCAL YEARS JUNE FINANCIAL PLAN COMPARED TO JANUARY MODIFICATION RISKS TO THE FINANCIAL PLAN CITY FUNDS INCREASE BY $7.8 BILLION OVER THE PLAN PROJECTED TOTAL-FUNDED EXPENDITURE GROWTH IN FYs PROJECTED CITY-FUNDED EXPENDITURE GROWTH IN FYs TAX-SUPPORTED CAPITAL COMMITMENTS FOR FYs HAVE INCREASED IN ALL FUNCTIONAL AREAS THE BURDEN IS PROJECTED TO LESSEN WITH IMPROVING DEBT SERVICE AND TAX REVENUE FORECASTS ii

5 l. Overview The city ended FY 2016 with a surplus of almost $4 billion. The surplus, built from a combination of higher-than-forecasted revenue collections plus expenditure savings, will be used to prepay FY 2017 expenses. Most of the surplus, about $3.6 billion, will be used for the prepayment of debt service and the remainder, $400 million, for NYC Health + Hospitals expenses. It is important to note that the city was able to achieve this surplus even after funding agency new needs of $918 million, increased pension costs of $530 million, as well as additional contributions of $500 million to the Retiree Health Benefits Trust and $179 million to Health + Hospitals. The FYs Financial Plan presents a balanced budget for FY 2017 but, with recurring expenditures growing at a faster rate than revenues, outyear gaps of $2.8 billion in FY 2018, $2.9 billion in FY 2019, and $2.3 billion in FY 2020 exist. There is pressure to both revenue and expenditure forecasts that are likely to occur, which will require the city to maintain its conservative budget management practices. In the financial plan, the city projects that city-fund revenues will grow 13.2 percent from FY 2017 to FY Last year at this time, city-fund growth was more conservative at 10.9 percent over the years of the plan. The city expects city-fund revenue growth to drop to 0.5 percent in FY 2017, following 1.6 percent growth in FY This comes after two years of robust growth in FYs 2014 and Modest growth is expected to return in the outyears of the plan. In a less uncertain environment the city s forecast would be easily achievable. Nevertheless, the sharp deceleration of city-fund growth to 1.6 percent in FY 2016 presents a timely caution that strong growth cannot always be relied on. In our March 2016 staff report, we noted that the economy appeared to be in transition to a slower growth path. Adding to the uncertainty is the vote of the United Kingdom to leave the European Union. With that in mind, the city should continue to be cautious in its revenue forecasts, primarily in the business taxes, and review its decision to reduce reserves for the property tax in the outyears of the plan. These concerns may be partially offset by increased miscellaneous revenues. The growth on the expenditure side comes mostly from higher salaries and wages related to the settled collective bargaining contracts, high healthcare costs, and rising debt service. The contractual agreements with almost 99 percent of its employees have given the city crucial budget certainty. The healthcare savings agreed to in collective bargaining, $1.3 billion of recurring savings, are beginning to take hold. These efforts must continue and increase as the next round of collective bargaining continues. Debt service costs are rising due to the high amount of debt that has been and is expected to be issued to support the city s capital program. Debt service is projected to grow 23 percent from FY 2017 to FY It must be noted that the city, in projecting debt service costs, utilizes conservative interest rate assumptions. The current plan anticipates that the prevailing low interest rates will increase. If, however, they do not, there will likely be budget savings. At this point, we already believe, that at a minimum, debt service costs in FY 2017 will be lower by $75 million because it is unlikely the city will undertake short-term borrowing given its extraordinarily high unrestricted cash balances.

6 Two other areas that we believe will be sources of expenditure pressure are pensions and increased subsidies for Health + Hospitals. In FY 2016 the city, at the City Actuary s request, updated mortality tables and increased the pension contribution by $600 million. Pension fund investments in FY 2015 returned only 3.3 percent, which is lower than the required seven percent return. The financial plan already assumes the phase-in of increased contributions to make up the loss. The investment return in FY 2016 was even worse. While we do not have the official results at this time, it is likely that the city will have to begin phasing in additional contributions starting in FY 2018 growing to over $400 million by FY The second concern is Health + Hospitals. The city has prepared a report that projects cumulative losses of more than $5.4 billion over FYs for the system. The city sites the structural budget imbalance is due to reduced safety-net funding, increased competition for Medicaid patients, underutilization of hospital beds, and the declining use of hospital services. In FY 2016, the city had provided a $160 million subsidy and waived $337 million of miscellaneous revenue reimbursement related to debt service, fringe benefits, and judgment and claims. In addition, since settling the recent round of collective bargaining, the city has chosen to absorb the wage increase for covered employees in Health + Hospitals. The city has developed a plan to maximize federal and state support, as well as reduce costs. To the extent that this plan is not successful, there will be continual pressure for the city to increase its subsidy. Overall our analysis projects risks that could range from about $200 million in FY 2017 to almost $900 million by FY The city, however, is well positioned to deal with these risks and the additional pressures we identified. FY 2017 contains $1.5 billion combined in the general reserve and capital stabilization reserve, and each outyear has $1 billion in the general reserve. The city has prudently already announced plans to develop additional agency savings to be included in the November modification to the financial plan. These actions should produce recurring savings to stay ahead of the financial pressures that are likely to occur. 2

