Paying for Local Government

Local government services and programs cost money. Cities and counties have to pay the people who work for them. Local governments must also provide the buildings, equipment, and supplies for conducting public business. They must pay for public services they buy from businesses or community groups. In North Carolina local government services and programs cost billions of dollars each year. In 2001, North Carolina county governments spent more than $9.3 billion, and North Carolina cities and towns spent more than $6.8 billion to provide services for the people of North Carolina.

Within limits set by the state, local officials are responsible for deciding what to spend for local government and how to raise the money to cover those expenses. This chapter focuses on these issues.

A budget is a plan for raising and spending money. North Carolina law requires each city and each county to adopt an annual budget every year, including planned expenditures and revenues for the following year.

The State of North Carolina sets very strict requirements that local governments must follow in managing their money. That was not always so. During the 1920s many cities and counties in the state borrowed heavily. When the stock market crashed in 1929 and thousands of people lost their jobs, many local governments went even more heavily into debt. By 1931, the state's local governments were spending half of their property tax revenues each year on debt payments. More than half of the state's cities and counties were unable to pay their debts at some time during the Great Depression of the 1930s.

To restore sound money management to local government, the General Assembly created the North Carolina Local Government Commission and passed a series of laws regulating local government budgeting and finance. The Local Government Commission enforces those laws and with the Institute of Government of the University of North Carolina at Chapel Hill provides training and advice to local government budget and finance officers.

State regulation provides a strong framework for sound money management. But local officials still have primary responsibility for using city and county funds wisely and well. During the past 50 years, North Carolina local governments have established a national reputation for managing public money carefully and providing the public with good value for their dollars.

BUDGETING

In North Carolina, local government budgets must be balanced. That is, the budget must indicate that the local government will have enough money during the year to pay for all the budgeted expenditures. Expenditures can be paid either from money received during the year (revenue) or from money already on hand at the beginning of the year (fund balance). A balanced budget can be represented by the following equation:

Expenditures = Revenues + Fund Balance Withdrawals

Thus, if a local government plans to spend $1 million, it must have a total of $1 million in revenues and fund balance. If it plans to raise only $900,000 in revenue, it needs to be able to withdraw $100,000 from the fund balance. If it plans to raise $950,000, it will need to draw only $50,000 from the fund balance.

The fund balance is like the local government's savings account. It helps the government deal with unexpected situations. Local government revenues are discussed later in the chapter. However, it is important to note here that the budget is based on revenue estimates—educated guesses about how much money the city or county will receive during the coming year. To be safe, local officials usually plan to spend nothing from the fund balance. That is, they budget expenditures equal to estimated revenues. Then, if actual revenues are less than expected, they can withdraw from the fund balance to make up the difference. If revenues exceed actual expenditures, the money is added to the fund balance. If a government regularly withdraws from its fund balance, it will eventually use all its savings and have no "rainy day" money left.

Deciding What to Spend

In North Carolina, annual budgets run from July 1 of one calendar year to June 30 of the following calendar year. This period is called the government's fiscal year because it is the year used in accounting for money. ("Fisc" is an old word for treasury.) "Fiscal year" is often abbreviated "FY." FY 2002, for example, means the fiscal year from July 1, 2001, to June 30, 2002. Each year the local governing board must adopt the annual budget before the new fiscal year begins on July 1.

Several months before the fiscal year begins, each local government department estimates how much more or less their services will cost in the coming year. For example, if a solid waste collection department is going to continue collecting the same amount of waste from the same number of places at the same frequency, its costs will be about the same. Fuel for the trucks may cost a little more, but if services do not change, next year's expenditures should be quite similar to this year's expenditures. (Raises for employees are often considered separately from department estimates. They will be discussed later.)

If, in the example, the city council decides to reduce the number of trash collections from twice a week to once a week, the department can reduce the number of employees and the number of miles driven by the trucks. The department will pay less in salaries and fuel bills and perhaps not have to buy replacement trucks as often. The change in services will therefore reduce estimated expenditures for the department.

