City revenue update is a mixed bag

Last week the City Budget Office sent the City Council the customary November update on city revenue projections for this year and next, in time for the Council to incorporate the new figures into its budget planning. The news was mixed; it’s also a bit complicated and takes some unpacking to fully understand.

The first bit of news is that the closing of the sale of the Mercer Megablock property has once again been delayed, bumped into the first quarter of 2022 and pushing $66.5 million of revenues out into next year with it. On paper, that looks like a $66.5 million shortfall in 2021, and an equivalent increase in revenues next year. But in reality, the money has already been spent: the city lent itself $66.5 million from another City fund, with a promise to repay it when the sale closed. The fix for the delay is simple: the city will simply extend the “interfund loan” out until the first quarter of next year. That will require a bit of paperwork for the Council, but it’s a routine matter and not a big deal.

As for the rest of the $1.66 billion in General Fund revenues for this year, about 20 of the sources are seeing notable variances; some up, some down, mostly cancelling each other out. There are a few larger misses — and windfalls — that are worthy of note, however. The two largest misses are the payroll tax, and parking tickets.  The payroll tax revenues for 2021 are now projected to come in about $17.6 million below earlier estimates, due to large Seattle companies delaying the “return to work” for their employees until January. The parking ticket revenues are $7.2 million lower than original projections because the city has suspended citations and collection of fines and because high vacancies among the Parking Enforcement Officer division has led to a lower number of citations issued.

On the revenue upside, B&O taxes are projected to be $11.8 million higher than the August estimate. There is also $3 million in a grant from the State of Washington “to assist with one-time costs related to law enforcement and criminal justice related legislation enacted between January 1, 2020, and June 30, 2021.”

Collectively all the changes add up to a decrease in projected General Fund revenues for 2021 of $14.2 million, or about 0.8% of the August forecasted amount.

With regard to restricted-use revenues, the commercial parking tax and the sweetened beverage tax have both taken hits, together about $7.2 million, while the notably volatile Real Estate Excise Tax (REET) is coming in $18.6 million higher. In sum, the restricted-use fund revenues are projected to be up $12.8 million. If the extra restricted-use funds could be used to offset the General Fund shortfall, that would leave the budget only $1.4 million short — a rounding error that would easily be covered by underspending by city departments this year. Unfortunately, the restricted uses make it more difficult, and the Council will need to look for some places to do “dollar swaps” to free up General Fund dollars where REET could be used instead. REET can be used for transportation infrastructure projects, and for affordable housing investments; the latter might be the best opportunity to swap some money. But even if the Council can’t, $14 million is a fairly small amount of money in the city’s budget; this is an annoying problem, but it’s not an earth-shattering one.

The City Budget Office’s projections for 2022 lower General Fund revenues by another $4.9 million, due primarily to the continuing shortfall in parking ticket revenues. But it projects another increase in the restricted-use funds of $6.2 million, with some sources up, some down, and another $7.5 million in extra REET. A dollar-swap in next year’s budget to fix this is logistically easy, though politically difficult, because Councilmember Mosqueda has insisted on following the payroll tax spending plan to the letter — and it devotes tens of millions of dollars that would otherwise be unrestricted General Fund to affordable housing investments that could be covered with REET. Mosqueda has gone to great lengths to chastise Mayor Durkan for proposing an alternate spending plan for the payroll tax revenues that would have used federal ARPA funds for affordable housing and repurposed payroll tax revenues for other priorities, and it would be tough for her to walk that back and change the spending plan to do exactly what she refused to allow Durkan to do.

In the Council Briefing this morning Mosqueda was clearly irked by the notion of having to deal with the surprise General Fund revenue shortfall, laying the blame on the City Budget Office (and the Mayor by extension) for switching to the middle-of-the-road “baseline” revenue forecast over the summer when the economy was booming, rather than sticking with the “pessimistic” forecast it had used for the previous year and a half. That’s a convenient political scapegoat, but that’s not what’s really going on here. The reality is that the City Council, and in particular the Budget Chair, depends on a November revenue forecast that projects revenue upside (and by extension, earlier “pessimistic” forecasts that lowball revenues) in order to have money to spend for Councilmembers’ priorities. The Mayor’s proposed budget, delivered in late September, is a balanced budget that allocates all of the known revenues at the time; if the Council wants to spend money on things that it wants but the Mayor didn’t include, it has three choices:

  • create additional revenues, mainly through raising taxes and/or fees;
  • decrease spending on items in the Mayor’s budget; or
  • hope that the November revenue forecast has upside and delivers money that the Mayor hasn’t already spent.

