Published: May 09, 2008 09:58 am            

The State of the City: An Independent Analysis of McAlester’s Financial Condition

Editor's note: This information is solely the responsibility of the writer.



Everybody knows the city is not in the best financial shape and everybody knows why: we have too much debt. While this statement is true, it’s important to understand just how this debt load affects us.

Saint Peter, don't you call me, 'cause I can't go; I owe my soul to the company store...(1)

Long-term debt is not a bad thing. Every city of any size uses long-term borrowing as part of its financial equation. McAlester’s debt load is certainly on the high side. With more than $120 million in principal and interest payments to be made over the next 25 years, that works out to almost $5 million per year. It varies from a high of $6.6 million in 2014 to a low of $3.4 million in 2034. For the most part, the debt payments are covered by dedicated sales tax receipts. There is a balloon payment on the Economic Development bonds due in 2014 that is worrisome, but absent a significant decline in sales tax receipts, the money should be there to make the other required payments.(2)

So if getting the bonds paid off is not the problem, what is?

There are really two problems tied to our long-term debt. First, the city has no borrowing power. The last bonds the city sold in 2003 and 2004 were issued without a rating. Had the bonds been rated, they would have received ratings equivalent to “junk bonds.” Therefore, the city’s bond advisors chose not to seek a rating and consequently the bonds carry a very high interest rate in order to make them marketable. If we no longer wish to issue junk bonds with their high interest rates, we have to pay down our debt to the point that we have projected excess sales tax receipts we can use to dedicate to new or restructured debt. This takes time.

The second problem has to do with how the proceeds from the bond debt were spent. A basic business tenet is that you use long-term debt to finance long-term assets. By doing this, you continue to get the benefit from the long-term asset while you are paying off the long-term debt. When it’s time to replace the asset, you have the debt paid off and can start the process again. Using long-term debt to finance current operations is a recipe for disaster.

Unfortunately, in McAlester’s case, a significant portion of bond proceeds were used for purposes other than acquiring long-term assets. We all know that some of the proceeds were used to fund buybacks by a former city manager. In the investigative audit commissioned by the city in 2005, the BKD auditors found $3.2 million in bond proceeds that could not be identified as having been used for the intended purpose. This audit only covered the Series 1999 and 2002 bond issues. Bond issues for 1992 and 1995 have not received the same level of scrutiny.

In addition, we now know that the city has been spending the excess(3) sales tax receipts related to the third penny tax the voters approved for capital improvement projects (the “CIP” tax). Although the city council recently confirmed that these excess receipts must be segregated and restricted to bond principal and interest payments only, it is likely that at least $7 million and possibly more than $10 million has been previously spent that should have been set aside. An audit is currently underway to confirm the amount.

By combining the dollars from bond proceeds that weren’t spent on bond projects and the excess CIP tax receipts that weren’t set aside, it’s not far-fetched to estimate that the total is in the $15-20 million range. Whether, and to what extent, this money may have been used in an illegal manner is a legal question and will not be argued here. What will be argued is that it is likely that the large majority of this money was used to finance normal city operations. Yes, there were some illegal buybacks, but mostly the money was used to pay the bills and keep the city operating.

Municipal operations are financed in a variety of ways but, in Oklahoma, the two largest components by far are sales taxes and charges for services (water and other utility bills). Let’s take a look at each area as it pertains to McAlester.



Slicing the Sales Tax Pie

In McAlester, we pay a sales tax of 9% on every dollar of taxable purchases. Who gets that 9% is shown in the following charts.

The City receives only 3.75% of that 9% tax. Two percent goes into the City’s General Fund and can be used for normal city operations. The remaining 1.75% is restricted as to its use. One percent is restricted to principal and interest payments on the Series 1999 and 2002 CIP bonds. One quarter percent is restricted to Economic Development including the required principal and interest payments on the Series 2003B and 2004 bonds issued for that purpose. One quarter percent is restricted to payment of principal and interest on the Series 2003A school bonds with any excess divided 50/50 between the school systems(4) and a fund to retire the bonds early. One quarter percent is passed through the City to the McAlester Regional Health Center Authority for support of the Wellness Center.

I mentioned that two percent goes into the General Fund. You may ask “What are ‘funds’ and why should I care?”



Fund Accounting

The financial activities of municipal governments are segregated into self-balancing sets of accounts called funds. Each fund is established for the purpose of carrying on specific activities. The General Fund accounts for all moneys received and disbursed for general governmental purposes. The departments included in McAlester’s General Fund include Police, Fire, Parks & Recreation, Streets, Codes, Central Garage, Administration, Finance, Legal and several others. The General Fund represents about 62% of the city’s operating budget for the current fiscal year.

The second largest fund we have is the McAlester Public Works Authority (MPWA). The MPWA is referred to as a “business-type” or “enterprise” fund because it is designed to operate in a manner similar to a private business enterprise, where the intent is that the cost of providing goods or services to the public be financed or recovered primarily through user charges. The water, liquid waste, sanitation and landfill operations are included in the MPWA and the charges we receive on our utility bills are designed to cover the cost of these services.

