To: Honorable Mayor and Members of Town Council
From: David L. Corliss, Town Manager
Title
Discussion/Direction: Sales Tax on Food for Home Consumption
Body
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Executive Summary
Town Council has been discussing the Town’s tax on food for home consumption (FHC), more commonly known as the grocery tax. Most recently, Council discussed the topic at its August 14 budget work study session.
Several questions arose during that session surrounding what impacts eliminating this revenue source would have on various Town operations. Also mentioned were the option of an income-based rebate program for residents paying the tax, and the comparability of the Town’s revenue sources to those of neighboring communities.
As staff has analyzed this issue in recent years, one thing has remained clear: the tax on food for home consumption is one of the Town’s most vital revenue sources. Estimated to generate over
$7 million annually, it presently accounts for 14% of the Town’s total sales tax revenue. Said another way, FHC tax provides as much revenue for the Town in a given year as all sales at the Outlets at Castle Rock. In fact, six of the Town’s top 10 sales tax-remitting business for 2017 are grocery stores, or stores with a significant grocery component.
Staff does not recommend an elimination of the FHC tax, nor does it recommend a phase-out of the tax without a replacement revenue source. Staff believes that the consequences of eliminating this revenue source would be of enough impact to the Town’s levels of service that the community should have input on if or how that should be carried out.
This memo attempts to further the discussion surrounding the FHC issue, primarily focusing on the items raised at the August 14 budget work study session.
Discussion
Public safety needs comprise the bulk of the Town’s General Fund expenditures. For 2019, of the recommended $51 million in General Fund expenditures, only $19.6 million, or 38%, are not in the Police or Fire departments.
Beyond their own budgets, the Police and Fire departments - and all Town departments, whether sales tax-supported or non-tax-supported - depend on support from other departments housed in the General Fund. Public safety employees depend on strong Human Resources support for benefits, recruitment and more. They depend on the Division of Innovation and Technology for support for dispatch and technology such as body-worn and in-car cameras. They depend on Finance to track their budgets and process their payroll; on Facilities to ensure their buildings are clean and in good repair; on Community Relations to facilitate community outreach and involvement; and on the Town’s Municipal Court to adjudicate citations Police officers issue. Therefore, it is impractical, when examining options to reduce General Fund expenditures to accommodate for the potential loss of the Town’s tax on food for home consumption, to isolate public safety areas from the impact.
General Fund impacts
Removing the FHC tax would cause an estimated annual revenue loss to the Town of $7.5 million and growing, using 2020 numbers. Under current allocations, $5.3 million of that impact would hit in the General Fund, necessitating a 9.8% expenditure reduction to include core services areas.
Applying that impact across-the-board would require cuts of $1.5 million in Police and $1.7 million in Fire, as well as $1.5 million in general government and about $550,000 in Parks.
In terms of personnel, $1.5 million represents what it costs to employ about 14 police officers, and $1.7 million represents the cost of about 16 firefighter/EMTs. That is 19% of the 75 sworn Police Department members and 21% of the 78 line Fire Department members in the Proposed 2019 Budget. Of course, any actual budget cuts would be structured in a way to minimize impacts to core service areas.
However, the fact remains that 72% of all expenses planned within the General Fund for 2019 are personnel-related. Non-personnel expenses proposed total only $14.5 million and include necessities like paying for utilities at Town facilities and parks; keeping gas in the Town’s vehicles; and maintaining the various software programs Town staff needs to do their jobs. So, the reality is, the Town would need to eliminate some positions within the General Fund to accommodate a $5.3 million loss in revenue if FHC tax is removed.
As part of its 2019 Budget process, the Town took a detailed look at how actual spending compared to budgeted amounts over a 10-year period and adjusted recommended budget items accordingly. This included reducing the Division of Innovation and Technology’s recommended budget by $186,417, and the Municipal Court’s budget by $23,858, to name a couple examples. This is on top of a wholesale budget-cutting effort undertaken by Town staff during the Great Recession, which reduced the Town’s General Fund budget by $743,000 annually.
The Town prides itself on conservative financial management, so any FHC-related expenditure reductions would cut straight into needed funds, because the Town’s budgets run lean. See Attachment I for more detailed information about variances between the Town’s budget and actual spending, as recently requested by Council. Please note that most variances cannot be expected to duplicate year after year. (Those that would are addressed during the annual budget process as previously noted.)