7 TABLE 1 ($ in millions) JUNE FINANCIAL PLAN: THE CITY'S OPERATING PROJECTIONS FOR FISCAL YEARS FY 2017 FY 2018 FY 2019 FY 2020 Revenues Taxes: General Property $23,945 $25,330 $26,840 $28,111 Other Taxes 29,904 31,092 32,081 33,182 Tax Audit Revenue Sale of Property Tax Liens Miscellaneous Revenues 6,407 6,434 6,678 6,777 Less: Intracity Revenues (1,764) (1,764) (1,759) (1,765) Disallowances (15) (15) (15) (15) Total City Funds $59,271 $61,871 $64,619 $67,084 Other Categorical Grants Interfund Revenues Federal Categorical Grants 7,673 6,811 6,680 6,618 State Categorical Grants 13,673 14,293 14,763 15,249 Total Revenues $82,116 $84,456 $87,479 $90,363 Expenditures Personal Service $44,846 $47,177 $49,533 $51,244 Other Than Personal Service 34,949 33,910 34,194 34,095 General Obligation, Lease & TFA Debt Service 6,579 6,949 7,456 8,115 Budget Stabilization & Prepayments (3,994) Capital Stabilization Reserve General Reserve 1,000 1,000 1,000 1,000 Subtotal $83,880 $89,036 $92,183 $94,454 Less: Intracity Expenditures (1,764) (1,764) (1,759) (1,765) Total Expenditures $82,116 $87,272 $90,424 $92,689 Gap To Be Closed $0 ($2,816) ($2,945) ($2,326) 3

8 TABLE 2 ($ in millions) CHANGES TO THE CITY'S OPERATING PROJECTIONS FOR FISCAL YEARS JUNE FINANCIAL PLAN COMPARED TO JANUARY MODIFICATION FY 2017 FY 2018 FY 2019 FY 2020 Revenues Taxes: General Property $152 $265 $446 $469 Other Taxes (561) (305) (408) (485) Tax Audit Revenue Sale of Property Tax Liens Miscellaneous Revenues (214) (243) (112) (115) Less: Intracity Revenues Disallowances Total City Funds ($609) ($260) ($52) ($109) Other Categorical Grants Interfund Revenues Federal Categorical Grants State Categorical Grants Total Revenues $4 $175 $503 $595 Expenditures Personal Service ($237) $66 ($151) ($144) Other Than Personal Service 2, General Obligation, Lease & TFA Debt Service (139) (224) (222) (108) Budget Stabilization & Prepayments (1,699) Capital Stabilization Reserve General Reserve Subtotal ($10) $689 $489 $158 Less: Intracity Expenditures Total Expenditures $4 $712 $511 $180 Change to the Gap Decrease/(Increase) $0 ($537) ($8) $415 4

9 TABLE 3 RISKS TO THE FINANCIAL PLAN ($ in millions, positive numbers are offsets to risks) FY 2017 FY 2018 FY 2019 FY 2020 Stated Financial Plan Gap $0 ($2,816) ($2,945) ($2,326) Estimation Property Tax (100) (200) (200) (200) Business Taxes (100) (100) (100) (100) Miscellaneous Revenue STARC Bond Repayment (50) (200) (150) 0 Police Department Overtime (58) (70) (63) (61) Uniformed Services Overtime* (165) (250) (249) (249) Pension Investment Loss 0 (139) (278) (417) Short-term borrowing savings Risk Total ($223) ($784) ($890) ($877) Total FCB Estimated Surplus/(Gap) ($223) ($3,600) ($3,835) ($3,203) *Includes Fire, Sanitation and Correction Departments 5

10 II. Balancing the FY 2017 Budget The June 2016 Financial Plan includes a balanced budget for FY 2017 of $82 billion in total funds, which is $248 million smaller compared to FY City-fund revenues comprise $59 billion of the total budget, for a year-over-year growth of $273 million. The revenue gain reflects rising tax collections, particularly the real property tax, which is partly offset by the projected declines of some other revenue categories like audits and miscellaneous revenue. In contrast, noncity-fund revenues, at $23 billion of the total budget, decelerate year-over-year by $521 million, incorporating a federal cutback in categorical aid that possibly could be reversed as the year progresses. The FY 2017 budget is balanced with the application of $4 billion of FY 2016 surplus resources that prepaid $3.6 billion of FY 2017 debt service and $400 million of Health + Hospitals expenses. The city has not identified a surplus for FY 2017, and our analysis shows a net risk to budget balance of over $200 million. However, the FY 2017 budget includes reserves totaling $1.5 billion to address uncertainties that may arise during the fiscal year, and the potential for debt service savings from a continued low interest rate environment. Any portion of the reserves that is left unused could function as surplus resources to facilitate closing the budget deficit of $2.8 billion projected for FY CITY FUNDS EDGE UP $172 MILLION AS FY 2016 COMES TO A CLOSE The June 2016 modification contains $172 million in additional FY 2016 cityfunded revenue compared with the April modification. This modest revenue gain was used to help future budgets by prepaying some expenses before the close of FY The property tax contributed an extra $98 million to the year-end revenue gains, but this was partly offset by a downward adjustment to the nonproperty taxes of $59 million. The personal income and sales and the real property transfer taxes weakened at the close of the year, while the unincorporated business and the mortgage recording taxes gained strength. Miscellaneous revenue increased by $131 million. Since the April modification, total revenues are up by $298 million in FY 2016 because of the previously mentioned cityfund increase and a $135 million improvement in categorical grants that was slightly offset by a downward adjustment of $9 million to interfund revenue. 6

