That the City Council receive and file the Proposed Fiscal Year 2024-2025 (FY 24-25) Budget and direct staff regarding any revisions.

Executive Summary

Staff in City Administration, Finance, and City departments have worked collaboratively over the past several months preparing the FY 24-25 Proposed Budget for City Council review. The proposed $182.8 million overall municipal budget, which includes a $62 million proposed General Fund budget, is balanced; however, the proposed General Fund budget includes a number of budget and service cuts that are being recommended in order to keep expenditures within available projected revenues. As the General Fund is the City’s primary operating fund for most City programs and services, it’s proposed budget will be discussed in detail in this report.

The City of La Habra has a longstanding practice of being fiscally prudent and balancing its budgets, even during past recessions, without a reliance on depleting reserves. When prior economic conditions improved, and following City Council policy direction, the City was prudent in how it restored prior cuts and remained conservative in its staffing levels, labor negotiations, and overall spending. Despite a narrow revenue base, the City has been strategic with its use of funds over the years by building up key reserves, investing in new parks, public facilities and infrastructure, and continually upgrading programs and services with the goal of improving the quality of life for La Habra residents and building a strong economic base to support the local business community.

In a commitment to the principles of fiscal sustainability, or essentially “living within its means”, the City has retained a number of prior year cost-cutting measures and has consistently run lean. However, in the upcoming FY 24-25 budget year, the City will be facing unprecedented fiscal challenges. Rather than being impacted by a cyclical economic event like a recession, which has an end and a subsequent recovery period, the City is facing several systemic fiscal challenges that will seriously impact the General Fund budget and the City’s ability to continue funding programs and services at current levels.

LA County Fire Services Contract Costs

The first, and most immediate, of these challenges is the recent renewal of the Los Angeles County Fire Department (LACoFD) fire services contract. After months of negotiations, the City was able to partially reduce the unprecedented proposed increase in fire and paramedic services cost as it worked to negotiate a new 10-year extension with LACoFD. Based on these negotiations, the cost of the fire service contract is increasing to $14.4 million in FY 24-25, which is almost $3.2 million more than what was budgeted a year ago, even after taking into account the closure of a La Habra Fire Station. Staff was able to negotiate with LACoFD to retain an annual 4% fee cap through the first six years of the ten-year contract extension. Nevertheless, the increase in the City’s fire services contract alone has outpaced increases in Citywide revenue growth, and will likely continue to do so as the contract can increase by almost $600,000 each year.

Because various cost-cutting measures that minimized impacts to services have already been employed in prior years, the sharply higher costs of the LACoFD fire services contract necessitates that the City find ways to absorb these higher costs at the expense of other Departmental budgets in order to keep the General Fund (GF) budget balanced. While some cities in similar situations opt to draw down reserves to temporarily balance budgets, staff views this approach in this situation as unsustainable, as it can unnecessarily expose the City to risk if a one-time emergency like a natural disaster or pandemic, similar to COVID-19, occurs and is therefore not recommended. Collectively, the City’s Administration and management staff are recommending employing immediate budget balancing measures this fiscal year, that include cuts to each department, albeit painful and that will impact City services, to remain fiscally sound. The cuts being recommended are being done with the goal of enabling the City to continue functioning while limiting impacts to the community; however, there will be some impacts that will be unavoidable.

Measure T

Another significant fiscal challenge facing the City in the near future is the scheduled sunsetting of Measure T in 2028, which is a locally controlled revenue that the state cannot take. Measure T, the City’s local ½ cent voter approved Transaction and Use (Sales) Tax, is estimated to generate approximately $7.8 million in FY 24-25 and will comprise approximately 13% of the City’s General Fund. The General Fund is the City’s primary operating fund for the provision of a broad array of services to the community including Police, Fire and Ambulance services, City programs, services and events, funding for capital projects, and resources for other critical needs and unanticipated emergencies.

