Major City Council Budget Test: The Cost Allocation Program

The City’s staff is now working on the City’s 2017-2018 City budget that will be made public (probably) at the 27 September City Council business meeting. The biennial budget lays out where some million$ of taxpayer and ratepayer’s dollar$ and some grant funding are going to be spent in the following two years.

The City Council will raise property taxes the maximum extent allowed by state law … that’s a virtual given.

New hires will be proposed … and at an average cost of over $125,000 per city employee, that’s no small dollar matter since any new personnel expenditures will most likely continue on for many years. But, the population is increasing and that means a larger  municipal government.

But before the dividing up of the dollars into priorities and programs, the City Council has their once every two year opportunity to “fix” the two most unjust and broken programs in the current City budget.

This post will discuss the first: The Cost Allocation program.

The citizens and organizations getting financially screwed are primarily the COBI sewer ratepayers and storm and surface water (SSWM) ratepayers. That’s less than 25% of the island’s residents but includes most of the Island’s businesses.

In the simplest of terms, the City’s cost allocation program allocates financial charges for staffing overhead to the City’s General, Street, Water, Sewer, SSWM, Development, and Building Funds.

This post will focus on just three utility funds (Water, Sewer, SSWM) since those funds are enterprise funds where the City runs a monopoly business and ratepayers pay a utility fee for services provided.

Cost allocation includes salaries, benefits (an additional roughly 40% on top of salary expense) and “rent” for the allocated employees  use of City Hall space. “Rent” includes a collection of charges, some logical and others,  such as depreciation costs for City Hall and the farmer’s market area and even the land on which it is built, seemingly illogical. And not only do the lucky utility ratepayers pay off the City Hall debt with their property taxes, they get an additional whammy by having bond interest payments and depreciation charges included in their utility rates.

Ratepayers aren’t complaining.

It is probably because citizens don’t have the  time to read and understand the City’s cost allocation system, and/or they believe the City staff and City Council are looking out for them as utility ratepayers, which is a fundamental role of a City Council.

Being unable to decipher the cost allocation system is the norm.

Having City Council look after the interests of utility ratepayers is only a theory … it has happened only once in the past decade when Steve Bonkowski and three other  members of a past City Council took over a meeting agenda item and reduced the water rates a second time over the objections of the City Manager and staff.

Overhead charges for City utilities are clearly appropriate, but what is broken in this City, and in many other Washington State cities, is that with the 1% plus new construction limitation on annual tax increases, governments have intentionally and creatively increased  general government revenue by cost allocating an increasing percentage of utility fees using cost allocation methodology and increasing local utility taxes.

It requires considerable accounting skills to understand cost allocation … something the City Council members simply lack because there are no trained accountants on the City Council. Aside from their lack of accounting skills, it appears the Council has neither the  time nor interest to fully understand COBI’s cost allocation system.

It only took me some four years and maybe 20 public record requests to figure out how the financial staff  performs their calculations … and in my opinion,  no COBI City Council member has ever come even close to fully understanding  the cost allocation process.

So, here are some basics of how the City set up a cost allocation system.

When Washington State voters approved an initiative to limit the growth of property taxes some 16 years ago, the then Bainbridge Island Mayor announced utility rates would be increased by 21% to help make up for the expected general fund revenue slowdown.

That was only the start of a cost shift of paying for general government to city utility ratepayers.

A utility ratepayer’s lawsuit in 2009 resulted in an outsourcing study of the City’s water utility. The City was charging 9.6 FTE (full time equivalent) employees to the water utility when the study started. That included both direct labor and overhead.

A consultant hired to determine the efficient personnel allocation told the City staff the water utility could be properly operated and managed with 3.9 FTE.

Both the City Manager and Deputy Manager were tight jawed with that consultant recommendation, but City staff reluctantly settled on 4.2 FTE to fully operate and manage  the water utility.

The FTE reductions were 1 FTE from direct labor and 4.4 FTE from bloated cost allocations.

City water rates were subsequently reduced by more than 60% in two separate rate reduction actions, the last one during a testy City Council meeting that indirectly led to yet another expensive public records lawsuit.

The major lesson from the original ratepayer lawsuit was that the City’s cost allocation system for the water utility was grossly overcharging City staff hours to the water utility.