11 TAXES IMPROVE BY $1.5 BILLION IN FY 2017 BUT CITY FUNDS INCREASE ONLY $273 MILLION City funds increase by $273 million to $59.3 billion in FY 2017 for a slight gain of 0.5 percent compared with revenues in FY Improved tax collections of $1.5 billion are largely offset by declines in most other revenue sources, as shown in the figure. Climbing property values are driving up city property tax revenue by $1.1 billion, yearto-year, to $24 billion in FY The nonproperty taxes increase by $347 million even though some taxes, like the property transactions taxes, are weakening. The gains to city funds are small because aside from taxes most other revenue categories are falling. Tax audits decline $346 FY 2017 City-Fund Revenues Increase by $273 Million ($ in millions) Property Tax $1,112 Nonproperty Taxes 347 Audits (346) STAR Aid (258) Unrestricted Aid (6) Miscellaneous Revenue (483) Nonrecurring Revenue (92) City Funds $273 Categorical Aid (593) Interfund Revenue 72 Total Change in Revenues ($248) Note: Numbers may not add due to rounding. million to $714 million. Miscellaneous and nonrecurring revenues shrink by a combined $575 million to $4.6 billion. Total revenue declines by $248 million, to $82.1 billion. The weaker FY 2017 total revenues include shifts in categorical grant programs, which are down by $593 million. Part of the city s allocation of the state s school tax relief program (STAR) has been shifted between the city and the state. Accordingly, STAR revenue declines by $258 million to $556 million while city tax collections are scheduled to increase by a like amount. City revenues are unaffected by the change and city taxpayers will be held harmless. The state will pay part of the subsidy directly to city taxpayers. The weakness in categorical aid results from an $865 million reduction in federal aid. State grants climbed by $166 million and private grants improved by $106 million, but these gains were not sufficient to offset the large federal cutback. Categorical aid from all sources is $22.2 billion in FY 2017, of which $7.7 billion is federal aid, $13.7 billion is from state programs and $853 million is from private sources. The decline in grants follows a two-year uptrend. Grants from all sources were $22.8 billion in FY 2016, up from $20 billion in FY 2015 and $18.9 billion in FY State and federal grants had both been increasing over these prior periods, but not private grants. It is possible that some grant cutbacks will be restored as the year progresses, in particular disaster recovery assistance for Hurricane Sandy could increase again in FY The city recently received approval for $9.4 billion in Federal Emergency Management Agency (FEMA) grants to repair and improve city hospitals, public housing, schools, beaches and boardwalks, roads and lighting systems, and wastewater treatment plants and pump stations. Of these $9.4 billion in approved grants, FEMA has reimbursed the city $1.5 billion for its grant outlays. The city is currently working with FEMA to develop grants for an additional $500 million in funding. In addition to these FEMA grants that could total nearly $10 billion, the city is investing $4.2 billion of Housing and Urban Development (HUD) funding to help recover from the hurricane damage to private 7

12 housing, local businesses, city infrastructure, and to make coastal neighborhoods more resilient to flooding. State grants increase by $166 million in FY 2017, reflecting $535 million in additional education aid less planned decreases to other aid programs. The extra resources reflect the state s ongoing commitment to strengthen city educational programs from pre-kindergarten through higher education. State aid, which is $13.7 billion in FY 2017, increased from $13.5 billion in FY 2016, up from $12.1 billion in FY 2015 and $10.9 billion in FY In the state s budget, the majority of the increase to education aid supports city education, pre-kindergarten and CUNY programs. The state restored funds for $87 million in future cuts. The state budget also provides nearly $2 billion in new capital resources for supportive and affordable housing statewide. In another action that is linked to the Sales Tax Asset Receivable Corporation (STARC), the state is intercepting a portion of the city sales tax amounting to $50 million in FY 2016 and $200 million in FY The city s financial plan in FY 2017 only reflects $150 million intercepted by the state. As a result, we are holding $50 million at risk in FY The city expects the nonproperty taxes to increase by $347 million to $29.3 billion in FY These taxes increase by 1.2 percent in FY 2017, repeating the same lackluster 1.2 percent growth rate of FY These two back-to-back periods of fragile growth mark a sharp deceleration in the nonproperty taxes, which had averaged 8.2 percent in FYs The individual taxes in this group are growing unevenly with most showing sluggish or negative growth; the result being an overall growth rate that is barely over one percent in FY The personal income tax in FY 2017 increases by $422 million, or 3.9 percent, and the city sales tax gains $168 million, or 2.4 percent. The business taxes improve by a combined $48 million, or 0.8 percent. Other increasing taxes are the commercial rent tax with growth of $25 million, or 3.2 percent; and the utility tax with an increase of $21 million, or 5.8 percent. The city projects declines for the property transfer tax, which is down $138 million, or 8.1 percent, and the mortgage recording tax, which falls $142 million, or 11.6 percent. The hotel tax drops by $29 million, or 5.1 percent. The minor taxes are down by $26 million, or 4.3 percent, largely due to scheduled reductions in payments in lieu of taxes (PILOTs). EXPENDITURE HIGHLIGHTS The city ends FY 2016 with surplus funds totaling almost $4 billion. The surplus, built from a combination of higher-than-forecasted revenue collections plus expenditure savings, will be used to prepay FY 2017 expenses. Most of the prepayment, about $3.6 billion, will be for debt service and the rest, $400 million, will prepay expenses in NYC Health + Hospitals. The FY 2017 adopted budget assumes city-funded expenditures of $63.3 billion, which is $4.3 billion more than what was spent in FY After accounting for the FY 2016 surplus to prepay FY 2017 expenses, the net increase in city-funded expenditures between FYs 2016 and 2017 is about $273 million. Additionally, FY 2017 maintains reserves totaling $1.5 billion to address uncertainties that may arise during the fiscal year. 8