It’s not only the General Fund that would be impacted by the removal of FHC tax. The Transportation (roads maintenance) and Community Center (Recreation Center and Miller Activity Complex operations) funds would be impacted, as well.
Under current allocations, $1.8 million of the $7.5 million FHC tax removal impact would hit in the Transportation Fund, and the final roughly $393,000 in the Community Center Fund. This would require expenditure reductions of 7% and 5%, respectively, within those funds.
Transportation Fund impacts
To reduce transportation expenditures by $1.8 million would mean the scope of the Town’s pavement maintenance efforts would need to be reduced by 18% each year, if staffing in Public Works remains as-is.
Every lane mile of pavement maintenance equals about $75,000 in expenses, so roughly 25 fewer lane miles could be maintained each year with $1.8 million less in funding. The Town currently maintains about 130 lane miles each year, which would need to fall to closer to 105 lane miles with more constrained funding.
Deferring maintenance due to declining revenue would compound the problem the Pavement Maintenance Program was created to resolve; street conditions grow worse as time goes on,
and repairs become costlier.
Community Center Fund impacts
Reducing Community Center Fund expenditures by about $393,000 annually would mean operating the Recreation Center, the Miller Activity Complex and, possibly, the Town’s two outdoor pools, a total of 2,230 fewer hours per year. This could come in the form of operating fewer hours each day, or fewer days each year. Such choices would require a delicate balance, as recreation hours often are available at the beginning or the end of residents’ days. So, opening these facilities later, or closing them earlier, could disproportionately impact the community’s access to these facilities, causing further declines in revenue to the Community Center Fund.
Options for moving forward
Given the magnitude of the reductions that would need to occur to remove FHC tax from the Town’s revenue stream, staff is recommending three general options for Council consideration on this issue:
1) Maintain the status quo and retain the FHC tax as currently approved
2) Retain the FHC tax but offer a rebate program for income-qualified residents
3) Phase out the FHC tax and supplement revenue with increased property tax
Projected financial outcomes for each option for the years 2020-2029 are outlined in attachments to this memo.
A vital point is that any alternative revenue source desired by Council would need voters’ approval under the State’s Taxpayer Bill of Rights (TABOR). Additionally, increasing the property tax, as presented in Option 3, would require a charter amendment, as the Town Charter presently restricts annual growth in property tax revenue to 5.5%.
If Council wishes to pursue a phase-out of the FHC tax, staff would recommend putting the question of phasing out FHC tax and phasing in a higher property tax to a vote.
For nearly 25 years, the Town’s tax structure has been to have a higher sales tax rate and a lower property tax rate. This takes advantage of the fact that Castle Rock is a regional commercial hub,
so nonresident spending accounts for as much as half of the Town’s sales tax revenue. That said, increasing the Town’s property tax in exchange for removing the FHC tax could help stabilize the Town’s revenue streams over the long term, as property tax is not as susceptible to economic cycles as sales tax.
The property tax increase options modeled in Attachments E and F would bring the Town’s property tax to 7.830 or 8.330 mills at the end of the 10-year phase-in. Both of these mill levies are on par with the current Front Range average of 8 mills. The first option would bring the average homeowner’s annual property tax owed to the Town to $341.47 in 2029, and the second to $363.28. This is a significant increase compared to the $35.74 paid in 2018. Still, it would only moderately impact a homeowner’s total property tax bill, which in 2018 ranges from $1,727 to $4,085.
In the 2017 Community Survey, residents were asked if they think they are getting their money’s worth for their tax dollars. Four out of five residents who responded said they believed they are getting their money’s worth. Further, in November 2016, Town voters were asked whether the Town should refund $714,580 in “excess” revenue under TABOR, or whether it should keep those funds
to use for Police, Fire, EMS and transportation purposes. Voters at that time overwhelmingly
(22,640 yes/9,867 no) opted to let the Town keep the money to use toward those core services.
In order to further understand the long-term impacts that the loss of FHC tax could have on the impacted funds, staff prepared a baseline financial forecast through 2029 (Attachment B). The forecast assumes conservative sales tax growth and does not account for any potential recession. (Attachment A offers more detailed information about the assumptions used in the projections.)
This forecast generally outlines Option 1 - Maintain the status quo and retain the FHC tax as currently approved.
Attachment C shows what the Town’s long-term financial forecast would look like if FHC tax was completely removed beginning January 1, 2020. This is not recommended due to the impacts outlined earlier in this memo.
