Closing the Budget Gap through Tax Base Appreciation.

This article describes how the City of Hollywood, Florida, is closing its annual budget gap through an innovative program designed to create tax base appreciation through public capital investment.

Every year, local governments throughout the nation face the difficult challenge of balancing their budgets while simultaneously holding the line on taxes and user fees. Public demand for more and better services must be weighed against citizen opposition to the tax and fee increases necessary to pay for enhanced services. Meanwhile, a growing segment of the population is living on fixed incomes, limiting their ability to absorb increased tax rates and user fees.

In response to these challenges, public administrators typically revert to traditional budget approaches aimed at reducing costs, maintaining service levels, and, to the extent possible, containing tax rates and user fees. Cost reductions can be strategically implemented to reduce expenses, but only to the extent that services are not adversely impacted. As a result, such measures often fail to provide sufficient solutions, leaving public administrators with the unpalatable alternative of recommending tax increases to pay for new programs or to enhance existing ones.

Built-out communities, where virtually all parcels of land have been developed, must confront even greater budgetary challenges. Limited growth in the tax bases of these communities places additional constraints on their ability to maintain service levels. At the same time, the costs associated with providing services continue to rise. This article describes how one such community is meeting this challenge through an innovative program designed to create tax base appreciation through public capital investment.

Widening Budget Gaps

With a population of 139,357, the City of Hollywood, Florida, is the second largest municipality in Broward County. The community is located on the state's east coast, approximately 40 miles north of Miami, and encompasses an estimated 28.5 square miles. As a relatively older, built-out jurisdiction, buildings and properties have taken on an overall appearance of general aging and moderate disrepair. A shortage of development opportunities is underscored by the fact that developers are forced to assemble multiple properties to create developable parcels.

For years, the city has had to cope with limited revenue growth attributable in large part to diminished expansion of its tax base. Over the last five years, revenues have grown 2 to 3 percent per year. The city's primary source of general revenue is ad valorem taxes--taxes imposed at a rate percent of value such as the property tax. These taxes account for more than one-third of all general fund revenues. Other sources of general revenue include user fees, permit fees, licenses, state-shared revenue (sales tax), and various franchise fees. These revenues have remained relatively constant because of political pressure against increasing fees. Any increases in revenue associated with these fees are usually offset by commensurate increases in service-related expenditures.

While revenue growth has been limited, expenditures have increased substantially. From 1997 to 2001, for example, expenditures increased from $87 million to $104 million. The city's expenditure growth has very closely paralleled that of the region at large, evidence that the growth has been the result of higher costs as opposed to new or enhanced services. Regionally, the costs of labor, services, products, and materials have increased by approximately 5 percent a year for the last five years. During the same period, wages and salaries have increased by 3 to 4 percent a year while healthcare costs have increased by 5 to 7 percent. The local rate of inflation has risen from 1.6 percent in 1997 to 3.5 percent in 2001, and is projected to continue to grow at approximately the same pace. Overall, the cost of providing services is expected to increase 4 to 5 percent over the next several years.

The difference between revenue and expenditure growth has fueled a recurring budget gap. As a mostly built-out community, Hollywood has been forced to resort to a variety of cost-containment measures in a futile effort to close this gap. Still, the administration has found itself in the uncomfortable position of having to recommend a series of modest tax increases to balance the annual budget. Because of strong public opposition and political pressure, however, the governing body has refused to increase taxes enough to completely close the budget gap. Consequently, the administration has been forced to implement deeper and more severe cost reductions.

Layoffs have been avoided to date, largely because of the administration's aggressive efforts to cut costs by other means. Such measures have included hiring freezes, wage reductions, consolidation of positions, and cross training of employees. The effects of several years of these actions on service delivery now are beginning to show. Residents have become increasingly vocal, demanding new and improved services, as well as program enhancements. Although cognizant of the legitimacy of these demands, the administration has become reluctant to recommend additional tax increases.

To further complicate the situation, annual growth in the city's property tax base--as measured by total assessed value--has decreased from 6.1 percent in 1999 to 4.6 percent in 2001, as shown in Exhibit 1. One important factor in this decline is the Broward County-appointed Value Adjustment Board (VAB), which was created as a mechanism for property owners to dispute the assessment of their property. Based on a five-year analysis of Hollywood's tax base, it was estimated that the Value Adjustment Board eliminated more than $98 million of growth in assessed value. Since growth in the tax base is essential to generate the additional revenue needed to keep up with increasing costs, the Value Adjustment Board's friendly disposition toward property owners is only exacerbating the city's budget woes.

