Staff Report on the City of Philadelphia s Revised Five-Year Financial Plan for Fiscal Year Fiscal Year September 24 Revision

Transcription

1 Staff Report on the City of Philadelphia s Revised Five-Year Financial Plan for Fiscal Year Fiscal Year 2019 September 24 Revision October 14, 2014

2 Pennsylvania Intergovernmental Cooperation Authority 1500 Walnut Street, Suite 1600, Philadelphia, PA Telephone: (215) ~ Fax: (215) pica@picapa.org Secretary/Treasurer Rhonda Hill Wilson, Esquire Board of Directors Vice-Chair Michael A. Karp Assistant Secretary/Assistant Treasurer Joseph A. DiAngelo Member Gregory S. Rost Member Lawrence Tabas, Esquire Ex-Officio Members Representative of the Commonwealth of Pennsylvania Charles Zogby Secretary of the Budget Representative of the City of Philadelphia Rob Dubow Director of Finance Staff Harvey M. Rice, Executive Director Stephen K. Camp-Landis, Director of Research and Analysis Dora Andonova Ward, Senior Associate Deidre Morgenstern, Accounts Manager Kim Richardson, Secretary/Receptionist Professional Advisors Authority Counsel Reed Smith LLP Independent Auditors Heffler, Radetich and Saitta LLP

3 Executive Summary and Staff Recommendation On September 24, 2014, the City submitted to PICA a proposed revision to the Five-Year Financial Plan for Fiscal Years 2015 through The revision was required under Section 209(j) of the PICA Act, which requires that [i]f the city executes a contract or a collective bargaining agreement which is not in compliance with the plan, the contract or agreement shall not be void or voidable solely by reason of such noncompliance, but the city shall submit to the authority a proposed revision to the plan which demonstrates that revenues sufficient to pay the costs of the contract or collective bargaining agreement will be available in the affected fiscal years of the plan. Since PICA s approval of the City s FY15-FY19 Plan on July 21, the City has received new arbitration awards for police officers represented by the Fraternal Order of Police (FOP) and First Judicial District employees represented by District Council 47, Local 810. In addition, the City reached an agreement with AFSCME District Council 33 (DC33). The FOP award covers the FY14-FY17 period, and the DC47, Local 810 award covers FY15 and FY16. The DC 33 contract covers the period FY10 through FY16. The FOP and DC33 awards resulted in substantial costs to the City in excess of the amounts reserved in the version of the Plan approved on July 21, and therefore required a Plan revision under the PICA statute. The Revised Plan incorporates the additional costs of these new labor contracts, while also making a number of other changes. The changes include revisions to FY14 estimates of revenues and obligations, revisions to tax revenue projections, changes in projected pension costs based on newly-adopted actuarial assumptions, revisions to disability and workers compensation costs based on recent experience, and projected savings from initiatives to reduce Fire Department overtime costs. In addition, the reserve for future labor costs in the Revised Plan includes costs for certain bargaining units that had not been included in the approved Plan. The effect of these changes, in aggregate, is to reduce the projected fund balances somewhat below the levels in the Plan approved by PICA in July. Like other major US cities, Philadelphia continues to face fiscal stress related to the impact of the recession and the slow recovery over the past six years. The City is to be commended for reaching an agreement with its two major non-uniformed unions, DC47 and DC33, over the past year, and for ensuring that these agreements are affordable. Nonetheless, the City continues to face substantial fiscal uncertainty, resulting from unresolved labor contracts with the International Association of Fire Fighters (IAFF) and some smaller bargaining units. In addition, the City s pension fund remains a major risk, with one of the lowest funded ratios among major city pension systems. With economic growth continuing at a modest pace, the City will remain challenged to maintain service levels and economically competitive tax rates in the near future. It is the opinion of PICA staff, that the Revised Plan, as submitted to PICA on September 24, does meet PICA Act criteria for reasonableness of its assumptions. Staff recommends Board approval of the Revised Plan on this basis. Nonetheless, staff remains concerned about the risks faced by the Plan, which were detailed in its July 21 report. In addition, staff continues to believe that the City should take a more proactive approach to addressing some of its most serious financial challenges by incorporating strategic initiaitves into future versions of the Plan. 1

