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Review of the Financial Plan for the City of New York:
Fiscal Years 2001-2004
December 2000

H. Carl McCall
State Comptroller

Office of the State Deputy Comptroller for the City of New York

Report 6-2001


  1. Executive Summary Fiscal Year 2000
  2. Fiscal Year 2001
    1. Revenue Estimates
      1. Tax Reduction Program
      2. Taxes
    2. Expenditure Estimates
      1. Collective Bargaining
      2. Pension Contributions
      3. Police Overtime
      4. Health Insurance
      5. Debt Service
      6. Medical Assistance
      7. Board of Education
  3. Out-Year Budget Gaps
    1. Revenue and Expenditure Trends
      1. Revenues
      2. Expenditures

I. Executive Summary

            New York City ended FY 2000 with a record budget surplus of $3.2 billion, has implemented tax cuts with a recurring value of more than $3 billion, and its credit rating has been upgraded to reflect the strength of the City’s economy and its current financial condition. In fact, New York City already projects a budget surplus of nearly $1.3 billion for FY 2001, which we expect will grow larger as the year progresses. Since these resources are unlikely to be needed in the current fiscal year, they have been used in the November Four-Year Financial Plan to reduce the budget gap projected for FY 2002 (see Table 1).

            While these are positive developments, there are still reasons for concern, particularly for the out years of the Plan period. Even though the City has recorded unprecedented budget surpluses in recent years, it has not made progress aligning recurring revenues and expenditures. For FY 2002, the City projects a budget gap of nearly $2.5 billion, about 9.5 percent of City fund revenues. In both absolute terms and as a percentage of City fund revenues, this is the largest budget gap, at this point in the financial planning process, since FY 1981 when the budget was first balanced in accordance with generally accepted accounting principles. In addition, the out-year gaps have grown in size and are among the largest projected by the City, despite the City curtailing a proposed tax reduction program and raising revenue forecasts.

            Moreover, the City’s out-year gap estimates make no provision for wage increases during those years. Nearly all of the five-year labor agreements with the City’s employees have expired and the four-year Plan includes resources only to fund new two-year agreements at the projected inflation rate. The municipal unions are seeking larger wage increases, and teachers and police officers are seeking wage parity with their suburban counterparts. Wage increases at the projected inflation rate would increase costs by $400 million in FY 2003 and $875 million in FY 2004, increasing the projected budget gaps to about 13 percent of City fund revenues in FY 2003 and 15 percent in FY 2004. In total, we have identified budget risks that could increase the budget gap to nearly $4.7 billion by FY 2004, compared with $3 billion projected by the City (see Table 2).

            While the City’s economy remains strong, there are signs that the national economy has begun to slow. In addition, the stock market has been volatile and Wall Street activity has been the driving factor behind the growth in business and personal income tax revenues, the primary sources of the record surpluses in recent years. Although bonuses paid to securities industry employees could reach a record high of $13.3 billion this year, due largely to the profitability of merger and acquisition activity, the City is more reliant now on personal income tax revenues than ever before and thus more vulnerable to a slowdown. Personal income tax revenues have more than doubled over the last decade and now comprise nearly 21 percent of City fund revenues, 50 percent more than a decade ago.

            The value of the City’s pension funds invested in the stock and bond markets has declined 6 percent through the first five months of the fiscal year. While these losses could be made up during the balance of the fiscal year, they reinforce concerns raised last year about accelerating the recognition of extraordinary investment gains of recent years (i.e., market value restart). Even though a loss would not present a budgetary problem in the current fiscal year, it could have a significant impact in future years as the loss is phased in over a five-year period.

            City-funded expenditures have grown at a relatively rapid rate in recent years and are projected to grow by 9.1 percent in FY 2001, three times the projected inflation rate, after adjusting for the transfer of budget surpluses from one year to the next. During the balance of the Plan period, City fund expenditures are projected to grow 50 percent faster than revenues, and the City’s estimates make no provision for wage increases during those years. The major factor behind the growth in spending continues to be debt service costs, which are projected to grow by more than $500 million, or 14.8 percent, in FY 2001. During the remainder of the Plan period, debt service costs are projected to grow at an average annual rate of 6.4 percent and will consume 19 percent of City tax revenues by FY 2004, compared with 15 percent in FY 2000.

            Furthermore, health insurance costs for municipal employees and the indigent (i.e., Medicaid) have resumed growing at a relatively rapid rate after a period of restraint. Health insurance premiums for municipal employees have risen by 9.9 percent this year and are expected to grow at a similar rate in subsequent years. Medicaid costs exceeded the City’s initial estimates by nearly $400 million last year and could be higher by a similar amount this year. Overtime costs in the Police Department could set a new record of more than $300 million this year, nearly three times the FY 1996 level.

            In January 2001, the Mayor will present his preliminary budget for FY 2002 and a detailed program to balance the FY 2002 budget and narrow the gaps projected for subsequent years. In the absence of another record budget surplus, the City may have to curtail planned spending or identify new sources of revenue. The City has indicated that agency spending could be reduced by as much as $1.5 billion and that it will look to the Federal and State governments for help. The City has demonstrated a commitment to fiscal discipline and the January Plan will present another opportunity to address major budget risks and make progress toward structural budget balance.

