By Nottley, Mark W.
Government Finance Review , Vol. 11, No. 3
Increasingly, Michigan's municipalities are embracing the concept of financial modeling. Typically, this involves the creation of an automated multiyear budget model which can be used to estimate or forecast the future years' finances of the general fund.
This article examines the reasons for the growing use of this budgeting technique in the public sector and the benefits that can be derived from a five-year future financial model. The City of Lincoln Park, a long-time advocate of financial modeling, is utilized as a case study.
Growing Popularity of Financial Modeling
Michigan's municipal governments have been subjected to a series of fiscal challenges. Since 1978, local taxing ability has been limited by the Headlee Amendment to the state constitution, a statute which requires millage rollbacks when property value increases exceed the rate of inflation. Potentially more onerous, the recently enacted Proposal A, places an inflationary cap on the increase in individual property assessments; a restriction which may severely limit future revenue growth in many municipalities.
Additionally, federal assistance has been significantly curtailed and state-shared revenue has proven to be a volatile, less-than-predictable funding source. Coupled with rapidly rising costs, mandates and increasing service demand, the financial outlook dictates a prudent, planned approach to long-term resource management.
The short-range nature of traditional budgeting systems often renders them inadequate to meet the emerging fiscal challenge. Annual budgets typically consider only incremental changes to existing programs and services, and consequently do little to prepare a municipality for dramatic, unexpected events such as Proposal A. In the absence of a large fund equity, a municipality that is wholly dependent on short-term budgeting may be inviting financial crisis. In contrast, a five-year budget model, properly constructed, may provide the early warnings that are necessary to develop a long-term program which stresses service priorities and sound fiscal practices.
The City of Lincoln Park: A Case Study
The City of Lincoln Park, located in the "downriver" area of Southeastern Michigan, provides a classic example of the successful application and implementation of a financial modeling system. As an older, established municipality with a population of approximately 42,000, Lincoln Park has faced the ongoing challenge of balancing a limited resource base with the service requirements of the community. The city has been generally successful in this regard, largely as a result of belt-tightening and prudent financial practices.
Like many older Michigan cities, however, Lincoln Park entered the 1990s with a degree of financial uncertainty and apprehension; more specifically:
* some population loss was expected as a result of the 1990 census (with a corresponding decrease in state revenue sharing),
* property tax revenue could not be expected to increase dramatically during the 1990s,
* wages and benefits were consuming an inordinate amount of general fund budget,
* expenditures for items such as health care and solid waste disposal were far exceeding the rate of inflation, and
* infrastructure and rolling stock were aged and would require significant investment.
In light of these, and other financial considerations, the city required an overall game plan for assessing on-going financial conditions and determining spending priorities and cost containment strategies. This requirement was met through the development of a five-year financial model.
Developing the Lincoln Park Five-year Financial Model. The development of a five-year financial model for the City of Lincoln Park was a joint effort involving the mayor and city council, department heads and the city's financial consultants. The process involved a line-item by line-item evaluation of general fund finances, including identification and analysis of all factors that would likely impact the city's financial condition in each of five future fiscal years. …