2008-2009 Adopted Budget 2009-2010 Budget Plan Economic Analysis & Revenue Assumptions
Overall Economic Conditions The assumptions used in preparing the FY2008-09 revenue budget and the FY2009-10 revenue plan are based on a review of information concerning the national, state, regional, and local economies for the remainder of FY2007-08 and for FY2008-09 through FY2009-10. Several respected sources of data were used including the UCLA Graduate School of Management, the Los Angeles Economic Development Corporation (LAEDC), Bloomberg News, and economic analyses from various other respected sources. National Economy On the national level, the economy has deteriorated over the last few months as the housing slump and resulting credit crunch have spilled over into other areas in the economy and are significantly hampering economic growth. The revised Real Gross Domestic Product (GDP) grew at an annualized growth rate of 1% in the first quarter of 2008 after growing only 0.6% in the fourth quarter of 2007, which was equal to the weakest quarter since 2002. Many economists now believe the economy has or will slip into a recession and expect economic growth to be slow or negative for the next few quarters. The June 2008 UCLA Forecast for the Nation and California projects GDP growth at less than 1% for all of 2008 (although there will likely be a temporary bump in the second quarter 2008 due to the economic stimulus checks). Real GDP is not expected to hit the 3% rate of growth that most economists suggest is neutral until 2010. 8.0% 6.0% 4.0% 2.0% 0.0% Real GDP Growth vs. Unemployment Real GDP Unemployment 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: UCLA Anderson Forecast The slump in the housing market has been a major contributor to the economic slowdown, as both the volume and average sales prices continue to decline. Sales of existing homes in June 2008 were down 15.5% from the same period last year, on an annualized basis, and median prices were down 6.1%. New home sales and housing starts show a similar pattern, and foreclosures are at record levels in many areas of the country. The National Association of Realtors forecasts more of the same for the remainder of 2008 before the market bottoms out and begins a slow recovery in 2009. For 2008, as a whole, sales of existing homes are projected to decrease 6.1% from 2007 levels with a 6.2% decrease in prices. The outlook for new home sales is even worse with sales volume and prices projected to decrease 32.3% and 3.2%, respectively, in 2008. In 2009, existing home sales are expected to show a modest 5% increase with a 4.3% increase in median prices. Other key economic indicators such as unemployment, consumer spending, and consumer 2009 85
confidence are also reflecting U.S. Existing Home Sales recessionary-type conditions. The June 2008 unemployment Home Sales in Millions Median Price in Thousands rate was 5.5%, compared with 4.6%, one year ago and is likely 8.0 $250 to continue to increase. The 6.0 $200 UCLA Forecast projects an $150 4.0 unemployment rate of 6% by the $100 fourth quarter of 2009. Retail 2.0 $50 sales have been fairly flat in 0.0 $0 recent months as major purchases, particularly new auto 2003 2004 2005 2006 2007 2008 2009 sales, have been declining. Source: National Association of Realtors Consumer Confidence as measured by the Conference Board has plummeted recently. The June 2008 figure decreased 13% from May and was 52% less than one year earlier. Inflation, particularly in food and energy, has been increasing significantly in recent months leaving less disposable income in consumers pockets for other purchases. In summary, it now appears that the economy is in, or very close to, a recession. However, there is some disagreement about the length and severity of the recession. There are some indications that the recession will be fairly short by historical standards and that a mild recovery will begin by the second half of 2008. However, the Index of Leading Indicators, which attempts to measure the future course of the economy, decreased in June after two months of small decreases, and the index is well below the level of one year ago. The stock market has struggled due to concerns about the economy and the potential impact of the continuing housing and credit difficulties. Between April 1 and the end of June, the Dow Jones Industrial Average declined by nearly 14%. The Federal Reserve (the Fed) has ended its cycle of interest rate cuts, which lowered the Fed Funds target rate from 5.25% to 2%. The Federal Reserve is expected to keep the Fed Funds rate flat until late in 2008 in an effort to boost the sagging economy, but increasing inflation may force the Fed to raise rates earlier, which could hamper the economic recovery. The biggest threats to economic growth continue to be the housing market and inflation. State Economy 600 400 200 0 California Housing Market Single Family Home Resales in Thousands Median Price in Thousands 2002 2003 2004 2005 2006 2007 Source: National Association of Realtors $600 $400 $200 $0 The issues for the California economy are essentially the same as for the nation. The key factor is the residential real estate market. Although existing single family home sales in June increased for the second month in a row after declining for thirty consecutive months, median prices were down 37.7% from a year earlier. Also, the California economy, like the national economy, is showing other signs 86