On the other hand, if the city plans to annex several neighborhoods, the department may need to add trucks and crews to collect solid waste there. These new expenses for additional service will add to estimated expenditures for the department.

After department heads determine how much they think they will need for the next fiscal year, they discuss these estimates with the manager. The manager also looks at expected changes in the other expenditures. For example, health insurance premiums for employees might be expected to increase. Or, employees' salaries might need to be raised so the local government can stay competitive with private employers. In addition to department requests, the manager must add increases that affect all departments.

At the same time, the manager also prepares revenue estimates for the coming year. After all the estimates for both expenditures and revenues are complete, the manager compares the totals. If estimated revenues exceed estimated expenditures, the manager may recommend lowering local tax rates, adding to the fund balance, or beginning new programs and services. If estimated expenditures exceed revenues, the manager may recommend cutting expenditures, raising taxes or fees, or making withdrawals from the fund balance. It is the manager's responsibility to propose a balanced budget to the governing board.

The proposed budget lists the amount of money each department will spend in the coming year. It also lists the amount of money expected from each revenue source for the coming year and the amount the manager proposes to withdraw from (or add to) the fund balance.

The governing board reviews the proposed budget. With the proposed budget is information about the current year's budget, expenditures, and revenues. Council members and commissioners usually pay particularly close attention to proposed changes in spending to decide whether the services their government provides are the best use of public funds. They also pay careful attention to proposals to raise tax rates or the fees people pay for services.

Before the governing board adopts the budget, it must hold a public hearing. This provides people in the community an opportunity to express their views about the proposed budget. At any point in its review, the board can change the proposed budget. The annual budget must be adopted by a majority of the board.

In the News . . .
Photo by Tony Dills / Western North Carolina Nature Center The Nature Center was one of several parks and recreation facilities considered for improvements by the Buncombe County Commissioners.
Funding Will Determine How County Addresses Recreation Needs By Julie Ball
Replacement of the Erwin pool, renovations at Owen Park and improvements to the WNC Nature Center are at the top of Buncombe County's list of recreation needs, but just how quickly those needs are addressed will depend on funding. "It all depends on funding," said Recreation Services Director Annette Wise. Wise presented the county's recreation needs to county commissioners during a recent retreat. The Recreation Services Department plans to seek increases in fees at the Nature Center, pools, golf course and for Aston Park memberships, but the increases are designed to cover growing operational costs, not capital needs, according to Wise. Wise said she hopes the county can get grant money to help pay for some of these projects. "I think a lot of our projects are going to require federal grants," she said. The most pressing needs are replacing the Erwin pool and renovations at Owen Park. The Erwin pool is in desperate need of replacing, according to Wise.	"We're hoping we can get through this summer. It's debatable now," Wise said. "The winter really took its toll on that pool. If there isn't a leak under the pool, we can open." The pool is 25 years old—the oldest of the county-run pools. The cost of replacing the pool and decking is estimated at $900,000. Another $400,000 is needed for improvements to Owen Park. The needs at Owen include replacing the lighting system, fence work and drainage. County manager Wanda Greene said those crucial projects will get first priority, and the county will do its best to fund the Erwin pool and Owen projects in the upcoming budget. "We see the Erwin pool as a 'have to'," she said. The Recreation Services Department also wants to make improvements to the Nature Center to address parking problems and a growing need for classroom space, but those projects may require other funding sources. The amusement rides that have been a tradition at Recreation Park have been sold, and Wise said there are plans to redo the park. Plans include adding a large playground, adding a "kiddie water park" near the Rec Park pool and adding a Nature Center visitor center.	The Nature Center gift shop would move into the visitor center. There would also be space for traveling exhibits and possibly an area for Nature Center visitors to eat. Initial Nature Center projects are expected to cost between $5 million and $7 million. "It's a wonderful thing to have, but it's not as high a priority," Greene said. Eventually, Wise said Recreation Services officials want to tackle several other projects including improvements at Lake Julian, renovations at the Skyland Recreation Center, improvements at the golf course and adding parking at Aston Park. "Those projects may be a bit further away," Wise said. Long-range goals also call for adding an athletic park in the Erwin district. —Reprinted by permission of Asheville Citizen-Times News February 8, 2001

