EASTON MD 21601-8907

Easton Town Council
c/o Mr. Robert Karge, Town Manager
14 South Harrison Street
Easton MD 21601

Re: Request for follow-up to my testimony at the Budget Hearing, 5/3/2011

Dear Council Members:

First I would like to congratulate Mayor Willey and his staff on the Town budget proposal which is well thought out and which accomplishes a number of objectives while at the same time keeping the town property tax at this past year’s level. Thank you also for the opportunity to speak at the meeting and for your attention to this matter.

Easton has an opportunity to make more efficient use of the Town’s assets, namely Easton Utilities (EU). As you know EU was founded in the second decade of the last century to bring electricity to the town of Easton. The utility has expanded its role over the past century to include provision of gas, water, waste water, internet (including VOIP) and cable TV. While many municipalities in the state of Maryland formed utilities over the years the current number of municipal owned utilities has shrunk to only 5 including EU. By all accounts EU has served the public well and has been on the forefront of providing top notch service and excellent pricing to its customer base. Unfortunately, as the town has grown through annexation not all members of our community can access electric service from the utility because of a ruling by the Maryland Public Service Commission. Those residents are being served by other utilities.

As part of the TCTA’s due diligence in preparation for the reviewing the Town’s budget we examined the Town’s financial statements including those of Easton Utility. In EU’s 2010 balance sheet presented in the Town financial statements dated 6/30/2010 it is apparent that the Utility has an extraordinary cash position in light of its size and capital structure. EU’s cash position was roughly $ 19.4 million. That balance remains about the same today and has been in that vicinity for a number for years. In reviewing the cash position with senior management of EU we were not offered any concrete reason to maintain that level of cash. While some vague references were made to unspecified future projects, the need to manage margin calls (although there has never been a margin call and margin calls are normally handled by Letters of Credit issued by a bank) and to support its credit rating (bringing up the question of why a credit rating is important).

According to www.Investorwords.com (a glossary for business terms on the web) “Excess cash is defined as an additional amount of cash beyond what a company normally needs to have on hand. As a general rule, a company is said to have excess cash if its cash on hand equals more than 20% of its revenues”. The best way to determine a cash position that would make sense for EU is to look at comparable companies. Unfortunately, given its unique status in Maryland (one of 5 municipal owned utilities in the state) the only close comparable is Hagerstown Light (HL) which, while somewhat larger, is a good comparable. In addition I have looked at two major utilities in the state, Pepco and BG&E, to determine how they manage their capital structure at year end 2010.

Please note both Pepco and BG&E are YE 12/31/10 while EU and HL are 6/30/10. The chart below is revealing:

CASH TOTAL ASSETS TOTAL SALES CASH TO TOTAL ASSETS CASH TO SALES
EU $19.4 $ 108 $ 46.5 18.000 % 43.000 %
HL $ 7.4 $ 157 $ 50.8 4.700 % 14.500 %
PEPCO $39.0 $8,900 $7,039 0.004 % 0.005 %
BG&E $50.0 $6,667 $3,461 0.007 % 0.014 %

CASH NUMBERS ARE IN MILLIONS OF DOLLARS

In order to expand the universe of comparables I was able to identify all publicly traded utilities in North America (11) with sales between $10 million and $250 million. I am attaching that list as an appendix to this letter. The average cash to total asset level is 1.54% while cash to sales is 6.38% .

Finally, in evaluation of EU’s cash position, we explored the after tax rate of return for utility operating companies. According to Citibank’s Global Utilities Group (which was one of the global groups I ran prior to my retirement) the weighted average cost of capital (e.g. return on assets) is expected to be in the range of 7 – 8%. EU’s return on assets is 1.5% – dragged down in large part by having 18% of its assets invested in the Maryland Local Government Investment Pool, generating just $41,000. The average interest rate on the funds invested in the Maryland Local Government Investment Pool was just 21 basis points.

Clearly EU has too much cash.

We would recommend that the Mayor and Town Council direct EU to evaluate ways of returning a large portion of its cash to the tax payers of Easton. Given its unique ownership structure and the regulated nature of its business careful consideration must be taken to determine how best to accomplish this task. We believe that a minimum of $10 million should be repatriated which can be used for reduction in Town taxes and/or reduction in the Town’s outstanding debt. Even after a reduction of $10 million of cash EU will have 32% more cash than its larger comparable, Hagerstown Light.

Respectfully submitted:

Charles F. Bohn, Jr.
Vice President, TCTA
7881 Fort Stokes Lane, Easton MD 21601
home phone: 410 822 4688
mobile: 281 702 0287
email: charlie.bohn@gmail.com

Dipping into the money set aside from sale of the Town’s electric utility several years ago, the Commissioners elected to pay off the remaining $5 million in bonds. The Town issued these bonds in 2006 in order to fund the street renovation program which is still going on in the Town. By doing this, the Commissioners will eliminate future debt service expenditures.

Through meticulous examination of expenditures and numerous, difficult planning discussions, the Commissioners established a tentative budget for FY 2012 that will permit them to pass back to taxpayers a large portion of the debt service savings.

The Commissioners voted to reduce the Town’s real property tax rate by 9.4%, to $.58 per hundred dollars of assessed value from $.64. For town businesses, they voted to reduce the personal property tax rate by 10.7%, to $.58 per hundred dollars of personal property value from $.65.

