Staff will provide the City Council with a formal budget update at the December
17, 2013 Council meeting. At that meeting, staff intends to focus the presentation
on the City's FY 2012-13 external financial audit, current fiscal year projections,
issues related to Home Depot sales tax allocations, and property taxes and other
revenue projections. For this CM Update, the Finance Department is providing
background on these items for the Council to consider prior to the December 17,
2013 meeting:

Fiscal Year 2012-13 Year End Results
As of this week, the City's external auditors Maze and Associates are completing
their field work and, as usual, anticipate presenting their results before the end of
the calendar year. Overall expenses are projected to be approximately $430,000
less than anticipated, made up largely of personnel savings. However, in the
course of closing out the fiscal year, it has become clear that revenues for the
General Fund did not materialize in certain areas as projected. As a result, staff
anticipates that General Fund reserves will decline from approximately 1 0% to
approximately 8%.

Because expenses were lower than budgeted, this change is entirely driven by a
loss of revenue, the largest decline related to the actual Utility Users Tax (UUT)
receipts compared to projections. The original projection for UUT revenues was
based on actual receipts and the final inclusion of all EBMUD collections into
revenues last fiscal year. Into May 2013, staff believed that these projections
would be achieved. However, actual receipts appear to have fallen short of
projections by over $400,000, or approximately 1.3% of the estimated 2% fall off in
fund balance.

Staff has yet to determine the reason, and is currently analyzing the data as well
as considering engaging an outside firm with expertise in auditing receipts and
vendors subject to the UUT, which includes many large and small cell phone
providers in numerous iterations. There is also some concern that certain vendors
are not participating and/or some payment(s) were not remitted as required. Staff
will keep the Council apprised of this issue. Other revenue shortfalls were in
property tax receipts and sales tax.

The issue of the proper amount of reserves and their purpose was discussed by
the City Council during last year's budget process. The Financial Advisory Board
is currently analyzing the issue with staff as well. It is staff's expectation to bring
this matter to the City Council in early 2014 for discussion and possible direction
on the appropriate amount and use of reserves and an approach for increasing
the amount above current levels over the coming fiscal years.

Fiscal Year 2013-14 Analysis and Projections
General Fund Expenditures: Based on expenses through October 2013, the
expenditure budget in the General Fund remains roughly on track to meet or
slightly exceed the adopted budget. Since adoption of the budget in July 2013, the
City Council has increased expenditures by $134,000 (most of which consists of
the grant match for a ladder fire truck) with no offsetting revenues. Staff continues
to look for opportunities to reduce expenses, and current projections indicate the ·
projected shortfall could be lowered before the end of the fiscal year. As has been
discussed extensively in the past, approximately 80% of General Fund expenses
are personnel-related, therefore expenditure savings would likely consist of staff related
costs, mostly through vacancies.

General Fund Revenues: Projecting revenues early in a fiscal year is very
challenging, as property taxes have not yet been received and other tax revenues
are not received until 2-3 months or more after the month in which they were
collected. At the Mid-Year budget review in February, there will be a much greater
certainty in actual revenues for the current fiscal year.

Overall, the City's revenues remain a challenge. In spite of regular talk about
improvements to the economy, growth in revenues is slow, while expenses have
increased consistently at a higher rate. Until assessed values more closely mirror
the current high market prices for most homes and there is little economic growth
related to new construction, staff anticipates revenues to increase moderately but
at a much slower rate than in prior years. At this point, staff is cautiously optimistic
that revenue projections are on target but do have some concerns in certain
areas, including property tax, sales tax (particularly those related to the Home
Depot store), and special funds. In regard to the UUT revenue decline, initial
receipts are consistent with budgeted projections but more time is needed to have
a greater degree of certainty that actual UUT revenues will achieve budgeted
amounts.

Property Taxes: As described in the past, property tax revenues had been
trending down during the past three fiscal years. Unfortunately, based on actual
property tax receipts in the prior year, it now appears that the projected property
tax revenues for the FY 2013-14 did not take into account all of the adjustments
that occur after the revisions to assessed values are applied to the tax base, most
notably the Proposition 8 assessed value reductions that have occurred during the
past five years. As a result, the projection for FY 2013-14 was based on gross
assessed values as opposed to net assessed values. Staff has revised FY 2013-
14 property tax projections based on net assessed values, which is more
consistent with the prior three year actuals. Although staff is now confident in the
revised projection, actual revenues will not be received until December, allowing
for a true-up of the projection.

Sales Taxes: Staff and the City's sales tax consultants are projecting a significant
increase in sales tax due to a revised projection based on a full year's receipts and
a large increase in the City's "sales tax in lieu of property tax" (known as the
"Triple-Flip") which will largely make up for the difference in the revised property
tax projection. Because of a number of negative adjustments to revenues made by
the Board of Equalization and concerns over the City's share of current and prior
sales tax revenues from the Home Depot store, staff's sales tax projection was
conservative. Although the City has not recovered the significant decreases from
the loss of Target and the Guitar Center, overall sales taxes continue to increase
at a solid level. It is our hope that the recent loss of OSH will simply redistribute
the revenues to other competitors within the City.