Table 1

Four-year Financial Plan Revenues and Expenditures

($millions)

 

FY2001

FY2002

FY2003

FY2004

REVENUES

 

 

 

 

Taxes

 

 

 

 

  General Property Tax

$   8,064 

$   8,467 

$   8,916 

$   9,365 

  Other Taxes

13,835 

13,600 

14,200 

14,742 

  Tax Audit Revenue

412 

425 

425 

425 

  Tax Reduction Program

(103)

(469)

(597)

(846)

Miscellaneous Revenue

4,367 

4,207 

3,964 

3,826 

Unrestricted Governmental Aid

564 

564 

564 

564 

Other Categorical Grants

365 

361 

352 

346 

Less: Intra-City Revenues

(1,206)

(1,228)

(1,184)

(1,140)

        Grant Disallowances

      (15)

      (15)

      (15)

     (15)

    Subtotal City Funds

$26,283 

$25,912 

$26,625 

$27,267 

Inter-Fund Revenues

      291 

      285 

      285 

      285 

    City & Interfund Revenues

$26,574 

$26,197 

$26,910 

$27,552 

Federal Categorical Grants

4,370 

3,853 

3,796 

3,782 

State Categorical Grants

   7,582 

   7,636 

   7,683 

   7,702 

    Total Revenues

$38,526 

$37,686 

$38,389 

$39,036 

 

 

 

 

 

EXPENDITURES

 

 

 

 

Personal Service

20,559 

20,991 

21,225 

21,369 

Other Than Personal Service

17,223 

17,318 

17,671 

17,697 

Pay-as-you-go Capital

85 

75 

80 

80 

Debt Service

419 

1,961 

2,923 

3,374 

Budget Stabilization Account

1,252 

345 

- - - 

- - - 

MAC Debt Service

- - - 

488 

490 

489 

General Reserve

         194 

        200 

        200 

      200 

    Total

$39,732 

$41,378 

$42,589 

$43,209 

Less: Intra-City Expenses

    (1,206)

    (1,228)

    (1,184)

    (1,140)

    Total Expenditures

$38,526 

$40,150 

$41,405 

$42,069 

 

 

 

 

 

Gap To Be Closed

$     - - - 

$(2,464)

$(3,016)

$(3,033)

 

 

 

 

 


Table 2

OSDC Evaluation of the Four-Year Financial Plan

($millions)

Better/(Worse)

 

 

FY2001

FY2002

FY2003

FY2004

Projected Budget Gaps

$(2,291)

$(3,716)

$(3,361)

$(3,033)

   Budget Stabilization Account[1]

2,291 

      1,252 

       345 

         - - - 

Remaining Gap To Be Closed

$     - - - 

$(2,464)

$(3,016)

$(3,033)

 

 

 

 

 

OSDC Identified Risks and Offsets

 

 

 

 

   Labor Productivity Plan

(250)

  (265)

(280)

(300)

   Medicaid

(134)

(153)

(153)

(153)

   Pension Contributions

- - -

(70)

(70)

(70)

   Police Overtime

- - - 

(150)

(150)

(150)

   Health Insurance

- - -

(110)

(110)

(110)

   Port Authority Airport Lease Payments

         - - -

(345)

(200)

(135)

   Prior Years’ State Education Aid

         - - -

(96)

(72)

(104)

   Labor Costs

         - - -

         - - -

(400)

(875)

   Sport Stadia Funding

90 

194 

289 

- - - 

   Prior Years’ Expenses

200 

         - - - 

         - - - 

         - - - 

   Revenues

200 

250 

250 

250 

      Subtotal[2]

$     106 

(745)

(896)

(1,647)

 

 

 

 

 

OSDC Projected Budget Gaps

$     106 

$(3,209)

$(3,912)

$(4,680)

 

II. Fiscal Year 2000

            New York City ended FY 2000 with a budget surplus of $3.2 billion, unprecedented both in absolute terms and as a percentage of City fund revenues (see Graph 1). The City also posted record surpluses of $2.6 billion in FY 1999, $2.1 billion in FY 1998, and $1.4 billion in FY 1997.

            Most of these surplus resources, including $429 million that was deposited in the budget stabilization account at the beginning of FY 2000, result from higher-than-anticipated revenues (see Table 3). These higher revenues stem mostly from record Wall Street profits and bonuses that boosted business and personal income tax revenues beyond the estimates in the adopted budget. In addition, the City significantly reduced its planned pension fund contributions by accelerating the recognition of extraordinary pension fund investment earnings from prior years. The City used $2.3 billion of the FY 2000 surplus to balance the FY 2001 budget, and the remaining $905 million was deposited at the start of the fiscal year in the FY 2001 budget stabilization account.

Table 3

Major Sources of the FY 2000 Surplus

($millions)

Budget Stabilization Account per FY 2000 Adopted

$    429

 

 

        Tax Revenues

1,997 

        Pension Contributions

591 

        Prior Years’ Expenses

206 

        General Reserve

200 

        All Other (net)

   (231)

     Increase in Stabilization Account

2,763 

 

 

Total FY 2000 Surplus

$ 3,192

 

                          Data Source: NYC Office of Management and Budget

III. Fiscal Year 2001

            The November Plan adds $347 million to the FY 2001 budget stabilization account, bringing the total to nearly $1.3 billion, even though the City identified new funding needs of $578 million (see Table 4). The addition to the stabilization account was made possible by curtailing a proposed tax reduction program ($315 million) and because tax revenue collections exceeded the relatively conservative estimates in the adopted budget ($422 million). The City assumes that the resources in the stabilization account will not be needed to maintain budget balance in the current fiscal year, and instead has used them to narrow the budget gap projected for FY 2002.