The Talbot County Taxpayers Association commends the Commissioners for their diligent work on the coming year’s budget and the high regard they have for the Town’s residential and commercial taxpayers who are struggling in this very difficult economic environment.

Ted Doyle
President
Talbot County Taxpayers Association

Dipping into the money set aside from sale of the Town’s electric utility several years ago, the Commissioners elected to pay off the remaining $5 million in bonds. The Town issued these bonds in 2006 in order to fund the street renovation program which is still going on in the Town. By doing this, the Commissioners will eliminate future debt service expenditures.

Through meticulous examination of expenditures and numerous, difficult planning discussions, the Commissioners established a tentative budget for FY 2012 that will permit them to pass back to taxpayers a large portion of the debt service savings.

The Commissioners voted to reduce the Town’s real property tax rate by 9.4%, to $.58 per hundred dollars of assessed value from $.64. For town businesses, they voted to reduce the personal property tax rate by 10.7%, to $.58 per hundred dollars of personal property value from $.65.

The Talbot County Taxpayers Association commends the Commissioners for their diligent work on the coming year’s budget and the high regard they have for the Town’s residential and commercial taxpayers who are struggling in this very difficult economic environment.

Ted Doyle
President
Talbot County Taxpayers Association

The Talbot County Taxpayers Association understands that taxation is necessary to fund government services that are appropriate for government and which are delivered efficiently and effectively.

This begs some questions.  What services and at what levels are appropriate for government and not the private sector to provide?  If the services are not provided by the private sector, should we automatically assume that they are appropriate for government to step in and provide?  In attempting to answer these questions, government and the public must distinguish between things they must have versus things they would like to have — necessities versus luxuries.  Politics and interest group pressures many times blur these distinctions.

Are the appropriate services being delivered in the most efficient and effective manner?  Vigorous competition is almost always the best way to obtain the most efficient and effective delivery of a service.  So wherever possible and practical, governments should look to outsource service delivery into a competitive environment.

Sometimes there are no competitive choices available or permitted, policing and public schooling are two examples.  In cases like this, the public and the government must be especially diligent in making sure that efficiency and effectiveness are not compromised over time.  Evidence of a problem here shows up when departments or agencies simply request funding for annual budgets that maintain the status quo, but at a higher delivery cost.  Many times more money is requested to add new service extensions — delivering services to more and different groups than originally intended, “empire building” and adding politically attractive “bells and whistles.”  Rarely is any critical examination ever made about whether types of services and the delivery methods are still appropriate and cost-effective.  Again, politics and interest group pressures work against taking a critical look.

REAL PROPERTY TAXES

Unfortunately, it is usually easier for politicians to raise taxes than to take on the politically difficult task of confronting interest groups and their sympathizers.  The only weapon the taxpayers have, and one that they have used effectively for almost 40 years in this country is to put a cap on the amount by which taxes can increase in any year.  This started famously with Proposition 13 in California.  The idea spread to other states in the late 1970s when property taxpayers were suffering from the extreme inflationary run up of housing prices.  The Talbot County Taxpayers Association began championing a charter amendment to impose a property tax cap about that time.  The Association gathered the thousands of signatures on a petition to put this amendment proposal on the ballot.  Voters approved the cap by an overwhelming majority.  The County Council later used its power to place it back on the ballot to be rescinded.  The voters made it crystal clear that they wanted the tax cap and overwhelmingly voted down the Council’s ballot measure.    Special interests challenged the tax cap in court.  This battle was fought in the 1990s and in the end resulted in the tax cap we now have in our Charter.

The Talbot County Council may not increase the amount it receives in property taxes on properties on the rolls at the beginning of the fiscal year by more than the lesser of 2% or the inflation rate.  It was this taxing limitation that, we believe, protected County taxpayers from an explosive increase in property taxes when property values increased dramatically from the mid-90s through about 2007.  How many residents on low or fixed incomes would have otherwise been put in jeopardy of losing their homes?

New Jersey finally discovered the benefits of capping real estate taxes after years of allowing special interests to prevent state and local governments from raising property taxes to pay for even more of their favored agencies and programs.  New Jerseyans now have the distinction of paying the highest property taxes in the nation.  Last year, Gov. Chris Christie pushed a hard tax cap through the New Jersey Legislature.  Interestingly, it limits property tax increases to the same 2% as ours.

Our Talbot County cap does not appear to be as strict as New Jersey’s.  Our tax levy limit is placed on properties on the rolls at the beginning of the year.  Properties that come on the rolls during the year are outside the tax cap limitation for that year, so their property taxes can be added to that year’s levy.  During the last 10 years, the average growth of Talbot County’s property tax receipts averaged 5.1%, well above the Charter’s 2% limit.  The additional 3.1% annual growth, for a 10-year total of $37,700,000, in property taxes above the Charter’s limit resulted from the new properties that came on the tax rolls during those years.  It is noteworthy that inflation was relatively tame during this 10-year period, averaging 2.4%.

There are some who say that Talbot County is very wealthy and its property owners are under taxed.  The State’s educational establishment takes this position.  For this reason they have chosen to give Talbot County Public Schools the lowest amount of support provided to any school system in the state.  Even so, Talbot County makes up for this shortfall by locally providing 66.5% of what the schools need.  This percentage is second in the state behind Worcester County, which has the enormous commercial property tax base in Ocean City providing it with extraordinary tax revenue.

