Council is working through the budget process. On Tuesday, July 3 council passed the broad outlines of our four year budget. The debate continued across across two consecutive council meetings, the first of which left council sharply divided on key points.
Here is a high level overview of what we hope to accomplish over the next four years and how it fits within the 10 year plan to wean the city off our historical dividend, though as we have seen in the last few weeks, the details may change.
There is a lot of information here. Some key points:
The annual deficit is shown on the first line. This council inherited a $16.4 million deficit. This 4-year budget hopes to close that gap by $9.3 million, with about $4 million in spending cuts (at minimum), to $7.1 million by 2023.
Council voted to include a modest municipal consent and access fee (MCAF) on utility bills beginning in 2019. It passed 8-1. Mayor Clugston was the lone dissenter. (Two weeks earlier, on June 18, another MCAF motion was defeated 4-5.)
MCAF is cumulative. Increasing by $1 million each year. It will bring in $1 million in 2019, $2 million in 2020, $3 million in 2021, $3 million in 2022.
We are assuming a dividend of $3m each year from GenCo, our electric utility. NGPR continues to lose money.
The amount of reserves we are using to cover the deficit are listed on the final line. We’re covering our operating deficit out of the Electric Equipment Reserve. We are projecting to use $44.4 million over 4 years.
Finding the Balance
The 10 year process to stabilize city finances was proposed by last council and branded as Financially Fit for the Future. Financially Fit attempts to positively brand what will be an uncomfortable period for the city. I have no doubt we can fix this problem, but it won’t be as painless as the friendly graphics suggests.
The philosophy behind Financially Fit is reasonable. We spread the shock of losing the dividend over time. We use a balanced mixture of spending cuts and fee/tax/utility increases to close the gap. There is no magic solution. Exactly what is the right mix of cuts and fee/tax/utility increases will be the subject of much debate.
Our first introduction to Financially Fit was a survey that asked residents which services they valued. I thought this was a bad idea at the time, I said it was a bad idea during the campaign and I still think the survey was a mistake. It was a mistake because it pitted services against each other.
We could also have easily guessed the survey’s results. Road & infrastructure, police and fire services were high priorities. Transit, a service few use, libraries and arts & culture identified as the lowest priorities.
We could have guessed the results because our city, like others, naturally allocate spending along these lines. Here is how we spend your money and it mirrors the survey’s results pretty well. Emergency services and Infrastructure, the top priorities, use up 51+% of our budget. Transit, cultural services and the library, the lowest priorities according to the results, take up 15%.
This doesn’t included major Municipal Sustainability Initiative grants from the Province of Alberta that fund a lot of infrastructure upgrades in Medicine Hat. So 14% is not the complete amount that is spent on maintenance and infrastructure.
What action should council take given the Financially Fit survey results? That we should drastically cut transit, the public library and the Esplanade since they ranked at the bottom of our priorities? We could shut down the Esplanade, the public library, and transit and that would get us to half our deficit.
Almost 40% of our budget is spent on emergency services. It would be hard to balance the budget purely through cuts without some cuts to the high priority areas, something people have indicated they don’t want. If a balance of spending cuts and tax increases is reasonable, I think it’s also reasonable for spending cuts to be spread across city services.
What’s the benefit of owning our utilities?
Spreading tax/fee/utility increases across the community to share the burden is also reasonable. Part of this balancing was to begin charging market rates for electricity and natural gas. Historically, one of the main areas where residents felt the benefit of owning our utilities came in the form of below market rates for electricity and natural gas. We subsidized power and gas with money from our natural gas and petroleum resources division (NGPR) and our electric generation division (GenCo). In the past two decades alone we subsidized our utility rates by $200 million. It wasn’t a sustainable model. Once these divisions faltered the city couldn’t sustain subsidizing these costs.
When council moved to charge market rates for electricity and natural gas a few years ago it represented a big change for the city. The idea behind market rates is that in the long run market rates should reflect a sustainable model since we have to pay market rates for natural gas, labour and infrastructure. Since we can no longer depend on the dividend we need to at least recover our costs in order for our utilities to be sustainable.
However, the obvious question presented itself. If we’re charging residents market rates for utilities and we own our utilities—what is the benefit to owning our own utilities?
There are other benefits from owning our public utility.
They will still return profits to the city on occasion. Profits that will be used for the benefit of the city.
Since we also own our own electricity distribution network we are exempt from paying for the provincial grid that Altalink operates. Every other Albertan pays Altalink to maintain our provincial electric transmission network. All things considered, the absence of this charge alone should make our rates cheaper than anyone else's (though we still have to pay for the maintenance of our own transmission network).