Although the city has numerous other funds, the General Fund and the MPWA combine for about 87% of this year’s operating budget and 93% of the budget for personal services (salaries, wages and benefits). Personal services account for about two out of every three dollars of the operating budget (68%).



How the Bills Get Paid

The General Fund is primarily financed by the 2% sales tax mentioned above. It also receives revenue from other taxes, fees, fines, and state and federal grants. The MPWA receives its revenue primarily by charging its customers for its services (your utility bill). By state law, no fund is permitted to have a negative balance. Ideally, both the General Fund and the MPWA bring in enough revenue to be self-sustaining. However, if a fund falls short, its revenues must be supplemented from another source. This is where interfund transfers enter the picture. If, for example, the General Fund is forecast to have more appropriations (expenses) than it has resources (revenue), then it must be balanced with a transfer of resources from another fund. In McAlester, it has been normal practice in recent years to transfer amounts from the MPWA to the General Fund in order to maintain a positive balance in the General Fund. For this year’s budget, the estimated transfer amount was $2.4 million. This represented roughly 20% of the total operating budget for the General Fund.

Do You Want the Good News or the Bad News First?

The bad news is that the General Fund is not now self-sustaining and has not been for a number of years. Whether one views this as revenues being too low, expenses being too high, or a mixture of both, the result is that transfers from the MPWA have become routine in order to keep the General Fund in the black. The good news is that the MPWA has been generating enough excess revenues to make these transfers. However, the good news is not all that good when one looks a little closer.

The MPWA has been able to create an excess of revenues over expenses in recent years for two reasons. First, the amounts charged for services have significantly exceeded the expenditures for those services. Second, the amount by which the revenues from the one penny CIP tax exceeded the currently required interest and principal payments on the CIP bond debt has been considered available for other purposes – including transfer to the General Fund.

This second source of transfer revenue has now been eliminated by the city council’s decision to strictly follow the 2002 ballot language on the sales tax question which appears to limit this tax revenue to bond principal and interest payments only. The original budget for the MPWA for this year included approximately $650,000 for this excess. With this money now restricted, the city estimates that only about $2 million will be transferred from the MPWA to the General Fund. Transfers from the Emergency Reserve Fund will be needed in order to balance the General Fund.

The fact that without this sales tax excess, the MPWA will still be able to transfer $2 million to the General Fund suggests that at least one of two scenarios must be correct. Either the users of the MPWA’s services are paying more for those services than is needed – allowing the MPWA to operate at a substantial profit rather than at breakeven; or revenue that should be used to adequately maintain the MPWA’s operations is being diverted to the General Fund. The answer may be a combination of the two.

A review of recent sales tax trends points out that even with the excess tax revenue on the one penny CIP tax no longer being available for operations, the estimated tax revenue for the General Fund is 21% higher than it was in 2005 when the excess was included.



If sales tax revenue continues at this high level, it is reasonable to assume that restricting the CIP excess revenue should not result in the need to dip into the emergency reserve fund. However, substantial transfers from the MPWA will still be necessary.

Priorities and Trade-Offs

Every municipal government has more wants and needs than it has resources to fulfill those wants and needs. Therefore, every spending decision establishes priorities and results in trade-offs even though priorities and trade-offs may not have been specifically considered. The City of McAlester is no different.

In recent years, we have chosen to supplement the General Fund with transfers from the MPWA. These transfers vary from year to year but have typically been in the $2 million range. The operating costs of the General Fund consist primarily of wages, salaries and benefits (78% of the current operating budget). Therefore, we are primarily using the excess revenues generated by the MPWA to fund the employee costs of General Fund employees – police, fire, etc. There is nothing inherently wrong with this but it does result in money not being available for other purposes.

So, Where Are We?

As was stated in the beginning, the state of our city is impacted by our debt load. Because we have so much, we are not in a position to borrow more. Because we have sometimes used debt proceeds and related excess sales tax for normal operating costs rather than for long-term assets (infrastructure), we now have an operating cost structure that must be supported by large transfers from the MPWA and we have no funds with which to address our crumbling infrastructure.

Because sales taxes have been at record levels during the current oil and gas boom, we have managed to keep the budget roughly in balance. But, as city management has acknowledged, it is only a “maintenance” budget with no money for infrastructure. With current economic trends, balancing next year’s budget will be a challenge.

We also have the issue relating to the city’s use of the excess CIP tax revenues in prior years. As noted, an audit is currently underway to quantify the amount but it certainly will be several million dollars. If these amounts must be repaid, balancing the budget will be even tougher.

Anybody Have Any Good Ideas?

Eventually we will have to address our infrastructure needs. The longer we put it off, the more costly it will be. Where do we get the money? The two broad categories are to generate it ourselves or to get it from somewhere else.

We can generate resources either by increasing revenues or decreasing expenses.