The State’s educational establishment has accepted the fallacy that high property values equate to a healthy ability-to-pay.  It is true that Talbot County has a high real property tax base.  There are many very high income individuals with large estates in the County.  Their ability to pay cannot be questioned, but there are not that many of them.  The great majority of the property owners in Talbot County are middle to low income.  These are people, who are retirees living on fixed incomes, watermen, farm workers, construction workers, retail workers, and those working in the dining and hospitality industries.  Their homes have become accidentally very valuable because of the run-up in property values from the mid-1990s through 2007 driven by second home buyers and others speculating on the County’s historic housing and waterfront/water-view properties.  Easy credit and low interest rates fueled this bubble.

A house is an illiquid asset.  It cannot be quickly or easily converted to cash in order to provide the funds to pay for property taxes.  The rapidly increasing real property tax base can only be used to generate tax revenue if the owners have the ability to pay out of current income.  It does not appear that Talbot County citizens generally have a large amount of excess income.

The average annual pay in Talbot County was $36,046 in 2009, which are the latest data available.  This is only 71.3% of the state average.  Now one may ask, what about all of the retirement and investment income Talbot citizens receive?  Well, that’s not as much as one would think.  The median household income in the County is $59,633.  This measurement includes all sources of income, including wages, retirement income, investment income and other sources, received by all members of the household.  Talbot’s median household income ranks only 15th among the State’s 25 counties.  By these measures Talbot is hardly one of the state’s “wealthiest” counties.

Another element to consider is that the County must set a flat property tax rate.  This means that the same rate is applied to low-value properties as it is to high-value properties.  The County cannot direct its property tax burden mainly on the high-income individuals.  Any increase is going to hit everyone.  This raises serious fairness questions.

Even if the County Council wanted to increase property taxes beyond the existing cap, it does not have the legal authority to do it.  So, this avenue cannot be used to help close the coming year’s budget gap.

INCOME TAXES

Talbot County has an income tax rate of 2.25% of a tax filer’s Maryland taxable income.  The State of Maryland limits County income tax rates to a maximum of 3.2%.  So there is some, but not much, room for the County to increase its income tax revenue.

As with property taxes, the County must apply a flat rate to all taxpayers.  As noted above, County taxpayers generally do not have high incomes.  Nevertheless, there is still a small, dwindling group of very high-income taxpayers in the County.  The following statistics are revealing.

In 2009, 30% of the total taxable income in the County was on only194 of the 13,615 returns filed.  This small group’s average taxable income was $1,350,000.  The remaining 13,421 filers had an average taxable income of $47,000.  The bottom 50% of earners in the County had average taxable incomes of only $15,100.

Between 2007 and 2009, about 1500 filers, or almost 10%, fell off the County’s income tax rolls.  More importantly, the County lost 148, or over 43%, of its highest income taxpayers.  Certainly the recent recession and market collapse has moved some of these individuals out of this very high-income group.  Another, and possibly the main reason for the dramatic decline of high-income individuals residing in the County was the 32% increase in Maryland’s income rates on millionaires that became effective in 2008.  This is a highly mobile population who can choose to go elsewhere if the tax environment becomes too onerous.  If the new Maryland rates are the reason they left, we will not see them returning.  Regardless of the reason, they are gone.  Their loss accounted for almost 75% of the County’s lost income tax revenue since 2007.

To recover this large loss through an increase in income tax rates means putting the burden on the rest of the taxpayers in the County.  If the income tax rate were increased to the State limit of 3.2%, it would increase County collections from the top 194 individuals — probably fewer now — by about $2.5 million, only 30% of the increased collections.  But, because the County is not allowed to have a progressive rate that puts a greater burden on those high-income earners with the greater ability to pay, the other tax filers in the County would have to pay almost $6 million, 70% of the increased collections.  To recover the County’s income tax revenue losses since 2007, 75% of which came from a decline in the County’s very wealthiest citizens, a tax rate increase would direct 70% of the recovery amount to the other lower-income taxpayers. This highlights the significant fairness issue with raising the County’s flat income tax rate.

Individually, this would add $445 in taxes to the non-wealthiest average filer.  This doesn’t sound like much, but it will make a very big difference in a retiree’s or a working family’s budget.  In today’s environment of rising fuel and food costs, this group has little, if any, discretionary income.  Think of the lower-income half of the County’s taxpayers with only $15,100 of taxable income.  They would have to pay an additional $143 on average.  For this hand-to-mouth income group, this seemingly small amount can represent the tipping point.

Even so, if the County decided to increase its income tax rate, which we would not support, the soonest the new rate could be effective would be for calendar year 2012.  The County would not see the revenues until its FY 2013.  This is not a solution to closing the FY 2012 budget gap.

Recordation and transfer taxes

In FY 2010, about 11% of the County’s revenues came from “other local taxes,” which consisted mainly of recordation and transfer taxes on real estate transactions.  Since 2007, the value and number of real estate transactions, likewise the revenues from this source, have dropped by more than 45%.