A municipal consent and access fee (MCAF) is another charge that appears on utility bills across the province, but not on ours. MCAF is a licensing fee that municipalities charge electric and gas utility providers. MCAF is the right to provide services to the community. It compensates the municipality for direct costs related to the use of municipal land, restrictions on planning and development due to utility rights of way, sterilization of land, as well as inherent risks to utility access.
When council began charging market rates for electricity and natural gas it did beg the question. What counts as market rates? Do we mean ‘market’ in the narrow sense of recouping the costs to generate and deliver electricity and natural gas? Or do we mean ‘market’ in the broad sense of charging similar rates to other utility providers, even if local circumstances are materially different?
A lot hinges on this question. For the city, implementing a transmission charge and MCAF would mean more revenue at a time when the city sorely needs it. But implementing both charges would erode what could be part of a sustainable Medicine Hat advantage.
I believe it should be interpreted in the narrow sense—that the charges on our utility bills should reflect only what is needed for the sustainable delivery of heat and power.
2013-2017
Let’s leave that for the moment and recap the general situation the city is in.
Last term, 2013-2017, council oversaw an unprecedented spending spree, the highest in the history of the city. Over 10 major new capital projects including (but not limited to): Canalta Events Centre, Family Leisure Centre expansion, the new seniors centre, two new fire stations, police station expansion, flood berms, and a 43 MW electric generator.
You can make a good case for each of these capital projects, but is somewhat surprising since the city’s financial position was clearly weakening during this time with NGPR steadily losing money, not typically a good environment for more spending.
Debit Limit
This debt update is from the June 5 council packet after we approved borrowing $7.5 million for a new substation for the Aurora development.
Each time council borrows money for new projects there is a little information box in the briefing note. This box outlines where this new debt leaves us against our borrowing limit. Provincial guidelines allow any municipality to borrow double what our annual revenue is. For 2017 Medicine Hat’s debt limit was $593.6 million. Our long term debt sits at about $321 million. We are at 54% of our limit. That is at acceptable limits, but obviously hitting the debt limit would not be a good thing.
Hitting the debt limit would be dangerous for any city as it would severely limit our options should we need money for any emergency. Hitting 80% of a city’s limit triggers the Province of Alberta and the city is placed under debt watch and is closely monitored for its fiscal health.
Debt Watch
Our debt is higher than $321 million. If we add our future abandonment gas well liabilities ($250 million, basically another kind of debt) that is $571 million of total debt/liability. That seems like a common sense view of our obligations and this combination puts us pretty close to our limit. The province technically doesn’t calculate Medicine Hat’s debt in this way, good thing for us, but it does underscore the challenge the city is facing.
SHORT TERM, LONG TERM
In the short term the city is fine. Yes, we have a $16 million annual deficit, but with our savings we’re fine for the next few years. What concerns me is the medium term—what the city will face in 5-10 years.
If our gas wells lose their profitability sooner than expected (and this is conceivable the longer gas commodity prices remain in the basement) the city will be forced to pony up even faster for abandonment costs, money that we have not adequately saved for (see previous column for a fuller explanation of our abandonment liabilities).
The silver lining is GenCo, our publicly owned electric generation utility. Over the next two years GenCo is estimated to earn significant profits beyond what we’ve budgeted. Estimated at $30 million this year alone. The profits have come from lower than anticipated natural gas costs and sales to the external provincial grid.
Past two years it’s unclear what to expect from GenCo. Alberta is in the midst of changing the way our electricity market is regulated. Currently the province operates an “energy only market.” In an energy only market, consumers experience price volatility as electricity prices are based on supply and demand. Generators are only paid for the electricity they generate and sell to the market.
The next few years are a good opportunity for the city to save significant money. Money that would give us options. The big new industries coming to town, Aurora and Hut 8, were great news for the city. They also require significant power and the city will therefore need additional electric generation sooner than expected. Our last generator, the 43 MW Unit 16, was purchased for a borrowed $55 million. I’d be uncomfortable adding another $55 million in new debt in five years for power generation considering where we are debt wise. But high debt or constraining the city’s growth? That’s a tough choice.
Saving this money would save us from this dilemma.
Spending Problem or Revenue Problem?
Two comparative graphs from the City of Calgary on average municipal tax rates. We’ve ticked up since 2014, but Medicine Hat is still on the low end of taxes.
I am not advocating this path, but if we closed our deficit purely by tax increases our taxes would be on average about what Lethbridge residents pay on a per capita basis. We would still have competitive tax rates, though we'd be around the middle of the pack.
This slide also illustrates something counterintuitive.
