Capital forecast - capital requirements funded from taxation

Options to reduce the capital funding gap

The funding gap from the re-stated LRFP II to LRFP III has increased by $683 million. The difference is attributable to the increase of $539 million in the net City tax-supported capital requirement and a decrease of $144 million in revenue assumptions.

The funding gaps vary by category of capital and by available funding sources. The following table shows that while funding gaps exist in the renewal of assets and strategic initiatives category, there is no gap in renewal for transit or solid waste.

Options to address the renewal funding gap

Council has approved a debt strategy where progressively less debt is being applied to the renewal of City assets category of capital. Therefore, the only option to address the funding gap in the renewal of City assets category is to increase the contribution to capital for renewal of City assets from increased taxation.

This option has a direct impact on total taxation. Revenues would be contributed towards requirements identified in the renewal of City assets category, as this category has a higher priority than the strategic initiatives category. A 1% increase in taxation will increase the capital contribution by $9.5 million. A yearly increase of $9.5 million in the contribution to capital would reduce the funding gap by $522 million over the 10-year timeframe.

Options to address the strategic initiatives funding gap

Options to address the funding gap in the strategic initiatives category of capital are as follows:

1. Reduce spending in the strategic initiatives category
   Council has heavily scrutinized the strategic initiatives category in the past. However, there are growing pressures from the community to undertake projects in this category that respond to needs resulting from changing demographics.

   Changes in the development charge legislation have caused this category of capital to increase, as certain service areas are no longer eligible for funding through development charges. Constraining this category will also limit the achievement of initiatives that implement master plans, acquire environmental areas, and advance the City Corporate Plan. The projects identified as strategic initiatives (excluding regulatory projects) total $1,228 million over the 10-year period, $73 million of which has been funded from dedicated sources like cash-in-lieu, housing reserve, development charges, and some gas tax revenue.

   When Council sets its priorities in the City Corporate Plan, it can choose whether or not to proceed with capital strategic initiatives.

2. Increase the amount of debt funded from taxes
   LRFP III maintains the City policy regarding debt. Debt supported by taxes will be limited to what can be accommodated by the debt servicing envelope. As approved by Council in LRFP II, all other new debt will be funded from gas tax revenues or other non-tax sources. In total, $239 million of non tax-supported debt has been identified as required over the next 10 years.

   Of the shortfall identified in the strategic initiatives category, more than $400 million in the 10-year period is eligible for debt financing. Increasing annual debt levels by $9.5 million per year would reduce the funding gap by $95 million, but would require that debt servicing of $31 million be paid from increased taxation over the same 10-year period.

The City's debt is approximately one-third of the level the Province has set as its debt limit. While the total value of debt financing must be managed in order to maintain the City's credit rating, modest increases to the amount of tax-supported debt are presented as an option because the debt enables more capital projects to be achieved within the 10-year timeframe. As the change in the total debt forecast to be authorized has decreased significantly since LRFP II, the risk of having the credit rating reduced is diminished. Council will consider the options identified above as it sets the guidelines for drafting the 2007 to 2010 budgets.

When it was presented to Council in the fall of 2004, LRFP II outlined capital projects requiring funding from taxes for 2005 to 2014. The plan included a number of new non-tax capital revenue sources announced in 2004. Assumptions were made about how these new funding sources would be applied and the amount they would generate for use over the 10-year forecast period. The difference between capital needs and estimated revenue was projected to be $757 million over the forecasted 10-year period.

There have been a number of revisions to revenue assumptions since LRFP II was adopted by Council. Major revisions have resulted from provincial and federal announcements, including municipal use and funding levels of gas tax revenues, clarification of treatment of the GST rebate, and establishment of the Hydro Ottawa endowment fund with its potential rate of return. A description of these changes and their impact on the projected LRFP II funding gap is presented below.