4 PICA Staff Report on the Revised Five Year Financial Plan This report contains an analysis of the Revised Five-Year Financial Plan for Fiscal Years 2015 through 2019, submitted to PICA on September 24 (the Revised Plan ). The Revised Plan was submitted in accordance with Section 209(j) of the PICA Act, which requires the City to make a revision to the Plan in the event that it enters into a new labor contract with costs that are not consistent with the assumptions in the previously approved Plan. This revision was necessitated by three new labor contracts: a new arbitration award covering the Fraternal Order of Police, issued on July 30; an arbitration award covering First Judicial District employees represented by DC47, Local 810, issued on August 6; and a new contract with District Council 33, ratified on September 9. The costs of these contracts had not been included in the Plan submitted to PICA on June 26 (the June 26 Plan ) and approved on July 21. The new contract with the FOP resulted in an additional $97.8 million in costs in excess of the June 26 Plan assumption. The DC33 contract resulted in an additional $132.9 million in costs beyond the June 26 Plan. The September 24 Plan Revision takes these additional costs into account. Other significant changes in the Revised Plan include incorporation of increased pension obligations due to revised actuarial assumptions adopted by the Board of Pensions and Retirement at its June meeting. It also incorporates updated projections of FY14 revenues and obligations. Finally, the Revised Plan also includes, in its reserve for future labor cost increases, the following new costs: potential costs associated with a future labor contract with DC33 Local 159, which includes Prison System employees; potential costs associated with a future contract with Register of Wills and Sheriff s Office employees represented by the FOP; and the estimated cost of raises recently granted to nonunion, non-civil service employees. The Revised Plan also includes projected savings in each of its fiscal years from new initiatives to reduce overtime costs in the Fire Department. It also projects that savings achieved in the disability and workers compensation program in FY14 will recur in each year of the Plan. The Revised Plan also makes changes in revenue projections. The revisions reflect two primary changes: (1) revisions to projected revenues based on updated estimates for FY14 revenues; (2) revisions to projected wage, earnings, and net profits tax revenues based on revisions to the projected schedule of tax rate changes. The Revised Plan projects positive fund balances in each of its fiscal years, with the fund balance projected at $131.9 million in FY15, and declining to a low point of $40.5 million in FY17, before increasing to $83.9 million in FY19. These fund balances continue to be relatively low in relation to Table 2.1 Summary of FY15-FY19 Five-Year Financial Plan, September 24 Revision ($ in Millions) FY13 Actual FY14 FY15 FY16 FY17 FY18 Revenues $3,698.0 $3,812.2 $4,470.5 $3,831.1 $3,915.2 $4,020.4 $4,095.3 Obligations 3, , , , , , ,079.5 Prior Year Adjustments Adjusted Operating Surplus/ (Deficit) (58.5) (66.5) (59.5) (31.9) Prior Year Fund Balance Current Year Fund Balance FY19 Est 2