While 2028 may seem distant, it is a short period of time for the City to plan for a reduction in services and/or staffing to try to offset the loss of this revenue source. The dual challenges of the fire services contract increase and the loss of Measure T will create a severe structural deficit that needs to be addressed now so that a plan can be implemented and put in place over the next several fiscal years.

Past Cost-Cutting Measures and Strategic Revenue Maximization

Recognizing the impacts that the loss of local revenue sources would have on City services provided to the community, prior City Councils convened Ad Hoc Fiscal Review Committees to examine the City’s economic landscape and provide policy guidance during turbulent times, both in the mid-2000s, and again as recently as 2019.

La Habra, like many other California cities during the mid-2000s, faced significant and unanticipated operational cost increases arising from factors like the imposition of State and Federal mandates, the growing cost of public works projects, and “take-aways” of cities’ and redevelopment agencies’ revenues so that the state could balance its own budget. Additionally, CalPERS, the organization that manages and administers pension plans for most California cities and public agencies, posted diminishing returns following the “Great Recession”, which meant that cities were required to contribute more to pension funds to make up for investment losses. Around this same time, the City of La Habra faced the loss of its previous Utility Users Tax, which was generating approximately $5 million per year.

In 2005, the City Council began responding to these challenges by aggressively controlling budget growth and by creating the Fiscal Review Committee. The purpose of the Committee was to review the City’s revenues and expenditures, evaluate the programs and services the City provided, evaluate budgetary challenges affecting the City, provide an independent evaluation of the City’s fiscal health, and provide guidance and policy recommendations to the City Council that might help ensure the City’s future fiscal stability.

The City Council directed staff to implement many of the Committee’s recommendations, and has adopted budgets to ensure that the City continued to operate efficiently even as revenues improved. An example of this is that today there are fewer full-time General Funded employees working for the City than there were 20 years ago, despite a growing community and level of service.

Pension System Reforms

The City further controlled its costs and worked towards reducing its liabilities through a host of significant pension reforms, including lower pension formulas (even before the state enacted its own statewide pension reforms), cost sharing with employees and, most recently, the issuance of very low fixed interest rate pension obligation bonds (POB) along with the adoption of a pension funding policy. The lowered pension formulas and new cost sharing with employees reduced the City’s financial liability and ongoing costs, while the issuance of the POB saved the City $22 million over a 20-year period.

Each year, CalPERS issues new actuarial valuation reports and recalculates member agencies pension liabilities as of the new valuation date, which is typically two years prior. The Unfunded Accrued Liability (UAL) may, and likely will, increase or decrease from year to year, primarily due to the following factors:

The variables the City has some control over include how many employees work for the City and the salaries that they are paid. The City’s staffing has remained relatively stable, if not lower, than 20 years ago and the City attempts to keep salaries at or near the County average pay rates for similar positions so that the City can try to remain competitive in recruiting and retaining its employees.

A significant fiscal challenge cities across California are facing is the fluctuation in CalPERS’ investment performance and expected earnings rate, which cities cannot control. If the value of the funded assets is above the City’s liability amount, the City’s pension plan would be considered “superfunded.” If the value of the funded assets are below the liability amount, the City’s pension plan will incur a new UAL at that point in time. Based on the June 30, 2022, valuation date and due to CalPERS’ under-performance based on that point in time, the City’s new UAL was reported at approximately $38 million and is projected to grow to $44 million. This new UAL has resulted in adding $984,945 to the City’s FY 24-25 General Fund expenses. It should be noted that, based on favorable market conditions this past year, it is quite possible that CalPERS will meet, or exceed, its investment return target as of June 30, 2024, which could then potentially lower the City’s UAL in future years.

Current and prior City Councils in La Habra have consistently established policy priorities over the years that focus on supporting the local business community. In support of this policy direction and understanding the need to foster local economic growth and build on the City’s existing sales tax revenue base, staff has kept focused on developing and implementing programs that directly support local businesses.

