Monday, May 24, 2010

Consequences of the Budget, Part One

The FY 2011 budget passed by the Montgomery County Council is an historic event. Many things that would have seemed unthinkable just a few years ago happened at the same time: double digit funding reductions in many departments, no pay increases for employees, furloughs, repeal of a negotiated pension benefit, serious questions about the county’s AAA bond rating and an absolute drop in county spending. This was a moment when the unreal became all too real.

Let’s understand that few of the above decisions were made willingly. The nearly billion dollar deficit was created by a horrendous recession and a resulting massive drop in income tax collections. Suddenly, the county’s tax base was nowhere large enough to support the $4+ billion government it had built up in good times over prior years. Some, like County Executive Ike Leggett, Council Members Marilyn Praisner and Phil Andrews and a few merit staffers had warned that the big spending increases approved during Doug Duncan’s last term would be unaffordable over the long run. But no one believed the crash would hit with such acute and devastating force.

The County Executive proposed a Fiscal Year 2011 budget that reduced county spending by 3.5%. The budget passed by the council contained an overall reduction equaling that amount, but there were differences with the Executive’s proposal. For the record, here is a comparison between the Executive’s last budget of April 22 and the final budget passed by the council.

The events of the last few months will have wide-ranging implications in a variety of ways. First, the specific tax hike chosen by the county to help close the deficit will have dire competitive consequences. Second, the County Council’s relationship with the school system and the unions has fundamentally changed over the medium term. Third, the extremely serious challenges for the county’s long-run financial viability are becoming impossible to put off. And finally, all of the above will have political impact. Over the course of this week, we will examine each of these items in turn.


The most consequential decision in the budget process was one that was made by both the County Executive and the County Council very early on: not to break the charter limit on property taxes. The county’s charter requires a supermajority vote by the council to raise property taxes above the rate of inflation. The council voted to break that limit four times in seven years (FY 2003-2005 and FY 2009) in fiscal times that were not nearly as bad as now. The voters replied by passing the Ficker Amendment, which raised the supermajority required to break the limit from seven council votes to all nine. County elected officials perceived pushback from the electorate and vowed not to break the limit again – especially not in an election year.

This decision had a powerful impact on the budget. Property taxes account for 51% of all local tax revenues. The county already charges the maximum amount allowed by state law – 3.2% - on its income tax and that accounts for another 39% of local taxes. So now 90% of the county’s revenues were off the table for increases. The energy tax, which accounts for just 5% of local taxes, was the biggest remaining revenue item and so the executive branch targeted it for a hike.

But the problem with the energy tax is that it disproportionately impacts business customers, who pay 73% of the total levy. The Executive originally proposed increasing the tax by 39.6%. But warnings by bond rating agencies prompted him to revise the increase to 63.7% and a revenue writedown caused him to propose doubling it.

A council memo illustrated the devastating competitive consequences of that idea. Here is a comparison of the rates commercial customers would pay between different jurisdictions if MoCo’s energy tax had been doubled.

In the end, the council increased the tax by 85% but split the increase 50-50 between residents and businesses. Business customers faced a 58% tax hike. One council source explained it this way:

I think the decision to reduce the energy tax for the business community was a significant move for a council that is often thought of as anti-business. We reduced it by 42% from what Ike originally proposed through a combination of reallocation to residential customers (i.e., voters) and reduction of the overall tax by 15%. Ike’s proposal was almost obscene in terms of its impact on small business.
That may be true, but because the county made a political decision to avoid the property tax, it instead chose to rely on a job-killing measure that targets employers to help close its budget gap. (Fairfax chose to raise its property tax rate to deal with its own budget crisis.) Even with the reduction in the energy tax hike passed by the council, MoCo charges a FAR higher rate than its competitors. And MoCo raised this tax right after losing Northrop Grumman. Here is a transcript of a conversation between two business owners that will almost certainly take place at the next board of trade networking luncheon.

Business Owner A: “I’ve maxed out on my office space and am looking to move. What do you think about Montgomery County?”

Business Owner B: “They have a big, liberal government that spends a lot of money. And when they get into trouble, they sock it to business.”

Business Owner A: “Guess I’m not moving there!”
This sort of talk will go on for a long, long time and will be a BIG problem in attracting jobs. No new economic development authority will compensate for it.

We’ll look at the schools tomorrow.