Closing the Budget Gap Through Public Capital Investment

Samuel A. Finz, Noah A. Simon, and Suzanne E. Utnik 
Most local governments, at one point or another, face difficulties in balancing their budgets without excessive tax increases or significant changes in fees. Policymakers must juggle an increasing demand by the public for more and better services without raising taxes or user fees. The recent slowdown in the U.S. economy has had a tremendous impact on cities and counties and has made the necessary choices for policy makers even more difficult to make. Governments at all levels are not only contending with declining revenues, increasing expenditures, and rising public demand for more and better services, but also are facing larger budget shortfalls and wider budget gaps.
The concept of increasing tax base through public capital investment was designed and developed as a tool to forecast economic trends, in expenditures and revenue, specifically for the purpose of closing a budgetary gap faced by Hollywood, Florida. The concept proved beneficial to the Hollywood community, and now these same principles are being applied in College Park, Maryland, to close the budgetary gap existing there. While College Park has just begun using this concept, tangible results have already been achieved through the application of this concept in Hollywood. 
The budget gap may be defined as the excess of projected expenditures over projected revenues from taxes, fees, state and federal grants, apportionments, and so forth. If expected expenditures exceed expected revenues, then there is a projected shortfall that must be closed through budgetary “maneuvering” before an annual budget can be adopted by an elected body.
Surprisingly, the budget gap can be forecasted based upon prior-year statistics of revenues and expenditures available to most local governments. For example, many localities can accurately project real property tax-base appreciation and therefore can, with some degree of certainty, project revenues from tax-base value increases. Tax base would typically comprise more than a third of a city’s revenues; in Hollywood the ad valorem tax revenue comprised 35 percent and in College Park 35.6 percent.
Apportionments that are tied to formulas from such state revenues as gas and amusement taxes are easily calculated. Expenditures and expenditure increases are often predictable. As a case in point, personnel spending tied to collective bargaining agreements, or cost-of-living increases tied to inflation rates, make predicting expenditures fairly accurate to predict with a high degree of accuracy. Even before adjustments are made to a preliminary budget, the budget gap can be predicted.
Hollywood’s revenues historically had risen at an annual rate of 1 to 2 percent, with expenditures climbing annually at the rate of 3 to 4 percent. The city faced these increases year after year, in part because of the fact that more than 80 percent of its operating budget was tied to personnel expenditures. With five collective bargaining units on a three-year contract composing some 90 percent of the workforce, increases were fixed (therefore, predictable for the purpose of forecasting future trends) for at least three years.
As shown in Figure 1, the method, once employed, has expenditures increasing at a constant rate while altering the course of revenue as a means of closing the budget gap. The method can also be used to predict the time frame for closing the gap—five-years in this example—given certain assumptions about changes in revenue and expenditure patterns. Such patterns, if caused to improve in a timely manner, would alter the course of events so that the normal expectations of revenue and expenditures could change, closing the gap over time.
Simply put, if revenues could be made to increase and expenditures made to fall at an increasing rate (or stay steady), then the gap could be closed without the need for a large—or possibly any—increase in a city’s tax rate. The goal in College Park is to close the budget gap within five years, beginning with a more aggressive CIP implemented in 2004. As tax base revenue increases through public capital investment, as depicted in Figure 1, the gap between revenues and expenditures begins to narrow and eventually closes.
Because traditional efforts by most localities take a considerable amount of time, it is important to know which measures can be taken that will have the most significant impact, in particular on revenue increases. In Hollywood’s case, it was believed—and proven to some extent—that significant investment by the municipality in capital projects such as roads, streets, and streetscape and infrastructure improvements would have the greatest impact on encouraging private sector investment.
In a relatively short time, these projects, when successfully implemented, had the effect of increasing the tax base and generating significant rises in revenues—ones that exceeded the increases to be gained from traditional approaches to economic development and redevelopment.
Short-Term Strategies
Faced with budget gaps, most governments employ some variation of an “instant return” strategy. Such tactics 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.
Long-Term Approaches
The strategies mentioned above represent valid solutions to closing the gap in the short term. These strategies, however, are not sufficient in the case of a recurring or ongoing revenue shortfall. In such a case, a government must take a closer look at its revenue structure to identify fundamental weaknesses. When the weakness is linked to the rate of growth of the jurisdiction’s tax base, economic development initiatives may prove more helpful.
Many local governments use traditional economic development programs like incentives to attract development. Incentives often include tax rebates, tax abatement, providing city services at reduced rates, or cash payments. Jurisdictions that are rich in tax base—those, for instance, with an abundance of developable land—can leverage revenue 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 climb, and greater revenues are realized.
