The Optional Fiscal Year: Is It a Good Option for Your Municipality?
Cities and towns may change their budget year from a December 31 year-end to a June 30 year-end under RSA 31:94-a. Currently, eleven cities and seventeen towns in New Hampshire operate on a fiscal year running from July 1 to June 30. There are a number of advantages to adopting the optional fiscal year, as well as a number of ways to fund the transition to a June 30 year-end.
Advantages of the Optional Fiscal Year
The primary advantage in changing to the optional fiscal year deals with the benefits afforded in terms of cash flow. With a December 31 calendar year-end, a municipality that issues tax bills twice a year receives its first property tax payments around July 1, six months into the fiscal year. The second property tax bill is generally due around December 1. So, property taxes are not paid in full until nearly the end of the fiscal year. In other words, the municipality is billing in arrears: it provides municipal services for six months (January through June), before receiving property tax revenue for those services. Services are then provided for five more months, before final payment is received in December.
For many municipalities, this calendar year/semi-annual billing cycle requires short-term borrowing through tax anticipation notes to meet cash demands prior to receiving property tax revenues. This borrowing comes at a price, based upon current interest rates.
When the optional fiscal year is implemented, the semi-annual billing cycle stays the same (July and December), but the cash flow shifts as a result of the change in the budget year. Instead of property tax revenue arriving in arrears, the July bill provides cash at the very beginning of the fiscal year. The December billing then provides cash five months into the fiscal year, rather than at the end of the fiscal year. This change in cash flow virtually eliminates the need for short-term tax anticipation note borrowing.
A second advantage of the change to the optional fiscal year is the fact that the annual meeting may be held at a later date. Under RSA 39:1-a, a town that has changed to a June 30 year-end, may vote to hold its annual meeting on the second Tuesday in May, rather than in March. If a town has adopted the official ballot referendum, otherwise known as SB 2, then the annual meeting may be held in either April or May. One of the disadvantages of a March town meeting is that the operating budget isn’t adopted until nearly two and a half months into the fiscal year. With the optional fiscal year and an April or May annual meeting, the operating budget is adopted prior to the July 1 start date of the fiscal year, thereby providing town officials with a full twelve months to implement any new programs or react to any budgetary changes voted upon by the annual meeting.
An April or May town meeting date also changes the timeframe for preparation of the operating budget, lessening the amount of work needed to be completed during the November/December holiday season, which may be appealing to budget committee members and other municipal officials involved in the budget process. And finally, a later annual meeting date may also provide the opportunity for town meeting participation from those residents who spend the winter months away from home.
Funding the Transition to the Optional Fiscal Year
In order to change to a June 30 year-end, a municipality must budget for an 18-month transition period. This budget period would run from January 1 until June 30 of the following year. After the transition year, the fiscal year would then return to a 12-month period running from July 1 through June 30. Preparing an 18-month transition budget is generally not the more challenging aspect of changing to the optional fiscal year; the more challenging aspect is how to fund the extra 6-months of municipal services during the transition period. Fortunately, there are several funding methods available to finance the 18-month transition budget.
The Just Do It Method: This method funds the entire 18-month transition budget through taxation. It will result in a one-time increase of approximately 50 percent in the municipal portion of the tax rate. There would be no effect on the school, state education or county tax rates. The advantage of this method is that the cost of the transition budget is funded in one year, and then it’s over and done with! To avoid taxpayer “sticker shock," this funding method should be broadly publicized and well understood by citizens prior to implementation.
The Save Ahead Method: RSA 35:1-a authorizes the establishment of a capital reserve fund to set aside money in anticipation of the change to the optional fiscal year. Utilizing this funding method, a municipality would appropriate money into the reserve fund for use at a future date when the 18-month transition budget is adopted. For example, if a municipality typically raises $1,000,000 to fund annual town operations, then the anticipated 18-month transition budget would be approximately $1,500,000 ($500,000 to fund the additional 6-month period). A municipality could plan to appropriate $125,000 each year for four years into a capital reserve fund. At the end of the four-year period, there would be $500,000 in the reserve fund to offset the $1,500,000 transition year budget. The result would be little or no impact on the tax rate during the transition year since the tax rate impact was spread over the previous four years when the reserve was funded.