13 FY 2016 Surplus Funds Over the course of FY 2016, the city had recognized $2 billion of higher-thanexpected revenue collections and a $2 billion net spending decrease, which together generated $4 billion of surplus funds. The spending decrease was produced through a combination of expenditure savings and budget actions net of higher spending for agencies and pension costs. In addition to the higher spending, the city also allocated funding to the Retiree Health Benefits Trust fund (RHBT) and subsidized Health + Hospitals. Expenditure Savings As shown in the figure to the right, the city generated more than $2.1 billion of savings in FY The largest part of the savings comes from the implementation of an agency savings program totaling more than $1.1 billion. As discussed in our June 2016 report, agencies were asked to find measures to reduce spending. 1 Through the April modification, total savings were $878 million. The June modification adds $224 million, which brings the total to $1.1 billion. On top of the agency savings program, the city also recognized debt service savings totaling $572 million that largely materialized from more favorable interest rates than had been assumed, reduction in lease expenses and elimination of cash flow borrowing, as well as other budgetary and labor reserve adjustments of $470 million. Budget Actions The city had also taken a number of budget actions in FY 2016 that produced additional savings of almost $2 billion. The city reduced its general reserve by $980 million leaving $20 million to close out the fiscal year, transferred $500 million in capital stabilization reserves to FY 2017, and took down its reserve of prior-year payables by $500 million. Expenditure Increases FY 2016 Surplus Funds City Funds ($ in millions) Revenue Increases Tax $1,570 Miscellaneous 427 Total Increase $1,997 Expenditure Savings Savings Program ($1,102) Debt Service (572) Budget Adjustments (276) Labor Reserve (194) Total Savings ($2,144) Budget Actions General Reserve ($980) Capital Stabilization (500) Prior-Year Payables (500) Total Budget Actions ($1,980) Expenditure Increases Agency New Needs $918 Pensions 530 RHBT 500 Health + Hospitals 179 Total Increase $2,127 Total Net Spending Decrease ($1,997) FY 2016 Surplus $3,994 Offsetting expenditure savings and budget actions were higher spending on agency new needs and pension costs. Also, the city allocated funds to the RHBT and provided a subsidy to Health + Hospitals. As reported in our June 2016 report, the city 1 See Expenditure Savings in the FCB June 2016 Staff Report, starting on page 11. 9

14 had added $900 million over FY 2016 to cover agency new needs. 2 The June modification adds $18 million to that figure for a total of $918 million. In addition to agency new needs, the city added $530 million to cover costs associated with an actuarial audit and changes in mortality tables based on the City Actuary s recommendation. The city also allocated $500 million to the RHBT bringing its funding level up to an all-time high of almost $4 billion. Nonetheless, this funding level is still far below what is necessary to meaningfully reduce the Other Postemployment Benefits (OPEB) liability. As of June 30, 2015, the outstanding OPEB liability stands at $85.5 billion. This figure is somewhat improved compared to June 30, 2014 when the liability was $89.5 billion, a reduction of $4 billion over the fiscal year. The reduction was primarily due to lower premiums and healthcare savings that were agreed to by unions in the last round of collective bargaining. The healthcare savings are integral to the recent labor settlements, and as of February 2016, the Office of Labor Relations reports that these savings remain on target. In addition to funding the RHBT, the city also directed $179 million to the Health + Hospitals. The main component of that allocation was a $160 million subsidy to help firm up the fiscally troubled system. Expenditure Changes between FYs 2016 and 2017 As shown in the figure to the right, FY 2016 ended with total city-funded expenditures of $59 billion. For FY 2017, the city expects to spend a net $273 million more after accounting for the prepayment of FY 2017 expenses. A portion of the higher spending will provide more agency funding. The adopted budget assumes that agency spending will increase by $1.4 billion, which includes agency new needs of almost $1.1 billion and City Council initiatives of $352 million. About 40 percent of the increase in agency spending is for Health and Welfare Services. The Department of Social Services (DSS) will benefit the most from an allotment of $318 million. The city has ramped up spending in FY 2017 to support the growing Net Increase in Spending Between FYs 2016 and 2017 City Funds ($ in millions) FY 2016 Expenditures $58,998 Agency New Needs $1,052 City Council Initiatives 352 Total Agency Increase $1,404 Other General Reserve $980 Debt Service 652 Prior-Year Payables 500 Capital Stabilization Reserve 500 Pensions 137 Miscellaneous 93 Total Other $2,862 Total Increase $4,266 FY 2016 Prepayment (3,994) Total Net Spending Increase $273 FY 2017 Expenditures $59,271 Numbers may not add due to rounding. needs related to the many services DSS offers. 3 Another department receiving support is Health and Mental Hygiene, which gains $110 million in FY on page For a detailed explanation see Expenditure Increase in the FCB June 2016 Staff Report, starting 3 DSS provides services to combat poverty, inequality and homelessness, and to increase the economic well-being of families and individuals. Benefit programs administered are Cash Assistance, Emergency Assistance, Supplemental Nutrition Assistance and Medical Assistance to support low-income 10

