Surprise! The Nation’s Most Fiscally Fit Cities are in California!

California has a reputation for fiscal mismanagement, so I was surprised to see several Golden State cities at the top of a city financial strength ranking I recently compiled for The Fiscal Times. The fact that California has some judicious public agencies does not necessarily negate the fact that, taken as a whole, the state’s public sector has shown poor fiscal stewardship. Last week, we estimated that California government obligations total $1.3 trillion or 52% of Gross State Product. The ability of some cities to maintain strong financials in such a spendthrift environment is worth examining. So, I investigated why Irvine, Fontana and Moreno Valley took first, second and third place for financial strength among US cities with more than 200,000 people as of 2015.

Some readers of the Fiscal Times ranking questioned my ranking criteria. I developed them over five years of studying public sector fiscal performance – and especially fiscal crises – dating back to the Depression. Some of my research was commissioned and published by the State Treasurer’s Office in 2013. In general, I have found that governments get into trouble when they have a heavy debt burden, suffer declining revenue and have an insufficient general fund balance.  My scoring method relies on these three factors.

For the most part, these variables conform to intuition, but some readers may be confused as to why I focus on general fund balance as opposed to overall cash. In statistical analysis, general fund balance proves to be a better predictor of financial distress than total cash. As an example, Vallejo declared bankruptcy in 2008 citing general fund exhaustion as a cause even though it had $100 million in cash (the city adhered to government accounting guidelines prohibiting inter-fund loans that can’t be paid back within one year).

The top three cities are all in the Greater Los Angeles Area, but display some interesting contrasts.

Irvine

Irvine, a rapidly growing city in Orange County, had the strongest fiscal health as measured by my criteria. The city has no bond obligations and a general fund balance equal to 75% of annual expenditures. Pension obligations when measured against overall revenue are modest compared to other major California cities, in part, because the city contributes extra funds to its CalPERS plans each year (over and above the actuarially determined amount).

Irvine was incorporated in 1971, at a time when it had only 11,000 residents. According to City Manager Sean Joyce, the city was able to grow in a sustainable manner because residents and councilmembers largely adhered to a master plan created by the Irvine Company, which originally owned the city’s land. Irvine now has a quarter million residents and enjoys a 3.3% unemployment rate.

Joyce told me that the city recently increased its target for unencumbered general fund reserves from 15% to 20%. While Irvine weathered the Great Recession better than most cities, it did experience a precipitous drop in sales tax revenue, illustrating the need for a robust cash cushion. The city is heavily dependent on sales tax revenue because it receives a relatively small proportion of ad valorem tax revenues collected by Orange County.

New infrastructure that provides citywide benefits is funded with cash reserves assigned to the city’s Asset Management Plan. In recent years, Irvine completed two grade separation projects with these savings, avoiding the need to issue bonds. The two projects – at Jeffrey Road and Sand Canyon – speed traffic and improve pedestrian safety, by replacing railroad crossings with underpasses. (California Policy Center recently recommended that High Speed Rail funds be re-purposed to fund grade separations along the CalTrain line in Silicon Valley).

For developments that benefit residents in specific neighborhoods, the city forms special assessment districts and issues bonds serviced by incremental property taxes charged to property owners in those districts. When I expressed the concern that this practice does not allow the city to minimize financing costs by leveraging what would almost certainly be a AAA bond rating, Director of Financial Services Kristin Griffith advised me that the city’s special assessment districts are borrowing at very low interest rates without using a rating agency. In 2015, an Irvine assessment district floated a series of bonds yielding ranging from 0.85% for a one year maturity to 4.34% for a 27-year maturity, without paying a rating fee to Moody’s or S&P.

Fontana

Fontana is located just 13 miles west of San Bernardino in California’s Inland Empire. While San Bernardino went bankrupt in 2012, Fontana kept its house in order and now ranks second in my national fiscal survey. In a press release announcing its high ranking, Mayor Acquanetta Warren said: “a commitment to living within our means has made us financially strong and able to provide the services and programs our city deserves.”

This outcome shows that socioeconomic factors do not necessarily determine a city’s fiscal fate. Institutions and management also play important roles. Lisa Strong, Fontana’s Director of Management Services told me about one major institutional difference between the two municipalities: Fontana is a general law city, while San Bernardino is a charter city.

