Deficit ahead: Phoenix expects looming $103 million shortfall, can manage for now
Phoenix can balance its budget this year but it expects massive deficits in the two years after that will force the mayor and City Council to cut spending or find new money.
The city is expecting a one-time surplus of $80 million in the upcoming fiscal year as part of its $2 billion projected budget. The surplus is due in part to vacancy savings, plus maneuvers the city made to finance capital costs with bonds instead of operating revenue.
But circumstances change next year. The shortfall could be as high as $103 million in the fiscal year starting July 2025 and as high as $53 million the next year.
"That's equivalent to the size of the entirety of the library and Human Services Department," City Manager Jeff Barton said. "That's the context and the scope we're talking about."
The projected deficits are not the worst Phoenix has had to weather, but they are close.
The city experienced a $277 million deficit at the height of the Great Recession. Phoenix was still struggling through a $38 million deficit years later in 2014, outraging councilmembers. After the pandemic first hit, Phoenix budgeted a $26 million deficit in the fiscal year that began in July 2020.
Deficits in the past have meant slashing personnel, dropping pay and cutting city services. Deficits in Phoenix's future could mean the same. That could affect any number of programs, from libraries to parks to homelessness.
Those discussions aren't slated to happen for about a year, but Barton said when they do, the city will rigorously seek public input.
The deficits could also mean raising the city's sales tax rate, which sits at 2.3%.
The city's Budget and Research Department briefed the City Council on the estimates on Tuesday and said the shortfalls stemmed from the state ending residential rent tax collections starting in January 2025 and after the state underestimated the cost of passing a flat income tax.
Mayor Kate Gallego lobbied Gov. Katie Hobbs from the dais on Tuesday, asking her to delay implementation of the rent tax for one year. She said Republicans, who pushed the rent tax elimination, had previously supported assisting cities through the cut.
"When Kari Lake was running for governor, she talked about backfilling cities or having a slower implementation. We've had very conservative legislators who've wanted to get rid of this but suggested a five-year phaseout," Gallego said.
She noted it would affect public safety.
"It is not hypothetical to say a cut of this magnitude can't happen without impacting public safety. In the case of Phoenix, our voters have allocated these dollars that were cut to public safety. It's the equivalent to 350 sworn officers," Gallego said.
The projections, which also reflect rising operational costs, mean Phoenix has 17 months to consider solutions since the shortfall isn't expected until July 2025.
But some council members debated whether to act sooner in hopes it would demonstrate financial responsibility and protect the city's credit rating.
Barton said "There's no need to rush it right now," noting the city's good relationship with rating agencies and history of strong financial management.
"We can be methodical, and we can also take into consideration the things that are important to our community," he said.
Barton will present the upcoming fiscal year's rough draft budget to the City Council on March 19.
The details aren't ironed out, but he warned the council he is going to suggest saving the $80 million surplus and not adding any new spending.
Cut programs or raise taxes: Where the council stands
Councilwoman Kesha Hodge Washington said if the Legislature didn't step up to fill the shortfall caused by the rent tax, the city would need to consider increasing taxes because cutting services wasn't a realistic option.
"There's only two options on the table for us as a council. It's either we reduce our expenses or we increase our revenue. And I can tell you, from the calls we receive in my office, we are constantly being asked for more services. So I don't think that's an option" Hodge Washington said. "The only other realistic option ... is the city would be forced to increase our revenue. And the way we do that is through a three-letter word. And many of us don't like that word."
Councilmembers Yassamin Ansari and Betty Guardado also stressed preserving services, suggesting it would risk trust in vulnerable communities.
Residents got used to "not expecting much" from the city after cuts from the Great Recession, Guardado said. Given Phoenix has only recently turned that around, the councilwoman said, "I'd hate to go back to that place" where services are cut for working-class families that depend on them every day.
Ansari said lower-income parts of the city were already concerned about receiving fewer services than wealthier parts of the city.
"If our residents understood the magnitude of what's at stake and things that could be cut, I do think they'd recognize the importance of making sure those services are not cut," Ansari said.
Councilman Jim Waring, a conservative, suggested instead cutting newer city programs that he thought residents probably weren't "wedded" to, such as the police monitor, Phoenix's Office of Accountability and Transparency.
Waring also took aim at spending on homeless programs, saying the city should reconsider them depending on how the U.S. Supreme Court rules in the City of Grants Pass v. Johnson case.
The case could significantly alter how cities respond to homelessness if the U.S. Supreme Court overturns a decision made by the Ninth Circuit U.S. Court of Appeals. The Ninth Circuit declared urban camping bans unconstitutional if no alternative shelter is available.
For Phoenix, the decision has meant scrambling to prop up shelter beds, but if it is overturned, the city may not be legally obligated to do so. The city filed an amicus brief in the case, asking the U.S. Supreme Court to overturn it.
Councilmembers Ann O'Brien, Laura Pastor and Guardado questioned how the shortfalls could affect the new $500 million bond program that voters approved in November.
The general obligation bond is the city's first in nearly two decades and will fund new fire and police stations, parks and roadway improvements. It's also supposed to help Phoenix buy land along the Rio Salado as part of the "Rio Reimagined" vision to extend Tempe Town Lake across south Phoenix.
The city's authority to issue $500 million worth of bonds will not change based on budget projections because voters gave the permission in November 2023. City officials could delay or abstain from issuing the debt though, if there were concerns about repayment.
Barton and Amber Williamson, director of Budget and Research, said there are no plans to interrupt the bond program. The sale is scheduled for this spring, and city staff is already designing certain projects, Barton said.
Otherwise, the city manager suggested the most important thing was to act responsibly moving forward so rating agencies wouldn't downgrade the city's credit score. A downgraded credit score would likely mean Phoenix pays more in interest on the bonds.
Phoenix uses federal funds, issues debt to avoid shortfall this year
The rent tax elimination and flat tax are set to cost Phoenix's general fund $54 million this upcoming fiscal year, but the city made several maneuvers to relieve pressure and avoid a shortfall.
Last week, the City Council redirected $15 million in one-time federal funds toward homeless programs that would otherwise be funded by the operating budget. The general fund will need to absorb the costs when the federal money runs out. At this point, that's not feasible, but Barton said the move gives the city time to figure out solutions.
Phoenix spends on homelessness programs: But can they afford it?
The city also saved on expenses by issuing debt to pay for vehicle replacements and other capital costs instead of pulling from the general fund. The city will have to pay interest on the bonds, but Barton said it was "not much" and would help relieve current pressure on the general fund.
The details
The city anticipated an $80 million one-time surplus in the upcoming fiscal budget. For the following years, the city offered worst-case, baseline and optimistic projections.
The fiscal budget starting in 2025:
Worse case: $103 million shortfall
Baseline: $92 million shortfall
Optimistic: $66 million shortfall
The fiscal budget starting in 2026:
Worst case: $54 million shortfall
Baseline: $31 million shortfall
Optimistic: $19 million surplus
If it weren't for the rent tax elimination and flat tax, Barton and Williamson said the general fund would have projected a baseline $134 million surplus this upcoming year, a balanced budget the following year and a surplus the year after.
Taylor Seely covers Phoenix for The Arizona Republic / azcentral.com. Reach her at tseely@arizonarepublic.com or by phone at 480-476-6116.
This article originally appeared on Arizona Republic: Phoenix expects $103 million deficit after state tax changes