15 Elsewhere, the city s Departmental Agencies, which encompass Libraries, Aging, Cultural Affairs, Housing Preservation, Environmental Protection (DEP), Finance, Transportation, Parks and Recreation, and Citywide Services, are gaining $386 million. The two biggest allocations are for DEP and Housing Preservation, which gain $106 million and $77 million, respectively. Funding has been increased for these two agencies to address system operations maintenance and support needs in DEP, and to cover costs associated with the New York City Housing Authority to aid it with façade repair costs. The city s Uniformed Services will experience budget growth of $231 million in FY 2017 with about 60 percent of the increase supporting the Department of Sanitation. A major portion of the increase is due to the nonrecurring value of waste surplus and landfill closure savings recognized in FY The Fire and Correction Departments will also experience budget growth of about $100 million collectively to support operational needs. Elected Officials find an extra $47 million in their FY 2017 budgets compared to FY 2016, while Organizations, comprised of the Department of Education (DOE), The City University of New York (CUNY), and Health + Hospitals, experience a small net decrease in spending of $76 million. City Council initiatives add $352 million to FY 2017 expenditures. 4 Departmental agencies receive the bulk of the Council funding totaling $195 million. The remaining funds are divided mainly among two other budget areas, with Health and Welfare being allocated $81 million and Organizations receiving $53 million. On top of the $1.4 billion of new agency spending is about $2.9 billion of other increases. The city will maintain a general reserve of $1 billion in FY 2017, which accounts for $980 million of the year-to-year variance. Also, the city projects higher debt service, miscellaneous spending, and pension costs totaling $982 million. Lastly, the city had transferred from FY 2016 capital stabilization reserves of $500 million into FY 2017 and adjusted prior-year payables by $500 million. When aggregated, agency and other spending total around $4.3 billion, which is almost fully paid for by the $4 billion prepayment of FY 2017 expenses. After accounting for the prepayment, the net increase from year to year is $273 million, bringing total FY 2017 city-funded expenditures to $59.3 billion. New Yorkers. It also assists individuals in returning to or entering the workforce by offering job training and education. 4 The largest of the City Council initiatives are to support education with about $27 million provided to the DOE and $17 million toward higher education. The Council also directed to housing agencies about $16 million. Other large initiatives are for Health and Welfare agencies with children services receiving $15 million and mental health agencies awarded about $13 million. 11

16 III. The FYs Financial Plan While the June 2016 Financial Plan presents a balanced budget of $82 billion for FY 2017, it forecasts revenues growing slower than expenditures thereafter through FY 2020, when revenues total $90.4 billion and expenditures $92.7 billion, even with revenue projections less conservative than before, as spending in certain areas is growing rapidly. The gap between revenues and expenditures fluctuates from $2.8 billion in FY 2018 to $2.9 billion in FY 2019 and $2.3 billion in FY Total revenues increase by $8.2 billion, or 10 percent, over the four-year period, from $82 billion in FY 2017 to $90 billion in FY 2020; whereas city-funded revenues climb by $7.8 billion, or 13.2 percent, from $59 billion in FY 2017 to $67 billion in FY While the experience of some recent years suggests that the city s growth projection is achievable, the current plan is less conservative than the comparable plan that the city presented one year ago. One concern is the flattening of city-funded growth in FY 2016 after two stronger periods of growth. Another concern derives from reports indicating that the national economy could be in transition to a slower growth path. It is also not clear how the local economy might be affected by the uncertainty emanating from the recent vote in the United Kingdom to exit the European Union. Meanwhile, total expenditures increase by $10.6 billion, or 13 percent, from $82.1 billion to $92.7 billion between FYs 2017 and 2020, fueled largely by growth in debt service, fringe benefits, and salary and wages. The surge in debt service costs is due to the high amount of debt that has been and is expected to be issued to support the city s capital program. Debt service is forecasted to surge from $6.6 billion to $8.1 billion, or 23 percent, between FYs 2017 and In projecting debt service costs, the city utilizes conservative interest rate assumptions, allowing for the possibility of savings that can be applied to reducing budget gaps. The cost to provide healthcare insurance is the largest component of fringe benefits. Driven mainly by premium payments, it is expected to increase by 25 percent from $6.1 billion in FY 2017 to $7.6 billion in FY Salaries and wages is increasing by 16 percent over FYs , to reflect the phase-in of funding to cover labor settlements for the latest round of collective bargaining. Based on our review of the June 2016 Financial Plan assumptions, we believe that revenues could be less than projected and expenditures more aggressive than stated. We estimate that there is a risk to budget balance in FY 2017 of $223 million, and the stated gaps could be higher by $784 million in FY 2018, and almost $900 million in each of FYs Prudently, the city has set aside $1.5 billion of reserves in FY 2017 to address uncertainties that may arise during the fiscal year, and an additional $1 billion of reserves in each of FYs that offset the risks. THE OUTLOOK FOR REVENUE GROWTH City-fund revenues increase by $7.8 billion, or 13.2 percent, from $59.3 billion in FY 2017 to $67.1 billion in FY 2020, as shown in Table 4 on page 13. Last year at this time, 12