Short-Term Gap-Closing Strategies

Faced with budget gaps, most governments employ some variation of an "instant return" strategy. Such strategies aim to balance the budget by trimming expenditures until they are brought in line with projected revenues. This is commonly achieved through across-the-board spending reductions, the elimination of luxury items, restrictions on employee hours, and, in the most severe cases, layoffs. Such actions, however, can have a negative impact on employee morale, service delivery, and customer satisfaction if they are not carefully orchestrated.

Collective bargaining agreements often must be taken into account when budgetary alternatives involve employees. For obvious reasons, governments cannot implement cost-cutting measures that do not comply with the terms and conditions of negotiated labor contracts. For instance, these contracts may stipulate the level of employer contributions to retirement programs. In such a case, the government would be legally precluded from reducing these contributions as a means of reducing its expenditures.

Long-Term Gap-Closing Strategies

The gap-closing strategies outlined above represent valid solutions to short-term budget difficulties. However, such measures are not sufficient in the case of recurring revenue shortfalls. In such cases, governments must take a closer look at their revenue structure to identify fundamental weaknesses. When the weakness is linked to a jurisdiction's tax base, economic development initiatives may prove most helpful.

A common (if not controversial) component of most economic development programs is the use of incentives to attract development. These incentives may include rebates, tax abatement, or even cash payments. Jurisdictions that are tax base rich--those with an abundance of developable land--can leverage revenues from their growing tax base to fund a variety of incentive programs. As new properties are developed and added to the tax base, property values increase and new revenues are generated.

In built-out communities, the scarcity of land and the difficulty of in-fill development present substantial challenges in designing incentive programs that can effectively compete with tax base rich jurisdictions. Because cash incentives are not an option, these communities rely more heavily on rebates, tax abatement programs, interest loan subsidies, and non-financial incentives that are usually not as effective in attracting development or encouraging redevelopment.

The successful administration of economic development incentive programs in built-out communities is difficult at best. Tax incentives can easily negate the revenue generated by development activities. The goal of these programs always should be to enhance the government's revenue stream by expanding the tax base. As such, it is essential that these programs be carefully administered so as to secure the desired results.

Tax Base Appreciation as a Gap-Closing Strategy

A taxing authority's property tax base is the assessed value of all parcels, or properties, located within a given jurisdiction. There are two ways that assessed value can increase: expansion and/or appreciation. Expansion occurs as vacant land is developed and the property is added to the tax rolls; appreciation occurs as the value of existing property increases. Both expansion and appreciation generate additional ad valorem tax revenue. The difference between the two is crucial in built-out communities where growth in the tax base can only be accomplished through tax-base appreciation.

Opponents of the property tax, however, have successfully passed tax limitation legislation in many states, effectively minimizing the potential revenue from tax-base appreciation. In Florida, for example, a voter referendum dubbed the "Save Our Homes" initiative was passed in 1994, limiting growth in the assessed value of residential properties to 3 percent, or the rate of inflation, whichever is lower (Florida State Statute [ss]193.155, 2000). Since residential property typically accounts for most of a jurisdiction's property tax base (70 percent in Hollywood), the potential for generating additional revenue through tax-base appreciation has been severely constrained by this initiative.

Closing the Gap

After several years, Hollywood's administration concluded that continued reliance on traditional gap-closing approaches was nor enough to resolve the city's ongoing budget problems. Instead of passively responding to the symptoms of the problem every year, city leaders decided to proactively engage the heart of the matter--declining growth in the tax base. The goal was to decrease reliance on cost containment and tax increases by generating additional revenue from an enhanced tax base. Toward this end, city leaders devised a strategy to create tax base appreciation through an aggressive public capital investment program.

Prior to 1990, the city had invested very little money in its infrastructure. As a result, the city's infrastructure began to deteriorate, further complicating economic development activities. As businesses closed, it became increasingly difficult to attract new investors to the area. Not surprisingly, growth in the tax base began to stagnate and property values in many areas began to decline. The visual impact of the decline was evident in the city's commercial corridors where properties appeared old and obsolete. This marked decline in aesthetic appeal deterred redevelopment and led businesses to "younger" jurisdictions that offered open space, wide roads, and attractive landscaping and streerscaping.

To reverse this disturbing trend, city officials determined that the city needed to recommit itself to public capital improvements in order to stimulate private investment. Along the city's commercial corridors there was a particular need for streetscaping and for improvements in the water and sewer systems. City officials believed that by creating attractive, pedestrian friendly commercial corridors and by alleviating expensive distant utility connections, existing business would be enhanced and new businesses would invest in the city. Previously defunct commercial corridors would be transformed into sources of economic growth and stability.