Home Depot: As discussed since 2006, the distribution of sales tax at the Home
Depot store at 11939 San Pablo Avenue has created uncertainty regarding
revenue collections. As background information, in 1991 the City of El Cerrito and
the City of Richmond entered into an agreement to split the sales tax from Home
Depot, 70% for Richmond and 30% for El Cerrito, based on the approximate
proportion of land in each jurisdiction. Once Home Depot began reporting sales
tax to the State Board of Equalization (BOE), BOE distributed 100% of the
revenue to Richmond, and Richmond sent El Cerrito its share of the revenue
under the agreement. In 2006, BOE began sending 100% of the revenue from
Home Depot to El Cerrito instead, and El Cerrito sent Richmond its percentage.
The situation became more complicated in 2010. At that point, BOE decided that
the sales tax from Home Depot should be split 50-50 between the two cities and
that the 50-50 split should have been effective starting in the fourth quarter of
2005. As a result of that determination, BOE also said that some reallocation of
tax between the cities would be implemented. BOE did not adjust the distribution
of sales tax revenue, however, so El Cerrito continued to receive 100% of the tax
from Home Depot.

BOE changed its mind again in April 2012, deciding that the tax should be split
97% Richmond, 3% El Cerrito, based on the percentage of sales taking place at
the Home Depot cash registers located in each city. As a result of that
determination, BOE also stated that a different reallocation of tax between the
cities would be required. As a result, the City of El Cerrito sent Richmond a
$350,000 "true-up" payment last fiscal year pursuant to the sales tax sharing
agreement thinking there was now some degree of certainty. BOE did not
implement that reallocation or the distribution of sales tax, so El Cerrito continued
to receive 100% of the revenue.

Most recently, in October 2013, BOE issued another decision, confirming the 97%-
3% split. That decision also came with a new reallocation of tax between the cities
back to 2005, overriding the allocations that had already occurred between the
cities and stating that $2.5 million would immediately be taken from future sales
tax allocations to El Cerrito and presumably redistributed to Richmond. This
"reallocation" came with no supporting documentation. The City filed a request
with BOE to delay implementation of the decision so that staff can determine
whether and how to respond to that decision. BOE granted the request.
To further complicate matters, in addition to El Cerrito's Measure R and Measure
A, Richmond has its own local transactions and use tax (which BOE sometimes
calls a "district tax"), all of which could apply to sales at Home Depot. BOE's
solution to the issue is to apply a single 0.5% district tax to sales at Home Depot,
regardless of which register is used. In April of this year, BOE decided that the
same 97%-3% split of revenue should apply to the district tax and implemented a
reallocation of revenue between the cities, regardless of what the voters actually
approved.

At no time has BOE included in its deliberations the existence of the agreement
between El Cerrito and Richmond, although it is aware that the agreement exists.
In May 2012, Richmond acknowledged and stated that it will comply with the
agreement. If BOE implements a reallocation of tax from El Cerrito to Richmond,
the effect will be less because Richmond should simply return a portion of that
money to El Cerrito in accordance with the agreement. However, at this point, staff
and the City's sales tax consultants have not been able to reconcile the amounts
collected and distributed among El Cerrito, Richmond and the BOE. Staff will be
attempting over the next few weeks to confirm and agree upon the flow of funds
with Richmond and determine our next steps with the BOE.

Special Revenue Funds: As the pressure on the General Fund has increased ·
since the "Great Recession" began and Redevelopment was eliminated, Special
Revenue Funds have become an increasingly important source of funding,
particularly for Public Works functions. Public Works has relied upon Special
Revenue Funds for eligible expenses (such as for street improvements, storm
drain repairs, transportation improvements, and other similar costs), instead of the
General Fund in an effort to retain service levels since there is limited or no ability
to increase revenues in other areas, such as Police or Fire. While this decision
has in fact helped maintain City services, a number of. these funds, as described in
the budget book, are expected to spend more than they receive and will need at
least one more fiscal year to recover.

In 2004, the General Fund contributed 22% of Public Works funding, rising to 31%
in 2009. By 2013, the General Fund's contribution had decreased by more than
$200,000, and as a percentage to 21%. The FY 2014 adopted budget for Public
Works drops the General Fund contribution to 12%, even as overall budgeted
expenditures are decreasing.

This increasing reliance on Special Revenue Funds is not sustainable, as those
revenues are limited to specified uses and those functions need increased
attention. As a greater percentage of these funds are utilized to support areas that
were previously paid for by General Fund revenues, it is becoming increasingly
difficult to optimize the specific activities in which these Special Revenue Funds
should be targeted.

Staff is in the process of developing a plan to not only balance these funds by the
end of next fiscal year but to identify additional revenue sources, potential service
reductions and/or the necessary General Fund backfill that will be required in
order to maintain all public works functions. Staff will be presenting this Plan to
Council in more detail in the next few months.

Next Steps
Staff will provide a more detailed update to the City Council at its December 17,
2013 meeting. We plan on additional Council sessions after the New Year related
to reserves and the Special Revenue Funds. As always, staff will provide the
Mid-Year update in February and any proposed adjustments for consideration.

Please feel free to contact Finance Director, Lisa Malek-Zadeh with any questions
or comments.