The city of Oak Harbor’s days of clear financial sailing appear to be over as the economic storm plaguing state and municipal governments across the nation has finally caught up with Whidbey Island’s largest city.

On June 15, Finance Director Doug Merriman briefed the City Council with a grim six-year financial outlook. If his current revenue and expenditure estimates hold true, the city will be looking at a $272,952 hole in the 2011 general fund budget.

And things only get worse from there. The gulf between revenue and costs will increase each year until 2016 when it reaches $1.6 million. Although the report came as no surprise for some council members, it didn’t make the news any easier to hear.

“We knew it was coming but I don’t know what we’re going to do,” said City Councilman Jim Palmer, who is also the chair of the Finance Standing Committee.

It’s still too soon in the budget development process to know how the council will choose to fill the gap in next year’s budget, said Palmer, much less decide on a course to address the problem over the long term. However, he said he favors making cuts over raising or creating new taxes.

The budget gap is the result of increased expenditures and decreased revenues. Over the next six years, Merriman is estimating that expenditures will grow on average between 4 and 5.5 percent per year while annual revenues will increase between 2.2 and 3.1 percent. However, he said he is purposely calculating revenue estimates on the low side.

“I think this is a good, conservative approach,” Merriman said during the meeting.

Unlike many municipalities and county governments across the state, Oak Harbor has felt few effects from the national recession. Island County has been hit particularly hard. Addressing a budget shortfall of $4.2 million over the past two years, officials have cut more than 50 positions, reduced office hours, and implemented work furloughs and cheaper medical plans for many employees. It’s facing another $1.2 million shortfall in 2011.

The county’s budget woes are largely the result of crashing revenues, from construction and development fees to a massive reduction in sales and real estate excise tax income. Real estate excise tax revenues alone have shrunk from $17.71 million in 2005 to just $6.68 million in 2009. It’s also been hit hard by declining investment earnings, which have dwindled from $860,575 in 2008 to $218,309 in 2009.

According to Palmer, Oak Harbor has faced all the same problems and would have suffered similar economic hardship had it not been for Merriman. Between 2006 and 2007, governments everywhere were enjoying a spike in revenues generated from the housing boom. But with his background in banking, Merriman accurately predicted that it was just a temporary cycle and persuaded the council to use just 60 percent of the extra revenues. The remaining 40 percent was put into the city’s reserves.

He also predicted a spike in federal investment earnings as a temporary luxury. To provide more stable and long-term income, Merriman negotiated three-year investments with fixed rates at 5 percent. While they have helped the city weather the economic downturn, as unfixed rates have plummeted over the past two years, several of those investments matured in 2009 and more are set to mature this year.

But the city’s financial health may be due to other factors as well. For example, it can collect and rely on revenues unavailable to the county. One of the largest is Oak Harbor’s utility tax, said Island County Budget Director Elaine Marlow. Separate from the revenues received from monthly utility bills, it added about $2.5 million to city coffers in 2009 and accounted for 20.54 percent of the general fund.

“They can tax their utility services and we can’t,” she said.

Marlow made it clear she is not disputing Merriman’s contributions. However, utility tax revenues make up a big difference between the city and county’s budgets and has no doubt played a role in how each has been able to weather the economic downturn.

Another big difference is sales tax revenue. Oak Harbor’s many commercial businesses, especially big-box stores such as Walmart, are another large revenue generator for the city not shared by county government.

“The difference is we don’t have those large commercial businesses,” Marlow said.

According to Merriman, Oak Harbor’s sales tax revenue is on the decline. Since 2009 it has dropped 12 percent, from $3.30 million to $2.90 million this past year. While they are expected to start climbing again in 2011, Merriman’s estimates they won’t reach 2009 levels again until 2016.

The city does have a healthy financial reserve. The current $2.88 million balance accounts for 21 percent of the city’s budget. While only 5 percent of that would be needed to pay the city’s annual expenses, Merriman said it would be unwise to reduce reserves to anything lower than 15 percent, the minimum balance he says a national finance group, the Government Finance Officers Association, recommends for municipalities.

While the financial cushion the city’s reserves provide will come in handy over the coming years, Merriman said the city can expect tough budget times ahead.

“I think this will be the most difficult year we’ve had building a budget,” he said.

Tuesdays meeting was the first of a series of public hearings that will take place concerning the 2011-2012 budget. No firm dates have been scheduled yet, but Merriman said most of the hearing would be held in August. However, the budget will be discussed at the Finance Standing Committee’s July 14 meeting. State law requires a balanced budget be adopted no later than Dec. 31.