The first two are difficult and messy; the third is free and easy money.

Not only is the Council not getting free and easy money this November, it will need to find some money from other sources to cover the revenue shortfall — and before it gets to spend money on anything it wants. When Mosqueda was delivered the revenue update last week, she was in the midst of assembling her “balancing package” from a subset of a very long list of additional spending requests in her colleagues’ 190 proposed budget amendments. She was counting on the revenue update to make her task easier, and instead it made it just a bit harder. she has already signaled that she intends to claw back $47 million from investments in a series of community-led investment programs to increase BIPOC community safety; that now might turn out to be the bulk of the money she has to spend, and on Wednesday we will see how she decides to allocate it.

But there’s a very good chance that this won’t be the end of the Council’s revenue headaches, because there is one very large question-mark still looming large: the payroll tax.

Passed in the summer of 2000, the Council wrote the payroll tax to be effective as of this year — but the 2021 revenues would not start to be collected until February 2022 (technically the last opportunity to accrue them to the 2021 fiscal year). And yet the Council spent the projected 2021 revenues in this year’s budget, and is now writing the 2022 budget to spend the projected 2022 revenues — all before a single cent has actually been collected.

Once a tax has been in place for at least a few years, there is a fair amount of certainty as to the expected range of revenues. But a payroll tax is new for the City of Seattle, so it has no past data to help it make accurate revenue projections. When drafting the legislation last year, the Council obtained some data from the State of Washington to provide some general guidance on employers and employees in Seattle, but according to City Budget Director Ben Noble, it is still using that original state data to guide its projections; it has not received updated information, and it still has no data of its own.

Here are some of the reasons to question the accuracy of the city’s projections:

  • The 2021 payroll tax revenues already took a $17.6 million hit this year because companies delayed their employees’ return to the office. There is no guarantee that they won’t do so again, and in fact there are good reasons to believe that they will further delay it. Every three months that it is delayed will cost the city another $17.6 million.
  • Even when the employees do return to the office, many companies are planning for “hybrid” work plan for their employees, where they are only in the office part of the week. The city’s current revenue model assumes employees working in the office 3 days per week; if in reality it is on average 2 days per week, that will mean $18.3 million dollars less payroll tax revenue for the city.
  • The employment figures that the city is using, supplied by the state, are from the early days of the pandemic. Since then many companies have restructured their workforce, including in some cases moving workers out of Seattle (or allowing them to work entirely remotely). Others have laid off workers and are still in the process of hiring people back — though there is no guarantee that they will hire back up to their pre-COVID levels. Because its data is old, the city has no idea how many workers will really be covered by the payroll tax, and it won’t until February when the first payments roll in.
  • While the city so far has been victorious in court challenges to the payroll tax, there is potentially one large one still ahead: Amazon. The payroll tax was written to single out Amazon, and only Amazon, for a higher tax rate than all other companies. If the company chooses to challenge it in court as a punitive tax, it could get some or all of the tax legislation thrown out — and likely retroactively, meaning that the city might not be able to collect the tax revenues it has already spent. That would blow an enormous hole in the city’s budget, as much as $234 million per year.

It’s an understatement to say that there is a lot of speculation in the city’s payroll tax revenue projections for 2021 and 2022, uncertainty that won’t be resolved until February at the earliest. There are several downside risks; there is also some upside — including the possibility that Amazon won’t sue and will simply choose to pay the higher tax rate (the city’s revenue estimate assumed Amazon would pay a lower rate, since the state wouldn’t give the city detailed information on a single employer — only aggregated information).

Last week the City Budget Office sent a memo to the Council explaining its revised revenues projections, with a discussion of the individual revenue line-items. It calls out the payroll tax in particular, and notes:

At present, we have not reduced the formal forecast for 2022 PET revenues to reflect continued delay, but this represents a very tangible and specific risk to the current forecast.

Last week’s revenue update was not good news (though not particularly bad news either), and will create a bit more work for the Councilmembers over the next two weeks as they finish putting together the 2022 budget. But lots of folks in City Hall will be keeping their fingers crossed until there’s some hard data on the payroll tax.

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