Dear Management Doctor:

My community is in the process of enacting impact fees while at the same time facing a sharp decline in tax revenues. We have a hiring freeze and possible reduction in forces coming at us in the near future. I have been following the revenue stream for my department over the last ten years and due to our explosive growth, fees collected have exceeded department expenditures in the last three years by a few million dollars.

The dilemma is if I note this extra revenue in an attempt to counter the possible budget shortfalls by suggesting revenues provided by the development community need to be reinvested into the building department, I can only assume the development community will take note and use this information to question why the impact fees are necessary. In the end, the loss of the impact fee will have its own consequences to the community that exceed the extra revenues generated by my department and I see this having long term negative impacts. I understand that impact fees and building permit fees are different and are to be spent for the purpose they were created. While that argument can be made, I believe the development community will see this as more ammunition to sink the impact fees. I also understand that building departments often provide a source of "free" money that councils like to use for special discretionary projects. I am using the past revenue history plank in our political arena.

Finally, do you have any experience with building departments being run as enterprise funds? In reviewing the revenues for the last fifteen years, it is clear that if the building department were operated out of such a fund we would be in a good position not only to forgo budget cuts, but also expand our services to the development community and increase our services to them.

I would prefer not have my name or community identified.

Thank you,

Dear Unidentified,

My answer might depend on what state you are in and your state laws. In California and a number of other states, it is illegal to make money for the General Fund without a vote of the people.

In most communities, building permit fees have generally made money, including in California. Three years ago I worked with a California city that was putting five million a year in the General Fund from fees. When I told the Finance Director that he may well be sued, I could see the sweat on his brow. Communities who have not been making money, or at least breaking even, have simply not set their fees properly.

One of the reasons building permits have traditionally made money is the way fees have been set by valuation of the project. In these systems, large projects tend to pay more than the cost of service and small projects pay less. In California, the Attorney General has said there is no apparent Nexus between valuation and the cost of service. For example, does it take longer to plan check and inspect a high value kitchen with granite counter tops, expensive cabinets, and top of the line appliances vs. a standard kitchen? Obviously not. California has had a couple of smart attorneys traveling the state and suing communities about their building fees. As a rule, the courts have not supported the communities and they have had to change their fee structures.

I think it is important that you get your community and the developers to distinguish between impact fees and processing fees. According the Supreme Court, the impact fees also need to meet a Nexus. However, they are almost always substantially higher than the processing fees and do generate more resistance from developers.

On the other hand, processing fees are much smaller and of less concern. In fact, in our studies which we have done in 27 states, virtually all developers say they are more than willing to pay increased processing fees for good service. What they don't agree to is to pay increased processing fees for poor service (the tradition in many communities) or pay increased processing fees to support the General Fund.

Finally, the question of what may appear to be excess revenue. I see more and more communities either going to an Enterprise Fund or at least an account or Fund Balance where the fees are segmented from the General Fund and do not go to General Fund activities. These funds can be used for special projects, technology up-grades, and a reserve to be used when development drops off so you don't have to lay off staff. As a rule of thumb, I suggest a Fund Balance equal to nine months of the normal budget. This may have to be built over a number of years. Nine months may be a bit large for many communities so you may want to shoot for four or five instead.

When you set your fees, note that it is reasonable to include a substantial overhead that can pay for the other city service departments. This is like going into the General Fund but if it is well documented the development community will buy it. We often see 30 to 40% over direct costs. We are currently working with a community that charges 2.7 times the pay rate when they calculate hourly employee costs.

In summary:

  1. Separate Impact Fees from Processing Fees.
  2. Focus on good service rather than fees. All developers want the same thing, faster processes and more consistency and they are willing to pay for it.
  3. Set your fees at a true cost of service and not on valuation.
  4. Feel free to add overhead charges to your fees. This will make the Finance Department and City Manager feel good and may help get their support for the Enterprise Fund or Fund Balance.
  5. Build a substantial reserve account.

The Management Doctor

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