The County’s recordation and transfer tax rates combined are much in line with the rest of the counties on the Eastern Shore.  Nonetheless, they are little low when compared to nearby counties such as Queen Anne’s, Dorchester and Caroline.  So, an increase in taxes on property transactions will help with the coming year’s budget gap, but not much because this is a relatively small source of income for the County.  Further, the value and number of property transactions may still be falling — certainly not increasing appreciably.

SUMMARY

Tax increases can play only a small part in closing Talbot County’s coming year budget gap.  The Charter limitation on property tax increases and the timing delay for income tax increases mean that these two major sources of revenue cannot be used to close that gap.  Other local tax rates can be increased, but these revenue sources are small and can only go a little way to closing the FY 2012 gap.

The County has some cash reserves that it built up when times were good two years ago.  It has drawn through most of those in order to balance the last two years’ budgets.  It has very little left that is not committed, such as for funding the pension plans of County employees.  While it may tap into these reserves again for this coming year, the County must preserve some of these in case of emergencies or further unexpected declines in revenues.

So there it is.  The County cannot increase tax revenues and it has insufficient reserves in order to balance the coming year’s budget.  All that is left is to drastically reduce expenses.  Public schools consume more than 50% of the County’s revenues.  For the last two years the County has focused its cuts on the other half of its budget.  There is no longer much room in those departments for further cuts.  Now, regardless of the State mandated Maintenance of Effort requirement, the County must take a very hard look at school funding.  We addressed this issue in our last article.

Have we come to the end of an era of generous school funding in Talbot County? Statistically it looks like the era ended with the housing and financial collapses 2 to 3 years ago.

County revenues from all sources peaked in 2008. Since then the changes have been dramatic. Revenues have dropped about 30%. However, so far, the County has only reduced spending by about 16%. It has made up the difference by drawing down its reserves to where now they are almost exhausted.

During this three-year period when the bottom fell out of County revenues, the County Council cut funding for non-educational services by 30%. While funding for these departments was being painfully squeezed, funding for the County’s public schools was increasing — by more than 8%. This increase was funded by the drawdown of cash reserves.

For the last 10 years, the County has increased funding for its public schools at an average rate of about 4% per year. This may not sound like much but it represented a total increase of school funding of almost 50% over that 10-year period. Incidentally, inflation during that period was relatively tame, averaging about 2.35% annually.

During the last decade, the added spending was not driven by an increase in school enrollment. The student population was essentially flat during those 10 years, staying very close to 4500 students each year. Because personnel costs represent almost 90% of the school’s budget, budget growth must be due in large measure to increases in these costs — the number of teachers and other employees, wage increases and benefit cost increases.

Now we need to look forward. Things certainly don’t look good for the coming year. The County Council has to find a way to close a $10 million gap between projected revenues and the estimated cost of government. For the most part, funding for public safety services must continue. If funding for public schools is not touched and police, fire, and emergency services are mostly protected, what is left to cut are services like libraries, parks, recreation, road maintenance, mosquito control, social services, offices of economic development and tourism, and county administration. The concentration of budget cuts into such a small portion of the total budget will mean the virtual elimination of many of these services for next year.

Into this equation the Board of Education has submitted a request for an additional $2.74 million for the public schools. This is a bump of 8%. They are not going to get this. If they are lucky, the schools will be funded on a per-student basis at an amount equal to last year. That would mean no raises again this year for teachers — they haven’t seen them for the last two years of their present four-year contract either. And, the school system will have to find a way to fund an additional $1.7 million it needs to pay the 12% increase in employee health insurance premiums and employment taxes. This money will have to come from reducing funding in other areas of the school budget.

Given the enormity of the gap the County Council must fill, it would not be a surprise if they decided to cut the school budget below its last year amount. This may be the year for other reasons to violate the state Maintenance of Effort mandate, because the penalties would be minor.

So the current dire situation for public school funding will be getting worse in the near future. Looking out a little further, the situation may not improve for many years. The State has cut almost all of its support to the County and proposes moving a multimillion dollar teacher pension cost to the County sometime in the future. So even if the County starts to see revenues pick up, it will still not get back to where it was until the State sorts out its own finances. Further, as revenue picks up, the County is probably going to direct more funds initially to those services that have been so drastically cut before it looks at the school budget.

With what is likely to be a flat or declining school budget for the foreseeable future, it is time for the Board of Education to get to work. It must start looking at its own policies and practices that are driving the school budget. Dr. Karen Salmon, the schools’ superintendent, is not responsible for policies. It is time for the Board to step up to their responsibilities — do the studies, evaluations and make the hard choices.

The ones being hurt most by this deteriorating situation are our teachers. Unless the Board of Education can develop and institute a plan for sustainable teacher pay and benefit support, teachers are going to face a pretty gloomy future. This is not right! Our teachers deserve to know the truth. If changes of pay, benefits and staffing structures are in the offing, they must be informed and involved from the start. An answer must be found before negotiations for a new contract start with the Teachers Association next year.

In a previous ad we talked about looking at contracting out the student transportation services. Other counties on the Eastern Shore contract out all or virtually all of these services for an average cost savings compared to Talbot County of 30%. This represents close to $1 million.

The number of classroom instructors increased 10% over the last 10 years, but there was no increase in enrollment. The way in which employees can get sustainable pay increases is through increases in productivity. An increase in classroom instructors with no increase in students is negative productivity. It is time for the Board to take a very hard look at its staffing, both in the classroom and elsewhere. To maintain the present staffing levels is to harbor unfounded hope that things will improve. This is a luxury the Board can no longer afford.

