Revenue shortfalls place downward pressure on Santa Ana’s city budget

Santa Ana officials say they’re working hard to plug major long-term budget shortfalls, as auditors warn the deficits will become harder to bridge in future years due to rising employee pension costs and a slowdown in revenue growth.

If the deficits continue, and the city has to draw from rainy day funds, it could be pushed to the brink of bankruptcy a few years from now, like it was in 2011. City staff say they’re trying to find ways to save costs and grow revenues so they don’t have to draw from the reserves.

“We’re going to be working really, really hard to not touch [the reserves],” Deputy City Manager Robert Cortez said in an interview.

The City Council is scheduled to vote the week of June 19 on downsizing the city jail to save costs, but there would still be a roughly $9 million annual gap in each of the next two fiscal years, which is expected to grow even larger afterward.

If the City Council, staff and unions come to an agreement that finds $9.3 million in additional ongoing savings next fiscal year, Cortez said, that solves the next two years of shortfalls and helps significantly with any shortfalls beyond that.

City staff are projecting major structural budget shortfalls that grow significantly in the coming years: $2.2 million this fiscal year, $14.4 million next fiscal year and $19.5 million the year after.

And it’s expected it could get worse if nothing’s done.

“As we’re going into this period now of an economic slowdown … the bad news is that expenditures are not gonna slow down,” said Mark Alvarado, an auditor hired by the city to examine its reserve policies, during a recent presentation to the council.

“It’s gonna be more difficult to be balancing budgets in year three, and in year four, and in year five than it is in the ’17-’18 budget.”

Pointing to the shortfalls, several council members are now taking a hard-line position on expanding the city workforce and growth of employee compensation in labor negotiations.

Additionally, auditors found the city, under former City Manager David Cavazos, wasn’t transparent about the fact that in the middle of the fiscal year, it was changing the use of funds that had been budgeted to fill vacant employee positions.

And the news comes after years of rosy budget projections from Cavazos, who was ousted by a majority of the City Council in December.

The budget shortfalls are largely due to the recent elimination of the city’s contract with U.S. Immigration and Customs Enforcement to house its detainees in the city jail (loss of $11 million per year) and skyrocketing pension costs (up $22 million since 2014 and continuing to rise). Another factor is the city reducing its potentially illegal transfers from enterprise revenues – generated by water, trash and sewer bills – to cover city operating costs for general services like police and parks.

And as employee pension costs continue to rise significantly, tax revenues are expected to slow in their growth in the coming years, further exacerbating the shortfall.

The city’s share of pension costs have skyrocketed in recent years, from $11.9 million in fiscal year 2014 to $25.5 million this fiscal year and a projected $33.8 million next fiscal year.

About a quarter of the city’s employees work for the police department, and police account for 61% of the anticipated pension costs next year.

City officials expect to have to use $2.2 million in reserves to cover this year’s shortfall. The latest available figures put the city’s general fund reserves at $77 million last June.

Among the options City Council members are slated to vote on next week is a directive to downsize the city’s mostly empty jail from a 512-bed Type II jail to a smaller holding facility. That move would save $4 million next fiscal year and $8 million the following year, according to staff.

Even with those savings, city staff say another $18 million in reserves is needed over the following two fiscal years – $9.3 million and $8.9 million, respectively – if additional cost savings and revenue increases aren’t found.

Last week, council members voted to change the city’s reserve policy to allow operating reserves to dip to 16.7% of annual expenditures, from the current level of more than 20%.

The decisions came just after Alvarado presented council members with the reserves analysis performed by his company, Kelly Associates Management Group.

Among other issues, auditors found problems with the way the city, during Cavazos’ time as city manager, was having city departments not fill their empty budgeted positions and then re-designating those funds for other purposes in the middle of the fiscal year.

While it’s not uncommon for other cities to find savings through unspent personnel costs, Alvarado said, a formal process was put in place in Santa Ana to “take those savings” from department budgets in the middle of the fiscal year and redirect those expenditures to something else.

That left the public with the impression that the city could fund, say, 200 police officers, when in reality it was only allocating the money for 180 officers, he said.

Alvarado stressed that if this process continues, it’s important to make clear how many employees the city actually can fund based on the dollar amount in the department’s budget.

Councilwoman Michele Martinez said she was frustrated at the “misinformation” that Cavazos provided the City Council about city finances.

She said she had introduced the proposal to hire an auditor in December “due to the financial inaccuracies” about the city’s financial positions. She was a deciding vote that month to oust Cavazos from his position as city manager.

Martinez said she wants to be able to hire more police and code enforcement officers, “but the reality is that we need a true assessment” of the city’s finances, not just the reserves. She indicated she wouldn’t vote for the city budget or move forward with labor negotiations until that happens.

In the long term, Alvarado said cities across board are looking at potential shortfalls caused by costs increasing – particularly for employee pensions – while revenues slow down and potentially decline.

“Pension spikes” are going to hit cities “hard,” he said.

Alvarado said it’s important that the city do long-term financial projections “frequently,” which should be factored into the city’s labor negotiations.

Santa Ana’s general fund reserves have dramatically grown in recent years, he noted, reaching $77 million at the end of the 2016 fiscal year – which he said was “great.”

But in a word of warning, Alvarado said those reserves had been above $40 million about a decade ago, but experienced a “huge drop” during the economic downturn, to the point where they were nearly depleted.

The city came close to having to declare bankruptcy in 2011 and ended up outsourcing its fire department and cutting police spending to make ends meet.

Councilman Sal Tinajero, who is among the council members who have clashed with the city police officers’ union over the past year, said the city’s financial sustainability will require limiting the growth of employee costs.

He said it’s important for the public and unions to understand “we cannot continue to increase different salary scales” when there’s an economic slowdown, since the city would ultimately have to cut staff.

In a comment apparently aimed at Councilman Jose Solorio, who often says the city needs to fill more employee jobs to provide key services, Tinajero said when council members say they should increase positions, “they are acting in a very irresponsible manner.”

Solorio, meanwhile, said “the city has a history of underestimating revenue,” which he said keeps the number of employees smaller than it could be.

He said he believes the city has in the past been content to let itself “shrink and shrink and shrink” instead of doing things like additional business taxes to keep the city at the “same levels of services” and staffing “and to grow it.”

To raise revenues, council members also talked about a potential tax increase.

Listening in the audience were the heads of the city’s two main labor groups: Gerry Serrano of the police union and Mike Lopez of the general employees’ union.

Lopez told council members the general employees he represents stand ready to partner with the council on generating extra revenues and saving costs. Serrano didn’t comment publicly.

Mayor Miguel Pulido had a different takeaway than the rest of his colleagues, saying “as we have more revenue, and this, this audit gave us a pretty good picture of things, we’ll be able to do more” for community members.

“Whatever we can afford, let’s try to get those positions filled,” Pulido said, adding the city will get “a lot of revenue” from the OC Streetcar project and over $1 million per year from a proposed hotel project on Main Street.

This story was reported by Voice of OC, a nonprofit investigative newsroom, as part of a publishing agreement with TimesOC. Nick Gerda covers county government and Santa Ana for Voice of OC. You can contact him at ngerda@voiceofoc.org.