17 city-fund growth was much more conservative at $6.2 billion, or 10.9 percent, over the years of the plan. In the current plan, weak nonproperty taxes, along with downturns in miscellaneous and nonrecurring revenues, diminish city-funded revenue growth in FY The growth rate of city funds drops to 0.5 percent in FY 2017, following growth of 1.6 percent in FY These two consecutive years of flat growth follow two years of robust growth in FYs 2014 and 2015, which saw gains of 7.3 percent and 7.5 percent, respectively. Moderate growth returns with gains of 4.4 percent in FYs 2018 and 2019, after which growth slows to about 3.8 percent in FY Rising tax receipts, aided by climbing nonrecurring revenues are driving the city-funded revenue growth. The real property tax increases by $4.2 billion, or 17.3 percent, and nonproperty tax collections gain $3.3 billion, or 11.3 percent, over FYs Nonrecurring revenues soar by nearly 700 percent and increase by $408 million. TABLE 4 CITY FUNDS INCREASE BY $7.8 BILLION OVER THE PLAN ($ in millions) FY 2017 FY 2018 FY 2019 FY 2020 FY FY % Change $ Change Property Tax $24,025 $25,410 $26,920 $28, % $4,166 Nonproperty Taxes 29,348 30,557 31,548 32, ,303 Audit Revenue Miscellaneous 4,584 4,563 4,562 4,545 (0.9) (39) Nonrecurring STAR Aid (4.5) (25) Disallowances (15) (15) (15) (15) Total City Funds $59,271 $61,871 $64,619 $67, % $7,813 Federal Grants $7,673 $6,811 $6,680 $6,618 (13.7%) ($1,055) State Grants 13,673 14,293 14,763 15, ,576 Private Grants (2.6) (22) Categorical Aid $22,199 $21,941 $22,278 $22, % $499 Interfund Revenue (10.1) (65) Total Funds $82,116 $84,456 $87,479 $90, % $8,247 The fact that city funds have achieved growth rates averaging 7.4 percent in two recent years indicates that the city could in normal times easily meet the challenge of a 13 percent growth plan that is spread out over three years. Nevertheless, the sharp deceleration of city-fund growth to 1.6 percent in FY 2016 presents a timely caution that strong growth cannot always be relied upon. We noted in our March 2016 report that the economy appears to be in transition to a slower growth path. Adding to the economic uncertainty is the surprise vote by the United Kingdom (UK) to remove itself from the European Union (EU). These factors could dampen the city s robust economic performance. In these circumstances it is not clear that this is the right time for the city to upgrade its revenue growth plan. Total revenue increases by $8.2 billion, or 10 percent, from $82.1 billion in FY 2017 to $90.4 billion in FY At the start of the plan, revenues decline by 0.3 percent in FY This weak projection follows three years of uneven total revenue growth averaging 4.8 percent annually. The past stronger revenue growth was lifted by increases in tax collections, federal assistance to rebuild following Hurricane Sandy, and by state education grants. After the weakness in FY 2017, total revenue increases by 2.8 percent in FY 2018, 3.6 percent in FY 2019 and 3.3 percent in FY

18 Categorical aid, which consists of federal, state and private program-specific grants, falls by $593 million in FY 2017 to $22.2 billion. Grants drop slightly in FY 2018 followed by a two-year upturn at the end of the plan. This source of aid reaches $22.7 billion by FY 2020, up $499 million, or 2.2 percent higher than the grants scheduled for FY Gains in state aid are sufficient to offset the decreases in federal aid and private grants. Over FYs , state aid increases by $1.6 billion, or 11.5 percent, due to the state s support for the city s education budget. Federal aid diminishes by $1.1 billion, or 13.7 percent. This decline reflects a pullback of federal involvement in the city s budget, after furnishing Sandy reconstruction aid in the years following the storm. Grants could be modified upward as program milestones are achieved and funds still in the pipeline are released. Private grants fall by $22 million, for a decline of 2.6 percent. Property Tax Growth Property tax revenue increases by $4.2 billion, or 17.3 percent, from $24 billion in FY 2017 to $28.2 billion in FY Property tax growth drops to 4.9 percent in FY 2017 from the 7.5 percent growth rate recorded in FY Revenue growth accelerates to 5.8 percent in FY 2018 and to 5.9 percent in FY 2019 after which growth drops to 4.7 percent in FY The June plan added $44 million to the previous property tax estimate for FY 2017 in the April modification. This small increment of extra revenue was recognized after billable assessment growth improved slightly to 6.8 percent in the final tax roll for FY 2017, up from the preliminary estimate of 6.7 percent that was based upon the tentative tax roll. Because this uptick on the latest tax roll was so slight, the city did not make any adjustment to the outyear property tax levy and made only small changes to contingency reserves. Up to this point, billable assessments had been on an upward trend but growth appears to have topped out. Billable growth accelerated from 4.4 percent in FY 2013 to 5.7 percent in FY 2014 and 6.1 percent in FY These increases reached a maximum of 6.9 percent in FY 2016 and edged down to 6.8 percent in FY 2017, after which growth is scheduled to slow in stages to 4.6 percent in FY We are satisfied that the city has acknowledged the possibility that billable growth could be slowing down. Nevertheless, the city has upgraded its outyear property tax plan in each plan modification over the past year. Prior-year collections and lien sales were adjusted upward in the November 2015 modification, after which the city raised the levy component in January. In the April plan the city elevated revenue by shrinking contingency reserves such as those for delinquencies and cancellations; and finally, with small reserve shifts in the current June plan. The net result of all these incremental increases is that the three-year property tax growth total expanded from $3.2 billion, or 14.1 percent, in the June 2015 plan to $4.2 billion, or 17.3 percent, in the June 2016 plan. In past reports, we have favorably noted how the city would supplement property tax revenues before the close of each fiscal year by reducing contingency reserves that had not been fully utilized. However, trimming outyear reserves at the start of the plan could expose the city to the risk of running short of reserves in the event that contingencies rise unexpectedly. We therefore believe that property taxes could be lower than the city s plan by $100 million in FY 2017 and by $200 million in each of FYs