10% 6% 2% -2% of weakness. Statewide Sales Tax collections for the fourth quarter of 2007 were essentially flat with the same quarter in 2006, and the slowdown is expected to continue. Growth in personal income and taxable sales in 2008 and 2009 are projected to be at the lowest rates since 2003. The State budget also continues to be a significant threat. The Governor and State Legislature were forced to take extraordinary steps to try and resolve a multi-billion dollar deficit in FY2007-08 and the State faces further deficits in FY2008-09 of up to $20 billion. There is the possibility that the State will borrow local property tax and transportation revenues to balance the FY2008-09 budget. The State unemployment rate increased to 6.9% in June 2008, up from 5.3% one year earlier, and is at its highest level since October 2003. The June 2008 UCLA Forecast projected that State unemployment will remain near 6% throughout 2008 and 2009 before decreasing in 2010. Local Economy California Taxable Sales & Personal Income Growth Taxable Sales Personal Income 2002 2003 2004 2005 2006 2007 Source: UCLA Anderson Forecast 2008 Within this context, the City's economy is expected to grow slower in FY2008-09 and FY2009-10 than in recent years. Santa Monica benefits from a more diversified tax base than many cities. For example, the City s five major tax sources, Transient Occupancy Taxes (TOT), Sales Taxes, Property Taxes, Utility Users Taxes, and Business License Taxes each make up between 10% and 15% of General Fund revenues. In many cities, sales and property taxes alone account for up to 60% of revenues. City of Santa Monica Property Transfers However, most of these tax sources are Number of Transfers Average Per Transfer economy-driven and 2,000 $6,000 will be affected by 1,500 the current economic $4,000 1,000 slowdown. $2,000 500 The declining real 0 $0 estate market has had 1998-1999- 2000-2001- 2002-2003- 2004-2005- 2006-2007- an impact in Santa 99 00 01 02 03 04 05 06 07 08 Monica. While Santa Monica has not seen Source: County of Los Angeles Registrar Recorder the same sort of price declines as other areas, the number of property transfers this fiscal year was down 26.1% from last year and was the lowest number of transfers since the City implemented its own Real Property Transfer Tax in FY1992-93. This decrease in transfers will likely affect property tax receipts in future years. The temporary closure of Santa Monica Place will 2009 87
City of Santa Monica Permits & Valuation Valuation (In Millions) Number of Permits $250 3,000 $200 2,750 2,500 $150 2,250 $100 2,000 2003-04 2004-05 2005-06 2006-07 Source: City of Santa Monica Building & Safety Division negatively impact Sales Tax revenues in both FY2008-09 and the beginning of FY2009-10. Additionally, legal challenges still pose a threat to the telecommunications portion of the City s Utility Users Tax revenues. Tourism, which provides a strong stimulus to the local economy by creating jobs and producing revenues, while expected to remain relatively strong, has shown signs of weakness in recent months. Historically, Santa Monica has tended to be impacted less during times of economic downturn and recover faster than many other jurisdictions. However, the recovery may be a little slower this time as Santa Monica is being impacted by many of the same factors dragging down the national and State economies, particularly declines in property sales and automobile sales. In addition, building permit activity indicates that there may be a slowdown in development. These factors are projected to limit General Fund revenue growth to 2.6% in FY2008-09 and 3.6% in FY2009-10. 88
Major General Fund Tax Base Projections Utility Users Tax 13% Transient Occupancy Taxes 15% Sales Taxes 13% Property Taxes 14% General Fund Revenues Diversified Tax Base Business License Taxes 10% Parking Facility Tax Real Property Transfer Taxes 2% All Other Non- Tax Revenues 30% Local Taxes represent approximately 70% of projected FY2008-09 General Fund revenues. Five of these tax sources, Transient Occupancy Taxes (TOT), Sales Taxes, Property Taxes, Utility Users Taxes (UUT), and Business License Taxes, account for $162 million out of the $175 million in local taxes projected to be received in the next fiscal year. The remaining tax revenues are from Parking Facilities Taxes, Real Property Transfer Taxes, Vehicle License Fees, and Condominium Taxes. The projections reflect a