Memorandum

City of Lawrence

Finance Department

TO:	Dave Corliss City Manager
FROM:	Ed Mullins Finance Director
CC:	Debbie Van Saun, Asst. City Manager Casey Liebst, Budget Manager
Date:	May 18, 2007
RE:	Sales Tax Projections

Background 

Sales tax in Lawrence has not been meeting expectations.  The slow down became more obvious in the first quarter of 2007, but was evident in 2006 with city and city-share of the county sales tax only growing by 2.7%.  Due to higher gasoline prices consumers have less discretionary income to spend on other purchases.  This has negatively impacted the purchase of large ticket items, especially automobiles.  All major automobile manufacturers experienced sales declines in April.  It is not expected that gasoline prices will moderate in the near future.

Lawrence has also been hit with a slow down in new home construction.  This reduces sales tax as the material that goes into building a house is taxable.  In addition, appliances and furnishings are not being purchased.  UBS Financial Services states that, “We believe both housing starts and building permits will resume their downward trend and find a trough by year-end 2007.” 

Analysis

The table below shows the 2007 budget amount for sales tax and the projections of Commissioner Chestnut and the Finance Department.

Sales Tax Projection	2007 Budget	Chestnut	05/07 Finance
City Sales Tax	12,850,000	12,258,373	12,336,823
County Sales Tax	8,550,000	7,909,091	8,120,359
Use Tax	1,650,000	1,556,711	1,536,362
Total	23,050,000	21,716,175	21,993,544

Commissioner Chestnut’s projected sales tax assumes that each monthly sales tax distribution will be the same percentage of the total annual sales tax distribution over time.  If April's distribution averaged 8.5% of the annual total sales tax, it is assumed that this will hold true for future April distributions. 

The Finance Department projection makes use of the trend function in Excel.  It is a time series regression analysis that looks at the historic growth of sales tax over time. The city and county projections start in 1999 while the use tax starts in 2002.  The use tax increased significantly in 2002 because of a statutory change.

Either method is defensible.  Neither method is good at projecting when a trend change will occur.  The methodology that attempts to do so is called multiple regression analysis.  It uses independent variables such as income or GDP growth that correlates with our sales tax distributions.  You then plug in future projections of those independent variables to project future sales tax projections.  To work, the projections of the independent variables need to be accurate and their relationship to our sales tax distributions must be maintained over time.  The typical error from this method is usually at least 2%.  With our sales tax projected to be about $22 million, a 2% error equals $440,000. 

Recommendation

Absent a major rebound in retail purchases, it is likely that sales tax distributions in Lawrence will fall below the 2007 budget amount by more than $1 million.  To offset this revenue shortage, staff is calculating the effect of reduced expenditures in 2007.  If 2007 expenditures are held to 95% of budget, along with revised revenue projections in the General Fund, it is currently estimated that the 2007 deficit will be approximately $267,000 and the unencumbered year end fund balance will be 20.02% of expenditures.  The City Commission adopted policy range for the General Fund balance is 15-30%.

Assuming a 3% growth in 2008 expenditures and no change in revenue rates, the General Fund deficit is projected to increase to $430,000 and fund balance reduced to 18.66%.  This creates an obvious need to bring revenue and expenditure growth more in line in 2008.  It is essential that the gap be closed utilizing revenue increases or expenditure reductions that will be continued in future years.  While one time reductions in expenditures will positively impact fund balance, they will not address the structural imbalance between revenue and expenditures projected to occur in the General Fund over the near future.

The attached spreadsheet illustrates the adjustments for 2007 and 2008 described in the preceding paragraphs.