Provincial gas tax

The 2004 assumptions about the provincial gas tax were that Ottawa would be able to access $350 million over the 10-year period. The entire amount was to be used in the capital program, either as a direct cash contribution, or to service debt issued to fund transit capital projects. The Province issued guidelines around the use of gas tax revenues shortly after Council approved LRFP II. These guidelines permitted the funds to be used only for increased transit operating requirements resulting from projects to increase ridership and for capital initiatives. Using these guidelines, Council permanently included $2.1 million in 2005 and a further $5 million in 2006 in the operating budget to fund transit. Applying this revenue to the operating budget, rather than the planned capital budget, means the capital funding gap forecast in LRFP II has increased by $66 million.

Federal gas tax

When LRFP II was presented in 2004, the federal government had just announced it would be contributing a portion of its gas tax revenues to municipalities. The allocation of funds was assumed to be based on a combined transit ridership and per capita basis. It was also assumed funds could be used for capital needs to support all forms of transportation, including roads and bridges. The actual agreement for the transfer of these funds and the application rules were not known until mid-2005.

The first change to affect the LRFP II forecast was that funds would be allocated to each city on a per capita basis only. This reduced the amount the City had forecast by $60 million from 2005 to 2014. In late 2005, the federal government agreed to increase the gas tax transfer for 2006 and 2007, which again changed the forecast revenue and reduced the total funding shortfall to $20 million over the 10-year period. This shortfall increased the net gap forecast in LRFP II.

The second funding change to affect the LRFP II forecast was that the federal gas tax could only be used for capital works in transit, water and wastewater, community energy systems and solid waste. The City funds water and wastewater from the water bill and was already implementing a strategy to deal with capital requirements for that area. Solid waste did not have a significant capital funding problem. This left transit as the only area that could benefit from these funds.

As mentioned previously, the assumptions on how to apply the federal gas tax were much broader in LRFP II. In that plan, $100 million in gas tax-supported debt was applied to non-transit projects. These projects, primarily roads and bridges, are not eligible for funding through the federal gas tax. The direct impact of this change is that the capital funding gap increased by $100 million.

The Municipal Funding Agreement Guide for the Federal Gas Tax, which was issued by the Association of Municipalities in Ontario in October 2005, included the following requirement:Canada and Ontario have agreed not to reduce other infrastructure funding sources and municipalities are agreeing not to displace current capital investment or use the revenue to reduce municipal taxes. The revenue must result in increased investment in environmentally sustainable municipal infrastructure equal to the amount of revenue received."

To ensure the City complies with this clause, reporting requirements have been put in place to monitor the City's capital investment in eligible areas where the gas tax is applied. Contributions to capital from the transit levy cannot be reduced without jeopardizing federal gas tax revenues. The result is that $661 million in federal gas tax debt for transit is no longer needed, since maximizing debt does not free up funds for other non-transit capital works. As this money is no longer available for roads, bridges and other non-transit capital projects, the capital funding gap has increased by $336 million.

Goods and Services Tax (GST)

In 2004, the federal government announced that municipalities would be rebated the full 7% GST, instead of only 4%. Initially, the federal government kept the additional 3% rebate separate from the other 4% and provided it to municipalities as an unconditional grant. LRFP II assumed that the federal government would continue this practice and contribute $170 million to the City of Ottawa over the 10-year period.

Instead, the federal government started combining the two rebates into one in 2005 and the City was no longer able to record the additional rebate as revenue. As a result, the contribution to capital has increased and the cost of projects has decreased for a combined value equal to the forecast.

Development charges

LRFP II was aligned with the Development Charge Background Study and its recommendations as presented to City Council on July 14, 2004. On December 8, 2004, City Council approved revisions to the Study, which reduced development charges and the amount available to fund the growth portion of capital projects. The decrease in development charge revenue is estimated to be $41 million over the 10-year period, which increases the City's funding portion of growth-related capital projects.