Spending Public Funds

In adopting the budget, the governing board formally appropriates the expenditures. That is, the board authorizes spending the amount to be spent for each department during the coming fiscal year. The finance officer keeps records of all expenditures. Before each bill is paid during the year, the finance officer checks to see that there is enough money left in the department's appropriation to pay that bill. Expenditure records also help the manager coordinate government operations and, as we have seen, help in planning the next year's budget. If the government needs to spend more than the amount listed in the budget for a particular purpose, the council (or commission) must pass a budget amendment.

Each local government's budget reflects the choice of services the local governing board has made. Local government budgets also reflect the way the General Assembly has allocated service responsibilities. Most municipalities spend much of their money on utilities, public safety, and streets. Most counties spend a majority of their money on education and human services.

Figures 7.1 and 7.2 show how North Carolina local governments spent their money in the 2000-2001 fiscal year. (The most recent figures and additional detail can be found on the state treasurer's web site at ncdst-web2.treasurer.state.nc.us/lgc/units/unitlistjs.htm.)

Local governments that borrow money to build new facilities must repay what they have borrowed—the principal—plus interest. Typically, these payments are spread over several years. These payments are called debt service. Debt service is often part of local government budgets, for reasons discussed in the following section.

CAPITAL PROJECTS

When a city buys land for a new park or a county builds a new jail or landfill, the project usually costs too much to be paid for from current revenues or from fund balance. Major purchases like land or buildings are called capital projects. Local governments usually borrow money to finance large capital projects, although annual revenues or fund balance may be sufficient for small projects.

Borrowing has several disadvantages. Borrowing money is expensive. The borrower (in this case, the city or county) must pay interest to the lender. Borrowing also commits the government to payments on the debt for a period of years, often 20 or more. Debt service payments will need to be included as expenses in each annual budget until the debt is paid off.

However, borrowing for capital projects also has advantages. One advantage is that by borrowing, the government can do the project right away. A new landfill or jail may be needed very soon, much sooner than the government would be able to save enough money to pay for the project. Another advantage to starting the project right away is that the costs of land and construction may go up while the government waits for funds to become available. While costs go up, the value of the dollar may go down due to inflation. Inflation helps the borrower, however. Because of inflation, the dollars the government pays back may be worth quite a bit less than the dollars the government borrowed several years earlier. Borrowing for capital projects also places responsibility for paying for the project on those who will use it. Capital projects have many years of useful life. Borrowing spreads out paying for the project over many of those years.

Governments borrow money by issuing bonds. Two kinds of bonds are used by North Carolina cities and counties. General obligation (G.O.) bonds pledge the "faith and credit" of the government. That is, the local government agrees to use tax money if necessary to repay the debt. Bondholders can even require local governments to raise taxes if that is necessary to pay the debt. Revenue bonds are repaid from revenues the project itself generates. Thus, if a parking deck is built with revenue bonds, the debt is repaid with revenues from fees paid by those who park in the deck.

Under the North Carolina constitution, G.O. bonds cannot be issued unless a majority of the voters approve. A referendum must be held to allow voters to approve or reject all G.O. bonds proposed by city councils or boards of commissioners. G.O. bonds are typically used for nonrevenue-producing projects like schools, courthouses, parks, or jails. Sometimes government officials also prefer to use G.O. bonds for revenue-producing projects like sewer plants, parking decks, or convention centers. This is because G.O. bonds usually have a lower interest rate than revenue bonds. Investors feel more secure about the repayment of their money when a bond is backed by local government's power to tax.

