As my readers know, the City of Costa Mesa is facing a $3.6 million revenue shortfall in this fiscal year. Thanks to the most recent Finance and Pension Advisory Committee (FiPAC) meeting, the study session a couple weeks ago and the City Council agenda for this week, we now have a clearer view of how City Hall proposes to fix it. As I feared, the City Manager is asking the City Council to waive the Capital Asset Needs (CAN) ordinance to allow a sufficient number of capital projects to be “deferred” to plug a big chunk of the hole.

Is that a bad idea? Let’s talk about it.

Why do we even have a CAN ordinance?

When this item comes before the City Council tomorrow, I won’t be shocked if the majority expresses skepticism — or perhaps outright hostility — to the CAN ordinance itself. And that’s because its principal proponent back when it was passed in 2015 was Steve Mensinger, former Costa Mesa mayor and the political bête noire of the current Democratic slate of council members.

There is no doubt that this ordinance was passed by self-styled arch fiscal conservatives for semi-ideological reasons. Mensinger and former council members Jim Righeimer and Gary Monahan formed a three-person majority for several years that pushed through all kinds of government-slashing reforms. It doesn’t stretch the imagination to assume that, in addition to using the CAN to enforce fiscal discipline, it was also intended as a tool to manage the size of City Hall. If a certain percentage of the budget must be spent on capital improvements, I bet they reasoned, it can’t be spent on long-term programs or salaries. And, ultimately, the CAN ordinance was passed back in 2015 on a 3-2 vote (then-Council Members Sandra Genis and Katrina Foley both voted no).

So I get it. The CAN ordinance absolutely represents yet another vestige of the Righeimer-Mensinger era. But before we have an allergic reaction to it, we should consider whether, in spite of its pedigree, it’s still a good idea.

Why the CAN makes sense

The biggest problem with the CAN is that it reduces budgetary flexibility. The City doesn’t always need to spend at least 5% of its general fund revenues on capital improvements. In some years, the immediate need might be much less. Spending money just to comply with a paper ordinance is wasteful. And then, when budgets tighten due to disaster, economic contraction, etc., forcing the city to spend money on capital projects when the alternative is layoffs or the reduction/elimination of critical city services seems foolish, too.

However, these criticisms are more persuasive in theory rather than practice. In the real world, boring maintenance spending routinely get cut in favor of preserving operating budgets and funding new, shiny infrastructure projects. Research shows that this is a pervasive problem across multiple levels of government. Part of it is political: 2- or 4-year re-election cycles can lead to planning myopia, with politicians avoiding toxic “cuts” to services at all costs. But those costs can be devastating: studies consistently show that deferred maintenance is significantly more expensive than routine maintenance, particularly in infrastructure assets that can catastrophically fail towards the end of their useful lives.

So forcing the city to take its medicine and chip away at the deferred maintenance backlog — remember, the city’s 5-year capital improvement plan “wish list” has almost $245 million worth of projects on it — is almost certainly a good idea. City councils and city managers must face some kind of consequence for deferring projects; otherwise, there is no incentive to stick to a conservative year-to-year operating budget. The piggy bank set aside for capital asset needs can continually be smashed open to plug any end-of-year hole, resulting in maintenance projects being perpetually deferred. Until, of course, they catch fire, explode, break down or collapse, resulting in a much more expensive problem down the road.

And that’s really the crux of something like the CAN ordinance: it is an enforcement mechanism for intergenerational justice. Deferred maintenance is debt. It is a financial burden pushed off on future taxpayers, and it accrues interest measured in inflation, service interruptions when an asset experiences total failure, and the ballooning cost of repair due to long-term neglect.

The problem with City Hall’s proposal

As mentioned above, city staff is proposing that City Council waive the CAN ordinance’s requirements to address immediate budget concerns. Their plan includes cutting $2.9 million from capital improvements this year and then “replenishing” these funds, as the ordinance requires, over the next ten years by increasing capital asset needs funding by $290,000 per year… if those future fiscal years have revenues that exceed expenditures.

That last proviso is important because, if revenues fall short of expenditures, the city would face a true “structural deficit“. The consequences of a structural deficit can be profound: if left unaddressed, in addition to the city bleeding money, it can cause the city’s credit rating to fall, make it ineligible to issue certain kinds of bonds, and can ultimately lead to state intervention. So obviously that should be avoided.

But… that proviso is also a bit of slight-of-hand from City Hall. Remember that City Hall itself proposes the budget every year. That means that it has some measure of control over the proposed operating budget. So, in future years, what if the Police Chief earnestly requests three new traffic control officers, or the public works department needs to buy new work trucks? If the City Manager grants such requests, “expenditures” in that year will rise, to the point such requests could crowd out the payments to the CAN. If the CAN payments aren’t prioritized, the CAN fund may never be truly replenished.

But let’s say the City Council does instruct the City Manager to prioritize CAN repayments in future budgets. Even then, the ten-year, straight-line approach doesn’t actually make sense. As noted above, deferred maintenance is, itself, a kind of debt. But, unlike conventional debt that amortizes cleanly, deferred maintenance typically compounds in unpredictable ways. Minor issues become major failures; temporary fixes become more frequent and costly; infrastructure deteriorates faster once it passes certain thresholds; and, eventually, replacement becomes necessary instead of repair, multiplying costs.

The elephants in the room: staff time and *gulp* next year’s budget

So obviously the solution is to find other cuts this year so we can maintain the CAN ordinance spending, right? Not necessarily. Let me explain.

