City Hall's short game: reserve funds pile up as Toronto struggles to spend capital budget

City Hall Watcher #238: Special guest Damien Moule on Toronto City Hall's troubling trend of undershooting their spending goals on repairs and infrastructure

Hey there! I’m still on semi-vacation, doing Dad Stuff like going to the playground, pushing the stroller around aimlessly to try to induce an afternoon nap, going to the playground again, power-washing our deck, making additional trips to the playground, and grilling various foodstuffs.

I did manage to see Barbie, though! Did you see Barbie? I liked Barbie.

Anyway, a short intro this week because we have a special guest. Self-described municipal policy nerd Damien Moule has dug through more than a decade’s worth of capital budget variance reports for an in-depth look at City Hall’s perpetual inability to actually spend the money it budgets for things like maintenance and infrastructure.

It has some real relevance to the ongoing fiscal crisis playing out at City Hall. While there are no easy answers, I do think it’s ridiculous to talk about Toronto’s fiscal situation without acknowledging the annual surpluses reported in the City’s financial statements and the swelling reserve funds. So let’s talk about them!

If you dig this kind of analysis and want to encourage more of it, share it with a friend and let them know they can subscribe! It’s just six bucks a month or sixty bucks a year. A bargain and a deal.

— Matt Elliott

@GraphicMatt / graphicmatt@gmail.com / CityHallWatcher.com

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Chronically capped capital: why can’t Toronto City Hall spend what it budgets?

By Damien Moule

I expect most City Hall Watcher readers will be familiar with the basic outline of the budget process that starts around the beginning of every new year. It‘s spelled out in the City website’s presentation of budget basics. There’s an operating budget covering City programming, staff and operations, and a capital budget covering long-term infrastructure investments. Staff present both proposed budgets to the mayor and the executive and budget committees. The mayor presents the budget to Council, where some councillors grandstand and introduce minor amendments, then there are a few votes, and the budgets get approved.

I suspect fewer people will be familiar with the variance reports, reserve balance reports, and audited statements of balance which make up the rest of the budget process. At the most recent City Council meeting on July 19 and July 20, Council adopted the operating variance report, the capital variance report, the reserve and reserve fund balances report, and the deferred revenue report for 2022, bringing a close to last year’s budget process. 

Unlike the beginning, the end of the budget process gets much less fanfare. Generally, no councillors make speeches or propose changes. In fact, at Council’s most recent meeting, the reports were all adopted without debate. Our intrepid host Matt covered the $395 million hole in the 2022 Operating Budget in the Toronto Star, and how it was closed. But beyond that, these reports mostly go unnoticed. 

And that’s a shame because, taken together, these reports show that every year City Hall has a big problem with its budget process — and it all stems from the capital budget. From 2006 to 2022, Toronto underspent the capital budget by an average of 35%. In 2022 alone, the City overestimated how much would be spent on capital projects by a whopping $2 billion. I chose 2006 as the starting point because that’s how far back I could find variance reports in TMMIS, but I would bet the City has underspent every capital budget since amalgamation. 

View an interactive version

You might be wondering why this matters. Okay, sure, there might be some room for improvement in estimating how much the City is going to spend on capital projects in any given year. Capital projects are complex, a lot of important factors are out of the hands of the City, and it’s a hard estimate to produce. So what?

The problem arises because every other part of the budget process treats the capital budget as if it’s an accurate estimate. 

To start, an increasing amount of the capital budget is drawn from reserves and reserve funds. In 2022, 37% of the 10-year capital budget was to come from reserves and reserve funds, up from 15%¹ a decade before in 2012. The city’s 265 reserves and reserve funds are: 

“monies set aside by Council to finance future expenditures for which it has authority to spend money, to defend the City against an unbudgeted or unforeseen event that may result in a budget deficit such as an economic downturn, to smooth out future program expenditures which may fluctuate from one year to the next, or to accumulate funds for future capital requirements or contingent liabilities.”  

Essentially they are funds set aside mostly for capital projects along with a few rainy day funds and some odds and ends like employee benefits. Some reserves have their own dedicated funding source, like development charges and wastewater user fees, while others receive funding directly from the operating budget. The issue is that the funding level for the reserves is based on budgeted capital spending, and City Hall keeps underspending the capital budget. As a result, money in reserves has increased dramatically from $2.9 billion at the end of 2012 to $11 billion at the end of 2022.

View an interactive version

This stockpile of reserves is occasionally controversial. Federal Finance Minister Chrystia Freeland recently cited them as a reason not to provide Toronto with additional money to help with the City’s operating budget. The City is aware of these criticisms and the 2022 budget book notes that Toronto’s per capita reserves are lower than some neighbouring municipalities, and a recent budget briefing note makes an argument the City frequently deploys: 

“The majority of the City's reserve amounts are restricted or committed funds based on legislative or third party agreements, Council-directed activities, or to fund expenses approved in the City's operating and capital budgets. As of September 30, 2021, all but $263.7 million in reserve balances were committed, leaving funding available for emergency requirements equal to 1.75% of the City's total 2022 Operating Budget.”