Examples include business development outreach efforts, direct business assistance funding during the COVID pandemic, working with commercial property owners to market their available properties and attract new businesses to La Habra, and ensuring that the public services the City provides are responsive to the needs of the local business community. These economic development efforts and programs are designed to support a solid and growing local business community with the goals of creating ample shopping opportunities for residents and visitors, maintaining and creating new local job opportunities, and bolstering a sales tax revenue base to support City programs and services.

City staff have also aggressively pursued grant opportunities over the years and leveraged General Fund dollars to obtain grant matches whenever possible. These efforts have resulted in more than $60 million of federal, state, county, and other grants awarded to the City over the past three full fiscal years. The City will continue to pursue grant funding opportunities when available, and depending on the funding available to provide for local match requirements.
 

Recognizing the approaching sunset of Measure T in 2028, the City Council in 2019 reconvened the Fiscal Review Committee to provide updated policy guidance and evaluate the City’s finances, to include:

The 2019 Committee recommendations, when combined with the earlier Committee recommendations, resulted in a number of strategies that were approved and put in place to help address the City’s finances. A key theme that was encouraged by both reports was for the City to be innovative and open to considering efficiencies and new ways of providing service at a lower cost. Over the years, this overarching guideline resulted in:

2023-24 Highlights and Accomplishments

Despite the limited and narrow types of revenues funding the City’s General Fund operations, La Habra continues to be a “full-service” City compared to other cities in Southern California that offer more basic or contract municipal services. The City Councils, both past and present, have prioritized improving the quality of life for its residents and improving the health, well-being, and safety of the community. The City has done this by offering a wide array of services, improving access to programs for residents at all stages in life, supporting the local business community, and investing in City facilities and infrastructure.

The following are some notable FY 23-24 highlights:

Community Services

Proposed FY 24-25 Budget

The overall FY 24-25 Municipal Budget totals $182,805,345 across all funds, of which the City's primary operating fund, the General Fund, currently comprises $62,040,208. This Proposed FY 24-25 Budget will discuss the following:

The proposed FY 24-25 General Fund revenue budget is $61.1 million, which is $2.6 million (4.4%) higher than the FY 23-24 amended revenue budget. In addition, staff recommends that the City Council approve a $984,945 transfer from the City’s Section 115 Trust to fund the new CalPERS unfunded accrued liability. The purpose of the Section 115 Trust, also known as the Pension Rate Stabilization Fund (PRSF), is to help offset future pension cost increases. This tool provides a mechanism for the City to set aside funds that could be invested to specifically help address current or future UAL obligations. The City Council’s adopted Pension Policy requires the City to transfer half of the annual savings realized from the issuance of the Pension Obligation Bond, estimated at $1.4 million for FY 24-25, into the fund which, as of April 2024, totaled approximately $10.6 million.

The proposed FY 24-25 General Fund expenditure budget is $62 million, which is approximately $3.6 million (6.1%) higher than the FY 23-24 amended budget. However, to achieve this proposed expenditure budget, staff is proposing $6.3 million in cuts and deferrals based on a variety of budget balancing measures, including reducing funding for vehicle replacement and other internal service funds, the recommended use of the Section 115 Trust, and significant cuts by each department, which will be detailed below.

The City’s General Fund relies primarily on two major sources of revenue to fund general municipal operations: property tax and sales/transaction taxes. When combined, property taxes and sales and transaction taxes generate over 77% of the resources dedicated to the City's General Fund. As a result, any long term or persistent impacts to either source of tax revenue could cause significant fiscal constraint for the City's general operations. This is especially notable considering that the City’s local voter approved Measure T ½ cent transaction and use tax currently accounts for $7.8 million, or 13%, of the City’s General Fund revenue and is scheduled to expire in December 2028.
 

Property tax, which is the largest single source of General Fund revenue, accounts for approximately 41% of the City's General Fund revenue base, and is expected to grow by approximately $1.8 million (7.8%) in FY 24-25.