Table 4

Major Changes Since the Adopted Budget

($millions)

Better/(Worse)

 

FY 2001 Budget Stabilization Account per Adopted Budget

$   905 

 

 

 

 

  New Resources

 

 

     Tax Revenues

422 

 

     Curtail Proposed Tax Reduction Program

315 

 

     Cost Reduction Initiatives

136 

 

     Non-tax Revenues

      52 

 

          Total

925 

 

 

 

 

  New Needs

 

 

     Pension Costs

(132)

 

     Police Overtime

(115)

     Federal Aid

(75)

 

     Medicaid

(65)

 

     Debt Service

(56)

 

     Energy

    (49)

 

     All Other

  (86)

 

          Total

(578)

 

 

 

 

Net Change in Stabilization Account

347 

 

 

 

 

FY 2001 Stabilization Account per November Plan

$ 1,252 

 

 

            Our review concludes that FY 2001 will end with a bigger budget surplus than projected by the City, although not as large as last year’s record. The City has addressed most major budget risks and already projects a surplus of nearly $1.3 billion (the amount in reserve in the budget stabilization account). Although the City has yet to reach agreement with its unions on labor productivity savings ($250 million), and Medicaid costs are likely to exceed the City’s forecast ($134 million), these costs could be offset by savings from overestimating prior years’ expenses ($200 million), and our higher estimate of tax revenues ($200 million). In addition, the City may not use $90 million set aside to construct or renovate sports stadia, or $194 million remaining in the general reserve.

            Nevertheless, two issues with significant implications for the future could take shape during the current fiscal year. First, labor agreements with all of the City’s major labor unions have expired, and the amounts set aside by the City are insufficient to fund new two-year labor agreements comparable to those negotiated by New York State’s unions. Moreover, the City’s teachers and police officers are seeking wage parity with their counterparts in neighboring suburbs. Second, the investments of the City’s pension funds have lost 6 percent of their value through the first five months of the fiscal year, compared with an expected gain of 8 percent for the year. Such a shortfall would not present a budget risk in the current fiscal year since the losses would be phased in over a five-year period beginning next year, but the budgetary impact in future years could be significant.

A. Revenue Estimates

            The City is projecting a sharp reduction in the rate of City fund revenue growth, with a gain of more than 6 percent in FY 2000 giving way to a modest 1 percent increase in FY 2001 (see Graph 2), to reach a level of $26.5 billion.  This slowdown is primarily due to projected declines in nonproperty tax revenues, which constitute more than half of City fund revenues.  Forecast growth in miscellaneous revenues is expected to be minimal, while property tax revenues are expected to show a modest gain.

            Nonetheless, the City’s forecast for City-fund revenues is now $737 million higher than that made in the Adopted Budget, primarily due to the expectation of higher tax revenues and a reduction in the value of the FY 2001 tax cuts.

            Total tax revenues are now expected to reach $22.7 billion in FY 2001, an increase of 0.7 percent from FY 2000 levels.  While property taxes are forecast to grow by 3.5 percent, reaching $8.1 billion, nonproperty taxes are expected to decline by almost 1 percent to $14.6 billion.  This projected decline, which follows last year’s 6.4 percent increase in nonproperty tax collections, is due to new tax cuts and a projected slowing in the economy.

1. Tax Reduction Program

            Compared to what was originally proposed in last June’s Adopted Budget, the City’s tax reduction program has been scaled back by $315 million for FY 2001 and somewhat lower amounts in subsequent years.  Originally valued at $418 million in FY 2001 but growing to $1.1 billion by FY 2004, the program has been reduced to $103 million in FY 2001 and now grows to $846 million in FY 2004. While it initially affected many different taxes, the program now has only four components: a restructuring and reduction of the 14 percent personal income tax surcharge, an extension of coop-condo property tax relief, elimination of the commercial rent tax, and a borough economic development program.

            The largest item in FY 2001 is the reduction in the personal income tax surcharge, which is valued at $87 million but grows to $202 million by FY 2004. Following State passage of enabling legislation that permitted the City to make changes in the surcharge, the City enacted a reduction in the surcharge to 7 percent for those below the top tax bracket for each filing status.  Those in the top brackets will continue to pay the full 14 percent surcharge.  Withholding table changes will take effect on January 1, 2001. The surcharge is still scheduled to expire on December 31, 2001, although the Plan assumes it will be extended. The other component that affects FY 2001 is a $16 million installment on the elimination of the commercial rent tax, which is still awaiting City Council action.

            The two remaining components will not have an impact until FY 2002.  The City Council has not yet approved an extension of coop-condo property tax relief, although it has approved earlier extension efforts.  Action on this item is not needed until next year.  Finally, a borough economic development program, which includes various tax credits and abatements for projects located outside of Manhattan, was part of State legislation passed in the spring. The City has valued the program at $10 million in FY 2002.

2. Taxes

            The City has not released an updated economic forecast since the one issued with the Executive Budget in April 2000. Thus, they are still expecting that both the national and local economies will slow in 2001 and that growth in the following three years will remain at levels well below that of the last several years.  For example, national Gross Domestic Product (GDP) is projected to grow by 4.4 percent in 2000, slowing to a milder pace of 2.9 percent in 2001.  Locally, growth in Gross City Product is expected to slow sharply from 4.6 percent this year to 0.8 percent in 2001 with a similarly sharp fall-off in the rate of employment growth.

            While the national economy has been slowing, and the implosion of the dot com boom and the associated fall-off in IPO activity has led to expectations of slower growth in New York, the City’s near-term economic assumptions remain too low given recent actual performance.  Current forecasts of national GDP growth are about 5 percent, while local employment growth through October is on pace to exceed the City’s 2.0 percent forecast for the year.  In addition, the City has not revised its expectations for securities profits, which are critical to revenue projections.  In the Executive Budget forecast, Wall Street firms were expected to post $10.5 billion in profits this year. For the first nine months of 2000, profits have totaled nearly $17.5 billion, an increase of about 85 percent from the level reported in the same period of 1999.  While performance in the fourth quarter will be much poorer given the recent problems in the market, total profits for the year should remain well above the record $16.3 billion level earned last year.

            Although there is no new economic forecast with the November Plan, the City has revised upward its projections of nonproperty tax revenues, even though these are still expected to decline — by $18 million or 0.1 percent in FY 2001 to total $14.7 million.  The $381 million increase from the June forecast that this level represents is primarily derived from year-to-date strength in collections from the personal income ($155 million), business ($130 million), and sales ($92 million) taxes.