Both of these arguments are mostly true. There are some problems, though. The rapid increase in the Tax Rate Stabilization reserve, in particular, from $91 million at the end of 2019 to $1.5 billion at the end of 2022, is awkward for the City. The purpose of that fund is to “provide funding for non-recurring expenditures required to eliminate any year-end operating deficit.” This increase in a rainy-day fund occurred at the same time that the federal and provincial governments were chipping in hundreds of millions per year in emergency funding for the COVID-19 pandemic. 

Via City of Toronto report

I also think that these arguments miss the point. It’s not enough to simply say other cities have higher per-person reserves than Toronto. Are those reserves necessary? Is it important to have such large reserves? And while it’s true that the reserves are (mostly) restricted to a particular use, that ignores why the reserves are growing. Year after year, the City plans to spend down the reserves on capital projects but doesn’t. The development charges balance has ballooned to $2.7 billion of money raised for new infrastructure that hasn’t been spent. A budget note from the 2022 budget shows the expected vs. actual reserve balances² for the five preceding budgets, which I think demonstrates the issue nicely:

Via City of Toronto report

The next problem with the capital budget underspending is debt. To fund the $5.6 billion 2022 capital budget, the City planned to issue just over $1 billion in new debt. And in 2022 the City did in fact issue $1.2 billion in new debt. But it only spent $3.6 billion of the capital budget. So the City issued debt and then didn’t spend the money it raised. So why… did it… issue the debt? The net result is Toronto is taking on debt to increase its reserves. Considering the City is very close to its debt limit, this seems not great. 

The final problem with consistently underspending the capital budget is its impact on the operating budget. In addition to transferring too much money to reserves every year, money from the operating budget is transferred to the capital budget as “capital from current.” For 2022 to 2031, the capital budget includes $3.7 billion in capital from current. However, when the 2022 annual budget was underspent, much of that capital from current was quietly transferred to the Tax Stabilization Reserve, which, as I mentioned, now sits at $1.5 billion. 

This has also been a source of controversy. The audited annual financial statements characterize the net transfers to reserves as savings and have reported that Toronto has run an operating budget surplus of more than a billion dollars per year since 2015. The City does not like this. It has been claiming a large hole in the operating budget and has been asking for additional money from the provincial and federal governments. The City claims the auditors show a surplus because of a difference in accounting methods. Henrik Bechmann, a long-time budget watcher and critic of the City’s accounting, has laid out the gritty details of the accounting differences, and I have to say, I agree with the auditors and Henrik. 

I should also note that I am not breaking news that Toronto underspends its capital budget. In 2019, the City paid Ernst & Young to perform a review of City expenditures to search for efficiencies. The report they prepared recommended (in very polite consulting language) that the City work to create “a true multi-year financial view focused on outcomes,” i.e. make more accurate capital budgets.

Former mayor John Tory, in an interview with Matt in late 2019, identified many of the same issues with the capital budget that I’ve outlined here, and said improving estimates (with a department target spend of 80%) would be a priority. And the City did improve its capital spending in 2020, spending 73% of the capital budget that year — the highest percentage since at least 2006. But City Hall quickly fell back into old habits in 2021 and 2022. Given all three of those years were impacted by the COVID-19 pandemic, any explanation from the City will need to look beyond the pandemic excuse. 

Okay, so, the City routinely underspends its capital budget and it has a number of unpleasant side effects. What can the City do about it? In the short term, I think there are some creative options to treat those side effects. Council should drastically reduce the amount of money transferred from the operating budget to reserves or the capital budget. New capital projects should be funded entirely with development charges and the assorted City building reserves. The Tax Stabilization Fund should be used for the small number of projects that couldn’t be funded this way. This would allow the City to avoid issuing any new debt, free up space in the operating budget, and actually spend down some of the billions of reserves that have built up. 

In the long term, though, I think you’d want to mitigate the side effects by, you know, making the capital budget better. If the City does better estimating its spending, this makes it much easier to estimate reserve funding and debt needs, and some of these side effects would just go away. Whether that means reducing the capital budget to match the City’s actual capacity, or increasing staffing to actually do the work it plans will depend in part on your political beliefs. Given the state of infrastructure and the depth of the housing needs in the City, I’d say Toronto could stand to do both.

Damien Moule is an engineer, municipal policy nerd, Ward 10 resident, father, and occasional volunteer with More Neighbours Toronto. You can find him on Twitter (or X or something): @damienmoule