5 a General Fund budget that approaches $4 billion annually. PICA staff has in the past expressed concern about the relatively low fund balances in the Plan. The June 26 Plan generally had higher fund balances, including a projected FY19 fund balance in excess of 3 percent of appropriations. As a result, the Plan included a General Fund contribution to the Budget Stabilization Reserve Fund of $24.6 million in FY19, a contribution that would have been required under the Philadelphia Code due to a projected fund balance in excess of 3 percent of appropriations. The current Plan does not include this contribution due to lower fund balances resulting primarily from additional labor costs for three recent contracts. Even with the incorporation of the cost of the new FOP, DC33, and DC47, Local 810 contracts, the Revised Plan is still subject to risks associated with future labor costs. The Revised Plan assumes no pay raises for most unions beyond the expiration of current labor contacts. In addition, the Plan s revenue projections assume continued economic recovery for the next five years. A national recession over the next five years would likely result in revenues below the level projected. General Fund Revenues The Revised Plan reflects updated projections of FY14 tax revenues. Based on actual collections through June, overall FY14 tax revenues are projected to be $12.7 million higher than the level of the June 26 Plan. The increase reflects a $15 million increase in wage and earnings taxes and a $7 million increase in the real estate transfer tax. These increases are offset by minor decreases in other taxes. On the basis of the revised FY14 estimates, the Revised Plan projects generally higher tax revenues in each year. While the projected annual tax base growth rates are unchanged from the June 26 Plan, the projected revenues are higher due to application of the previously assumed base growth rates to the higher estimated FY14 base. In addition, the Revised Plan reflects a smaller reduction of wage, earnings, and net profits tax rates in FY18 and FY19. The FY15 resident rate for these three taxes is 3.92 percent, and the nonresident rate, percent. The June 26 Plan had projected the resident rate at percent in FY18 and percent in FY19. The Revised Plan projects the resident rate at percent and percent, respectively, in FY18 and FY19. Similarly, the June 26 Plan projected the non-resident rate at and percent, respectively, in FY18 and FY19. The Revised Plan projects the non-resident tax rate at percent in FY18 and percent in FY19. The Plan s incorporation of a slower pace of tax reduction for the City s most significant tax revenue source is a reflection of the challenging fiscal situation the City faces, fully six years since the onset of the recession. Research has demonstrated the importance of continued reductions in the wage, earnings and net profits taxes to achieve a competitive and efficient local tax structure. No other city in the US relies so heavily on local income taxes as a source of tax revenue. Tax revenue in the revised Plan for FY15 through FY19 is projected to be $153.4 million above the June 26 Plan level. This increase reflects an increase of $132.9 million in the wage and earnings tax, and an increase of $41.8 million in the real estate transfer tax. These increases are offset by declines in the net profits tax ($8.5 million), sales tax ($10.2 million), and amusement tax ($2.7 million). The changes primarily reflect the application of the growth rates in the June 26 Plan to the revised FY14 estimate. In addition, wage and earnings taxes are revised upward in FY18 and FY19 due to the higher projected tax rate. Compared to the June 26 Plan, locally-generated non-tax revenues are projected to increase $29.6 million over the FY15-FY19 period, primarily due to a one-time $25 million revenue source in FY15. The July 2014 FOP arbitration award required the FOP health fund to return to the City a reserve fund that had been established under the previous, 3

6 Table 2.2 Changes in Projected General Fund Revenues from June 26 Approved Plan to September 24 Revision, FY15-FY19 Five-Year Financial Plan ($ in Millions) FY13 Actual FY14 FY15 FY16 FY17 FY18 Taxes Real Estate -- ($3.0) Wage and Earnings Business Income and Receipts (3.0) Sales (1.8) (1.9) (2.0) (2.0) (2.1) (2.2) Net Profits -- (1.0) (1.6) (1.7) (1.8) (1.6) (1.7) Real Property Transfer Amusement -- (0.5) (0.5) (0.5) (0.5) (0.5) (0.6) Other Total Locally-Generated Non-Tax -- (6.1) Revenues from Other Governments -- (11.1) (1.4) (5.7) (5.9) (5.8) (6.0) Revenues from Other Funds -- (21.2) Total General Fund Revenues -- (25.7) FY19 Est 2009 award. This reserve fund was created to allow payment of health claims in the event that the City and the union agreed to terminate self-insurance for the FOP health plan. The fund was deemed no longer needed as a result of the July 2014 award, and the full amount was returned to the City. Revenues from other governments in the Revised Plan are $24.8 million below the June 26 Plan level, which reflects a $28.8 million reduction in PICA City Account revenue. This reduction reflects a revision in projected PICA tax revenue due to updated estimates of the portion of wage, earnings and net profits taxes paid by city residents. (The PICA tax is a portion of the wage, earnings and net profits taxes paid by city residents. The tax is received by PICA and utilized to pay debt service on PICA bonds. The amount not required for PICA debt service or administrative costs is returned to the City through the PICA City Account.) General Fund Obligations The Revised Plan projects obligations over the FY15-FY19 period that are $250.1 million higher than in the June 26 Plan. This increase primarily reflects the impact of the FOP arbitration award, the new DC33 contract, the addition of a labor cost reserve to cover future contract costs associated with Correctional Officers and Sheriff s Office and Register of Wills employees, and higher pension obligations. While the June 26 Plan had reserved funds for the FOP and DC33 contracts, the revised projected FY15-FY19 cost of these agreements exceeds the June 26 Plan estimate by $230.7 million. Pension obligations in the Revised Plan are higher than projected in the June 26 Plan due to revised actuarial assumptions adopted by the Board of Pensions and Retirement at its June meeting. The most significant changes in obligations relate to the impact of labor contracts that have been finalized since the June 26 Plan. For the FOP, the June 26 Plan had included, in its future labor cost reserve, $121.1 million in potential costs. This estimate represented the cost of two consecutive 4