In built-out communities like Hollywood and College Park, the scarcity of land and the difficulty of doing infill development projects present major challenges in designing incentive programs that can effectively help them to 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 nonfinancial incentives that are usually not as effective in attracting development or encouraging redevelopment.
Tax-Base Appreciation as a Gap-Closing Strategy
Public capital investment by the local government as a means of creating tax revenue challenges traditional methods of economic development and other gap-closing approaches. It is true that revenue can be generated through traditional economic development methods, such as marketing, promotion, and incentives to attract new businesses to a community. While these economic development tools work effectively, the benefits that such tools provide are not by themselves sufficient to close budget gaps because the cost of incentives can negate the modest and sometimes slow process of creating additional revenue generated by development activities. The goal, therefore, of any economic development program regardless of the specific method used should be to enhance the government’s revenue stream by expanding the tax base.
A taxing authority’s property tax base is the assessed value of parcels, or properties, located within a given jurisdiction. There are two ways in which assessed value can increase: through 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 is accomplished mainly through value appreciation and not through new construction or reconstruction activity.
Closing the Gap Through Public Capital Investment
After several years, the administration in Hollywood concluded that continued reliance on traditional gap-closing approaches was simply not enough to resolve the city’s ongoing budget problems; instead, city leaders decided to face the problem proactively. The goal in Hollywood (and now in College Park) was to decrease the reliance on use of the undesignated reserve, balance the budget, avoid raising taxes and fees, and generate additional revenue from an enhanced tax base through public capital investment that would stimulate economic development and revitalization.
Hollywood had a particular need for streetscaping along commercial corridors and infrastructure improvements in water and sewer, roads, and other systems. The initial public capital investment in Hollywood was approximately $8 million. Two years after the completion of the improvement projects, private investors began returning to the downtown, while businesses began reinvesting in their properties and driving up property values. It is estimated that every dollar of public capital investment added $8 to Hollywood’s tax base.
College Park has a need for streetscape, road, pedestrian, public safety, signage, and intersection improvements. City officials believe that if they create attractive, pedestrian-friendly commercial corridors, then new businesses would be more likely to locate, and existing businesses would be enhanced and more likely to reinvest in their properties, thus adding to the tax base. As the tax base increases, tax revenue should rise at a commensurate rate. College Park is hoping for similar results to those achieved by Hollywood through investing capital in areas needing revitalization. It is anticipated that through aggressive capital investment, the increase in the tax base over time will provide College Park with additional tax revenue and close the budget gap.
Local governments should not ignore the value of making public capital investments in residential areas, too. College Park, again like Hollywood, generates more than half of its tax base from residential properties. While the return on public capital investments made in commercial areas is greater, public capital investment in residential areas provides an incentive to homeowners to invest or reinvest in their properties and gives the commercial areas a customer base. Public capital investment in residential areas promotes neighborhood revitalization. These projects should encourage homeowners to reinvest in their properties thereby increasing the residential tax base.
Public capital investment in commercial and in residential areas must go hand in hand to ensure that the community as a whole is improved. It would be counterproductive only to focus on public capital investments in commercial areas while, at the same time, the surrounding neighborhoods begin to deteriorate.
Local governments have a number of tools available to them to encourage private reinvestment by homeowners. A partial list of tools available to local governments are:
•	Starting a neighborhood self-help improvement program that works with civic associations to develop neighborhood improvement plans and projects. 
•	Channeling county and state financial assistance for housing rehabilitation to qualified residents. 
•	Promoting historic district tax credits. 
•	Encouraging public recognition of major reinvestment efforts. 
•	Setting up a community tool bank to facilitate renovation efforts. 
•	Enacting architectural conservation overlay zones within neighborhoods. 
•	Writing additional criteria for granting zoning exceptions for setbacks and lot coverage, in order to promote housing renovation that will meet the changing needs of households. 
•	Providing low-interest loans to residential property owners. 
Concept in Practice
College Park is implementing projects to stimulate and coincide with new development along U.S. Route 1, the major north/south arterial road and primary commercial corridor for the community. Revitalization of the U.S. Route 1 corridor is critical to the economic health and success of College Park, as the corridor is a key area offering economic development potential.
In Maryland, the Community Legacy Program enables local governments to apply for and receive funds to use for various projects related to preserving and revitalizing established communities. College Park received Community Legacy funding to acquire a vacant property; in turn, the city has agreed to sell the land to a developer who will build much-needed housing along U.S. Route 1.