The installment-purchase agreement is an alternative to borrowing that some governments use. Under this arrangement, someone else (a business or a civic group) builds or buys the facility the government needs. The government then gets to use the facility in return for an annual payment. Unlike rental agreements, however, in this kind of contract, the government is actually buying the property through its payments. Governments can not pledge their taxing power when entering into installment-purchase agreements. The debt is backed by the property being purchased. If the government fails to complete its payments, the facility belongs to those who are leasing it to the government.

REVENUES

Local governments get most of their money from taxes, user fees and charges, and funding from other governments. There are also several smaller revenue sources, including interest the government earns on its fund balance. The local economy and decisions of state and federal governments play a major part in local government funding. Local officials have only a few ways to increase the amount of revenue their local government receives.

Local Taxes

The property tax is the most important local tax. Property taxes are often the largest single source of revenue for a local government, sometimes providing more than half of all revenues. The property tax is based on the assessed valueof property.

Assessing establishes the value of property for tax purposes. Real property (land and the buildings and other improvements on it) is reassessed every eight years, although some counties do so more often. Personal property(cars, trucks, business equipment) is reassessed each year. According to North Carolina law, tax assessments are supposed to be at the fair market value of the property. That is, the assessed value should equal the likely sale price of the property. If a property owner thinks an assessed value is too high, he or she may appeal it to the county commissioners when they meet as the "board of equalization and review."

Economic development increases the value of property in a city or county, thereby increasing its property tax base. New real estate developments are assessed as they are completed, so they immediately add to a jurisdiction's total assessed value. Unless there is new construction, however, real property is reassessed only every eight years in most counties. The market value of property may change a great deal during the eight years between reassessments.

The property tax rate is the amount of tax due for each $100 of assessed value. If a house and lot are valued at $100,000 and the property tax rate is $.90 per $100, the tax due on the property will be $900.

The property tax is one of the few sources of revenue the local governing board can influence directly. For that reason, setting the property tax rate is often the last part of budget review. To set the rate, local officials must first determine how much the city or county needs to raise in property taxes to balance the budget. All other estimated revenues are added together. That figure is subtracted from the total expenses the local government plans to have. The balance is the amount that must be raised through property taxes.

To set the property tax rate, the amount which the government must raise through property taxes is divided by the total assessed value of property in the jurisdiction. That gives the amount of tax which needs to be raised for each dollar of assessed value. To get the tax rate per $100 of assessed value, we multiply by 100. For example, if a city has a total assessed value of $500 million and needs to raise $4 million from property taxes, its property tax rate would be $.80 per $100 of assessed valuation.

The higher the assessed value of taxable property, the lower the tax rate needed to produce a given amount of revenue. If the assessed value of property in our example above were $600 million, the city could raise $4 million from property taxes with a property tax rate of only $.67 per $100 of assessed value.

The property tax rate for the next fiscal is set by the local governing board when it adopts the annual budget. Sometimes there is considerable controversy over raising the property tax rate. Many people are quite aware of the property tax. Property owners get a bill from the local tax collector for the entire amount each year. Thus, people know exactly how much they pay in local property tax. (In contrast, the sales tax is collected a few pennies or a few dollars at a time. Most people lose track of how much they pay in sales tax.) Also, the connection between the property tax and the services government provides may be difficult to see. After all, people get public services all year long, but the property tax bill comes only once a year.

Most property owners pay their taxes. In North Carolina, more than 95 percent of all property taxes are typically paid each year. When taxes on property are not paid, the government can go to court to take the property and order it sold to pay the tax bill.

Property tax bills are sent out in August, early in the new fiscal year, yet no penalties for late payment are imposed until January. Therefore, most people wait until December to pay their property taxes. Local governments must pay their bills each month. They cannot wait until they have received property tax payments to pay their employees and suppliers. This is another reason the fund balance is important. Local governments need to have money on hand to pay their bills while they wait for property taxes to be paid.