            Despite the upward revisions, the City’s forecast does not reflect all the strength of year-to-date increases in nonproperty tax collections.  Collections are up by 7.3 percent for the personal income tax through November, and by 6.8 percent for the sales tax through October.  Business tax collections are up 30 percent through October, due primarily to strength in the general corporation tax.

            Property tax collections, for which forecasts generally undergo little revision at this time in the budget cycle, are projected to increase by $274 million, or 3.5 percent, over FY 2000 levels, to total $8.1 billion in FY 2001.  The City has made only modest technical adjustments to the Adopted Budget forecast, with an increase of $42 million primarily reflecting an increase in the value of the tax lien sale.

            Given the better-than-expected performance of the economy in 2000 and of tax collections thus far in FY 2001, we expect that nonproperty tax revenues will be $190 million higher than the City currently forecasts. Miscellaneous revenues are also likely to be $10 million higher due to strength in year-to-date collections.

B. Expenditure Estimates

            Total spending, including that funded with Federal and State categorical grants, is projected to total $38.5 billion in FY 2001. The November Plan shows that the portion of the budget funded with locally generated revenues and unrestricted Federal and State aid (i.e., City funds) is projected to decline slightly from last year’s level, to $26.3 billion. Our analysis, as discussed below, indicates that the rate of spending may instead be growing rapidly.

            The financial plan estimates reflect the City’s practice of transferring the budget surplus from one year to the next by prepaying a portion of the following year’s expenses, which can distort spending patterns. In addition, the financial plan excludes debt service on bonds of the Transitional Finance Authority and the Tobacco Asset Securitization Authority, which are issued to support the City’s capital program. In the past, such costs were funded exclusively with general obligation bonds and were included in the City’s financial plan estimates. After taking into account these factors, we estimate that City-funded spending would grow by 10.6 percent in FY 2001 ─ four times the projected inflation rate ─ continuing the rapid rate of growth in recent years (see Graph 3).

            Even excluding the $194 million general reserve and assuming savings from overestimating prior years’ expenses, City-funded spending would rise by 9.1 percent. The rise in City-funded spending reflects an extraordinary reduction in last year’s planned pension contribution associated with significant changes in the assumptions and methodologies used to calculate City pension contributions (see “Pension Contributions” later in this chapter). As shown in Table 5, growth is also fueled by a 14.8 percent increase in debt service costs; a 14.1 percent jump in spending at the Department of Sanitation, owing largely to the higher cost of transporting and exporting residential solid waste to landfills outside New York City in anticipation of closing the Fresh Kills landfill by December 31, 2001; a 11.3 percent increase in municipal employee health insurance costs; and a 16.4 percent increase in energy costs due to volatility in gasoline, natural gas and heating oil costs.

            The City’s estimates also assume successful implementation of the FY 2001 agency gap-closing program, which assumes savings of $324 million.[3] The value of the program declines to about $230 million in subsequent years because the program relies heavily on nonrecurring resources in FY 2001, such as funding shifts and re-estimates. We also note that the cost-reduction portion of the agency program is the smallest in at least a decade.

Table 5

Major Factors Driving Increased Expenditures

(City funds in millions)

                                                                                              Change in Spending

 

FY 2000

FY 2001

Dollars

Percent

Debt Service

3,423

3,931

$ 508

14.8

Pension Contributions

593

1,242

648

109.4

Health Insurance

1,466

1,631

165

11.3

Sanitation

822

938

116

14.1

Labor Reserve

57

145

88

154.4

Energy

427

497

70

16.4

All Other

18,881

19,618

   737

    3.9

     Total

$ 25,669

$ 28,002

$ 2,333

9.1

 

   

            The City-funded work force is expected to remain stable during FY 2001 at about 215,400 employees, but the total work force, including employees funded with Federal and State grants, will increase by about 4,400 employees. The largest increase is anticipated for the Board of Education, which expects to add 2,500 teachers. Since June 1997, the City has added 14,500 full-time employees (see Graph 4), mostly in the Board of Education and in the Police Department. In addition, the City increased spending on non-full-time and temporary employees by about 51 percent between June 1996 and June 2000 – the equivalent of about 11,500 full-time employees. The combined effect of these additions has more than offset staff reductions that took place between December 31, 1993 and June 30, 1997.

            Our review finds that expenditures could exceed the City’s estimates by a net of $94 million in FY 2001. The City has yet to negotiate productivity savings with its unions and Medicaid costs could be greater than planned. These costs could be partly offset with savings from overestimating prior years’ expenses. Last year, the City realized savings of $206 million from this source and has averaged savings of about $200 million over the past five years. The City also may not use $90 million set aside in the operating budget to renovate or construct sports stadia, projects that have been repeatedly delayed.

1. Collective Bargaining

            The five-year labor contracts between the City and its unions have expired and the City has only recently begun negotiations for new contracts. The Plan includes resources to fund wage increases at the projected inflation rate for only the first two years of the four-year Plan. No resources have been set aside to provide additional wage increases during the balance of the Plan period. Wage increases at the projected local inflation rate for those years would increase City costs by about $400 million in FY 2003 and by $875 million in FY 2004.[4]  In addition, the Plan assumes that the unions will agree to productivity or fringe-benefit savings ranging from $250 million to $300 million annually.

            The Mayor has offered wage increases based exclusively on performance (i.e., merit pay), rather than across-the-board wage increases that have been the practice in the past. The unions have rejected the Mayor’s proposal unless merit pay is in addition to a base-wage increase, such as negotiated in the recent agreement with public school principals and assistant principals. During a recent negotiating session with the United Federation of Teachers, the City also sought a three-week wage deferral to be repaid after employees leave service.

