Maintaining A General Fund Reserve

The City of Golden Valley currently has a $10,141,364 reserve, or 59% of expenditures, in its General Fund. Should more of that money be used to reduce the City’s tax levy?

Alternativespiggy bank

The City has taxing power—if it needs additional money for emergency purposes, it can raise taxes. So why does the City need to carry such a large reserve? Using the reserve would reduce the City taxes of the residents who were essentially responsible for creating the reserve in the first place. After all, when some corporations have extra money from successful operations, they pay dividends to their shareholders. Why can’t cities also pay "dividends" to their "shareholders" by using reserve funds to reduce the city tax levy?

On the other hand, using the reserve would only temporarily reduce the City’s tax levy. Once the reserve was gone, the tax levy would return to the previous level. This fluctuation would result in serious financial planning problems for taxpayers, mortgage companies, and others. Also, using reserve monies would not result in a dollar for dollar reduction in the tax levy. That’s because cities with significant reserve levels earn interest on the reserve monies and can eliminate short-term borrowing and reduce insurance premiums. If the City lost this net budgetary savings, it would have to make it up by increasing the tax levy.

Commentary

Sound long-term financial planning tries to avoid "quick-fix" strategies. Such planning requires that cities maintain a reserve level in the range of 55-70% of budgeted expenditures. Reserves at this level provide the benefits of higher interest earnings, lower interest costs, higher bond ratings, and lower insurance costs. For example:

  • The City does not receive the first dollar of the current year’s tax levy until the county sends the first half-year settlement in July. It receives the second half in December. Since the City has to meet expenditures beginning January 1, the reserve fund provides interim financing until the tax levy is received. Without a reserve, the City would have to borrow money to provide the interim financing. Golden Valley needs a minimum reserve level of about $6,018,902.91 to avoid any short-term borrowing.
  • The estimated reserve for 12/31/14 equals approximately 59% of the City’s budgeted expenditures, one of the main reasons Golden Valley has a high bond rating ("Aa1" from Moody’s Investor’s Services) available to a city its size. A bond rating measures the risk associated with a city’s debt. Investors are willing to accept a lower interest rate on the city’s bonds because of the low risk evidenced by the high bond rating. It’s very likely that eliminating or even significantly reducing the reserve would lead to a reduced bond rating, which would result in increased interest cost on Golden Valley’s future bond issues.
  • A significant reserve allows Golden Valley to go without umbrella liability insurance. This type of insurance covers liability claims and/or judgments over and above the liability limits on the City’s basic coverage, which saves the City approximately $45,000 a year.