The Board needs to take a good hard look at its student levels in each school and classroom. To a great extent this issue is related to the one above. We may have to forgo the benefit of a very low student-to-teacher ratio because the costs are just too high. Let’s see if we can’t leverage our classroom teachers through the use of technology. And, we may have to forgo the luxury of keeping schools like Tilghman Elementary open.

We have suggested only three obvious structural cost issues, but we are sure the Board and the school administration can find many others. These will be very difficult and politically-challenging issues, but the Board of Education must tackle them and support the efforts of Dr. Salmon, her staff and the teachers.

Tax increases seem like an obvious solution, but there are many problems here. Because of charter limitations and collection timing, there can be no increases in property or income taxes that will provide additional money to close next year’s budget gap. There are also issues that will work against using taxes for a long-term solution. The Talbot County Taxpayers Association will talk about these in our next article.

What you think? Do you believe this crisis is real and that Board of Education can step up to this challenge? We would like to know your thoughts.

Recently the Talbot County Public Schools published its 2010 Annual Report. This was sent to all County residents. It was a very informative and well-produced document.

It was very gratifying to see that our school system is one of the top performers in the State — in a state where schools are ranked among the best in the country. The Fact Book for 2009-2010 published by the Maryland State Department of Education lists many important instances where the State’s public schools are number one in the country.

The 2010 Annual Report shows Talbot County’s public schools performing at or better than state averages on the Maryland State Assessment tests. The number of Advanced Placement Scholars is high and growing each year. The Report notes that Easton and St. Michaels High Schools were cited by Jay Mathews of the Washington Post and Newsweek as two of the nation’s top high schools with challenging programs. They were in the top 5% of the nation’s 27,000 public high schools.

The really good thing about this outstanding performance is that the TCPS achieved it with costs 15%, or $2,063 per pupil, less than the average county school system in the State. Only two other county systems have lower costs per pupil.

Leveraging performance of highly qualified teachers through technology is almost certainly one of the important factors in the system’s efficiency and effectiveness. The Report shows that the TCPS well exceeds the State average in its percentage of “Highly Qualified Teachers.” The recently completed Johns Hopkins University study confirms the value of the high school one-to-one laptop program. Dr. Karen Salmon, Superintendent of Talbot County Public Schools, in her presentation of the 2010 Annual Report to the County Council talked of even more technology improvements in the classrooms.

A fair interpretation of this information would be that it demonstrates the efficiency and effectiveness of our public school system. The system is producing above-average results with far-below-average costs. This is a testament to the outstanding performance of the system’s superintendent, administrators and teachers. But, we are perplexed that TCPS is not touting this as a major accomplishment. The report seems to put a negative spin on its having the next-to-the-lowest funding in the state. We suspect it does this to bolster its case for $2.8 million in additional funding from the County in FY 2012, mainly for the purpose of providing raises for teachers and other employees. In our view, this effort is misdirected at the County.

During the current fiscal year, TCPS represent almost 53% of all County spending. The County Council is working on its budget for next fiscal year. Because of substantially reduced revenues, which we discussed in an earlier report, it is looking to dramatically reduce expenditures. Due to the State’s Maintenance of Effort mandate, the County cannot reduce spending per pupil below its current level. That means any reductions must come from other County services. The TCPS’ share of County spending could, therefore, increase up to 59%. TCPS is effectively squeezing out all other important County services.

By any measure the County is not underfunding the schools. It ranks fifth in the State for per-pupil funding of it schools. The problem is that Talbot County receives the lowest amount of combined Federal and State support of any county. TCPS should be directing its efforts at increasing the portion of funding the County receives from the State.

It must also direct its efforts internally. We are sure there are many ways it could find savings that over time could fund the raises it wishes to provide its teachers. One place to search for cost-savings for example would be transportation. According to The Fact Book, TCPS spends the fourth highest amount in the State per pupil for transportation. It spends 15% higher than the state average. More striking is that TCPS has the highest transportation cost on the Shore. It spends almost 30% more per pupil than the average of all school systems on the Maryland Eastern Shore. That difference amounts to almost $1 million. A possible reason for this might be that TCPS is the only system on the Shore that does not contract out all or almost all of its transportation requirements. Whatever the reason, this would be a good place to go next to look for efficiencies.

In summary, Talbot County Public School systems are performing very well and we should be proud of the job that they are doing with our students. The County by law must continue to fund its schools at per-pupil rate equal to prior year’s budget, even though its income tax revenues have dropped from $32 million to $19 million. All County departments and agencies have been asked to look for ways to cut costs. The Talbot County Public School system should be no exception.

October 26, 2010

Angela Lane, Talbot County Finance Director

Good Evening. Thank you for having me at your annual meeting. I will try not to bore you with

too many figures this evening.

My topic for tonight is: Talbot County – Where do we go from here?

What is actually happening in Talbot County Government today – and what is going to be the

fiscal reality for the next few years.

While Talbot County is going to face serious fiscal challenges over the next few years, at this

point in time, Talbot County is in good fiscal shape. We have money in the bank, our rainy day

fund is intact, and the County workforce has been reduced by –24 approved positions between

FY 2010 and FY 2011. We learned our lesson from the recession of the early nineties.

