SOUTH PORTLAND — A state law designed to give businesses tax relief has left the city struggling to fill a more than $690,000 hole in next year’s budget.

At a special workshop Wednesday evening, the City Council reviewed several options to close the projected revenue shortfall. The two choices generating the most support would rely on negotiating about $100,000 in pay freezes with unions. 

If those concessions are not agreed to by the unions, the city could be faced with more layoffs. 

The revenue shortfall is the result of a change in the way the state provides tax relief to businesses, a program known as Business Equipment Tax Exemption, or BETE. 

City Finance Director Greg L’Hereaux said that prior to 2007 the state would directly reimburse businesses for taxes paid on significant personal property investments, specifically non-real estate and non-retail inventory equipment. 

In an effort to gradually begin shifting the burden to municipalities and reduce expenses at the state level, L’Hereaux said the Legislature redesigned the program. Instead of reimbursing the businesses for taxes paid, the state would exempt new equipment purchases that met certain thresholds.

The new exemption, however, essentially reduces the amount of taxable property at the local level.

“The state is doing this to address their revenue shortfall,” L’Hereaux said. “The municipalities are the ones that are taking it on the chin.”

In the current budget, the state reimbursed the city for all of the $660,000 in lost revenue. However, the state is expected to gradually reduce that reimbursement to 50 percent by 2014. Next year, only 90 percent will be reimbursed.

L’Hereaux said he believes South Portland stands to lose more than any other community in the state, because of its semiconductor industry, which must constantly stay on top of new technology.

In the past, the city has created tax increment financing districts to shelter new investments made by National Semiconductor and Fairchild Semiconductor. However, under the new system, any reimbursement revenue received from the state goes into the city’s general fund. That reimbursement in turn increases the city’s valuation, which could lead to smaller state education subsidies, less money through revenue sharing and increased taxes the city must pay to Cumberland County. 

L’Hereaux said there was so much uncertainty about how the new rules would play out that state officials could not initially provide city leaders with any guidance about how best to handle it in their budgets. 

“I think there was no knowledge out there about what the impact of this was going to be,” L’Hereaux said. “We’ve had mixed answers, but now we’re at a point where we’re getting consistent answers from the state.”

Much of the confusion stems from the forms the city is required to fill out, L’Hereaux said. Instead of giving city leaders the option of putting their reimbursement back into a sheltered TIF account, he said state forms led the city to include it in the general fund.

By putting as much money as possible back into the TIF, L’Hereaux said the city would net millions in additional revenue over the life of the Fairchild TIF. The downside, however, is that TIF money can only be used on specific projects. 

Since $1.3 million in BETE revenue is included in the fiscal 2010 general fund budget, the city cannot make the necessary adjustments without creating a budget hole. That gap could only be closed with additional cuts or an increase in property taxes.

Councilors generally supported a plan that would allow the Cummings Road TIF district, which is not subject to the BETE program, to expire. That would put more than $390,000 back into the general fund, rather than capturing it in a TIF, which can only be spent on very specific uses but wouldn’t be counted towards the city’s valuation.

The council also supported paying for $33,000 of capital projects with TIF funds and a zero-percent increase in union pay raises, which would save about $100,000.

City Manager Jim Gailey said that five union contracts expire on June 30. Gailey said he has already started talks with two police unions with active contracts, the command unit and officers unions, about freezing scheduled increases.

Gailey said a cost-of-living adjustment for library workers cannot be renegotiated, because of their ongoing attempt to unionize.

The council will discuss the BETE shortfall again at their budget wrap-up session scheduled for May 11. 

Councilor Maxine Beecher said the council had an obligation to discuss at its final budget meeting the council’s health insurance benefit, which costs taxpayers about $70,000 a year. Putting council health care on the table would generate good faith when negotiating with the unions, she said.

“If the people that work for us feel like they’re getting a cut, then we as a council need to demonstrate that we’re willing to cut, too,” Beecher said. 

Beecher’s comment drew no response from other councilors. 

Randy Billings can be reached at 781-3661 ext. 100 or rbillings@theforecaster.net