While researching my last column on the history of the Medicine Hat Advantage I was continually amazed at how much money we used to have and how free we were with it. I listed numerous capital projects paid for by utility dividends and all the money returned to residents for low taxes and low utility rates. My instinct was that this lack of fiscal discipline would inevitably bleed into the cost of city operations. But this slide tells a different story—the cost of city operations are comparable on a per capita level with Lethbridge. If closing the gap through taxes put us in the range of Grande Prairie I’d be more concerned.
To add it all up. We have built great new facilities and power generation while our debt has increased. We have relatively low taxes and our operational spending is not out of whack. So a tax increase, as part of fixing our finances, seems a reasonable choice for council. Considering our debt load I would also argue that a tax increase is necessary to meet our obligations left from previous generations.
It’s understandable to feel that all governments are overspending when we hear of Alberta’s climbing debt or the federal Liberals running a deficit though the economy is doing well. But locally the situation is different. This doesn’t mean certain city departments aren’t inefficient or that city employees aren’t well paid, but it’s not as bad as I would have guessed.
But just because I believe a tax increase is reasonable, doesn't mean I don't understand it's a big ask for this city. We are asking for your help and understand the burden of our choices.
MCAF vs. Property Tax Increases
If additional revenue is a reasonable and necessary option, the question then turns to the best way to spread the burden. Two main options emerged: implementing a municipal consent and access fee or increased property taxes.
MCAF proponents argue that because the city now has a policy to charge market rates for electricity and gas a MCAF makes sense. Since every other municipality uses a MCAF we are out of step with the market. The Alberta Utilities Commission regulates the range of this fee, ie controls what a municipality may charge. The fee is collected by the utility as a flow through charge that ends up in the city’s general revenues.
It may seem silly to charge the utility we own for access onto our own lands, but it’s not out of line with city practice. Different departments charge each other for services as a way to keep track of their real costs. For example, solid waste collections gets charged waste disposal fees by our landfill. The IT department charges any department who uses their services. The land used for utilities right-of-ways cannot be used for other purposes—that is a real cost to the city.
Who should bear this cost? MCAF proponents will argue that it should be based on a user-pay model. The users who benefit the most from our utilities are the ones who use the most power/gas and they should pay the most. That is how a MCAF is structured. Since businesses typically consume more power/gas they will pay higher MCAF charges.
Okay, but then presumably a MCAF fee should be based, at least in part, on a real valuation of land that is used by the utility. Yet, I have not seen any information about the valuation of land that has been set aside for utility infrastructure.
Minus some foundation and justification for this new fee it’s an arbitrary charge that increases revenue for the city. That makes me uncomfortable because an arbitrary sum set by council for revenue generation sounds a lot like something else—a tax. But if it looks, feels and smells like a tax let’s call it a tax so it’s abundantly clear what council is doing.
Without a clear justification for the specific fee it feels misleading. I find it hard to believe that the framers of the legislation that regulates utilities wanted MCAF to be used as a way to generate income for municipalities. It’s meant to compensate municipalities, not generate income. But again there is a narrow and broad way of interpreting this rule.
Property Taxes
In the absence of a justification for a specific MCAF my preference is for increased property taxes of the equivalent amount, in this case 7% (an additional 3% on top of the 4% already scheduled). There is real value in government being upfront with the public. We need more revenue for municipal services and obligations? We have a direct way to do it—a tax increase. Everyone understands what it is and what it’s for. The MCAF line on your utility bill? I’d bet the majority of residents will have no idea what it is or what it’s for. Yes, they will feel the burden all the same, but government should be as easy to understand as possible.
Here is why I think increased property taxes is better than a MCAF, but we’ll need to first understand how property taxes are set.
Local taxes are calculated at the intersection of three factors: overall tax increase, tax rates and assessment. Fairly complicated when compared to how provincial and federal taxes are levied.
1. For example, when council announces a 4% tax increase that means overall we’re asking that much more from the community. In 2017 we collected $65.856 million in taxes, up 4% from 2016’s $63.124 million, but as you'll see the real world impact is not a straight tax increase across the board of 4%.
2. Less well known are the tax rates for different property types, which sets the distribution for the tax burden and are manually set by council.
From the April 10, 2018 council packet. The city also collects the education tax and a tax for seniors affordable housing on behalf of the province. Tax rates are multiplied by 1000 for ease of reading.
As you can see we actually reduced the amount of non-residential tax collected by -0.77% for 2018, though the tax rate remains over double of single family residential—the largest class of property.
The proportion of taxes from single family residences went up by 3.24% and multifamily and farm land went up by 5% each. (Farmland makes up a minuscule portion of taxes within city boundaries. We collect under $100,000 in taxes from farmland.)
3. To calculate your tax bill the assessed value of each property is multiplied against the tax rate. Because assessed value depends on local market conditions, which can be pretty volatile, you can see your tax bill sometimes fluctuate widely. I have heard horror stories, but at least Medicine Hat is not alone. There are news stories from Calgary of small business tax bills growing by 200% in a year.