7 wage increases of 2.5 percent in FY15 and FY16. The FOP arbitration award issued on July 30 resulted in additional costs of $219.1 million, $97.8 million higher than the reserve. 1 The July 30 arbitration award included wage increases of 3.0 percent effective July 1, 2014, 3.25 percent effective July 1, 2015, and 3.25 percent effective July 1, The award also included a bonus of $1,500 per member, which will be paid at the time the Police Department is accredited by the Pennsylvania Chiefs of Police. In addition, the award increased officer clothing allowances and payments to the FOP legal fund. The primary additional costs beyond the Plan assumption reflected the higher than anticipated wage increases and the fact that the award covers three fiscal years (FY15 through FY17), while the June 26 Plan had included the cost of FOP wage increases only through FY16. The June 26 Plan included $39.5 million in costs for a future contract with DC33. This cost estimate was based on the cost of the City s final offer to the union that the City was seeking Court of Common Pleas approval to impose, arguing that negotiations with the union were at an impasse. However, on August 21, the City announced that it had achieved a tentative contract agreement with DC33. The agreement, which covers the period FY10 through FY16, was ratified by the union on September 9. The full costs of the agreement are estimated at $172.4 million from FY15 through FY19, which exceeds the DC33 reserve in the June 26 Plan by $132.9 million. The reserve in the June 26 Plan, based on the terms of the City s final offer to DC33, included the cost of a 2.5 percent wage increase effective March 2013, 1 In the revised Plan, the amount shown in the Police Department line item increased $219.1 million, which reflects the full financial impact of the new FOP contract through FY19. However, it should be noted that, of this $219.1 million increase, $121.1 million was assumed in the June 26 Plan but shown in the labor cost reserve contained within the Civil Service Commission line item. Thus the Police Department line item increased $219.1 million in the revised Plan, while the overall projected costs for police officers represented by the FOP increased $97.8 million. a 2.0 percent wage increase effective January 2014, a $25 million lump sum payment to the union health benefits fund, change in overtime rules, pension changes, and prospective restoration of step and longevity increases that had been frozen effective June 30, 2009, when the previous contract expired. The Revised Plan includes the estimated cost of the actual FY10-FY16 contract, which differs substantially from the terms of the final offer. The final contract included the following terms: a 3.5 percent wage increase effective September 1, 2014; a 2.5 percent wage increase effective July 1, 2015; a $2,800 per member ratification bonus; a $20 million lump sum payment to the union health benefits fund; an increase in per member, per month payments to the health fund to $1,100 effective September 15, 2014 and $1,194 effective July 1, 2015; prospective restoration of step and longevity increases; pension and overtime changes; and increases in life insurance, legal services, and tool allowance payments. The costs of the DC33 contract for wages and restoration of longevity increases exceeded the June 26 Plan assumption. In addition, the contract included increases in per member, per month payments to the union health fund, a ratification bonus, and increases in legal services, life insurance, and tool allowance payments, which had not been assumed in the June 26 Plan. Further, the June 26 Plan assumption, based on the City s final offer, assumed that new employees would be required to participate in the City s hybrid defined benefit, defined contribution pension plan, known as Plan 10. This requirement was expected to result in substantial savings, to offset other costs, but the final contract did not include mandatory participation in Plan 10. Under the new contract, Plan 10 is optional, not required, for new employees in DC33. However, new DC33 hires who elect to participate in Plan 87, the City s traditional defined benefit pension plan, must make higher pension contributions than those who elect Plan 10. The Revised Plan includes, within the Civil Service Commission line item, a reserve of $284.5 million 5

