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Fixing San Diego's Finances

Interview with Carl DeMaio

Adrian Moore
February 22, 2008

Once highly regarded for its efficient and conservative management, the city of San Diego has been rocked in recent years by a severe financial crisis and political turmoil.

In 2003, Reason Foundation partnered with the Performance Institute, a national think tank, on the "San Diego Citizens' Budget Project." The project was planned as a three month examination of what was considered a well-managed city to see if additional efficiencies could be gained from implementation of more innovative management practices. Performance Institute founder and president Carl DeMaio led the project, which helped uncover secrets the city had been keeping on the true state of its finances.

San Diego faces multi-billion dollar liabilities for pension and health care benefits for retirees, failed to balance its operating budget for a decade, and neglected to maintain its community infrastructure (roads, utilities, public safety, etc.). On top of that, the city issued false and misleading financial statements for years—and used those statements to issue bonds on Wall Street.

DeMaio and Reason took these findings public and challenged the city's most powerful interests to respond by adopting immediate reforms. DeMaio also took these issues directly to the ballot box through the initiative process, and last year earned victories for pension reform and managed competition against stiff opposition from the city's powerful municipal unions.

DeMaio goes way back with Reason Foundation. In 2000, he led our Transition to Governance project, crafting recommendations for performance-based reforms of the federal government that led to President Bush's President's Management Agenda. He also helped lead the California Citizen's Budget project a few years later, a joint project of Reason Foundation and the Performance Institute.

After years of pushing for reform in his hometown, DeMaio announced he was stepping down from the two companies he founded and announced his intention to run for San Diego's City Council. And he's enlisted other like-minded reformers to run for city office. Big things are happening in San Diego that just might end up offering a case study for how to reform a modern big city.

Reason Foundation's Adrian Moore: You are best known as a national government reformer, through your work on Capitol Hill and most recently at the Performance Institute. Now you're leaving the national stage to focus on running for San Diego City Council. Why the jump into local politics?

Carl DeMaio: I've always been interested in making positive change happen in government—whether on Capitol Hill by promoting better congressional oversight and budgeting practices or by founding the Performance Institute to study "best practices" in government programs. It's frustrating to see a government program fail, and then turn around and ask for more tax dollars. Nowhere else but government can you have an enterprise treat its customers poorly, screw up a service, not achieve a result, and then turn around and ask for more money!

To me the big challenge is to rethink how government works to make it accountable, transparent, competitive and performance-based. I've worked with cities, counties, states, and federal departments across the nation on implementing these reforms. And guess what? Government can be reformed to provide a better service and a better outcome at a lower cost. Yes, you can implement business practices in government. Yes, you can deliver better value for the taxpayer if you approach problems from a "multi-sector" approach—borrowing the best from public, private, and non-profit sectors. The frustration has been that we've been making change happen on a program-by-program basis. My hope is to implement these reforms on a bigger scale—take an entire city government and reform every department.

One of the reasons why I'm running for City Council is to bring those practices into play within a single city. Certainly I'm interested in improving our situation here in San Diego. At the same time I believe we can have a positive impact nationwide. If we make San Diego city government a "model" of an efficient city, my hope is cities and counties across the nation will imitate. They sure are watching San Diego today and using our financial crisis to learn what NOT to do. It'd be nice to change that so that people are watching San Diego city government and borrowing from our reforms and successes.

Moore: You played a big role in uncovering the financial problems facing the city of San Diego and you took a lot of heat for that. How did—or even did you—know the city's finances were so bad and how did you weather the heat?

DeMaio: We stumbled across the financial crisis in San Diego. I had just finished working on the roll-out of the President's Management Agenda at the federal level and had just finished working the California Citizens' Budget Project with Reason Foundation. Naturally looking at a local government and defining a government reform agenda would be the next step. We thought we'd work on a three-month project and produce recommendations for saving around $20 million—enough to weather the city's official budget shortfall.