19 Nonproperty Taxes The nonproperty taxes increase by $3.3 billion, or 11.3 percent, in the city s financial plan, from $29.3 billion in FY 2017 to $32.7 billion in FY 2020, as shown in Table 4 on page 13. This growth plan represents a significant acceleration from the three-year growth plan of $2.7 billion, or 9.4 percent, that the city presented in June In the interim, the national economy had been slowing down even before volatility struck the financial markets in the aftermath of the Brexit vote. Real GDP growth slowed to 1.1 percent in the first quarter of CY 2016 from 2.4 percent for the whole of The most current economic plan, which was presented in April, appears to have been overtaken by the down-trending economic data. The city s plan projects GDP growth of 2.3 percent in 2016 and 2.7 percent in By comparison, the more current July Blue Chip consensus projection of 1.9 percent in 2016 and 2.2 percent in 2017 is considerably weaker than the city s estimate. The city projects uneven nonproperty tax growth of 4.1 percent in FY 2018, 3.2 percent in FY 2019 and 3.5 percent in FY While this growth path appears to be moderate, these estimates represent a significant recovery from the two preceding years for which the growth estimates were virtually flat. Previously, nonproperty tax growth dropped from 7.5 percent in FY 2015 to 1.2 percent in FY 2016, and the city projects that growth will remain stalled at 1.2 percent again in FY The fastest growing nonproperty taxes over FYs are the sales tax, which increases 15.5 percent, and the unincorporated business tax, with an increase of 14.3 percent. The hotel tax gains 13.3 percent, the commercial rent tax grows by 13 percent, the personal income tax increases 10.8 percent and the utility tax adds 10 percent. Also increasing are real property transfer tax, the general corporation tax, and the mortgage recording tax. The minor taxes remain flat, while the cigarette tax drops by seven percent. Business Taxes Two of the city s business taxes, the general corporation tax (GCT) and the banking corporation tax (BCT), have been combined and separate bank tax collections do not appear in the city s plan for FY The plan suggests that the unincorporated business tax (UBT) will grow more strongly than the two merged taxes. As a group, the business taxes climb 9.8 percent from $6 billion in FY 2017 to $6.6 billion in FY Whereas UBT surges by 14.3 percent, the combined GCT and BCT increases by a more moderate 7.4 percent. Although the city expects the new tax law to be revenue neutral, a cautious forecast is warranted by the difficulties of estimating the actual effects of the business tax changes. The Bureau of Economic Analysis (BEA) reports that pretax corporate profits dropped by 1.9 percent in the first quarter of 2016, year to year, following a decline of 2.9 percent in the fourth quarter of Profits for domestic financial corporations have declined for two consecutive quarters. However, in a hopeful sign, profits of domestic nonfinancial corporations increased in the first quarter following a decline in the fourth quarter. Profits of New York Stock Exchange member firms dropped from $16 billion in 2014 to $14.3 billion in 2015, and the city projects that profits will fall to $10.6 billion in 15

20 2016. The Intercontinental Exchange reported that Wall Street firms earned $3.4 billion in the first quarter of 2016, indicating that the city s downsized plan for 2016 is achievable. The FDIC reports that net income is down 1.9 percent in the first quarter of 2016 for all insured banking institutions nationwide. Because of these reports of declining profits, we place the business taxes at risk for $100 million in each of FYs 2017 through Linked as they are to business profits, the business taxes are often a harbinger of future trends in other major taxes. Should the business taxes actually weaken as FY 2017 progresses, it could be an early warning that weakness could spread to other city taxes. Sales Tax In the June financial plan, the sales tax forecast is for moderate growth that is in line with historical patterns, and current trends in consumer spending, income, and employment. Collections improve by $1.1 billion over the years covered by the plan, from $7.1 billion in FY 2017 to $8.2 billion in FY The city s presentation includes only reductions of $50 million in FY 2016 and $150 million in FY 2017 to repay the state for a prior-year refinancing of Sales Tax Asset Receivable Corporation (STARC) bonds. The state determined that $600 million should be repaid by the city for the STARC bond refinancing during the years covered by the city s financial plan. Thus, in the State Budget, there was legislation that authorized $16.7 million of city sales tax revenue to be remitted monthly to the state, which will total $50 million in FY 2016, $200 million in FY 2017, $200 million in FY 2018, and $150 million in FY We are holding at risk $50 million in FY 2017, $200 million in FY 2018, and $150 million in FY 2019, which are amounts required by state legislation and not reflected in the financial plan. Including reductions for the STARC bond refinancing repayment from FY 2016 through FY 2019, sales tax revenue rises 1.7 percent in FY 2017, 4.1 percent in FY 2018, 5.1 percent in FY 2019, and 6.3 percent in FY The city s forecast is achievable, and is based on modest gains in employment, income, and tourism during the financial plan period. The city assumes continued employment growth, but at more sustainable levels of about 50,000 jobs in both 2016 and 2017, and 30,000 jobs annually in In the last five years, from , the number of jobs created per year ranged from 85,400 to 129,800. The city anticipates a slow, but steady pickup in total wages from a gain of 2.8 percent in 2016 to about four percent annually during , assisted by higher finance sector compensation in the outyears. Consumer spending has improved from the first quarter of 2016 with more borrowing and credit card use, but it remains to be seen if this trend will continue or if households will again become cautious and reduce discretionary spending. So far, households are feeling confident, and benefitting from an appreciation in home values and a small uptick in wages. Lately, spending by households is more likely to be online and for new experiences rather than at traditional department stores. There is also less taxable consumption from tourism, where the appreciation in the dollar is negatively affecting the amount purchased by international visitors. While there was a record set in 2015 of 58.3 million tourists, and the city expects 59.7 million visitors in 2016, it is unclear 16