Hydro Ottawa endowment fund and Ottawa Hydro dividends

LRFP II recommended the creation of an endowment fund to invest the proceeds of the Hydro Ottawa refinancing ($200 million). It also recommended special legislation allowing investment in a broader range of financial instruments than is allowed under the Municipal Act. The special legislation was approved in December 2005 and the fund was established. An assumption was made in the LRFP II that the fund would have an investment return of 10% for capital projects. However, a more attainable target of 6.5% was established in June 2006 to ensure preservation of the initial $200 million investment. This reduced the amount available for capital projects by $83 million over the 10-year LRFP II period.

Assumptions regarding the Ottawa Hydro dividends also changed, resulting in a $7 million reduction in the forecast revenue over the 10-year period. This reflects actual dividends received, which are dependent on Ottawa Hydro's financial performance.

Contribution to capital

Each year, the City dedicates a portion of taxes as a contribution to funding for capital projects. LRFP II assumed contributions to capital would grow by 2% over 10 years to reflect annual inflation. This added $91 million over the 10-year period. However, costs associated with capital projects were not increased by inflation. LRFP II assumed the entire increase in the contribution would be offset by the increases in cost over time. Therefore, to ensure the costs and revenues are valued at the same time, the $91 million increase has been removed.

The actual decrease to the contribution to capital is only $11 million over the 10-year period, as the elimination of the assumption made about inflation is partially offset by the $80 million increase from GST revenues.

In summary, by re-stating the funding gap of $757 million in LRFP II to reflect changes in the way non-tax revenue can be used, together with the changes in assumptions made in the fall of 2004, the gap between the funding requirement for capital projects and the amount available increases to $1,401 million over the same 10 years. The following table itemizes these changes.

There have been a number of adjustments made to the capital needs identified in LRFP II's 10-year period. A comparison of gross costs, which includes projected revenues and development charges identified in LRFP II and the 10-year period for LRFP III, is shown below.

While the total capital funding needs have decreased, the capital funding needs in the renewal and strategic initiative categories have increased. An explanation of the changes affecting each category is provided below.

Inflation pressures within the construction industry

The City's capital projects are delivered by the Ottawa construction sector. The construction industry is subject to price increases that vary significantly from those experienced by most residential consumers. Statistics Canada reported that the Consumer Price Index for the Ottawa-Gatineau metropolitan area increased by 9.1% from 2001 to 2005. At the same time, the non-residential Building Construction Price Index (relates to cost increases in the construction of industrial, manufacturing and institutional structures) increased by 18%, with the largest increases occurring in the last two years.

The following graph shows the percentage change in these two indexes from 2001 to 2005.

Yearly change in Ottawa index

The non-residential Building Construction Price Index increased by almost twice the Consumer Price Index. However, the impact on construction costs can be much more significant (depending on the type of project), as contractors have had to deal with large variations and increases in the cost of construction materials. Examples of materials typically used in City capital projects, and what has happened to prices of each, are listed below (all increases are in Canadian dollars).

1. Steel - Rebar - Pricing fluctuations of more than 20% have resulted since a major price increase in late 2004. Rebar is a significant component in retaining walls, bridges, etc. The City purchases approximately 500 tonnes of reinforcing steel every year.
2. Asphalt - The cost of asphalt has increased by an estimated 15% between 2004 and 2005. From 2005 to 2006, it increased by another estimated 20%. The City purchases approximately 200,000 tonnes of asphalt per year.
3. Concrete - Cement powder and the price of concrete have increased 10-13% from October 2004 to October 2005. This material is a major component of bridges, structures, and sidewalks. The City purchases approximately 7,500 cubic metres of concrete every year.
4. Petroleum prices - Petroleum prices have increased 20-30% over the last year. This has had a major impact on costs, as fuel represents a high percentage of trucking and equipment operations. Oil is also a major component of asphalt; it has doubled in price in 2006.