“Your property taxes =
the tax rate multiplied by your assessment value / 1000 ”
Weirdly, council could lower the overall tax rate and lower your property type tax rate and you might still end up paying more in taxes if the assessment of your property jumps. I won’t pretend to understand how assessment works yet. (I'm working on it.) It is a highly regulated process that is kept at arm's length from council.
This complicated structure makes it hard to understand what the real world impact of tax increase will be, but in general a tax increase allows the city greater control over how the burden is distributed.
It would allow council to target tax increases to those areas where it makes most sense. Historically, business taxes in municipalities have outpaced residential taxes. This doesn’t make much sense to me since it’s not clear that commercial properties use municipal services more than residential properties. Yes, businesses benefit from infrastructure and emergency services, but double the benefit of a single family residence?
Here again are the tax rates for 2018. You’ll notice the non-residential (aka commercial) tax rate is about double the single family rate. In other words, a commercial property will pay double the taxes compared with a single family residence of the same value.
Tax rates are multiplied by 1000 for ease of reading.
I would suggest that a tax increase directed primarily towards single family residences and away from non-res and multifamily makes sense. Single family residences cost the city the most to service. Low density development requires lots of infrastructure spread over a wide area. The increased distance makes emergency services and transit more expensive to deliver. Contrast that to medium and high density developments, which are cheaper for the city to service. Yet single family residences have the lowest tax rates compared to multi-family and non-res. That seems backwards to me. I don’t have an opinion yet on what the right balance is, but I don’t believe our current balance is optimal.
I don’t have a preference between low density or high density developments. If people want single family homes fine by me, regardless developments should cover their expenses. Right now businesses and multi-family developments are subsidizing single family tax rates.
An aside. Comparatively high commercial taxes are found across Alberta, so Medicine Hat is hardly alone on this front. There must be a side to this argument that I haven’t heard yet. For your information here is how we compare with other cities.
Wrong road, Right direction.
At the end of the June 18 council meeting we were divided between the three key assumptions our budget would be based on: MCAF, property taxes, or do nothing.
Because GenCo is projected to earn considerable profits in the next two years one course of action is to defer the MCAF and tax increases until they were needed. This philosophy can be summed up as “Do not go to the taxpayer until it’s absolutely necessary.”
In the past we used our dividend to give us low taxes. However, it’s one thing to spend a dividend we’ve earned, it’s another to base our budget on projected earnings. The key word is projected as GenCo has not yet earned that money. We can’t base a budget on hope.
The longer we take to close the deficit, the more cash reserves we use, and our options diminish. I do not want to get to a place where our reserves are gone. But in the absence of a compromise between MCAF and property tax proponents council risked doing nothing if we couldn’t bring the two sides together and get at least 5 votes for a plan. And so I sacrificed my idealism and supported a modified MCAF because of the seriousness of our situation. I don’t think it was the best option or that it went far enough, but it’s a step in the right direction.
The MCAF is structured to come off the books in 2022 setting up an important issue for the next election.
Impact of MCAF
This is how much money MCAF will generate for the city, which is half what the original MCAF was planned for.
MCAF falls under a user pay model so the more electricity and gas used the higher the fee on your bill. Here is the estimated annual impact to you depending on your residential property.
This table breaks down single family residences according to property value and estimates the MCAF charges for the next four years.
It's harder to estimate the impact on business, but for an accurate picture of what your MCAF charge will be check your utility bill and use this formula.
Gas: (Service charge + Delivery charge) x 2.8% (for 2019)
Electric: (Service Charge + Facilities Usage) x 3.3% (for 2019)
just the beginning
Natural gas commodity prices began to collapse in 2009 setting off a decade long weakening of our energy division. Collapsing commodity prices also sent Alberta into a recession and many local jobs were lost, putting additional pressure on our city. When the economy weakens there is greater pressure on social services and first responders. Library usage goes up when the economy is weak. More people need housing support, more calls to police. Drug use also goes up because people are under greater psychological stress. This of course coincided with the greatest illegal drug crisis of our generation—the opioid epidemic. Less money from NGPR, more people unemployed and distressed, more drugs. Medicine Hat has been hit hard over the past few years.
There are no shortage of opinions of how our community should meet these challenges. I don't expect us to agree on everything. Council is still debating service levels and how much to cut—a topic for its own column. My personal goal is make everyone equally unhappy at the end of 4 years. There is no way to solve this without compromises and working together.
Correction July 31, 2018: An earlier version of this column stated that the two fire stations built during the last council term was paid by the city. This was incorrect, the funding came from the province though MSI grants.