            New York State recently concluded new agreements with its unions that provide compounded wage increases of 13.6 percent over a four-year period, higher than the projected inflation rate for that period. Similarly, the December 1999 agreement between New York City Transit and the Transport Workers Union (TWU) also provide annual wage increases larger than the projected inflation rate. A wage settlement for City employees similar to the State agreement would increase costs by $130 million in FY 2001, $285 million in FY 2002, $880 million in FY 2003, and $1.2 billion in FY 2004.

            Moreover, the City’s teachers and police officers are seeking substantial increases in wages to achieve parity with their counterparts in surrounding counties. The Chancellor for the New York City Board of Education has acknowledged that recruiting new teachers is difficult because starting salaries in the City are 30 percent below those of suburban areas. Similarly, the Patrolmen’s Benevolent Association (PBA) contends that its members are entitled to a large wage increase because of their efforts in reducing crime, and difficulties in recruiting new candidates. The Police Department was unable to fill 366 vacancies in the September police class even though it relaxed eligibility requirements. The PBA has pointed out that salaries for its members are also significantly lower than those in surrounding counties and that one-quarter of the police force will be eligible for retirement during the next five years.

            Sources of funding exist that could help mitigate the budgetary impact of a new labor settlement. A joint labor-management health insurance reserve has a surplus of about $500 million and the City and its unions have been discussing ways to use these resources. While the unions are seeking improved health and other fringe benefits, the City would like to use the surplus to help fund rising health insurance costs (see “Health Insurance Costs” later in this section) or new labor agreements. Furthermore, the New York City Employees’ Retirement System (NYCERS) could take on pension liabilities stemming from a new labor agreement without an increase in City pension contributions because its assets exceeds its liabilities.[5]

2.      Pension Contributions

            The Plan assumes the City-funded pension contributions will rise from $593 million in FY 2000 to $1.2 billion in FY 2001, and then rise to $1.4 billion by FY 2004 (see Graph 5). These estimates reflect savings from accelerating the recognition of extraordinary investment gains (i.e., market value restart); costs from reducing the actuarial assumption for future pension fund investment earnings from 8.75 percent to 8.0 percent; costs for enhanced pension benefits, such as permanent cost-of-living adjustments (COLAs); and other changes recommended by an independent actuarial consultant and the City Actuary (See OSDC Reports 2-2001 and 3-2001 for a detailed discussion of these issues).

            Despite substantial improvements in pension benefits, the City will be required to make only nominal contributions to the New York City Employees’ Retirement System, since its assets exceed its liabilities by a significant amount.  Nevertheless, total pension costs will approach $1.6 billion by FY 2005, reversing the decline of recent years but still less than the amounts contributed before the stock market boom.  Also, as shown in Graph 5, City pension contributions will continue to average less than 10 percent of salaries, far less than the 30 percent of salaries in FY 1982 and about the same level leading up to market value restart in FY 2000.

            The Plan anticipates that the pension funds will earn 8.0 percent on their investments. Any variance from the forecast will increase or decrease future pension contributions. During the first five months of the fiscal year, the investments of the pension funds lost 6 percent of their value. While these losses could be made up during the balance of the fiscal year, a loss of this magnitude could increase pension costs by about $100 million in FY 2002, $250 million in FY 2003, $450 million in FY 2004, and by $1 billion in FY 2006, when the losses are fully recognized.[6] Furthermore, the New York State Supreme Court has ruled that teachers’ summer school salaries and all other “per session” earnings should count toward their pensions. Unless overturned upon appeal, pension costs could rise by another $70 million as early as FY 2002.

3.      Police Overtime

            In response to rising crime rates, the City successfully lobbied the State Legislature in FY 1991 for authority to impose a temporary surcharge on personal income taxes to increase the size of the police force. In addition, more than 4,500 police officers have been hired under the Federal Community Oriented Policing Services Universal Hiring Program. As a result, the police force has grown from 31,985 officers at the end of FY 1990 to about 40,800 today, an increase of 28 percent (see Graph 6).

            Since 1990, there has been a dramatic reduction in the FBI Crime Index, which measures major reported personal injury crimes, such as murder and rape, and crimes against property, such as car theft. According to data submitted by the City, reported crimes have been reduced from 710,221 incidents in 1990 to 299,522 incidents in 1999, a reduction of 58 percent (see Graph 6).  Most dramatic has been the 70 percent reduction in the murder and car theft rates. Credit for the reduction in crime has been attributed to a number of factors, including the larger police force; management initiatives, such as Compstat, a computer statistics program to identify and track crime trends and patterns; emphasis on quality of life offenses; and changing demographics.

            Despite the largest police force in the City’s history, the City intends to spend a record $275 million on overtime in FY 2001. This represents an increase of $115 million over the amount allocated in the adopted budget and $28 million more than last year’s record of $247 million (see Graph 7). In subsequent years, the Plan includes about $100 million for overtime, about $150 million less than the Department plans to spend this year after accounting for certain non-recurring special events. As evidenced by the resources added in the current fiscal year, the out-years of the Plan do not include a reasonable estimate of police overtime costs.

            A large portion of the overtime resources allocated for the current fiscal year is devoted to fund Operation Condor, an anti-crime initiative begun in January 2000. However, the City’s Office of Management and Budget was unable to provide details on how the Department intends to spend the balance of its overtime budget. For example, OMB does not know how much the Department spent on the World Series parade, the July 4th celebration, the United Nations Millennium Summit, or other major scheduled or unscheduled events, such as holiday parades and security for visiting dignitaries.

            Operation Condor is designed to combat drug dealing and quality of life offenses, and since its inception has reportedly led to 120,000 arrests, overwhelmingly for misdemeanors, and a large portion for marijuana possession. The Department estimates that Operation Condor will cost $100 million during FY 2001, about $5,000 per officer, an increase of 10 percent over a police officer’s average salary.