In addition to the property tax, some counties and cities have been granted authority from the General Assembly to levy certain other taxes. These include taxes for the privilege of doing business, keeping a dog or other pet, or owning an automobile. More than 70 counties and a few cities have authority to levy occupancy taxes on hotel and motel rooms. A smaller number of local governments have authority to levy a tax on the price on restaurant meals or on transfer of land. The General Assembly limits the amount of these taxes, usually to a few dollars each.

State-Collected Taxes

The sales tax provides a substantial part of most local governments' revenues. State law permits each county to levy a tax of $.02 on each dollar of sales in the county, and all the counties do so. (The state levies an additional $.045 on all sales except food. The county tax applies to food, as well. Mecklenburg County has special authority to levy an additional half cent tax on sales in that jurisdiction.) Businesses collect the money from their customers each time the customer pays for a purchase. The state collects sales tax receipts from businesses throughout North Carolina and then returns the local portion of the sales tax to the counties and the municipalities within them.

Sales tax revenues are divided between county and municipal governments according to formulas established by the General Assembly. Each board of county commissioners decides whether sales tax revenues will be divided with that county's municipalities on the basis of a population formula or on the basis of the amount of taxes collected in each jurisdiction. City councils have no control over how much sales tax revenue they receive, and county commissioners can only decide whether to divide sales tax receipts with cities either according to population or according to where the tax was paid. Only the state legislature can raise the sales tax rate. Neither city nor county officials have control over how much money the sales tax produces for local government.

Because the sales tax rate is set by the General Assembly, the amount of revenue in any year depends on economic conditions. The more people spend on purchases, the greater the sales tax revenue. When the economy slows down and people buy less, sales tax revenues go down, too.

North Carolina has a separate tax on the sale of gasoline. A part of the state gasoline tax is distributed to each municipality in the state. This money, called "Powell Bill" funds, can be used only for the construction and maintenance of city streets. In FY 2001, more than $129 million dollars in Powell Bill funds were transferred from the state to North Carolina cities and towns.

Because the gasoline tax is a tax on each gallon of gasoline purchased, when gasoline prices go up and people buy less gasoline, Powell Bill funds go down. This leaves cities with less money for streets.

Cities and counties also receive money from the state for a variety of taxes on such things as sales of land, and beer and wine sales. The state also pays local governments money to replace some of the revenue lost when the state removed some property from the local tax base. Local officials have no control over these revenues, however. The General Assembly sets these tax rates and determines how the funds will be distributed.

Editorial cartoon by Donna Ree

County commissioners often struggle to finance local services like public schools while dealing with more state mandates and less state funding.

User Fees

Local governments charge customers for many of the services they use. These charges are called "user fees." You pay a fee to swim at the public pool or play golf at the public park. You pay a fare to ride on the city bus. Cities and counties with public water supplies and sewer systems charge water and sewer customers based on the amount of water used. Some North Carolina cities also operate the local electric service and charge customers for the electricity they use. These charges are all based on the cost of providing the service. The people who use these services help to pay for the direct benefits they get from them.

Photo by the City of Charlotte
Bus riders pay only a part of the cost of providing bus service. City and federal tax funds help subsidize bus service. The public benefits from bus ridership through decreased traffic congestion.

In many cases, the users do not pay the entire cost of providing the service, however. Governments subsidize services because the public also benefits from the service. For example, city bus fares are usually heavily subsidized because having people travel on buses reduces the number of cars on the streets. Bus riders reduce traffic congestion and parking problems for those who do drive cars. Bus riders reduce the need for new street and parking construction.

Local governing boards have the authority to set user fees. Next to the property tax, user fees are the largest source of local government revenue that local officials can control. As local governments have been asked to do more, local officials in many jurisdictions have begun to rely more on user fees to raise the necessary revenue. Fees for collecting solid waste have been established. Fees for building inspections and other regulation have also been increased to cover more of the costs of conducting these regulatory activities.

