Free Cash, the CIP, and the Supplemental Capital Budget: A Primer on Newton’s History of Capital Planning and Expenditures
There is a great deal of confusing terminology surrounding the City of Newton’s capital planning and spending process and our pattern of budgeting and funding capital improvements differs from most other communities and organizations. Here is a short primer for anyone who is interested in the topic.
I. Terminology
Here are some of the terms used to describe aspects of Newton’s capital planning and spending process:
Annual Operating Budget— Similar to other Massachusetts cities and towns, Newton develops an annual operating budget each Spring. The budget is submitted by the Mayor to the Board of Aldermen, which has the authority to cut it or disapprove it, but not to increase funding for any given item, although the Board may issue “resolutions” requesting increases in a given area. The Board of Aldermen has 45 days in which to act on the Mayor’s budget. If the Board fails to act within this time, the budget is automatically adopted as proposed. If the Board rejects the Mayor’s budget, a negotiation period ensues in which a budget acceptable to the Board of Aldermen must be filed and passed before the July 1 start of the new fiscal year. Historically, Newton’s annual operating budget has included conservative revenue estimates in order to generate the “free cash” (see below) used in funding the “supplemental capital budget” in the Fall. Because major capital expenditures are traditionally included in the supplemental capital budget, the annual operating budget usually only includes small, recurring capital items and routine maintenance. These budgeting practices were changed with the issuance of the Fiscal Year 2008 budget (see History, below, for more information).
Free Cash— At the end of each fiscal year, the total revenues and expenditures from the previous year are calculated. City financial officers then submit these numbers to the state, which determines the uncommitted fund balance, which it certifies as “free cash.” By budgeting revenues conservatively, Newton has been able to generate significant amounts of free cash historically. While some of our free cash has been expended on unanticipated snow and ice emergencies, most of it had been used to fund the “supplemental capital budget” (see below). For the last dozen years or so, a significant amount of free cash has been diverted to close budget gaps in the following year’s annual operating budget (see History, below, for more discussion).
Supplemental Capital Budget— Rather than including major capital expenditures in the annual operating budget, the City of Newton has for many years had a policy of conservatively estimating revenue during our annual budget process each Spring and then using the previous year’s free cash to fund a “supplemental capital budget” in the Fall that addresses some of our major capital needs, like fixing buildings and streets and replacing trucks.
Capital Improvement Plan (CIP)— The Supplemental Capital Budget is often confused with the Capital Improvement Plan (CIP), as it has been traditionally bound into the same volume. However, the supplemental capital budget is a list of expenditures for the current fiscal, usually funded out of free cash, while the CIP is a five year plan that lists and prioritizes projected capital expenditures for the next five fiscal years. Since we are currently in Fiscal Year 2008, this Fall’s supplemental capital budget will allocate funds to be spent prior to June 30, 2008 (the end of our fiscal year), whereas the CIP will list capital expenditures for Fiscal Years 2009 through 2013.
II. History
Former Mayor Ted Mann had a policy of spending an amount equal to 5-10% of the annual operating budget on capital improvements. During his last year in office (Fiscal Year 1993), more than $11 million (not including water and sewer system improvements, which are separately funded) was spent on capital improvements, compared with an operating budget that year of approximately $140 million.
In recent years, free cash has been diverted from use in the supplemental capital budget to close projected gaps in the following year’s annual operating budget. In this manner, funds that had been traditionally used to repair aging buildings and streets and to replace trucks and other equipment were shifted to cover salaries and other ongoing expenditures. This practice began under the Concannon Administration and has been continued during the Cohen Administration. In Fiscal Year 2006 (the most recent year for which full data are available), less than $8 million was spent on capital improvements (exclusive of water/sewer and Community Preservation Act-funded projects), as compared to an annual operating budget of nearly $300 million, which is a capital investment level of less than 3 percent (down from about 8 percent in 1993).
The current annual operating budget relies on a record $3.4 million of last year’s free cash. This reliance would not be sustainable in the new fiscal year by itself, but is further complicated by the introduction of a new financial practice in Fiscal Year 2008: ending the practice of conservatively estimating revenue. Since conservative revenue estimates were the primary source of free cash, it is reasonable to expect that at the end of the current fiscal year, we will find ourselves with very little free cash available to fund either the Fall, 2008 supplemental capital budget or the Fiscal Year 2009 annual operating budget.
The change in revenue estimation methodology would be prudent had it been coupled by a corresponding increase in the amount of funds allocated to capital projects in the annual operating budget (in effect obviating the need for the supplemental capital budget). However, the Fiscal Year 2008 annual operating budget only included an increase in capital spending of $500 thousand, coupled with increased revenue estimates of more than $3 million more than would have been arrived at using the conservative methodology.
The result of the changes in policy associated with the Fiscal Year 2008 operating budget is to build in a deficit to the Fiscal Year 2009 annual operating budget that will be deliberated this coming Spring. This problem is further exacerbated by other one-time sources of funding relied upon by the current year’s budget (most notably a one-time adjustment of $800 thousand to the amount set aside each year for tax abatements) and anticipated increases in spending that will begin next year (most notably the repayment of bonds issued in conjunction with the Newton North High School project).
Paying for the new high school presents twin challenges: protecting the annual operating budget against the diversion of funds to pay for this project and setting aside adequate funds to address the City’s other capital needs. The Cohen Administration’s current CIP anticipates the issuance of $160.3 million in new debt for capital projects over the five year span from Fiscal Year 2007 through Fiscal Year 2011, of which $141 million will be for Newton North High School. In other words, 88% of new debt issued over the next five years is anticipated in being spent on one project and that is before the recent price increases for the new high school. As a result, it will be necessary to fund needed capital improvements from other sources during this time, putting additional pressure on the annual operating budget.
III. Sources
All of the numbers referenced in this primer can be found in the City’s annual operating budgets and Capital Improvement Plans. Recent editions are available on-line through the City of Newton Web Site. Other financial analysis and data can be found on the Comptroller's page of the City Web Site. Older budget documents and CIPs are available in printed form from the City Clerk’s office. Here are links to some of the documents referenced in this primer:
Fall, 2006 Capital Improvement Plan