            As discussed previously in this report, the Department has had difficulty recruiting candidates and was unable to meet its hiring target despite relaxing the minimum eligibility requirements. In addition, police officers are leaving City service faster than expected, thus creating new vacancies. Consequently, the police force will be considerably smaller at the end of the fiscal year than forecast by the City, and a substantial surplus could accrue in this area.

4.      Health Insurance

City‑funded health insurance costs have resumed growing after a period of restraint. As shown in Graph 8, health insurance premiums grew at a fast pace during the early 1990s, but the City then negotiated a three‑year freeze in rates for fiscal years 1996 through 1998 as part of a package to help the City balance its budget during a period of fiscal stress. But in the two years that followed the rate freeze, health insurance costs grew at annual average rate of 5.8 percent.

City‑funded health insurance costs are projected to rise by 11.3 percent in FY 2001 to $1.6 billion, an increase of $165 million. The major factor underlying the rapid rate of growth is a 9.9 percent increase in non-Medicare insurance premiums. The Health Insurance Plan of Greater New York has indicated that premiums could grow by as much as 11.9 percent in FY 2002, and by similar amounts in subsequent years, compared with the Plan’s assumption of 4 percent.[7] A rate increase of this amount would increase annual costs by $110 million beginning in FY 2002.

5. Debt Service

            Debt service costs are projected to total nearly $4 billion in FY 2001, an increase of 14.8 percent — more than $500 million — over FY 2000.[8]  This unusually high rate of growth reflects the impact of past bond refundings that resulted in substantially higher debt service costs in FY 2001 (and future years) than in FY 2000, and from surplus Municipal Assistance Corporation funds which reduced FY 2000 debt service expenditures.  Over the remainder of the Plan period, debt service costs will grow at an average annual rate of 6.4 percent, an increase more indicative of ongoing expenditures needed to support the City’s capital program.

6. Medical Assistance

            City-funded Medicaid expenditures are expected to total $3.2 billion in FY 2001, an increase of $ 138 million, or 4.5 percent, over the amount projected in the adopted budget. Of this amount, $75 million is needed to cover the City’s unsuccessful effort to obtain additional Federal funding, and the remaining $65 million is due to recent trends that show rapidly rising costs for drugs, particularly for treating AIDS, ulcers and depression, and hospital payments. These increases reverse a declining trend in Medicaid costs over most of the last decade that resulted from State cost-containment actions, the introduction of managed care, and reductions in the number of Medicaid enrollees, in some cases as an unintended consequence of welfare reform (see Graph 9). As of October 2000, the number of persons receiving public assistance declined by 52 percent compared to March 1995, when the caseload peaked at 1,160,593 persons. Consequently, the cost of this program has been cut in half, producing recurring savings of about $450 million annually.

       

            Even with a substantial increase in Medicaid funding, our review finds that Medicaid costs may still be understated by $134 million, largely because medical costs are growing faster than projected by the City. In fact, last year the City was required to add $200 million during the year-end close to cover unanticipated costs. The recent addition of $65 million covers a portion of this liability, but such costs could exceed even the revised estimates by about $125 million annually.

            Medicaid costs could be higher by $9 million in FY 2001 and $28 million annually thereafter because about 100,000 children were enrolled in the Child Health Plus, a program funded by the Federal and State governments, when they should have been enrolled in Medicaid. The Federal government has called for these children to be enrolled in Medicaid and about 8,000 children will be transferred each month over the next 13 months. The State has now designed a unified application form for Child Health Plus, Family Health Plus and Medicaid to ensure that applicants are enrolled in the correct program.

            There is also the potential for Medicaid costs to increase further if the City successfully enrolls 900,000 uninsured persons, about half of the total number of uninsured persons in New York City, in various publicly-subsidized health insurance programs.

7. Board of Education

            The Plan includes nearly $11 billion for the Board of Education in FY 2001, excluding pension and debt service costs, $279 million more than last year. City and State contributions to education are essentially equal for FY 2001, and are projected to remain so throughout the Plan period. City and State funding for education rose steadily since FY 1997.

            A decision is expected shortly in the lawsuit brought against New York State by the Campaign for Fiscal Equity. The case alleges that State education aid formulas discriminate against minority public school children in New York City, and that State education aid to New York City is inadequate to provide a sound, basic education. A resolution in favor of the Campaign for Fiscal Equity could require the State to simplify and standardize education aid formulas, which the State Comptroller has long advocated.[9] The State Comptroller recently released a report criticizing the State for its unduly complex aid formulas and for ineffectively targeting increases in education aid.[10] The Comptroller urged that the education finance system be made more rational to help students with the greatest needs comply with the State’s new education standards.

            Attendance in the FY 2001 summer school session was less than anticipated because many high school students who registered failed to attend. Nevertheless, attendance rates for students in grades three through eight, and for students in special education, rose from 64 percent to 88 percent compared with the FY 2000 summer school session. About 33 percent of these students were held back in FY 2001, nearly twice the FY 2000 rate. Students who are held back are receiving additional services. For example, eighth graders who are held back are enrolled in the “Eight Plus Program,” which has a maximum class size of 20 students, and individualized instruction programs. A consultant has been retained by the Board of Education to evaluate the impact of summer school on student achievement and to assess program implementation, but the evaluation has not yet been completed.

IV. Out-year Budget Gaps

            The Plan shows budget gaps of nearly $2.5 billion in FY 2002, and about $3 billion for fiscal years 2003 and 2004, larger than those projected in the July Plan. The FY 2001 gap represents 9.5 percent of City-fund revenues (see Table 6), the largest gap at this stage in the financial planning process, both in absolute terms and as a percent of City fund revenues, since the budget was first balanced in accordance with GAAP in FY 1981. To close the gaps, the City is relying on agency actions ($1.5 billion) far more than in recent years, and an unrealistic infusion of Federal and State aid ($1 billion). In January 2001, the City will present a detailed gap-closing program that will identify the specific initiatives that will be taken to balance the FY 2002 budget and to narrow gaps projected for subsequent years.