First, recall the interesting little exchange between Public Works Director Raja Sethuraman and Mayor John Stephens at the initial study session on the projected budget shortfall. “… of these [projects proposed to be deferred], how many of them would we start… if we didn’t give direction to not use the funds?” Mayor Stephens had asked. Director Sethuraman then admitted that that, based on the Public Works Department’s already significant workload, these projects wouldn’t be completed in any event because he didn’t have sufficient staff time available to execute on them this year.

In other words, there is more than one budget involved when it comes to capital asset needs. In addition to the cash in the bank, there is also the budget of staff time and attention to consider. So, whether the City Council likes it or not, City Hall has already decided to defer these projects out of this fiscal year by directing its personnel to spend its hours on other projects.

If that’s the case, forcing the city to maintain CAN funding this year doesn’t actually put those CAN projects in the ground. It just defends the funds for those projects. But if we already can’t complete our list of capital improvement projects for the year, what’s the point of rolling those funds over to next year? City Staff will still be working through the backlog of in-progress projects. Therefore, even if the money is there, it is highly likely that these projects will be structurally delayed by City Hall deprioritizing staff time for them.

And the Staff seems to be anticipating that reality, too. As discussed at the Study Session a few weeks ago, there is already talk about requesting another CAN waiver next year — possibly up to the full amount of the CAN, leading to a potential total deferral of $9.5 million.

As raised by Mayor Stephens a few weeks ago, it’s arguable that the CAN ordinance permits a waiver for FY 2024-2025 because the current economic headwinds are “unforeseen.” However, as Mayor Stephens asked: is it right that the possible nationwide recession in future fiscal year 2025-2026 would also be “unforeseen”? JP Morgan says our likelihood of recession in the next year is 60%, while Apollo Global Management pegs the likelihood at closer to 90%. With odds like that, it’s hard to say that City Hall will be taken by surprise if revenue lags a bit. In other words, I think staff is asking for a waiver that, in all honestly, the ordinance simply can’t grant. But why?

Reading between the lines, maybe the coming anticipatory CAN waiver for next year isn’t about unforeseen circumstances, but foreseen ones. Perhaps the reality of much higher operating costs thanks to labor and material inflation is finally biting us. Perhaps the massive number of grant-funded projects we’ve had in the past few years, combined with ARPA-related infrastructure spending and projects, have overwhelmed our staff to the point we just don’t have the bandwidth to execute on the CAN for the foreseeable future.

If that’s the case…

Maybe the City should just be honest with itself, and repeal the CAN

Why something so drastic? Well, let’s recap:

• As currently written, the CAN ordinance’s requirement to “make a plan to replenish” waived funds creates an off-balance sheet debt, which can only be repaid by making the CAN spending requirements even more inflexible.
• Creating this ad-hoc debt instrument doesn’t actually address real infrastructure needs if the staff time necessary to execute the projects isn’t there.
• Therefore, capital projects can be structurally deferred due to staffing decisions, gutting the intent of the CAN.
• If the CAN will be routinely waived even when economic downturns are anticipated and CAN “replenishment” payments can themselves be deferred if operating costs > anticipated revenues, the CAN doesn’t actually enforce spending discipline.
• If the CAN doesn’t enforce spending discipline, then it doesn’t actually incentivize either City Hall or City Council to keep operating costs under control.

In other words: making paper debts to ourselves doesn’t solve anything. Sure, it rubs our noses in our prioritization failures, and maybe that’s worth something. I give the CAN ordinance full credit for making the deferred maintenance problem a tangible, quantifiable issue. But just doing so won’t replace our air handlers or fix our drains faster.

So, if the current ordinance is consistently unworkable, we should have a transparent discussion about whether it should be converted to a guidance policy rather than a requirement that gets waived whenever convenient. This would at least be intellectually honest about our commitments.

But if the CAN ordinance is repealed and replaced by a more flexible policy, that doesn’t mean that the spirit of its reforms should be discarded. It’s heart is in the right place.

How to fix the CAN so that it works for the taxpayers, not against them

So what if, instead of punishing the Costa Mesa taxpayer with an effectively unpayable debt, the policy aligned the City Manager’s incentives with fiscal prudence? I could think of a few of mechanisms to do this:

• Instead of creating future spending obligations, missing the CAN recommendations should require accountability from the City Manager and the Director of Finance. I’m thinking a long, painful, written report, both to City Council and in the budget itself, detailing why the target amounts aren’t being met. A “comply or explain” protocol would put the burden on staff to justify its proposal.
• Anticipated deviations from CAN guidance should go automatically to the FiPAC for review. Because the FiPAC is another layer of process, it would force Staff to begin the conversation early if CAN guidance is going to be breached. Thankfully we already have a great staff that alerted the public to the potential revenue shortfall early in the budgeting process. But will we always have such an attentive staff? Adding in procedural requirements would help enforce the culture of early disclosure and discussion.
• Add adherence to CAN guidance to the performance review criteria of the City Manager, the Director of Finance, and the Public Works Director. This is a tough one for me to suggest because, quite frankly, I like our city leadership quite a bit. But sometimes aligning incentives takes some tough love. While the City Council can’t directly influence how the City Manager evaluates subordinate directors, it can change the way it evaluates her job performance, which would likely have knock-on effects in her review of her directors.

Making sure the city stays on top of critical infrastructure spending is extremely important, and the CAN ordinance was a step in the right direction. Unfortunately, this period in Costa Mesa’s history is exposing all of its flaws. Hopefully the City takes steps now to address them. Otherwise, we will find ourselves in a deep financial hole of our own making.

And you know what they say is the first step to getting out of a hole: stop digging.