21 if the vote in favor of the United Kingdom leaving the European Union will affect international tourism to the city due to an unfavorable exchange rate. Personal Income Tax The latest personal income tax forecast for FYs relies on essentially the same economic and financial assumptions that were developed for the prior plan released in April. In the current financial plan, total revenue is augmented by over $200 million annually from FY 2017 to FY 2020 due to a technical change, where the state is taking over a tax credit that used to be offered by the city. 5 Personal income tax collections increase by $1.2 billion, from $11.2 billion in FY 2017 to $12.4 billion by FY After falling by 25.9 percent to $10.6 billion in 2016 from the prior year, securities industry profits during the forecast period are expected to reach a high of $16.3 billion in 2017, and eventually settle at $15.0 billion by Withholding, the largest component within the personal income tax at $8 billion to $9 billion annually, is projected to grow in the five percent range each year of FYs , which represents smaller gains than occurred during FYs , but an improvement over the 3.1 percent rise in FY After falling for the past two years in FY 2015 and FY 2016, the city projects that private sector compensation will increase by 1.4 percent in FY 2017, and four percent in both FY 2018 and FY This compensation forecast is modest by historical standards and includes salaries and bonuses in the finance sector, where the city does not expect compensation to exceed one percent annually until FY Job gains are another major support to withholding, but the city anticipates that the number of jobs created in each year will slow from 80,000 to 120,000 jobs during to 30,000 to 50,000 jobs during In terms of nonwage income, the city projects capital gains realizations to decline in from fewer real estate and financial transactions by taxpayers, before exhibiting very low growth in Consequently, installment payments will advance three percent in FY 2017 to $2.3 billion, after double-digit growth per year in FYs All in all, personal income tax revenue on a common rate and base grows 2.1 percent in FY 2017, 2.6 percent in FY 2018, 3.4 percent in FY 2019, and 3.7 percent in FY Yet this conservative forecast may not be conservative enough for reasons outside of the city s control, such as citizens of the UK voting to leave the EU in the referendum on June 23, Prior to the UK referendum, domestic financial institutions and investors were already dealing with uncertainty and anxiety from increased stock market volatility, weak 5 In the FY State Budget the existing city school tax relief (STAR) personal income tax credit is converted into a state personal income tax credit for city residents. As with the city credit in effect prior to 2016, city residents whose incomes are $250,000 or less will receive a STAR credit against their state income tax of $125 for married taxpayers filing jointly and $62.50 for all others. 6 Continuing base or common rate and base refers to tax collections that have been modified to remove the effects of tax programs and other adjustments to focus on the influence of the economy. 17

22 global economic growth, higher loan-loss reserves from the low price of oil, and future interest rate hikes by the Federal Reserve. Firms relied on cost cutting, including personnel and compensation, to prop up revenues and profits, while preparing for more regulations on executive compensation and higher capital surcharges. Major Wall Street banks were looking forward to a better environment in the second quarter of 2016 than in the first quarter, characterized by less market volatility, and more opportunities to generate profits from trading, and advising on mergers, among other business lines. Now there is another layer of uncertainty over how the UK will leave the EU, and if it will take two years. During the departure process, there could be other changes to the composition of both the EU and the UK. After the results of the vote were announced, global stock markets fell sharply, but now appear to be stabilizing. Central bankers are monitoring currencies and stock markets, and declared their intention to intervene, if necessary, to promote market liquidity. It will take time to see how all of this will play out for the city s economy and Wall Street. Miscellaneous Revenue In the latest financial plan, miscellaneous revenue falls 11.0 percent or $575.7 million to $4.643 billion in FY 2017 from the prior year. However, from FYs , miscellaneous revenue rises 7.9 percent or $368.9 million to $5.012 billion by FY 2020 due to more nonrecurring revenues in FY 2020 than in FY In FY 2020 the major nonrecurring actions are asset sales of land and taxicab medallions. Based on historical patterns of growth and recent collections, miscellaneous revenue could be higher than the city s projections by $175 million in each of FYs 2017 and 2018, and $150 million in each of FYs 2019 and Shifting the focus to recurring revenues, the core categories decline 9.3 percent or $310.6 million to $3.022 billion in FY 2017, after increasing 1.2 percent in FY During FYs , core category revenue increases 0.8 percent or $23.8 million to $3.046 billion by FY 2020, largely due to higher interest income. In the adopted budget, the $310.6 million negative variance in FY 2017 is across-the-board, to varying degrees, among the core categories of licenses, charges for services, fines, rent, interest, and miscellaneous. Possible explanations for the lack of year-to-year growth in FY 2017 are conservative budgeting at the beginning of a fiscal year, and new initiatives that offer recurring revenue growth will be part of upcoming modifications to the financial plan. In terms of specific categories, some of the momentum generated from new construction that is reflected in licenses and charges for services may continue into FY 2017 from FY The current strong pace of new construction of residential and commercial properties will eventually slow. Yet in FY 2017, revenues from permits issued by the Departments of Buildings and Transportation related to construction, and housing fees, may not fall as sharply as initially forecast. As an illustration, the estimate for the license category is a decrease of $59 million to $656.1 million in FY Also, fine revenue may not decline as steeply as projected in FY 2017, at $88.4 million to $904.8 million, from fewer building, environmental, and traffic code infractions. Fines act as a deterrent to prohibited actions and to promote safety, whether in constructing buildings or not speeding in a school zone, and it takes time to change people s behavior. 18