This program has acted as a catalyst for redevelopment of the site and the revitalization of the U.S. Route 1 corridor. Additionally, the city has applied for demolition funds for a now-defunct hotel. Again, the razing of the vacant structure could clear the way for redevelopment of a site that will generate additional tax base.
Public capital investment in commercial and in residential areas must go hand in hand to ensure that the community as a whole is improved.
College Park is applying for funding to enhance existing public and private capital projects for streetscape improvements in the downtown. City officials hope that development and redevelopment in selected pockets of the city will have a spillover effect, providing additional tax base and new tax revenue.
An example of this type of development is a new, large-scale housing project currently being implemented on U.S. Route 1. As part of this project, the developer will have to make significant improvements to the location. At the same time, the city will invest in streetscape improvements in an area across from the development. The hope is that, together, the private and public sector efforts will encourage property owners of both commercial and residential units in the surrounding area to reinvest in and improve their properties, resulting in higher real property values.
In the project review process, it is important to work with the development community to require new developments to invest in and fund public improvements like streetscapes. These improvements, coupled with the additional public capital investments, can go a long way toward generating additional economic development and tax base.
College Park is beginning the planning process for constructing a parking garage in the heart of the downtown. The proposed parking garage site is the current location of city hall. Plans call for selling the city hall site to a private developer, who in turn will develop a combination of parking and retail uses on the site, creating a taxable site. Proceeds from the sale of the site would fund the construction of a new city hall on a site already owned by the city.
College Park intends to build a second garage in the downtown area financed by revenue bonds and a tax-increment financing (TIF) district. Remaining revenue generated in the TIF district would fund additional capital improvements to the downtown. Through both of these projects, the city hopes to achieve further economic development and reinvestment in the central business district.
A housing plan was recently adopted by the city council that encourages residential public capital investment and includes policies and strategies aimed at neighborhood revitalization and public capital investment in infrastructure, streetlights, sidewalks, and other physical improvements, and improvements related to the enhancement of public safety in the community. 
Building private sector student housing for the University of Maryland students is a key component of the housing plan. Private sector student housing projects create additional tax base and discourages the conversion of traditional single-family homes from becoming rental properties. The city hopes new student housing will attract those students living in neighborhoods with single family homes converted to rental properties thus allowing those units to convert back to single family homes creating attractive neighborhoods. 
Annexation is another tool being used by College Park as a means to enhance the tax base. Properties are identified in terms of their potential to provide additional tax revenue, less the cost of providing services. For example, the city annexed a property within the past year containing the large retail outlet, IKEA, which has recently opened for business. The city offered a combination of incentives for the retailer, including traditional economic development methods (tax incentives) and nontraditional (the city agreed to take over maintenance of a number of public facilities along the property, including a park and landscaped median strips).
This newly annexed area adds to the city’s tax base and benefits from the improvements provided by the commercial developer and by College Park. Part of the annexation area includes a yet-to-be developed parcel that, when completed, will contain a mix of office, residential, and/or retail uses. The annexed area is now the city’s largest real property taxpayer.
Summary
In Hollywood, where the conceptual model for tax base appreciation was developed, it was forecasted to take at least five years from the initial period of capital investment to close the budget gap. Interestingly, only two years after the conceptual model was developed and introduced to the city as a means of closing the gap, Hollywood administrators were able to recommend a balanced budget without raising taxes. This was the first time in three years that the city did not face a potential tax increase. The public capital investment by Hollywood was one factor that enabled the city to close its budget gap.
In FY 2004, College Park did raise taxes and user fees; however, the management staff reduced expenditures and reliance on the use of the City’s undesignated reserve to balance the budget. The goal in College Park is to reduce the reliance on reserves eventually to stabilize the tax rate for the next fiscal year. Other jurisdictions across the nation have used public capital investment as a tool for economic development. But Hollywood and College Park are unique because public capital investment has been used not only as a tool for economic development but also to expand the tax base, realizing additional revenue, and closing the gap between expenditures and revenues. 

Samuel A. Finz is city manager of College Park, Maryland (sfinz@ci.college-park. md.us), and Noah A. Simon is assistant to the city manager, College Park (nsimon@ci.college-park.md.us). Suzanne E. Utnik is financial services manager, public utilities department, Hollywood, Florida (sutnik@bellsouth.net). This article is adapted from an article written by Finz and Utnik that appeared in the October 2001 issue of Government Finance Review, published by the Government Finance Officers Association.
“Closing the Budget Gap Through Public Capital Investment” was presented at ICMA’s Annual Conference, in Charlotte, North Carolina, in the session The Economy: Trends and Forecasting.
© 2003 International City/County Management Association.