It should be noted that for every $1 of property taxes that are paid in La Habra, the City’s General Fund receives just under 18 cents, with the remaining 82 cents distributed to other taxing entities.

After stronger-than-expected inflation readings from January to March of this year, Federal Reserve policymakers have indicated that they may wait several more months to ensure that inflation is back on track to its 2% target before considering reductions to interest rates. Although borrowing costs are significantly higher today than over the past several years, local housing market values remain elevated and housing supply remains tight. Some economists predict the Federal Reserve policymakers will loosen rates in the later part of 2024, yet home prices are expected to remain high, helping support property taxes.

Sales/Transaction Taxes

Combined sales and transaction taxes represent the City's second-largest source of revenue, accounting for 36% of the General Fund revenue budget. The strength of this revenue source is derived from the City’s continued and long term support of its business community and decades of investment in its primary retail/commercial corridors in the City that continue to attract a variety of shoppers from both within and from outside the City.

The City’s 1 cent Bradley-Burns sales tax accounts for 23% of revenues for the City, and the City’s local ½ cent Measure T accounts for 13% of revenues for the City. The 1% sales tax is projected to bring in $14.3 million in FY 24-25 GF revenue, a 3% decrease compared to the FY 23-24 budget. The ½ cent Measure T transaction and use tax is projected to bring in approximately $7.8 million in FY 24-25 GF revenue, which is approximately 1% more than the FY 23-24 budget.

The total sales tax rate in La Habra is currently 8.25%, of which 1.5% generates revenue for the City’s General Fund. Of that 1.5% share, the City’s ½ percent Measure T rate is currently scheduled to expire in December 2028.

The following is an example how the allocation of the sales tax rate in La Habra functions.

Another way to look at how local sales taxes that are generated in La Habra are distributed can be demonstrated as follows:

During the final quarter of 2023, economists saw a shift in consumer behavior with people opting for essential household items over more expensive purchases. With the slow movement expected by the Federal Treasury related to lowering interest rates, future sales tax revenue growth may stagnate in the near term. It should also be noted that sales taxes tend to be a more volatile revenue source that can fluctuate more quickly during a recession than property taxes, which typically take longer to adjust to significant changes in a real estate market.

The proposed FY 24-25 GF expenditure budget has been developed to achieve the City Council's goals, priorities and objectives, while holding to the principles of producing a balanced budget. As discussed above, the Total FY 24-25 GF Revenues are projected to be $61.1 million. Initial departmental GF expenditures were estimated at $63.2 million, which included previously negotiated labor costs and increases in the costs of services, supplies, and premiums. In addition to these rising costs, the FY 24-25 Fire Contract increased $3.2 million over FY 23-24 and the new UAL payment, due to CalPERS not meeting its investment targets, is nearly $1 million. With these additions, the preliminary General Fund expenditure budget grew by $4.2 million to $67.4 million, meaning the City’s initial FY 24-25 General Fund expenditure budget exceeded projected revenues by $6.3 million.

In order mitigate some of these increases, staff reviewed the budgeted allocation of internal service fund (ISF) transfers, which are charges assigned to departments to allocate the cost of certain shared activities or equipment replacement, such as Information Technology, Vehicle Replacement, and Risk Management. ISFs charge departments for their proportional portion of these shared costs and provide a more complete picture of the true cost of operating a department and its programs.

Based on staff’s review of ISF fund balances and anticipated costs, it is recommended that the City Council approve a 100% reduction in ISF charges for Vehicle Replacement Charges and a 50% reduction in IT and Risk Management ISF charges to General Fund departmental budgets. While this will save the General Fund approximately $1.8 million in FY 24-25, the ISFs impacted by these reductions in transfers will eventually need replenishment, which can be in the form of reestablishing the charges in future fiscal years, or utilize potential future year-end budget savings to transfer into those funds.