8 to cover the potential cost of future labor contracts. This amount is $70.9 million higher than the reserve in the June 26 Plan. The increase reflects the net impact of the following factors: A reduction of $121.1 million due to the allocation of the previous FOP cost reserve to the Police Department line item An increase of $132.9 million reflecting the difference between the actual cost of the new DC33 contract and the amount in the reserve Inclusion of $59.1 million in new costs associated with the following categories: wage increases for non-represented employees exempt from civil service ($28.0 million); potential costs of a new labor agreement with Register of Wills employees ($0.6 million); potential costs of a new labor agreement with Correctional Officers represented by DC33 Local 159 ($26.7 million); and potential costs of a new labor agreement with Sheriff s Office employees ($3.7 million) The projected cost of wage increases for nonrepresented, non-civil service employees represents the impact of a 3.5 percent wage increase granted effective September 1, Projected costs for new labor agreements with Correctional Officers, Sheriff s Office employees, and Register of Wills employees, is based on the projected cost of two consecutive 2.5 percent wage increases effective July 1, 2014 and July 1, The reserve for IAFF assumes two consecutive wage increases of 2.5 percent, effective July 1, 2013 and July 1, 2014 (the most recent IAFF contract expired on June 30, 2013). As in previous plans, the risk of actual labor costs exceeding the level in the Plan is substantial. For police officers represented by the FOP, DC 33, and DC47, projected wage increases do not assume wage increases beyond the period for which contracts are currently in force. For the IAFF, no wage increases beyond FY15 are assumed. For other smaller unions, there are generally no wage increases assumed after FY16. The past experience of actual costs far exceeding Plan assumptions indicates the potential that actual labor costs for many bargaining units will exceed the Plan assumption. This will pose significant fiscal challenges for the current Administration and the next. While a major strength of the Five-Year Financial Plan process is that the City is required to demonstrate that it can maintain fiscal balance given the requirements of currently executed labor contracts, in the opinion of PICA staff, it would be preferable if the City were to proactively indicate, as part of the Plan, the fiscal initiatives it planned to undertake to cover potential future labor costs. The Revised Plan also projects a $33.2 million reduction in the cost of disability and workers compensation programs. This revision reflects cost savings that were achieved in FY14. In recent years, the City has implemented an extensive program to promote workplace safety and monitor claims. This program appears to be paying off in the form of reduced costs. The Plan assumes that the cost reductions in FY14 will continue over the life of the Plan. Another notable change in the revised Plan is a $32.0 million reduction in Fire Department projected obligations compared to the June 24 Plan. This reduction reflects the City s plan to achieve overtime savings through management initiatives. City officials indicate that there are substantial opportunities to reduce overtime in the Fire Department, due to the commitment of management and initiatives that are now underway. Another substantial change is a projected $40.5 million increase in pension payments over the life of the Plan. This increase reflects the effect of new actuarial assumptions adopted by the Board of Pensions and Retirement at its June meeting. The new assumptions are based on the most recent experience study covering the period July 1, 2008 through June 30, The study compared actual experience to actuarial assumptions 6

9 Table 2.6. Changes in Projected General Fund Obligations from June 26 Plan to September 24 Revision, FY15-FY19 Five-Year Financial Plan ($ in Millions) Agency/ Cost Center FY13 Actual FY14 FY15 FY16 FY17 FY18 Behavioral Health -- ($0.3) City Controller -- (0.3) City Council -- (1.4) Civil Service Commission Commission on Human Relations -- (0.3) Debt Service -- (0.8) Disability/Workers Compensation -- (5.8) (4.8) (5.6) (6.6) (7.6) (8.6) District Attorney Finance -- (0.9) Fire (4.0) (7.0) (7.0) (7.0) (7.0) First Judicial District Free Library -- (0.4) Health Benefits -- (12.0) (0.5) (2.5) (4.7) Human Resources -- (0.3) Innovation and Technology -- (19.8) (0.5) (0.5) (0.5) (0.5) (0.5) Legal Services Licenses and Inspections -- (0.4) Parks and Recreation Pension Payments -- (20.0) (0.9) Police Prisons -- (0.6) Property Assessment -- (2.7) (0.5) (0.5) (0.5) (0.5) (0.5) Public Health -- (5.1) (1.0) (1.0) (1.0) (1.0) (1.0) Public Property -- (12.1) Revenue -- (0.8) Social Security Taxes Streets Unemployment Compensation -- (2.7) Total -- (77.9) FY19 related to salary increases, retirement, disability, and mortality. Among the most significant deviations were lower than expected salary increases and higher than expected mortality. The Board adopted new assumptions based on the most recent experience. The net impact of the assumptions is to increase the City s required annual minimum municipal obligation (MMO) payment for all operating funds by approximately $20 million, beginning in FY16. The Revised Plan reflects the impact of these revised assumptions, as well as a preliminary estimate of the impact of FY14 investment returns and higher employee pension contributions required under recent labor contracts. 7