I gathered a team of municipal finance experts to independently pour over the city's financials and budgets. What we found was that the city bureaucrats and politicians had intentionally misled the public about the true state of the city's fiscal health. The so-called $20 million deficit was actually $100 million—and that was not counting the $2 billion pension fund liability. We found evidence of securities fraud, millions in raids on fee-based enterprises in violation of the State Constitution, and programmatic failures. We took our findings to the then-Mayor and City Council, but they refused to act.

When we took the truth public they denied everything—and they got their powerful friends, lobbyists, and union friends to attack us. We stood our ground and began an intense public education campaign to clue the public in on what was happening at City Hall and just how bad the situation was. We even had to approach national news media—New York Times, The Wall Street Journal, USA Today—to get them to write the story before even the local paper would cover the story.

I didn't mind taking heat from the local powerbrokers as long as we were fighting for what was right. Too often political leaders worry about the consequence of what should be done and end up watering down or not doing what needs to be done. Then again, I wasn't in politics back then. (Laughs)

Moore: What would you say are the three top issues facing San Diego in the coming five years?

DeMaio: First and foremost, the city's financial crisis. The city must balance its budget for real and we must deal with the multi-billion dollar liabilities for pension and retiree health care. The city has barely addressed its budget imbalance and debt issues since we uncovered them four years ago. Add to that dire situation the fact that the tough economy will cut the city's revenue growth in the next few years—particularly in sales tax and property tax revenues.

Second, the city faces a massive infrastructure deficit. The city has for decades neglected its roads, public facilities, and public safety equipment needs. The city has failed to put aside the monies necessary for maintaining—let alone expanding—its infrastructure. That neglect is finally catching up to the city in the form of crumbling and traffic-clogged roads and community infrastructure inadequate to meet the needs of our growing population.

Third, the city will confront several environmental challenges—including water and sewer management, solid waste and landfill management, energy reliability, open space management, and storm water runoff. The environment in San Diego is the envy of the nation—it is our greatest asset. Yet we are seeing major risks emerge on our environmental quality that must be addressed.

Moore: Let's take each of those issues in turn. How will you address the financial issues?

DeMaio: You balance a budget for real by combining spending cuts and revenue growth. The first issue of cutting spending is easy from a technical standpoint. I've drafted balanced budgets for even the worst financial crunches, but none of those balanced budgets came with the most important ingredient: political spines! In cutting spending, politicians actually have to say "no" to powerful interest groups. And "no" can be a very lonely word in politics.

The biggest spending cut we can make in the city is to reduce labor costs. If you do that, every single service in government becomes more efficient. And it is what is happening in every sector of the economy—witness what is going on in the automobile industry with salary and benefits reform. The same thing must happen in government. We need to benchmark our salaries and benefits against the local labor market for similar skill sets. That will require in some cases salary cuts, and of course, reform of pension and health benefits. We need to reform the pension system to shift non-public safety workers to a 401(k)-style retirement system and provide choices for public safety members to choose a reformed defined benefit plan or opt into a 401(k) plan with higher take-home pay. Finally, salary adjustments in government should always be based on competitive labor market analysis—and performance. The old model was for the municipal labor union to come in and negotiate an across-the-board salary and benefits increase. We need to make increases merit-based.

Once labor costs are streamlined, we need to prioritize city services to focus the budget on the "core" services. How can this city government be spending money on a nine-story downtown library when we are cutting basic library hours city-wide? How can we be talking about funding a ballpark from the General Fund when we cannot give our police and firefighters adequate equipment? By focusing on the "core" and doing those services well, we can cover the primary functions of local government before getting over-extended.

Moore: You mentioned revenue increases—you mean raising taxes?

DeMaio: No. On revenue increases, you don't get those by raising taxes. I founded and ran two successful businesses. To borrow a market example, that would be like a company wanting to raise its revenues by raising prices. Your customer might walk—or be stolen by a competitor—and you'd end up with less revenue. We grow revenue by growing markets—offering a better service, helping your customers expand, seeking more customers, etc.

The same is true in government. You get revenue increases by supporting the economy and each hard-working family in your city. When your residents are successful in their endeavors and lives, the city government shares in that success. Our three primary revenue sources are property taxes, sales taxes, and tourism taxes. By fostering a competitive economic and jobs-friendly environment, we can grow revenues with every job created, every housing unit brought to market (did I mention our affordable housing crisis?), and every tourist brought in to enjoy the treasures our city offers.