A second budget balancing measure that is being recommended is the use of $984,945 from the City’s Section 115 Trust, which is a pension funding tool specifically created by Council for the City to set aside funds for investment to repay pension liabilities. The use of this fund for the UAL was discussed in the FY 23-24 Mid-Year Budget Staff Report, while continuing to budget and pay for the City’s normal pension liability charges as an operating cost in the proposed budget. The City’s Section 115 Trust currently has an available balance of $10.6 million for this purpose, and the FY 24-25 budget includes a new $1.4 million transfer from the City into the 115 Trust, as required by the pension funding policy.

Impact:

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Community Development – Target GF cut: $214,168

Impact:

Planning Division

Building Division

Code Enforcement Section

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Public Works – Target GF cut: $411,034·

Impact:

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Administration (City Council, Administration, City Clerk, Legal Services, Finance/IT and Human Resources) – Target GF cut: $296,107

Impact:

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Police Department – Target GF cut: $2,176,011

Impact:

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As is the case with most full-service cities, the majority of the expense in the General Fund is associated with the cost of personnel who provide service to the community; therefore, a significant portion of the departmental savings is related to the freezing/elimination of vacant positions. Some of these positions were frozen in late 2023 as staff began developing strategies to prepare for likely budget cuts. In total, nine full-time and one part-time General Funded positions throughout the City are recommended to be frozen in the FY 24-25 budget, along with reducing 5,200 part-time hours (approximately five part-time positions) in the Community Services Department.

As noted above, the City has fewer full-time staff in the General Fund in the proposed FY 24-25 budget than it did 20 years ago, despite a growing population and business community, increased traffic, and increased impacts of crime, homelessness and unfunded state mandates. The impacts of reduced staffing can already be seen in departments as the remaining staff have taken on additional responsibilities and workload, and as the City experiences turnover as experienced employees are retiring or resigning to take on jobs elsewhere. The table below illustrates this turnover in recent years:

A recap of notable increases in the proposed FY 24-25 General Fund budget include:

As is typical for most established, full-service cities in Southern California, public safety (Police, Fire and Ambulance combined) in La Habra continues to be the single largest spending priority in the proposed General Fund budget, accounting for 70% of total General Fund resource allocation, with all other non-safety departments combined accounting for 30% of resource allocation. The proportional allocation of resources for Public Safety costs has increased from 68% of the GF budget to 70% in a single year, primarily due to the significant, unanticipated increase in the LACoFD fire services contract, which rose by $3.2 million alone over last year’s amended budget amount, along with negotiated pay and benefits for Police staff.

Future Fiscal Challenges

The City was already facing fiscal challenges similar to other cities in the region, including a very competitive labor market, rising operating and maintenance costs, the lingering impacts of high inflation on all aspects of municipal operations, and the possibility of a mild recession. Additionally, staff in La Habra have been planning for new costs associated with maintaining two brand new community parks (Vista Grande and Woman’s Club), along with dealing with emergency storm drain repairs and aging infrastructure.

What was completely unexpected was the unilateral and wholesale change in the decades long cost-sharing agreement with the LACoFD. While the dramatic upcharge in the County fire services contract was unavoidable and outside the City’s control, the City must now contend with the immediate budget impacts, as well as the systemic threat it poses, to the current and future General Fund budgets. Due to the core municipal responsibility to provide the community with high quality, responsive fire service and address the annual increases in fire service costs that are likely to come, this is an issue that cannot be solved with one-time measures, such as depleting reserves or continuing to underfund internal service funds indefinitely.

Compounding this issue will be the sunset in 2028 of the City’s Measure T voter approved ½ cent local Transaction and Use (Sales) tax. This has been a significant local revenue source that cannot be taken by Sacramento to address their own budget needs. The structural deficit of the magnitude caused by the combined impact of the significant increase in fire service costs, along with the rising cost of labor in all other departments, including Police, along with the pending loss of Measure T, poses a serious threat to the City’s ability to continue providing the full complement of services that the community has come to expect. Without a corresponding increase in revenues and/or more substantial structural cuts to the General Fund expenditure budget, the City will be facing severe economic conditions beyond 2028.