Based on this belief, the city embarked on a public capital investment program designed to redevelop targeted commercial corridors. The first area to benefit from the infrastructure improvements was downtown Hollywood--one square mile comprised mostly of retail businesses along two main boulevards. Improvements in this area have included modernized water and sewer systems, road widening and resurfacing, pedestrian walkways, improved crosswalks, user friendly signage, and landscaping. The total cost of these improvements was approximately $8 million.

Two years after the completion of these improvement projects, private investors have returned to downtown Hollywood, improving their own properties and driving up property values. Prior to the improvements, the area's tax base was $158 million. Now it boasts assessed value in excess of $196 million. This $38 million return on the city's $8 million investment in public capital greatly exceeded expectations. The long-term vitality of the area has been assured and new businesses continue to locate downtown.

The overwhelming success of the project in downtown Hollywood led to additional improvements in other commercial corridors across the city. It is estimated that every dollar of public capital investment added $8 to the city's tax base. As a result, the tax base increased from approximately $5 billion to $5.4 billion between 1997 and 1999. Assessed value is expected to increase to $7.9 billion by fiscal year 2006--much more than the pre-investment projection of $7.4 billion (See Exhibit 2). This difference promises to positively impact the city's revenue stream in future years.

The Hollywood experience is dramatic evidence that public capital investment does indeed stimulate private investment, which in turn leads to increased property values and ad valorem revenue. As illustrated in Exhibit 3, the city estimates that revenues will catch up to expenditures by fiscal year 2006, closing the budget gap for the first time in 15 years. This projection is based entirely on appreciation of the tax base, not the tax increases or drastic cost-cutting measures of years past.

Hollywood's experience underscores the need for careful planning of public capital investment projects. The city prioritized projects in the downtown area based on need and impact. As such, the city started with underground improvements to its water and sewer and water systems. Once this essential infrastructure was in place, attention was turned aboveground--to road, curb, and gutter improvements, sidewalk construction and repair, streetlights, etc. Finally, the aesthetic appeal of the entire area was enhanced by streetscape and intersection improvements and the addition of walkways, bike paths, community parks, and other recreational and cultural facilities. All of these projects helped to reinvigorate the city and stimulate private-sector interest.

The recent reinvestment in commercial corridors across the city has had spill-over effect on the entire community. Besides the tax benefits of business reinvestment, area neighborhoods are also beginning to regenerate. The initial signs of residential redevelopment and revitalization are evident throughout the city, and this trend promises to further enhance the tax base.

Summary

Faced with recurring revenue shortfalls, the City of Hollywood, Florida, abandoned traditional cost-containment strategies in favor of a more long-term solution to its budget difficulties. This strategy consisted of an aggressive public capital investment program intended to stimulate private investment by providing the necessary infrastructure and aesthetic quality along commercial corridors. The improvements have had the desired result. As businesses have moved back into these areas and improved their own properties, property values have increased dramatically. This appreciation of the tax base is expected to generate enough revenue by fiscal year 2006 to cover expenditures and close the city's budget gap for the first time in 15 years.

SAMUEL A. FINZ is the City Manager a/the City of Hollywood, Florida. He is a recipient of the prestigious International City/County Management Association Award/or Program Excellence in Citizen Involvement (1998). SUZANNE E. UTNIK is the Assistant to the City Manager for Special Projects for the City of Hollywood, Florida. She is a specialist in government finance and capital budgeting, having worked five years in the Office of Management and Budgeting.

[Graph omitted]

Exhibit 1

GROWTH OF TAX BASE FOR FISCAL YEARS 1997-2001


Fiscal Year  Tax Base Value Increase  Percent Increase

1997                  225.3                 4.5
1998                  130.4                 2.6
1999                  306.5                 6.1
2000                  315.5                 5.7
2001                  265.9                 4.6



Note: Table made from bar graph
Exhibit 2

PROJECTED TAX BASE GROWTH BASED ON PUBLIC CAPITAL INVESTMENT

(RATIO 8:1)


Fiscal Year       Tax Base         Tax Base Value
             (Trend Projection)  (Ratio Projection)

   1997             5.0                 5.0
   1998             5.1                 5.1
   1999             5.4                 5.4
   2000             5.7                 5.7
   2001             6.0                 6.0
   2002             6.2                 6.3
   2003             6.4                 6.6
   2004             6.8                 7.0
   2005             7.1                 7.4
   2006             7.4                 7.9



Note: Table made from line graph