            The out-year gaps, however, could be considerably larger than shown in the Plan, because the City has set aside resources for only a two-year labor agreement. Wage increases at the projected local inflation rate for the remaining two years of the Plan period would increase the gaps to 12.8 percent of City fund revenues in FY 2003 and to 14.3 percent in FY 2004, making them the largest gaps in the past twenty years.

Table 6

Out-Year Budget Gaps

as a Percent of City Fund Revenues

($millions)

Based on First Quarter Submission

Year 2 Gaps

% of City Revenues

Year 3 Gaps

% of City Revenues

Year 4 Gaps

% of City Revenues

   FY 2001

$ 2,465

9.5

$ 3,016

11.3

$ 3,033

11.1

   FY 2000

   1,512

6.0

   1,953

7.7

   1,752

6.7

   FY 1999

   2,173

9.3

   2,922

12.5

   2,424

10.0

   FY 1998

   1,209

5.2

   2,705

11.4

   2,605

10.7

   FY 1997

   1,226

5.4

   2,129

9.4

   3,031

13.2

   FY 1996

   1,367

6.3

   2,315

10.6

   2,695

11.9

   FY 1995

      955

4.5

   1,547

7.1

   2,024

9.1

   FY 1994

   1,730

8.1

   2,513

11.4

   2,699

11.9

   FY 1993

   1,655

8.0

   1,984

9.5

   2,591

11.9

   FY 1992

   1,204

6.0

   1,810

8.8

   1,921

9.2

   FY 1991

   1,287

6.5

   1,444

6.9

   1,679

7.7

     Data Source: NYC Office of Management and Budget; OSDC analysis

 

            Our review has identified a number of major budget risks that could increase the out-year gaps by a net of about $750 million in FY 2002, $900 million in 2003, and $1.7 billion in FY 2004. If all these risks materialize, the City could face budget gaps of $3.2 billion in FY 2002, $3.9 billion in FY 2003, and $4.7 billion by FY 2004. The major risks are:

C           Airport lease payments from the Port Authority of New York and New Jersey of $345 million in FY 2002, $200 million in FY 2003, and $135 million in FY 2004 (The City=s estimates reflect its claim of underpayment for prior years and higher payments sought under a renegotiated lease, even though the PA is not discussing renewal of the existing lease with the City.)

C                     Labor productivity savings of about $300 million annually.

C                     Medical assistance costs of $153 million beginning in FY 2002, due mostly to rising medical costs.

C                     Police overtime costs of $150 million, largely because the Plan does not reflect the cost of Operation Condor, a major crime-fighting initiative funded through overtime.

C                     Health insurance costs of $110 million in FY 2002, because the Plan assumes that insurance premiums will rise by only 4 percent even though the Health Insurance Plan of Greater New York has already indicated it will seek a rate hike of 11.9 percent.

C                     Prior years= State education aid payments of $96 million in FY 2002, $72 million in FY 2003, and $104 million in FY 2004. (The State has made only minimal payments on education aid owed the City for prior years, and the City Comptroller has adopted a policy that would write off unpaid claims more than 10 years old.)

C                     Wage increases at the projected inflation rate that would increase costs by $400 million in FY 2003 and by $875 million in FY 2004 (The Plan includes resources to fund two-year wage agreements but does not include resources to provide additional wage increases during the balance of the Plan.)

A. Revenue and Expenditure Trends

            Overall, expenditures are projected to grow about 50 percent faster than revenues, exacerbating the existing imbalance between recurring revenues and expenditures (see Table 7). The rate of expenditure growth, however, could be even greater, because the four-year Plan provides no funding for wage increases during the last two years of the Plan period, and assumes the unions will help fund the cost of new labor agreements through productivity and fringe benefit savings. In addition, Medicaid costs are likely to be substantially greater than forecast by the City.

Table 7

Out-Year City Fund Revenue and Expenditure Trends

(Percent Change)

Increase/(Decrease)

 

FY 2002

FY 2003

FY 2004

Avg. Growth Rate

NYC Inflation Rate

2.3

2.5

2.6

2.5

 

 

 

 

 

City Fund Revenues

(0.8)

3.4

2.9

1.8

General Property Tax

2.8

5.3

5.0

4.4

Nonproperty Tax

(2.1)

4.3

2.8

1.7

   Personal Income Tax

(5.0)

7.0

5.7

2.4

   Sales Tax

(0.3)

3.3

3.1

2.0

   Business Tax

(5.8)

3.9

3.3

0.4

   Other Taxes

6.0

1.2

(3.7)

1.1

Miscellaneous Revenues

(3.9)

(5.0)

(2.6)

(3.8)

All Other

0.1

(0.1)

0.1

0.0

 

 

 

 

 

City Fund Expenditures

4.3

3.0

1.5

3.0

Salary and Wages

3.4

0.8

0.3

1.5

Pension Fund Contributions

5.9

3.5

2.6

4.0

Health Insurance

6.2

6.1

5.2

5.8

Medicaid

5.6

5.7

5.7

5.7

Sanitation

3.3

2.1

0.0

1.8

Public Assistance

(0.9)

0.0

0.0

(0.3)

Debt Service

8.1

5.8

5.4

6.4

All Other

2.6

2.7

(1.9)

1.1

 

         Data Source: NYC Office of Management and Budget

 

1. Revenues

            City fund revenues are forecast to remain subdued during fiscal years 2002 through 2004, averaging gains of 1.8 percent annually, with growth slower at the beginning of this period and somewhat faster at the end. Revenue growth is restrained by the tax reduction program, changes in State tax law, and a projected slowing in the local economy. With the projected growth in City fund revenues less than the forecast rate of inflation, revenues will decline in real dollars.