The funding needs in LRFP II were identified in early 2004 and reflected prices known at that time. LRFP III reports project costs in 2006 dollars. Due to inflation, most projects have increased between 5% and 10%, depending on their nature. Inflation is estimated to have added more than $200 million to the cost of capital projects required in the next 10 years.

Additional projects resulting from new initiatives or information

When LRFP II was presented, not all asset management plans had been completed. For example, the recently completed asset management plan for the City's parks identified an additional $100 million in renewal needs over 10 years.

Many new projects in the strategic initiatives category have been initiated since LRFP II. They include:

• Replacement of the main library - total increase of $154 million in 2011 and 2012
• Solid waste facility upgrade program - $100 million identified in 2016
• Vulnerable buildings strategy - increase of $19 million over the next 10 years to ensure the City's most needy buildings receive required maintenance
• Urban natural features initiative - increase of $38 million over the LRFP III 10-year period. In LRFP II, staff submitted an estimated 10-year requirement of $8.3 million. They did this without the benefit of the Urban Natural Areas Environmental Study (UNAEES), which was underway. The $38 million in LRFP III is based on a list of specific land parcels recommended for protection.

Affordable housing funding

LRFP II set a target to develop 500 affordable housing units a year for the subsequent 10 years. The average annual capital funding requirement was also estimated at up to $36 million for the 10-year LRFP II timeframe. This estimate was contingent on matching funding from federal and provincial governments. At the time, there was no federal or provincial funding program in place.

Since then, the Province of Ontario introduced the Affordable Housing Program (AHP), signalling the return of the federal and provincial governments to funding for housing after an absence of more than 10 years. The AHP provides federal and provincial funding to support the provision of new affordable housing. The City of Ottawa participated in the pilot phase of this program in 2004 and matched federal and provincial capital funds to support the development of 271 new housing units. In 2006, the AHP was revised, with the Province now fully matching the federal share. Total current AHP funding to Ottawa is $30.16 million, in three streams: home ownership grants up to $10,000 per unit (232 units); housing allowance subsidies up to $250 per month for five years (400 units); and, rental and supported housing grants up to $70,000 per unit for new development (315 units).

The City has been using funds in the Social Housing Reserve to match the AHP funding for the rental and supported housing stream, bringing the total per unit funding up to an average of $90,000 (varies between projects). This additional funding enables the program to reach the low-income targets established in Action Ottawa - 60% of the units must be rented to low-income households. To produce rents suitable to low-income households, Action Ottawa unit rents will not exceed 70% of the average market rent. Funding for 139 of the 315 AHP units was allocated in October 2005. The remaining 176 units will be allocated in 2007, subject to provision of an additional $1.3 million in capital funding in the 2007 budget.

LRFP III also projects the possible continuation of the AHP to 2013. Based on current information, the City can expect funding from the AHP for 80 additional affordable housing units in 2008. If the federal government delivers on its stated commitment in Bill C-48 for an additional $800 million in funding for affordable housing, it is possible the City could receive funding for approximately 90 units per year until 2013. To ensure these funds are able to meet the Action Ottawa low-income targets, the City would be required to contribute additional funding, approximately $18 million over six years. This projection reflects reliance on federal and provincial funding and clearly demonstrates the gap between that funding and the benchmark target of 500 units per year.

Advancement of the capital growth agenda

The capital growth category has decreased since LRFP II. In 2005 and 2006, $1,156 million in growth projects were authorized, compared to $860 million identified in LRFP II. The increase of $296 million was due to projects on the 10-year list advancing their start date. This reduces the capital growth requirement for the next 10 years by the same amount.

In LRFP II, growth projects were identified from the Development Charges Background Study and were not timed to coincide with the receipt of the development charges. The new development charge funding policy, approved by Council in May 2006, provides a basis for determining when budget authority for projects may be put in place. Under this funding policy, the amount of development charges that must be collected for a project to proceed is linked to the timing of the project in the whole development cycle. For projects such as recreation facilities, which are built towards the end of the development cycle, the development charges must have been collected prior to a request for project authority. Other capital projects, such as sewers, could be constructed prior to collecting the entire amount of the development charge. The result of implementing this funding policy is that there are fewer growth projects. The development community has indicated they are supportive of the current Council process.