What previous City Councils have fail to recognize and fix is the very same cost allocation system also applies to both the sewer and the SSWM utilities, and they too have excessive FTE’s being paid by utility ratepayers.

The sewer utility is charged for a portion of  52 individual City employees work hours, as well as City Hall rent. That’s 69% of all City employees (less City Council, Police and Municipal Court).

Those 52 employees hour allocations add up to 9.5 FTE.

Three city employees (3 FTE)  run the City’s Waste Water Treatment Plant (WWTP), and about 1.2 FTE are used for various routine electrical and mechanical field work. The City contracts out all significant sewer system design and repair efforts.

The sewer utility FTE overhead is greater than 100%.

The City could have done the same type of efficiency study when they contracted for the new City sewer plan. The same financial sub-consultant was hired that did the water utility efficiency study,  but neither City staff or City Council included that common sense element in the sewer plan. I’m quite certain that exclusion wasn’t an oversight. It was a deliberate decision intended to maintain the existing sewer utility money flow into paying for more FTE’s than necessary at City Hall.

That’s the primary reason for this sewer rate comparison chart in the City’s new sewer plan:

BI Sewer Plan Rate Comparisons

When City Council members say the sewer rates are high because the City just refurbished the WWTP and that needs to be paid for, that was partially true. Of course, that capital project was originally costed at an estimated $4.3 million, and ran unchecked by the City Council until it totaled some $15.8 million, but the real reason for Bainbridge finishing at the top of this sewer costs chart is the City’s cost allocation system.

The SSWM utility has the same cost allocation bloat disease. It’s not the only bloat disease affecting the SSWM utility, but that’s a future post subject.

The SSWM utility has 56 individual City employees being cost allocated to that utility.

Those 56 employees hour allocations add up to 9.41 FTE.

Direct labor for the non-bloated essentials required for the SSWM utility to meet Ecology’s National Pollution Discharge Elimination Permit (NPDES-II) requirements about 3.0 FTE field workers and 1.0 FTE NPDES-II Permit Manager.

So yet another City utility with a staff cost allocated overhead in excess of 100%.

City staff can write a convincing document (there is a draft for City Council review on the City Council’s agenda as I write this), and the Council is scheduled to  discuss it at the 7 June 2016 City Council work session.

The problem is the City Council doesn’t go into the details, and all the big problems  with cost allocation are buried deep in the financial minutia.

So here are three big picture questions the City Council should be asking.

• What are the direct labor and indirect labor charges for the water, sewer, and SSWM utilities?

The draft cost allocation plan doesn’t go there.

Cost allocated overhead is going to be significantly  higher in the sewer and SSWM utilities. That’s because the water utility has  been subjected to an outsourcing study and unjustified  overhead was sharply reduced.  Similar but not as dramatic results would happen to both sewer and SSWM if the Council had the motivation to make the necessary and logical changes to cost allocations.  City utility rates could be fair and reasonable like the State Supreme court says they should be.

• What is included as city hall “rent” charges?

The draft cost allocation plan doesn’t go there.

Council might be interested in why interest payments on City Hall and City Hall land are being allocated to utility ratepayers when the bond is being paid by voted taxes and therefore being paid by all Bainbridge Island citizens, but sewer and/or water utility ratepayers are incrementally paying twice or three times.  And why the City staff charges depreciation for City Hall and playhouse land when (1) the land is  appreciating in value, and (2) the collected depreciation is not going into a fund to replace city hall someday … it just goes to the general fund to be used in whatever manner general funds can be used for, which is just about everything that’s legal for a City to spend money on.

• Council should ask City staff what a fair utility overhead cost allocation (percentage) overhead should be.

For example, the City of San Jose’s City Council set a percentage (11%) allowable overhead to their water utility and directed the City to operate within that boundary, and then the City Council hired an independent auditor reporting to them, not City staff, to validate the City was staying within that overhead charge boundary. That apparently has worked very well.

COBI would need a significantly larger percentage overhead than 11%, but sewer and SSWM are in excess of 100% overhead now, and a set percentage could be an approach to getting the City staff’s objective to shifting general government costs to utility ratepayers throttled back.

Chances of this happening?

I’m guessing pretty close to zero because nobody on this Council seriously wants to question City staff, and there is no noticeable appetite to make changes that could impact the general fund’s revenue flow.