Having just said that the County is in reasonably good fiscal shape – there are serious fiscal

realities that the County will have to address over the next few years. The County Council will

need to make many difficult decisions that will impact every citizen of this County. These

decisions will be focused around increasing revenue streams -possibly through new fees and

increasing existing fees and taxes – while also containing the cost of government through

department reorganizations.

While we are officially out of the recession – our economy is not rebounding as quickly or as

consistently as we would like. A sluggish general economy means that government (whose

revenues are often income related) will continue to struggle.

To understand where we are headed we need to understand where we are now.

Let’s start by focusing on revenues

The County has 5 major groups of revenues:

• Property Taxes

• Other local taxes – Recordation Transfer and Public Accommodation

• Income Taxes

• Revenues from State & Federal sources

• Fees

I will briefly review these revenues.

Property Taxes – Due to either the visionary or radical leadership of this organization, Talbot

County has a property tax cap. The County has had a cap since the late 1970.s. The cap

structure was revised 1996- 1997. The current tax cap requires the County Council to set the

real property tax rate so that no more than 2% in additional real property tax revenues will be

generated in the upcoming year. The good news is that the County knows what Real Property

tax revenues will be from one year to the next. The bad news is that we have tax cap. Property

taxes account for 40% of the County’s FY2011 Budget.

Other local taxes – These are primarily Recordation, Transfer and Public Accommodation taxes.

Recordation and transfer taxes are closely tied to the real estate market. These revenue streams

have decreased in the last few years – and we are still not seeing a true stabilization in these

amounts yet. These taxes have decreased due to declines in values in the real estate market as

well as the general slowdown in number of sales. These revenues should be the first of the

County’s revenues to recover from this recession. Public accommodation taxes – better known

as hotel bed taxes will be another indicator of the economy improving.

Revenues from State & Federal Sources – This category represents just over 2% of our FY 2011

budget –One revenue in this category is Highway User Revenues. In 2010 the State reduced the

County’s portion of this revenue –all Counties and municipalities in the State were impacted by

this – not just Talbot County. But Talbot went from receiving over $2 million a year and over

$3 million some years in highway user revenues to receiving just $283,000 in the fiscal year that

ended June 30th. We are projecting to receive $ 98,000 for the current year. It is not anticipated

that there will be any significant restoration of these revenues until 2015.

One revenue stream that I did not mention is prior year’s unexpended funds. These are funds

from prior years that the County did not spend in the year that they were received… These funds

are essentially the County’s savings account. The FY 2011 budget includes almost $7 million

of prior years funds. In order to balance the current year budget, the county has taken money

out of our savings account. We do not have enough funds available in our fund balance to

continue supporting the Budget at this level going forward. This is also part of the challenges

facing the County in the next few years. How can we continue to sustain our current level of

spending?

Income Taxes Now to the big revenue question mark – income taxes. In FY 2009 Talbot County

received over $31 million in income tax revenues.  In FY 2010, the year that just ended June 30th,

that amount had dropped to $19.2 Million – a whopping 40% decrease in one year. The County has never

experienced a decrease of this magnitude in its income tax revenues.

The reasons for the decrease are many – but the major ones are:

Incomes have decreased – particularly investment incomes, we have fewer individuals filing

taxes in Talbot County. The Comptroller’s Office has indicated that during economic downturns

Talbot County historically has fewer tax return filers. And, I believe that the methodology used

by the Comptroller’s Office to distribute tax receipts to the County also contributed to this

decrease.  Obviously a 40% decrease in a major revenue is problematic for the County.

For the current fiscal year we are projecting to receive $22.6 from income tax revenues. Our

budget does not anticipate any significant restoration of our income tax revenues to the $31.6

million level of prior years. The current year budget of $22.6 million is a decrease of 29% from

our FY 2009 actual collections. This decrease is significantly greater than the actual decrease in

income tax revenues reported by the State of Maryland (11% over the past 2 years). I think the

FY2011 income tax revenue projection in very reasonable.

However, the County will not receive its first and most important and our largest income tax

distribution until November 30. We will be almost half way through the fiscal year before we

have any indication of whether our projection for 1/3 of our total income for the year will be

realized.

Now let’s look at the expense side of our budget:

I think it is important to repeat that between the adoption of the FY 2010 and FY 2011 budget,

the County has eliminated 24 full-time, benefited positions. A reduction of over 8% of the County

workforce in one year is significant and highlights our concern that we will be facing fiscal challenges for several years.

The Big Expense groups in the budget are:

• Education

• Public Safety

• Public works

• Other County Services

• General Government

The largest component of the County’s budget is education. This includes the Talbot County

Public School system and Chesapeake College. The County is required by State law to fund

both organizations at mandated levels. Since this is such a large portion of our Budget, I want to

spend a little bit of time discussing these two agencies.

Talbot County Public schools comprises over 52% of the County’s current budget. This includes

an operating appropriation of $34.3 million and annual debt service on School facilities of almost

$3.8 million. The operating appropriation to the TCPS is the amount required under “Maintenance of Effort”.

All counties are required by State law to fund Maintenance of Effort.  This calculation requires counties to fund

the same per pupil amount in the current year as was funded in the prior year.

