29 January 2020 - Beth Musgrave (Lexington Herald-Leader)
Lexington may have to implement cuts to public safety and other areas if it does not raises taxes or find new ways of generating revenue in coming years, a report released last week showed.
“If Lexington does not diversify its revenue, significant cuts will have to be made to the LFUCG General Fund Budget,” said the report by the Lexington Mayor Linda Gorton’s Finance and Economic Advisory Work Group.
The group, chaired by J.D. Chaney, executive director of the Kentucky League of Cities, included former auditors and state budget officials. It showed Lexington was too reliant on occupational taxes — a tax on wages — to fund most government services. Projections show revenues from those taxes will not keep pace with expenses.
Among other conclusions, the report found:
Lexington needs more options to diversify its revenue
Lexington is overly reliant on its occupational taxes, which limits revenue growth potential
The group stopped short of making recommendations to raise certain taxes or ask for either legislative approval or a constitutional amendment to levy new taxes currently not allowed by state statute or by the state constitution.
The report showed what Mayor Linda Gorton warned about in her first budget speech in April 2019 —the city could be facing a budget deficit of as much as $17 million by 2024 as projections show revenues are not keeping pace with expenses.
Susan Straub, a spokeswoman for Gorton, said the first-term mayor has not yet decided if she will propose a tax increase for the upcoming fiscal year that begins July 1.
“We are not at that point. We need to learn more about the budget. We don’t even have numbers yet. We need to continue to look for efficiencies,” Straub said.
Gorton will unveil her budget proposal in late April.
LEXINGTON’S LOW UNEMPLOYMENT IS PART OF THE PROBLEM
The report, which was released Jan. 24, is part of a broader effort by Gorton’s administration to look at cuts and other efficiencies, the city’s internal budgeting process and its revenues. That effort has been named ReThink Lexington.
The looming budget deficit is caused by two different factors, the report said.
The majority of the $379 million general fund budget comes from occupational taxes, sometimes referred to as employee withholding. That 2.25 percent tax on wages generated about $208 million in taxes or roughly 55.4 percent of the revenue used to fund the current budget. Net profits, a tax on business profits, is a distant second with $42.8 million or 11.4 percent of the total tax revenues.
On average over the past decade, Lexington saw its revenue grow by 3.7 percent. During the years after the recession, that revenue growth was almost 5 percent. That growth has dramatically slowed.
One of the lowest unemployment rates in the state and sluggish growth in wages.
Unemployment for Fayette County in November was at 2.9 percent, much lower than state and national averages.
“Because Lexington’s labor force is essentially fully employed and its employers are not giving substantial raises to their employees, the city’s revenue from payroll tax has slowed significantly,” the report said.
The current-year budget was built on a 15 percent cut to most operation budgets, the closing of one pool, freezing many new hires and limited raises. Even if those cuts continue in future budgets, there is not enough revenue to cover the increased payments to the state pension system in addition to increases in fixed costs, the report found. It also showed that the vast majority of the merged government’s general fund goes to pay for police, fire and corrections. Public safety is now 56.6 percent of the total general fund budget. In 2009, it was 54.4 percent.
Debt payments are a distant second at roughly 12 percent of the total budget.
An economist from the University of Kentucky Gatton College of Business and Economics told a Lexington-Fayette Urban County Council committee Tuesday payroll taxes are expected to generate $206 million in the next budget year, that’s a 2.5 percent increase. Net profits are expected to grow by 1.8 percent or to $44.4 million.
Michael Clark, an associate professor of economics, said initial estimates show there was some growth in wages in Fayette County in 2019, but that growth has been slow.
“We are predicting a small increase in jobs in fiscal year 2020,” Clark said. “But it’s not large.”
There is some good news. The city socked away $11.2 million in a separate fund from a budget surplus in 2017 in anticipation of the jump in pension payments to the state. It has set aside $2.2 million from that fund in the current-year budget, but has not yet drawn it down yet. That means there could be $11.2 million still left in that account to help plug future holes in the budget. The report noted the projected gap between revenues and expenses for the upcoming budget year is $4.5 million but that’s if the city uses some of that $7.8 million for pension payments and abolishes 42 positions that are currently frozen.
The city has a separate rainy day fund that has more than $35 million in it. But the rules regarding when the city can use that money are complex, making it trickier for the city to withdraw those funds to plug holes in the budget.
COULD A RESTAURANT TAX HELP?
Many members of the Lexington-Fayette Urban County Council attended the Friday meeting where the report was presented. But the council has not yet had a full discussion on the contents of that report, said Councilwoman Amanda Bledsoe, chairwoman of the Budget, Finance and Economic Development Committee.
“Many of us were shocked about the city’s over-reliance on the occupational tax,” said Bledsoe. The report also provided detailed information on tax rates for surrounding cities and counties. It also estimated how much money increases in various taxes would generate in additional revenue. “It provided a lot of background information including how we compare to other cities and counties that we will need.”
Gorton and the council will have its first budget retreat of the year on Thursday. It’s not clear if taxes and revenue will be discussed during that retreat.
In addition to payroll and net profit taxes, the city also receives revenue from a tax on insurance premiums, taxes on utility bills, sometimes referred to as franchise fees, and property taxes. The vast majority of property taxes go to the Fayette County Public Schools system and the Lexington Public Library.
The last time the city raised any of its primary taxes — insurance, franchise, property, payroll and net profits—was in 2013, when the council approved a 1 percent increase on gas and electric bills that was estimated to generate an additional $4 million a year. That increase was supposed to help offset a deficit in the city’s streetlight fund, which has traditionally been chronically underfunded.
The city has also raised sewer rates, most recently in 2019. That money does not go to the general fund, which pays for public safety, streets and parks. Those increases in those sewer rates are to pay for $590 million in sewer and stormwater projects needed to comply with a legal settlement with the Environmental Protection Agency over Clean Water Act violations.
The report also looked at asking for legislative approval for Lexington and other cities to levy new types of taxes not currently allowed by state statute.
A local option sales tax, which would allow local governments to tack on a city sales tax on top of state sales taxes, has been pushed in the state legislature in previous years but has never passed. Under previous proposals, the up to 1 percent sales tax would be used for capital projects and would have to be approved by local voters. The report did not have an estimate on how much money a 1 percent city sales tax would generate but said it could be “in the millions of dollars.”
Another option is a restaurant tax.
Larger cities in Kentucky can not levy a restaurant tax but some cities, such as Elizabethtown, can. If the legislature approved such a tax, a 1 percent tax on restaurant bills would generate $9.1 million in additional revenue for the city. That’s if Lexington was able to keep 100 percent of that tax. In some cities where restaurant taxes are allowed, about 25 percent of the restaurant tax goes back to the local tourism bureau.