Increased reliance on user fees means that more and more of the cost of public service is paid directly by the customer who gets the service. Less is paid as a subsidy from other sources, and so the cost for each user goes up. When the public has a great interest in seeing that everyone gets the service, regardless of ability to pay, user fees are kept low and taxpayers subsidize the cost of the service. User fees set at the full cost of service may mean that public benefits are lost. For example, if bus riders have to pay the full cost of buying and operating the buses, fares may be so high that most riders choose to have their own cars, adding to traffic congestion and the need for more street and parking construction.

State and Federal Aid

Local governments get some of their revenue from state and federal governments. Grants and other aid programs help local governments meet specific needs. During the 1960s and 1970s, intergovernmental assistance was a major source of local revenue. During the 1980s, many federal grant programs were abolished or greatly reduced and intergovernmental assistance became a much smaller part of local government revenues. Still, several important aid programs remain.

Community Development Block Grants help cities and counties improve housing, public facilities, and economic opportunities in low income areas. Projects funded under this federal program include installation of water and sewer lines, street paving, housing rehabilitation, and other community improvements.

Many social service benefits, such as Temporary Assistance to Needy Families, Medicaid, and Food Stamps are paid largely with federal funds. State grants also help to pay for some of the costs of social service programs. Local employees administer these programs. They determine who is eligible and see that appropriate benefits get to those who qualify. Counties also get some federal and state funds to help pay these administrative costs for social service programs, although most of the administrative costs must be paid from county funds.

State and federal funds are also provided to counties to support health and mental health services. A complex set of programs and regulations governs how these funds are used.

Other Local Revenues

When a city or county extends water and sewer lines to new areas, the owners of the property getting the new lines typically pay the local government a special assessment. The assessment helps cover the cost of constructing the new lines. Having public water supplies and sewer service available to the property increases its market value, so the owner is charged for the improvement. Similarly, cities usually charge property owners along a street for paving the street or installing sidewalks along it.

Interest earned on the fund balance can be another important revenue source. Most local governments try to maintain a fund balance equal to 15 to 20 percent of annual expenditures. This provides a ready source of funding for months when tax collections are slow. A sizable fund balance can also help cover an unexpected decrease in revenues. (Remember, local officials have little control over most of their revenues and cannot change the property tax rate once it is adopted with the annual budget.) Until the funds are needed, the fund balance can be invested and the interest added to government revenues.

For most municipalities, utility user fees are the biggest source of revenue. Property taxes are the county's largest source of revenue. Figures 7.3 and 7.4 show the various sources for FY 2001 municipal and county revenues.

REPORT TO THE PEOPLE

At the end of each fiscal year, every local government in North Carolina prepares an annual financial report. This document summarizes all of the government's financial activity: what it has received, what it has borrowed, what it has spent, what it is obligated to spend, and what it has in the fund balance. Each local government publishes its annual financial report, has it audited by an independent accounting firm, and files a financial summary with the Local Government Commission.

Preparation of the report helps local officials better understand the financial situation of their government. The independent audit and the report to the Local Government Commission serve as checks on the accuracy of the report and the legality of the government's financial dealings. And the publication of the report informs citizens about their local government's financial condition.

DISCUSSION QUESTIONS

1. Why is the annual budget important to each local government in North Carolina?

2. Why do local governments try to maintain a sizable fund balance?

3. How do user fees differ from taxes?

• What are the advantages of user fees as local government revenues?

• What are the disadvantages?

4. Get a copy of the annual budget for your county or city. How much did that government spend last year?

• How much did it receive?

• How large was its fund balance?

5. What are the local property tax rates for your county and city?

• What are the total assessed values for each of those local governments?

• How much additional revenue would an increase of one cent in the property tax generate for each?

Local Government in North Carolina, Second Edition- Chapter 7, Paying for Local Government.
Copyright © 2003 by Gordon P. Whitaker and the North Carolina City and County Management Association.