A very simple example of this is: if last year a county provided its school system with $1 million

dollars and this school system had 1,000 students, the per pupil funding is $1,000. If in the

current year, the school system has 1,200 students then the County is required to fund $1,000 for

each of these students or $1.2 million.

In Talbot County’s case we are currently funding $8,034.06 per student. This is the 4th highest

per student funding provided by a local jurisdiction to a school system in Maryland. Only

Montgomery, Worchester and Howard Counties provide more per student funding to their

school systems. I know many of you are thinking that you had heard that Talbot has the lowest

per student funding in the State not the 4th highest. Talbot County has the lowest per student

funding in the State when all funding sources – Federal, State and local are considered. The

dilemma and philosophical argument becomes who is not proving adequate financial support to

our public schools. That is a discussion for another night and another venue.

But back to the Public Schools budget.

The County Council provides funding to the Schools by 11 major categories – They are:

• Administration

• Mid-Level Administration

• Instructional Salaries and Wages

• Textbooks and Instructional Supplies

• Other Instructional Costs

• Special Education

• Pupil Personnel Services

• Transportation

• Operation of Plant

• Maintenance of Plant

• Fixed Charges

Again this category allocation is outlined in State Law. Once the budget is approved, the

County Council has NO oversight as to how funds provided to the Public Schools are spent. The

Board of Education decides how to spend these funds within each category.

I want to mention that the funding provided to the Talbot County Public Schools for the current

fiscal year provides adequate funding for the same number of teachers, Principals,

administrators and support staff as was funded last year (with no raises – the County Council did

not anticipate that there would be any salary increases to TCPS employees in FY 2011). Again –

it is the Board of Education that makes the determination of where staff are located, how

classrooms are staffed, and how staff are compensated.

I will leave you with another statistic – according to the 2008-2009 Fact Book Prepared by the

Maryland State Board of Education (available on their website) the student to staff (this is all

staff ) ratio is 7.19 students to 1 staff person for Talbot County. This ratio of 7.19 students to 1

staff member is the same as the State average. It appears that for the present time TCPS are

adequately staffed.

The next largest component of our education funding is Chesapeake College. Chesapeake

College is a regional Community College – and as regional Community College it has unique

funding stream. The five partner counties – Caroline, Dorchester, Kent, Queen Anne and Talbot

share in the” local” appropriation to the College. We allocate this “local” share based on the

enrollment of students from each county so each county’s appropriation can fluctuate from one

year to the next. Another feature of the regional local support is that all counties are obligated to

pay their share – the only way to adjust this is for three of the five counties to agree to adjust the

total local share of the College’s budget.

For the current year the total operating budget for Chesapeake College is over $20 million.

Of this amount, the Talbot County share to Chesapeake College is $5.5 million. Talbot County

funds $1,364,422 (including debt service) of this local share. This represents approximately 6.6%

of the College’s operating budget. This is actually a decrease in the proportion of Talbot County’s

support. In 1985 Talbot County’s operating appropriation to Chesapeake College funded

approximately 9% of its operating budget. In 2004 this percentage was still 9%. Now it is less

than 7%

The next largest component of the County’s budget is public safety. This represents 15% of our

Budget. Public safety includes the Sheriff’s Department, The Detention Center, Emergency

Services – our 911 Center, and our Emergency Medical Services division, the Volunteer Fire

Companies,  Building & Permits and Animal Control.

I don’t really have too much to say about this area. Government’s highest function is public

safety.  Although there are no mandatory funding requirements for any of these departments,

there are State mandated staffing requirements for the Detention Center and the 911 Center.

There are also common-sense requirements. We expect someone to answer when we dial 911

and we expect a sheriff’s deputy, the fire department or an ambulance to show up when we have

an emergency, regardless of when or where our emergency is.

As I go through the rest of my speech, please keep these segments of the County’s budget in the

back of your mind -Education which is 55% of the County’s total budget and Public Safety

which is 15 % of our budget. That leaves 30% for everything else- Roads, Library, Health

Department, State’s Attorney, Election Board, Parks & Recreation and General Government

operations.

When we start looking at areas to reduce our spending – 70% of our expenses are essentially

“untouchable”.

This is an overview of where we are as of today. If income tax revenues are received at the level

Budgeted, the County will continue to operate as usual for rest of this year.

So what are we afraid of? What is all this talk of fiscal doom & gloom that we read about in The

Star Democrat almost every day?

The reality is that Talbot County does not operate in a vacuum. We are afraid that the State current year

budget isn’t in such good shape. We are concerned that the State’s current year revenue projections

are too optimistic and that the State’s actual expenses will be more than the budgeted.

We are afraid that when the State legislature starts in January –they will need to balance the

current year’s budget – and if the current year is not balanced what will the State’s FY 2012 Budget look like?

The legislators will be looking at revenues that go to the counties or county expenses that the State pays.

The State has already taken our highway user revenues and police aid – so on the revenue side the

only thing left is income taxes. While this is an option –I think the State legislature will look at

the expense side before they will take County income tax revenues.

The big item on the expense side is teacher retirement benefits. The State pays the retirement benefits

for all teachers and school administrators in the State – for all the public schools, community colleges

as well as library employees. For Talbot County, this expense is currently $4 million.  Statewide the cost

is $900 million and is growing by approximately 12% a year. This is real money.  I am very confident

that we will be paying these retirement benefits in the future. The question is how much and when.