While general law cities are governed by state code, California’s 121 charter cities follow governing procedures set forth in their own, voter approved documents. Although it may seem that charter cities are more independent, their charters can often hamper management flexibility by setting pay policies or restricting the ability to reduce employee headcount.

In Fontana, city managers addressed declining revenues by sharply cutting employee headcount. Over four years, the city reduced the number of positions from 636 to 544 through layoffs, elimination of vacant positions and early retirement incentives. In San Bernardino, provisions of the city’s charter made a similar response more difficult.

Economic conditions in the Inland Empire have been challenging for a long time. Fontana has addressed this challenge through careful budgeting. The city maintains a 15% general fund reserve that is only to be used for extreme contingencies like earthquakes. Strong told me that the Great Recession did not rise to the level necessary to tap the reserve, and so the contingency funds were left untouched. Over and above this contingency. Fontana maintains general reserve funds designated for Economic Stability (fair game during the recession) and PERS Rate Stability. This latter pool of cash is used to cushion the impact of increases in CalPERS employer contribution rates. It is replenished in years when CalPERS contribution rates declined (something that hasn’t occurred in a while) or when unexpected revenues become available.

Fontana also has relatively little debt.  In 2015, the city’s lease revenue bonds and loans totaled less than $60 million or just over a quarter of annual city revenue – quite low by national standards. Strong told me that the city had relied on its Redevelopment Agency to fund most new development. When the state abolished RDAs in 2012, Fontana drastically reduced capital spending.

Moreno Valley

Moreno Valley is also located within a short drive of the bankrupt city of San Bernardino. Like its neighbors, the city suffered through a housing crash and a collapse in economic activity, but remained solvent.  City Chief Financial Officer Marshall Eyerman told me that the city established a minimum general fund reserve for emergencies and contingencies equal to 15% of annual spending before the recession, and managed to maintain that reserve despite reduced revenues. With the economy strengthening, the city’s general fund balance grew to 56% of expenditures – most of which is unrestricted and uncommitted.

Because the city contracts fire services to CAL FIRE (a state agency) and policing to Riverside County, it does not have to negotiate with public safety unions.   During the recession, the city realized contract savings by reducing the number of firefighters under contract.

City Manager Michelle Dawson told me that the city has leveraged one time funds to meet long term municipal priorities while minimizing ongoing costs. For example, the city invested in a $2 million city-wide camera system which allows a smaller police force to prevent and solve crimes more efficiently.

In addition to controlling spending, Moreno Valley focuses on attracting employers, thereby increasing revenue. It’s approach to recruiting new businesses is captured by the Economic Development Department’s web site at http://www.morenovalleybusiness.com/. The city provides a variety of incentives to encourage employers to relocate including reduced utility costs and a concierge service that helps firms navigate the regulatory process and obtain fast approvals for their applications. These options appear to be more sustainable than offering businesses outright subsidies or reduced tax rates.

Business recruitment efforts have added 9,000 new jobs in the city, including automotive jobs related to the recent arrival of Karma Automotive, a luxury electric car manufacturer. Moreno Valley’s success in attracting employers mirrors that of Mississippi’s Golden Triangle, profiled on 60 Minutes in December 2016.

City officials have a strong commitment to engaging citizens in the budget process. Moreno Valley implemented Balancing Act, a web-based tool from Engaged Public, which allows users to simulate the budgetary impact of various policy changes. User can share their budget models and comments with government officials. The city also recently began issuing a Popular Annual Financial Report – a shortened version of government financial statements accessible to users without an accounting or financial background.

Conclusion

These profiles show that cities can pursue a variety of policies to promote financial health. Options such as contracting out public safety services, maintaining special reserves for fluctuations in retirement contribution rates or making pension payments above those actuarially required may not be available to all cities. But establishing minimum general fund reserve requirements, and abiding by them even when times are tough, would seem to be a universal requirement for fiscal health. Judicious use of debt is also important.

It was a pleasure speaking to city officials who took obvious pride in their communities and showed such strong dedication to economic and fiscal stewardship. These conversations made me realize that despite the fact that we all live in a profligate state, there are cities that take fiscal sustainability seriously. Even if we don’t live in one of these cities, we can learn from them – or, perhaps more importantly, encourage our elected officials and senior municipal administrators to emulate their best practices.

Marc Joffe is the director of policy research at the California Policy Center.