The development charge funding policy recognizes that certain infrastructure must be put in place prior to the development that generates the development charge revenue. The funding policy was implemented to ensure the City is meeting the demand for capital growth projects, while minimizing the risk of building too far ahead of receiving the development charges to pay for the project.

Change in the net City requirement

LRFP II presented the City's net capital costs, which represent the remaining City funding requirement once revenues and development charges are deducted. The change in the net capital costs since LRFP II is shown in the table above.

The change in the gross amount of required capital funding does not always translate into a corresponding change in the amount the City must fund. The gross capital cost has decreased from LRFP II to LRFP III. However, the net amount to be funded from the City has increased. This is primarily due to the change in the types of projects that are proposed under the growth category. Every service eligible for development charge funding has a component funded from development charges and another amount funded by the City. The percentage funded by the City varies with the type of project. For example, some transit growth projects require 85% City funding, whereas road projects only require 5% City funding. The realignment of growth projects has resulted in the decrease of gross costs, but the net City funding requirement remains fairly constant.

The other change in revenue assumptions is in the strategic initiative category. In LRFP II, the inclusion of $403 million in social housing needs, 50% of which was to be funded from other levels of government, reduced the net requirement. The gross social housing forecast has now been reduced to $98 million. New projects added to the list do not have any revenue sources associated with them. As a result, the net City cost for strategic initiative projects has increased.

Overall, the City has to fund an additional $539 million in capital costs due to the change in the projects included in the forecast and the revenue and development charges associated with each.

The last category of capital needs is for all other tax-supported services and includes roads, bridges, sidewalks, street lights, City facilities, community and recreation facilities, parks, computers and communication technology, vehicles and equipment.

Assumptions for all other tax-supported projects

The assumptions built into this portion are as follows:

• The growth category has been funded first because the City has a legal obligation to fund its share of growth projects; Council also set this as the first priority in LRFP II.
• Interest earnings from the Ottawa Hydro endowment fund are assumed to be $13 million for each of the years 2007 to 2016.
• Ottawa Hydro dividends available for capital purposes, net of the annual $12 million transfer to the operating fund, are assumed to be $2 million in 2007, $7 million in 2008, $6 million in 2009, and $7 million for each of the remaining years 2010 to 2016. Actual dividends will be subject to the financial performance of Ottawa Hydro.
• Tax-supported debt is assumed to be $40 million every year, which represents the value of the "revolving debt" that is retired and reissued every year. The revolving debt limits have been shared between transit and all other tax-supported services.
• Forecast development charge revenues are based on average revenues collected over the past two to five years. Any changes, increases or decreases to projected revenues will affect the timing of the identified infrastructure projects. Identified growth needs are in accordance with the development charge funding policy that City Council approved May 24, 2006.
• It is assumed that growth-related projects identified in 2010 and later (beyond the current term of the Development Charge By-law) that are eligible for development charge funding will be included in subsequent terms of the By-law.
• It is also assumed that interest costs will be incorporated in the rates of future development charge by-laws and that debt repayment on current-term projects will also be included in the next term of the By-law.
• Revenues and subsidies from other levels of government, totalling $119 million over the 10-year period, have been included for a number of projects. Consistent with past practice, if these revenues or subsidies are not secured at the time of project approval, the project will either be deferred or project spending will occur only when the revenues are secured.
• It is also assumed that revenues and subsidies from other levels of government as identified in the Development Charge Background Study will be forthcoming. There will be an increased cost to the City if these revenues are not realized as identified. This may require projects to be deferred until the required funding is in place.
• As per Council direction, the minimum reserve fund balances for all tax-supported reserve funds, including the transit reserve fund, is $50 million. The forecast assumes that the opening balances are at the minimum level required. Any reduction in the opening balance will result in that year's capital program being constrained to return to the approved minimum balances. In order to fund as much capital as possible, there will be no balance in the city-wide reserve.
• As approved by Council, contributions to capital have been increased by the Infrastructure Construction Price Index (5.1%) in 2007 and remain constant for the full 10-year period. Capital expenditures over the 10 years are also in constant dollars.