Staff has examined in detail two additional options for Council consideration:
Option 2 - Retain the FHC tax but offer a rebate program for income-qualified residents (Attachment D)
Option 3 - Phase out FHC tax over a 10-year period while increasing the Town’s property tax mill levy rate each of those years as an alternative revenue source (Attachments E and F)
Worth noting is that while, under Option 3, the Town would obtain the legal authority to raise the mill levy, it would be Council’s prerogative to annually set the mill levy based on budgetary needs. If Council opted not to raise the mill in any given year, it would retain that right.
Attachment G shows what the Town’s long-term financial forecast would look like if FHC tax was phased out over 10 years without any alternative revenue sources. While easier to absorb than an
all-at-once elimination, this is not recommended due to the impacts it would create on core service levels.
Additional considerations
In the immediate area, the Towns of Parker and Elizabeth also tax FHC. Meanwhile, the cities of Castle Pines and Lone Tree, as well as Douglas County, do not. To provide Council additional context for this discussion, staff has surveyed many municipalities regarding their tax structures.
See Attachment H. In sum, about half of the cities surveyed tax FHC; the other half do not.
Beyond impacts to Town services, there are other consequences to altering the FHC tax that Council should consider. Among the most significant is the impact that removing FHC tax from the Town’s tax base would have on the Downtown Development Authority’s funding.
Of the $980,000 in sales tax increment the Downtown Development Authority’s received in 2017, approximately $750,000 was generated by FHC tax. Thus, removing or reducing FHC tax would drastically decrease the DDA’s ability to use sales tax-increment financing.
A possible solution for making the DDA’s funding whole in the event of an FHC tax removal or reduction is “resetting the base” for the DDA’s sales tax increment. How that would look:
The current base for the DDA’s sales tax TIF is $2.5 million. That means the Town receives the $2.5 million in sales tax revenue from the DDA area that it always had prior to TIF being implemented. The DDA, meanwhile, receives any sales tax revenue over $2.5 million.
Resetting the base would drop the “base” amount to reflect a tax base absent FHC tax revenue:
Removing the $750,000 in FHC tax generated within the DDA area, the “base” could be reset to $1.8 million. In that case, the Town would only receive the first $1.8 million in sales tax from the DDA area, with the DDA receiving amounts over $1.8 million.
While the DDA’s revenue could stay consistent in such a scenario, the Town would lose out on $750,000 in revenue it otherwise would receive from the DDA area.
In other words, the Town would have to cut an additional $750,000 in General Fund expenditures under this scenario, for a total of $6 million in cuts instead of $5.3 million,
if the FHC tax was eliminated.
Staff would not recommend making any adjustments to the DDA’s TIF base, as this would have direct consequences for core Town services.
Additionally, there are other impacts - including to repayment of transportation bonds, and of metro district bonds for the Promenade project - that should be considered when contemplating any changes to the Town’s FHC tax. Staff has previously detailed these items to Council.
Conclusion
Sales tax is presently the Town’s most important revenue source, but that might not remain the case as the community ages. Staff continually monitors the Town’s financial sustainability in attempt to ensure that the staff and infrastructure that are being added as our community grows can be maintained over the long term. It is important to remain ahead of the curve in this regard, so a gap does not develop between revenues and operations and maintenance funding needs. For this reason, transitioning some of the Town’s sales tax revenue to a more stable property tax revenue could be a positive step for the Town’s financial future.
Staff encourages Council to review and discuss Options 1-3 and provide staff any further direction on this topic.
It is important to reiterate that every sales tax dollar paid by nonresidents - estimated to be up to half of the Town’s total sales tax revenue - is a dollar a Town resident doesn’t have to pay in taxes. Under any scenario, removing or reducing the FHC tax would ultimately shift more of the cost of providing Town services to Town residents and property owners.
Attachments
Attachment A: Alternatives Information and Considerations
Attachment B: Baseline Financial Information - Option 1
Attachment C: Baseline With FHC Tax Removed - Not Recommended
Attachment D: Income-Qualified Rebate Program - Option 2
Attachment E: Phase-Out With 6.5 Mill Property Tax Increase - Option 3A
Attachment F: Phase-Out With 7 Mill Property Tax Increase - Option 3B
Attachment G: Phase-Out With No Alternative Revenue - Not Recommended
Attachment H: Municipal Tax Information
Attachment I: Town Budget Variance Information