Knoxville as business entity in trouble

By DAVID MOON, Moon Capital Management
April 25, 2004

In the waning days of his mayoralty, Victor Ashe warned that the next mayor and city council would have no choice but impose a whopping tax increase. Local pundits speculate about the algebraic definition of 'whopping' by estimating the current year's operating deficit and backing into a revenue increase that would prevent the city from continuing its practice of balancing the budget by reducing the city's fund balance ' the equivalent of spending its savings account.

That type of prediction ignores the structural weakness in the city's 'business model.' I love living and working in Knoxville. Our quality of life is excellent; ask people who've lived elsewhere.

But if the city of Knoxville were a business, you would not want to own it. It's upside down. Expenses are almost guaranteed to increase more rapidly than organic revenues. Common speculation is that the city faces a $10 to $15 million shortfall next year. But reducing expenses or raising taxes by that amount only solves the problem for one year. The following year the city will again face the malignant combination of anemic revenue growth and mandated expense increases. That's why Knoxville depleted $11.7 million, or 42 percent of its savings account in only the last two years. This, combined with the added annual pressure of $14 million in annual convention center debt service and operating subsidy, creates a long-term structural problem, not a short-term management challenge.

Police and fire protection comprise 46 percent of the city's General Fund budget. Not only are those two critical city services, each department is a powerful political constituency. Cutting either would raise the ire of both citizens and uniformed employees, but it's tough to make real changes in the city's expense structure without touching those sacred cows.

The city is legally required to increase wages 2.5 percent annually. Wages and related employment costs comprise 44 percent of the city's non capital and debt service budget. Would you like to be in a business where almost half of your expenses increase 2.5 percent each year, yet your market share is fixed?

A real business would either increase its market share or its prices. 'Increase market share' is annexation; the most 'profitable opportunities' for annexation are gone. 'Increase prices' is a tax increase, and that requires gutsy political skills, not just business acumen.

There are a few other ways to increase revenues, but they are controversial, minimal in their potential impact or can't be accomplished in a few months. No one may like a new residential or commercial development near his home, but each such rejected project ultimately requires either a tax increase or reduction in city services. Much hoopla is made about ways to increase city sales taxes, but that's less than a quarter of the city's operating budget. Increasing the real value of the property within the city offers significant opportunities for revenue growth, but that is both complicated and time consuming.

When Bill Haslam proposes his initial budget Thursday, it will be his first real chance to prove both his leadership and business skills. I'm just glad I don't own the business.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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