Moore: On the second issue—the infrastructure deficit—how will you address that?

DeMaio: The city needs to do two things: increase funding for infrastructure and improve its management of infrastructure projects. On funding, the city should "lockbox" a percentage of revenues to invest in infrastructure—even if it is for a set period of time, say five or seven years. It is too easy for the politicians to push off infrastructure investments into the future to fund increased services today.

Second, the city needs to require that new development pay its fair share of the cost of community infrastructure—as well as commit to using these funds to actually provide the infrastructure. I've seen the city collect development impact fees only to drag its feet and not provide the infrastructure improvements.

Third, the city must explore public-private partnerships to leverage private investment in community infrastructure. Borrowing from successes in other cities, we have ample opportunities for public-private partnerships in San Diego—from the Convention Center to even the City Hall complex.

You can't just throw more money at the problem though. You have to reform how we manage infrastructure in the city. First, we need to do a better job of real estate and asset management. A few years ago we discovered the city could not even tell you what assets it owned. We must "book" the depreciation of our assets using an accrual method so we know where the infrastructure deficits are. We have to ask whether the assets we currently own are being put to the best use for the taxpayer. Second, we need to do a better job of infrastructure planning—from devising individual community plans to adopting capital plans for specific elements of our infrastructure (such as the Regional Transportation Plan.) The problem I'm seeing in our planning is it takes a transactional or incremental approach rather than adopting a transformational approach. We cannot sustain the path we are on in many of our infrastructure systems—be it water/sewer, transit, freeways, parks, etc. Yet we draft these plans with all sorts of "happy talk" rhetoric on how we will get the infrastructure done. Then we tend to spread money around like peanut butter—and in doing so we fail to complete significant improvements. So we must revise our infrastructure plans to be more strategic and realistic—and actually follow them.

Finally, when implementing infrastructure projects (building a road or installing a sewer trunk) the city has an abysmal record of project management. As we move to more contracted services and the dawn of the "multi-sector workforce," we have to upgrade and overhaul our internal contract management functions. It is the most important investment we can make in an internal function of government outside of our human resources function. We also need to convert our contract vehicles to more accountable ones—using design-build, fixed price, and performance-based contracts. Finally, we must end the practice of using government contracts in infrastructure to manipulate labor rates in the market—prevailing wage, living wage, project labor agreements, etc. The federal and state government should be involved in labor rates, not the city. The city should be focused on its role: providing community infrastructure.

Moore: I did not expect one of the top three to be an environmental issue. Most Republicans aren't exactly known as environmentalists. What are your solutions for the environmental challenges?

DeMaio: First of all, I see Teddy Roosevelt as a key role model and consider myself an environmentalist. Secondly, it should be no surprise that a San Diegan wants to protect the environment. It is the core of our quality of life and it is the underpinning of our economy. If we lose the environment, we lose San Diego. I'm not about to let either happen—hence I'm an environmentalist. However I believe the best way to create a "Green City" is to harness market-based solutions. Regulations usually impose costs, but offer little improvement for environmental outcomes.

Some of the environmental issues are related to the infrastructure challenges we just spoke about. We must upgrade our water and sewer system as we have 100-year-old pipes bursting virtually every week. That's an infrastructure management challenge and frankly it is my top environmental priority. We can have a huge impact on water quality and protecting our beaches and bays if we get that system back-on-track. Our landfill is almost full. Right now the city is turning to regulations to mandate recycling to address that problem. Instead of regulating, why not provide incentives? If people have a financial incentive to reduce their throw, they will recycle. That will require a change in how we manage the entire waste management system for the city and I'm currently examining different models used by cities across the country to put together a proposal.

On energy and water, I see those two issues as linked—19% of the state's energy consumption is due to moving water throughout the state. If we find a way to address water, we make big gains on energy conservation. Outside of local conservation measures and more aggressive use of recycled water for irrigation, the city will not be able to address that challenge without a partnership with the state and federal government. I want to get San Diego as a leader in organizing a comprehensive water-energy proposal that would benefit not just our city, but the state as a whole.