A variation of the Save Ahead method was accomplished by one municipality through special legislation that authorized the town to assess and bill an extra one-twelfth of the municipal portion, without an annual appropriation by town meeting. This extra one-twelfth revenue, which was referred to as the “thirteenth-month bill," was placed in a reserve fund each year for six years. At the end of the six-year period, there was an amount available to offset the extra 6-month portion of the transition budget. The advantage of this Save Ahead method was that town meeting voted once for this process, and it was then in place for the next six years. Unlike the capital reserve method described in the previous paragraph, voters were not asked to decide every year whether or not to approve an appropriation into the reserve fund. However, as previously mentioned, this method was authorized through special legislation applicable to one town and would require similar special legislation before this process could be enacted by any other town.
The Bonding Method: RSA 31:94-d authorizes the issuance of bonds to fund the transition budget. Such bonds are limited to one-third of all taxes assessed and must be repaid within 20 years. The debt resulting from the issuance of these bonds is not included in the computation of the municipality’s debt limit. Just as the Save Ahead method spreads the cost over several years, the bonding method does the same. Under this method the tax rate impact is realized in the years subsequent to the transition period, while the principal and interest is being repaid. This cost, however, would be partially offset by any savings from not having to issue short-term tax anticipation notes.
The Quarterly Billing Method: This method was also authorized via special legislation and implemented by the City of Concord several years ago. It entailed issuing five quarterly bills during the 18-month transition period. There was a 12-month budget, funded by four quarterly bills, and then a separate 6-month budget funded by the fifth quarterly bill. The formula for this method relies on the fact that, in Concord’s case, one-quarter of all taxes assessed (municipal, school and county) provided an amount sufficient to fund 6-months of the municipal budget. After implementation, the city has continued with quarterly billing, issuing two bills in June, which are due July 1 and October 1, and two bills in December, which are due January 2 and March 31.
Although these funding methods may appear fairly straightforward, there are several nuances that may need to be considered before implementation. For example, when one town funded the change to the optional fiscal year via a one-time tax rate increase, there was a problem the following year with the semi-annual tax bill. Under the law, the semi-annual bill is one-half of the previous year’s tax rate. But in this case, the previous year’s municipal tax rate was inflated due to the 18-month budget. The town had to seek special legislation to allow the assessment of a more reasonable (that is, lower) semi-annual tax rate in the subsequent year.
One town that used the Save Ahead method neglected to account for the effects of inflation, resulting in the total amount in the reserve fund being less than what was actually needed to offset 6-months worth of the transition budget. This resulted in a slight impact in the municipal tax rate during the transition year, even though taxpayers had been advised in advance that this would not be the case.
And for many people, the quarterly billing method seems to defy logic. How can five quarterly bills issued in one year not result in double taxation? It doesn’t, but that’s not necessarily the easiest thing to explain to taxpayers, or to a judge in Concord’s case. But the quarterly billing method did in fact withstand court scrutiny, and in 2004, the provisions of Concord’s special legislation were placed into general law under RSA 76:15-aa, available for implementation by any municipality.
Municipalities that have changed to the optional fiscal year seem overwhelmingly satisfied with the resulting impact on their cash flow. Starting the year with money in the bank is a far more desirable financial position than waiting six months to be paid. Regarding the funding options, Kevin Clougherty, Finance Director for the City of Manchester, explained their reasons for choosing the bonding method. “It was the least disruptive means of financing the transition, and provided the most immediate benefit in terms of cash flow. The city instantly eliminated the need for short-term borrowing, and was able to repay the bonds within 12 years."
Since Concord did not want to incur additional debt through bonding, the quarterly billing option seemed a far more appealing financing method. According to Finance Director Jim Howard, “the quarterly billing process provided a more tolerable method in terms of cash outlay on the taxpayers’ part. For both businesses and residents, the transition was financed without a material cash impact."
Barbara Reid is a Government Finance Advisor for the New Hampshire Local Government Center.