Revenue Enhancement Possibilities

Increase the sales tax. Right now, it’s at 9%. That’s already at the high end of the scale in Oklahoma so increasing it would be tough to sell to the public. We do have the ¼ cent tax that supports the Wellness Center that is due to expire later this year. An extension could be placed on the ballot but there is already talk that the hospital wants to extend at least half of this ¼ cent tax for their own needs. The McAlester News-Capital has also recently reported that an additional ¼ cent county sales tax may be put before the voters as early as July of this year.(5)

Increase utility rates. The city council has the power to increase rates and might be forced to do so if the budget cannot be balanced by any other method. Doing this would be extremely unpopular given the current problems with the city’s water quality and the perception that rates are already quite high. With most Oklahoma municipalities operating their public works authorities at or near the breakeven point, it’s also difficult to justify producing even higher profits from ours.

Establish a city property tax. By a vote of the people, the city could begin assessing a city property (ad valorem) tax on real and personal property. This would allow the city to issue general obligation bonds that could be used for public projects such as streets, buildings and improvements. Oklahoma municipalities don’t often use this approach. There is an overall debt limit for property taxes that cannot be exceeded.

Increase the Hotel/Motel Tax. Proceeds from this tax are restricted to the promotion of tourism. However, McAlester’s tax rate is not high relative to other cities and our hotel industry is booming right now. Using this extra revenue to expand our tourism efforts might, in the long run, help increase our economic tax base.



Focus on Economic Development to Increase the Tax Base.

This is always easier to talk about than it is to achieve. How successful have we been up to this point?

Since 1950, McAlester’s population has remained relatively unchanged while Oklahoma’s population has increased by about 60%. Since 1990, McAlester’s population has been on the rise but its growth rate still trails the overall state rate. This indicates that except for the impact of two-earner families, for almost every new job McAlester has added, an old job has gone away. Another way of looking at it is that McAlester’s job opportunities are not enticing people to move here. We’re just shuffling the existing work force among jobs.

So while economic development has a very real potential to increase revenues for the city, it may require some imaginative new approaches to make it happen.



Decreasing Expenses

Cut staff and/or salaries. There is a substantial amount of statistical data that supports the viewpoint that some of our city departments are staffed at a higher level than other Oklahoma municipalities of similar size. There is also solid data supporting the premise that various city occupations receive compensation (salary and benefits) that exceeds the amount dictated by the local job market. In other words, the possibility exists in some areas to reduce the number of employees and in some areas to reduce the compensation level. In some cases, these areas overlap.

In the current situation, it seems unlikely that any significant reductions will occur. Relatively painless headcount reductions could be achieved through attrition but even this step seems far-fetched in today’s environment. A budget crisis could change the equation. It’s important to keep in mind that any serious cost reductions must include personnel costs since they represent two-thirds of the operating budget.

Improve productivity and internal control systems. This is another area that is easier said than done but it can be worth the effort. Any organization can be improved and governments tend not to be the most efficient. For instance, many of the recommendations made by the Partnership for Responsible Government remain open two years after they were issued.

Outsource. This is another “hot button” for many people but one that many municipalities have addressed with varying degrees of success.

Get Money From the State or the Feds

The number one legislative priority for the Oklahoma Municipal League this year is to try to convince the legislature that ½ cent of the 4½ cent state sales tax should be returned to municipalities and dedicated for streets and bridges. The success of this initiative seems highly unlikely given that both houses of the legislature recently passed a “stand-still” budget.

There is also talk at the state level of a bond issue package to include funds for roads and bridges. But even the most ambitious of the proposals might result, at most, in about $100,000 in annual funds for our city.

Unlike the city and the state, the federal government can legally issue a deficit budget – and usually does. Funding from the feds is at least possible in some areas. The city may want to consider a part-time or full-time grant writing position as an approach to increasing our share of the federal purse.



The Future is Now

The easiest thing to do is nothing. By using the remainder of the emergency reserve fund and provided that sales tax revenue doesn’t start dropping, we may be able to squeak by with a balanced budget for the next year or two. Infrastructure needs won’t be addressed but, with any luck, perhaps things won’t totally fall apart. We inherited this mess from a previous city council and city management, so why not pass it on to a future city leadership?

The reason why not is that leadership and leading imply going somewhere. You cannot lead if you don’t know where you are going. Our current course is leading us off a cliff. The only question is how close are we to the edge? The time for decisive action is now. It won’t be easy to achieve or politically the safe thing to do. It will be painful. It must be done.



Footnotes

(1) From the song “Sixteen Tons” written by Merle Travis, 1947.

(2) Bond payments in 2032, 2033 and 2034 may also be a problem since the sales tax is set to expire in 2031. The city must have about $12 million set aside at that time to make the final payments.

(3) Sales tax receipts that exceed the amount needed to make current bond payments.

(4) Until the school systems shall have received a total of $7 million including original bond proceeds.

(5) McAlester News-Capital, April 8, 2008.

        

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