Moore: In each of these areas, you're clearly challenging the status quo and proposing big reforms. Based on your work nationally and what you're finding locally, what do you think is the key to success at making major changes in a government setting?

DeMaio: You make change happen by clearly defining the problem for the public and by articulating real solutions that have been proven elsewhere. You need BOTH of those ingredients. Too often we rush to a solution before the public is even aware of the problem. Sometimes a leader's job is to speak truth to power—let the public know what is really going on.

On solutions, it is not enough to adopt a piece of legislation or enact a policy. Execution is everything. Anyone who has run a complex business understands this. If you don't implement properly, change does not happen. Politicians don't like the execution phase of change. They like to pass bills and make proclamations, but the real challenge is in implementation. That requires getting political leaders that actually know what it takes to manage an enterprise of human beings. Humans are the most change-resistant animals on the planet.

What I find is people change when they see success. I advise political leaders to get early wins under their belt to build credibility with the workforce and with the public. Once a reform is succeeding, others start adopting it. People like to copy success. Same is true even in the most change-resistant government bureaucracy. Start with a reform in one department (say Libraries or Park and Recreation) and once it shows success approach the directors of the other departments and sell them. Once a reform is implemented, a political leader has more political capital to spend on a new reform. And the change process can continue to build. If you don't implement that first reform properly, then you get no more political capital to spend and change is stymied.

The other key ingredient is human capital. You have to have a stellar management team—you cannot have any weak links. You also have to engage the workforce and aggressively communicate and reward. A political leader tends to see career staff as underlings—so much so that there is a big cultural divide between the political staff and career staff. Career staff have to respect their political leader and they have to speak the same language. If your human capital is allocated to support change, you'll get change.

Moore: So you're saying the antidote to the city's problems and the way to amass political support is to be really good at management. How can you balance the political and managerial roles as an elected official?

DeMaio: Yes, actually. The public is desperately looking for "good government." I think being a good manager makes for good politics. But you have to go into it not worrying about the politics. In fact, as I'm going around our city campaigning, I'm describing what we are trying to do as a bit of an "experiment." The experiment is this: How much change can you achieve if you don't worry about the political consequence of the solutions you are trying to implement?

Moore: Your brand as a reformer and your populist approaches have led to an unusual mix of supporters—I've noticed a number of key Democrats supporting you in addition to your Republican base. But you also have attracted the ire of the municipal labor unions. They tend to have a lot of power. Will their opposition be a problem?

DeMaio: I think the unions are afraid of change. They benefited from the old system—it's all they know. I don't think what we are proposing is anti-union. For the reasons I outlined earlier when I talked about the importance of human capital, I do think the agenda we are proposing is very pro-employee. That would probably surprise some of the union leaders here in San Diego. In making proposals, I'm very much looking to maximize the success of every city worker. That's what a good leader should do—look out for the well-being of their team. I want the city of San Diego to be an "employer of choice" rather than an "employer of last resort."

As we move forward with reform, my hope is to engage the unions and ask that they help be part of the solution to moving our city forward. One way is to go directly to the city workers themselves. We need to treat people with respect, engage the city workers so they feel positive and passionate again about their work, and start demonstrating success. My proposition to the unions and the city workers will be simple: we can continue down this terrible path we are on, or we can try something new. That requires both management and labor put down their weapons and actually work together for the common good.

My ultimate job, however, is to serve the best interests of the people. City government exists to serve the people, not the other way around. If we have to take things directly to the public, we can and will. The unions are free to spend their money on those campaigns and after a spirited debate we can let the people decide. I hope we end up getting the unions as our partners for turning the city around. It works best when you have labor and management working together for the public benefit.

Moore: So if you win, you have four years on the city council. Then what?

DeMaio: A vacation? Seriously, we have a lot of work ahead of us and I'm already focused on how we get the ingredients in place that we'll need to turn things around. That means getting a Mayor, City Council, and City Attorney that are all working together to advance reform in city government and complete the challenging task of restructuring the seventh largest city in the country and making it a model once again of municipal excellence.


Adrian Moore is Vice President, Policy


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