somewhat conservative approach based on the economic impacts described above and applying standard forecasting methodologies, such as trend analysis, known extraordinary circumstances (for example, the closure of Santa Monica Place), fiscal impacts of legislative changes, and professional judgment, to arrive at the revenue projection. Listed below are the basic assumptions used to develop the revenue forecast for the major tax accounts based on information known at this time. Many unknown variables, including economic changes and unforeseen legislative changes, could affect the ultimate amount of monies actually received. Property Taxes 14% of General Fund Revenues The continuing problems in the housing market are projected to affect Santa Monica in the short term. The number of property sales has decreased significantly over the last two years and the trend in housing prices has been mixed. Most economists believe that the housing market decline will not hit bottom until some time late in 2008 and will remain weak throughout 2009. In addition, the slowing economy may spill over into the commercial real estate market. Based on these conditions, it is anticipated that the assessed value growth in Santa Monica will continue, but at a slower rate than experienced during the last several years. The rate of City secured property tax increases, after accounting for the impact of the Earthquake Recovery Redevelopment Project Area (RDA), where no assessed value increases flow to the General Fund, are projected to increase slightly less than 4% annually in FY2008-09 and FY2009-10. Revenue from unsecured property taxes (such as airplanes) is projected to remain relatively flat throughout the forecast period. Pass-through revenues from the Earthquake Recovery RDA will approximate the rate of tax increment growth in the project 89
area. The State Public Safety Augmentation Funds are projected to grow at approximately the sales tax growth rate. Sales Taxes 13% of General Fund Revenues Sales taxes are expected to grow slowly in both FY2008-09 and FY2009-10, reflecting the economic slowdown, particularly in the area of new automobile sales, which is one of the City s largest sales tax sources. Baseline growth for FY2008-09 is 2% from ongoing FY2007-08 revenues. The FY2009-10 forecast reflects a 3.5% growth rate. The forecast is adjusted to account for loss of revenue for eighteen months from the closure of Santa Monica Place for renovation, and increased revenue from the renovated facility after it re-opens. Transient Occupancy Taxes 15% of General Fund Revenues Tourism is expected to remain strong, resulting in continued TOT growth, but at reduced levels from the last several years. Based on information provided by PKF Consulting and the Santa Monica Convention and Visitors Bureau, the baseline increases of 4% per year are entirely based on room rental rate increases as occupancy levels are projected to remain at the current high levels. In addition, the Shangri-La Hotel is expected to re-open in FY2008-09 after being closed for nearly two years for renovations. Business travel is being affected by the economic slowdown, and an extended recession could further impact revenues. Utility Users Taxes 13% of General Fund Revenues The forecast assumes an approximate annual growth rate of 3% for natural gas and cable television. Telephone is projected to increase approximately 1% per year, reflecting a decrease in hardwire services offset by an increase in wireless services. Taxes from electric utilities are driven by Southern California Edison rates and are projected to grow by 2% in FY2008-09 and 8.2% in FY2009-10, reflecting an anticipated general rate increase. Taxes from water and wastewater services assume utility rate increases in these areas. Business License Taxes 10% of General Fund Revenues Revenues reflect a slower rate of growth for FY 2008-09 and FY 2009-10. Baseline growth rates are projected at 3.7% in FY2008-09 and 1.8% in FY2009-10. Additionally, revenues are projected to be enhanced by about $210,000 per year from additional enforcement actions resulting from the addition of a Business License Inspector. The highest rates of growth are expected to be in the Professional and Service categories. Parking Facility Taxes 3% of General Fund Revenues Parking facility taxes are projected to increase by 4.2% annually, reflecting historical trends. Real Property Transfer Taxes 2% of General Fund Revenues Slowing economic conditions are significantly reducing property turnover in the City. The number of transfers in FY2007-08 through February is almost 20% less during the same period than last year and will likely end up at the lowest level since at least FY1992-93. FY2008-09 revenues are projected to be essentially flat with FY2007-08 reflecting continuing softness in the real estate market. FY2009-10 revenues are projected to increase by 9.5% from FY2008-09 as the real estate market begins to recover. 90