            Real property tax revenues, however, are projected to grow at the brisk rate of 2.8 percent in FY 2002, 5.3 percent in FY 2003, and 5 percent in FY 2004. The growth reflects anticipated increases in billable assessed property values for all City real property. For most income-producing properties, increases in actual assessed values are phased in over five years, resulting in a pipeline of future increases which can fuel billable assessed value growth independently of actual market conditions.

            Nonproperty taxes, the dominant source of revenues in the City, are projected to grow at an average rate of 1.7 percent during fiscal years 2002 through 2004. This is about one‑quarter the rate of growth experienced during fiscal years 1996 through 2000, but is an improvement from the decline expected in FY 2001. The City is anticipating that the local economy will weaken considerably in calendar year 2001 but that growth rates will rise in subsequent years. The Plan also reflects an increasing level of new tax cuts through FY 2004. Thus, nonproperty tax revenues are expected to decline by 2.1 percent in FY 2002, but then grow by 4.3 percent in FY 2003 and 2.8 percent in FY 2004.

            Wage growth begins to rise in calendar year 2002, causing growth in personal income tax collections to rebound beginning in FY 2003. Business taxes follow a similar pattern, based on a rebound in corporate profits growth in calendar year 2002.  Improved wage and personal income growth expected in calendar year 2003 would normally result in higher sales tax collections. Growth is held back, however, to 3.3 percent in FY 2003 and 3.1 percent in FY 2004, about half the rate of growth between fiscal years 1995 and 2000, because of the changes in State tax law, particularly from energy deregulation. An increase in STAR revenues boosts the growth in other taxes in FY 2002.

            Miscellaneous revenues decline at an average annual rate of 3.8 percent during fiscal years 2002 through 2004. The reduction in FY 2002 is a result of the decline in revenues for asset sales and lower water and sewer fees, although expenditures associated with water and sewer charges decline by an equal amount.  In fiscal years 2003 and 2004, the further decline in miscellaneous revenues reflects lower anticipated rental payments by the Port Authority for the City=s two airports.

2. Expenditures

            City-funded spending is projected to grow at an average annual rate of 3.0 percent, faster than the local inflation rate (see Table 6). The rate of expenditure growth could be even higher given the budget risks we have identified, such as an underfunded reserve for collective bargaining and higher Medicaid costs.

An especially significant factor driving the growth in projected spending is the rise in debt service costs. These costs are forecast to total $4.2 billion in FY 2002, $4.5 billion in FY 2003, and $4.7 billion in FY 2004, an annual average growth rate of 6.4 percent C more than twice the projected inflation rate and three times the projected growth in City fund revenues. As a result, the debt service burden (debt service as a percent of tax revenues and other revenues that offset debt service) would rise from 15 percent in FY 2000 to 19 percent by FY 2004 (see Graph 10), a high ratio by any standard. The City may find it difficult to afford both this level of debt and other essential services.

            Health insurance costs for municipal employees and for the indigent (i.e., Medicaid expenditures) are projected to grow at an annual rate of nearly 6 percent during fiscal years 2002 through 2004, more than twice the projected inflation rate. Moreover, the Health Insurance Plan of Greater New York has indicated it intends to seek increases in health insurance premiums of at least 10 percent annually. In contrast, the Plan assumes annual rate hikes of 4 percent. Each additional 1 percent increase in health insurance premiums would increase City costs by $14 million.

 



[1]               The Plan assumes that nearly $1.3 billion deposited in the budget stabilization account will not be needed in the current fiscal year and instead will be available to reduce the FY 2002 budget gap. Similarly, the Plan assumes that $345 million in anticipated proceeds from the sale of the New York Coliseum will be deposited in the budget stabilization account for use in FY 2003.

[2]                      The Plan includes a general reserve for unforeseen contingencies of $194 million in FY 2001, and $200 million annually thereafter.

 

[3] The agency gap-closing program also assumes revenues of $137 million in FY 2001 and about $37 million in subsequent years.

[4] The City projects local area inflation rates of 2.3 percent in FY 2001 and FY 2002, 2.5 percent in FY 2003, and 2.6 percent in FY 2004.

[5] We estimate that the assets of the NYCERS pension system exceed its liabilities by about $1.5 billion, even after recent improvements in pension benefits. This “cushion” would permit NYCERS to offset new liabilities that would increase costs by about $150 million annually.  We estimate that City contributions to NYCERS, in the absence of the cushion, would rise by about $9 million annually for each one percent increase in wages.

[6] Fluctuating stock market performances can dramatically impact year-to-year pension contributions. To ease the budgetary impact, unexpected investment returns (i.e. returns that vary from the 8.0 percent) are phased-in over five years, at a cumulative rate of 10 percent, 25 percent, 45 percent, 70 percent, and 100 percent.

[7] Under agreements between the City and its unions, premiums paid to HIP determine the City’s cost for all municipal health insurance providers. Each 1 percent increase in insurance premiums would increase City costs by $14 million annually.

[8]               Debt service estimates include City general obligation bonds, revenue bonds of the New York City Transitional Finance Authority (TFA), the Municipal Assistance Corporation and TSASC, Inc., and lease payments.  They have been adjusted for the transfer of actual and projected surplus funds.

[9]               See School Finance Reform – A Discussion Paper (October, 1995), An Agenda for Equitable and Cost-Effective School Finance Reform (October, 1996), School Facilities: Conditions, Problems, Solutions (October, 1997).

[10] A $3.4 Billion Dollar Opportunity Missed: Despite Four Years of Large Increases State School Aid Formulas Still Don’t Provide Equitable, Predictable or Efficient Funding (November, 2000).