Ten-year forecast of needs and revenues - Other tax-supported
($ millions)

The garbage collection and disposal program is now funded through the garbage user fee. To recognize the unique source of funds for this service, the capital needs and funding have been identified separately.

Ten-year forecast of needs and revenues - Solid waste services ($ millions)

Assumptions for solid waste services (garbage collection and disposal)

• It is assumed there will be an increase in the solid waste fee in 2007 to allow the renewal category to be fully funded. This funding base will be maintained over the next nine years. As a result, costs identified in 2008 will be deferred and funded in future years.
• The strategic initiatives category has not been funded. Council will deal with these initiatives as part of the City Corporate Planning process. If projects in this category are selected for advancement, the garbage fee will be adjusted accordingly.

As part of the light rail transit discussion, an analysis of transit capital needs and funding was presented to Council. That analysis was built on information available at the time. Information presented here, while very similar, reflects the work that went into creating LRFP III. The forecast has not changed, as transit capital needs can be met within the next 10-year period.

Assumptions for transit services

In building the revenue forecast, a number of assumptions were made, as detailed below:

• Projects that would fall into the strategic initiatives category were not funded if they required funds from contribution to capital. Council will deal with all strategic initiatives projects as part of the City Corporate Planning process.
• Over the 10-year period, provincial gas tax funding is valued at $373 million, $71 million of which will be transferred to the operating budget and $173 million will be used to service previously authorized or planned debt. This leaves $129 million over the 10-year period to be used as cash contributions to capital or for operating requirements as allowed. In this plan, all available provincial gas tax revenues have been applied to capital.
• Over the 10-year period, federal gas tax revenues are assumed to be $468 million, $85 million of which will be used to service previously authorized or planned debt. This leaves $383 million to be used for transit-related capital projects. The full $383 million is forecast to be spent in the 10-year period.
• Tax-supported debt is referred to as "revolving debt," as it replaces paid debt with new debt. The annual amount of tax-supported revolving debt is assumed to be $40 million per year or $400 million over the 10-year period. In total, $180 million of the $400 million in revolving debt is applied to transit.
• New debt that is beyond the amount covered by the current debt servicing budget is assumed to be repaid from gas tax revenues or other non-tax sources. This is consistent with the LRFP II funding strategy.
• It is assumed that growth-related projects identified in 2010 and later (beyond the current term of the Development Charge By-law) that are eligible for development charge funding will be included in subsequent terms of the By-law. In addition, debt repayments on current-term growth projects are assumed to be included in the next term of the By-law.
• It is assumed that revenues and subsidies for transit projects from other levels of government totalling $1,234 million over the 10-year period will continue. Consistent with past practice, if these revenues or subsidies are not secured at the time of project approval, the project will either be deferred or project spending will occur only when the revenues are secured.
• Consistent with Council direction, the minimum reserve fund balance is $50 million for all tax-supported reserve funds, including the transit reserve fund. As contributions to the transit capital reserve are restricted from being spent on non-transit projects, the tax-supported reserve balances will exceed $50 million by an additional $41 million over the 10-year period with the surplus going to the transit reserve fund.
• As approved by Council, contributions to capital have been increased by the Infrastructure Construction Price Index (5.1%) in 2007, but remain constant over the remaining nine-year period.
• It is assumed that the second phase of the Light Rail Transit project will be cost-shared with the provincial and federal governments at one-third for each level of government.

Ten-year forecast of needs and revenues - Transit ($ millions)