While not ideal, it will be necessary to continue evaluating the City’s capability to continue providing quality of life services like graffiti abatement, code enforcement, and community programs at the levels previously established. This may include homeless outreach efforts and sheltering services, which had traditionally been the County’s responsibility, but was transferred to cities several years ago. To date, the City has been fortunate to have access to certain non-General Funds dedicated to homeless services and outreach, but as these special funding sources continue to be reduced or fully utilized, more costs may need to be shifted to the General Fund in future years, depending on future Council policy direction.

With public safety now making up 70% of the General Fund budget, the net impact from the loss of Measure T, in addition to the increased cost of the fire contract, will exceed the ability for non-public safety Departments to absorb alone. This will need to lead to future budget discussions and policy decisions by the City Council to determine what other options might be considered for fire service provision for the community other than the Los Angeles County Fire Department’s services, and what impacts might be considered to Police operations as the City evaluates the possibility of shifting away from certain full-service policing operations in order to focus on core Police functions.

In addition to cuts, City Council may want to consider other ways to increase non-tax revenues, such as reducing or eliminating certain program subsidies and raising or instituting new fees. Currently, the City provides many benefits to residents, businesses, non-profits, and community groups with the City’s General Fund absorbing many of those costs. Some examples of these subsidies include:

2028 may be four years away, but given the magnitude of the cuts that will likely be required in the future, staff recommends that the City Council take a proactive stance and direct staff to begin planning now for the loss of Measure T, as well as the growing operating costs described in this report by reviewing additional potential budget cuts, staffing cuts, expense reductions, changes in subsidies, and potential new revenue streams. By doing so, staff can develop options and recommendations for Council consideration with the goal of continuing to provide a certain level of services to the City’s residents, community partners, and businesses in the least disruptive way possible. If future revenue streams can be identified, there is a possibility that certain cuts being proposed may be restored by future Council action. 

Summary

The proposed $62,040,208 FY 24-25 General Fund operating budget has been balanced without drawing on the General Fund reserve. The budget was balanced by utilizing a variety of measures including deferring internal service fund charges, utilizing the Section 115 Trust to pay for new unfunded accrued pension liabilities, and significant budget cuts throughout the City’s Departments. Staff in Administration, the Finance Department and from the Departments have provided input into these cuts with the goal of providing operations, programs, and services in line with City Council goals and objectives, with the least disruption to residents, businesses and the community.

The City’s non-General Fund budgets overall remain relatively stable with noteworthy changes in a few funds. The largest budget decrease was in American Rescue Plan Act (ARPA) funding, which declined from $7.7 million in the amended FY 23-24 to $0.8 million in the FY 24-25 budget. This decrease is due to the ending of ARPA funding to government agencies, which was borne out of the pandemic and must be allocated and spent by 2025. Community Development Block Grant (CDBG) funds have also seen a reduction of approximately $400,000 due to reductions in post-pandemic funding and are returning to pre-pandemic funding levels.

The Water Operations and Sewer Operations utility funds both had utility rates adjusted in January 2024 and revenues were increased to reflect the new rates. However, there was a sizable decrease in the Water Capital fund of approximately $6.8 million due to the successful completion of several capital projects, including installing new water mains on Euclid Street, replacing broken water valves, design of the Hacienda Pump Station, and constructing a Heli-Hydrant. The Water Authority also purchased Cal Domestic Water Company stock which provides the City with access to additional water resources and reduces reliance on other more expensive imported water sources.

The Park Acquisition and Development fund budget declined by $2.2 million due to several capital projects being completed in FY 23-24, including:

Staff recommends that the City Council receive and file the proposed FY 24-25 municipal budget report and presentation, and direct staff regarding any modifications.

None at this time. Final fiscal impact will be calculated upon further direction by the City Council and will be presented to the City Council when it considers and approves the City's FY 24-25 municipal budget at a public hearing that will be scheduled at the June 17, 2024, City Council meeting.