The ideal situation would be a phase-in of these costs starting in FY 2012 with some accommodation to

ease the Maintenance of Effort requirement for public school funding. I don’t think we will see this ideal situation.

So how is Talbot County going to come up with $4 million plus for teacher retirement benefits in FY 2012?

And how are we going to replace the $7 million dollars of Fund Balance that we used to balance this year’s budget?

These are big challenges

The County Council is going to have to look at additional cost containment – and by cost

containment, I mean additional reductions in County staff and reorganizations of County

Departments and possibly reduction in services to our citizens. But remember this has to come

from our non-mandated portion of our budget. The $7 million is over 9% of the total budgeted

expenditures– this $7 million is almost 20% of the non–education expenditures, and almost 30%

of the non-education and non-public safety expenditures. It is not realistic to think that the

County will cut all non-education and non-public safety services by 30% next year.

In order to truly balance our budget and fund the additional cost of  teacher retirement, the County

Council will also have to look at new and/or additional revenue streams as well as increasing

existing revenues.

Many difficult fiscal decisions will have to be made over the next few years that will impact all

of us.

Talbot County taxpayers spend more than half of the annual budget on education. The Talbot County Public School system would have us believe that there is no room to trim their budget due in part to lagging teacher salaries. In fact, the Board of Education just approved a $2.8 million increase for the coming year all attributable to teacher salary and benefit hikes.

Recently, The Talbot County Public Schools published and distributed to all Talbot County residents its 2010 ANNUAL REPORT. In it they presented a bar graph that shows average teacher salaries in Talbot County to be the lowest among all public school systems in the State of Maryland. This chart is totally misleading, in our view.

The data from which this chart was produced evidently come from The Fact Book for 2009-2010 put out by the Maryland State Department of Education. It appears the amounts presented in The Fact Book have not been controlled for two key variables — the average longevity/experience and average educational levels of each county’s group of teachers.

The Professional Salary Schedules for Maryland Public Schools published by the Maryland State Department of Education present the salary schedules for each public school system in the State. Advancement of a teacher within these salary schedules is a function of education level and years of teaching in the system. For the school year 2009-2010, Talbot County teachers at step 5 with bachelor’s degrees are the sixth highest paid in the State. These are the newer teachers who now have enough experience to become valuable assets of the system. This group of teachers is paid the highest among the Maryland counties on the Eastern Shore.

The salary for Talbot County teachers, at step 10 with Master’s degrees, ranks 14th — very near the middle — among the State’s 24 county school systems. Their salary ranks third among the nine Maryland counties on the Eastern Shore.

In fact, at no salary step level do Talbot County teachers rank last in the State, or even close to it. Therefore, it is seriously misleading to present, as the Talbot County Public Schools do in the Annual Report, a bar chart that implies teachers in Talbot County are the lowest paid in the State.

We have made some calculations from available data to control for the variables of longevity and experience. We cannot be precise because we lack the actual salary steps for all public school teachers in Maryland. However, we believe our calculations are good enough to provide reasonably accurate comparisons. Our calculations show that the adjusted average pay for Talbot County teachers is tied with Cecil and Worcester Counties for the 12th position, not last, among the State’s 24 county public school systems. Our teachers’ average salary level is tied for first place on the Eastern Shore, also with Cecil and Worcester Counties.

While it goes somewhat beyond the scope of the teachers’ salary chart, it is important to note that benefits are an important part of total compensation. Because teachers did not get their contractual salary increase, their contract stipulates that the school system pay 98% of their health-care benefits, rather than the usual 85%. We have not taken the time to evaluate the amount other counties pay for health benefits, but we are pretty sure 98% lies well outside of the norm. Factoring in the value of healthcare benefits could further improve Talbot County’s teacher compensation ranking, possibly up to 9th out of 24.

With our comments on relative teacher salaries among all the counties, we do not intend to judge whether the teachers in Talbot County are over or under paid. That is a judgment for others to make, who have better knowledge about all the relevant factors that should be considered in setting pay levels. We simply wish to put Talbot County teachers’ salary levels in a context in which they can be better evaluated during the budget process. Discussions and negotiations regarding teachers’ salary levels should always, in our view, take place in an environment in which accurate comparative data are available to all.

We hope that the Talbot Public School system will join with the other departments and agencies in the County seeking ways to trim their budget, not increase it in this time of belt-tightening for all of our citizens.

Faced with these realities, the County Council is charged with an almost impossible task of providing necessary services with a severely depleted budget.  Almost 70% of the budget is in so-called “untouchable” expense areas, namely education and public safety.  Education comprises 55% of the budget, public safety 15%.  For the Council to achieve a balanced budget, they have to reduce spending in the 30% of the budget left after education and public safety.  This segment of the budget covers roads, library, health, State’s Attorney’s office, election board, parks and recreation and general government operations.  To balance the budget, $10 million would have to be cut from these areas.  That would mean cutting almost 50% of the funds allocated to these expenses.  It is unreasonable to expect and impossible to take  the necessary cost reductions from this segment of the budget alone. 

Clearly budget reductions must occur in a wider sector of the budget.  We respectfully suggest that the education budget be examined for possible amendment.  Watch for upcoming articles on why we feel this is possible without serious detriment to our public school children.  Let’s support the Council as they search for ways to meet this challenge.