A budget overlay establishes a municipal cash reserve account. The purpose of the overlay is to provide a backup source of money that covers unexpected shortfalls in property tax revenue. The overlay account is a revenue offset account, so the money in this account can only be used to cover deficiencies in property tax collection and may not be allocated to other city projects.
A real estate owner may file a request for an abatement, which reduces the size of his property tax liability, or an exemption, which eliminates his liability. The city government doesn't know which property owners will receive an abatement or an exemption, but it does expect some property owners to qualify for these benefits. A court may take more than a year to decide whether to allow an abatement, so the city must also establish a reserve that covers previous years.
The municipal government collects money for the overlay account along with the other money it collects from property taxes. Unlike other types of tax increases, the overlay account is not part of the standard appropriations process. The city assessors can decide to raise the overlay rate whenever they feel it is necessary, so a public vote on whether to increase the overlay rate is not required, although state law establishes a low cap on the maximum overlay rate.
The city will charge a higher overlay rate if it is unsure of the amount of property taxes it will collect. According to the city of Arlington, Mass., website, a city will charge a higher overlay rate when it plans to assess the value of real estate, because if it assesses a parcel at an increased value, it's more likely the property owner will request an abatement. Many cities establish a regular schedule for assessments, such as once every five years, so the overlay will be higher in the fifth year. A city will also establish a larger overlay fund if property values are dropping, because a property owner may demand a new assessment at the property's current value.
A city may not need to use all of the money in the overlay account. If there is cash left over in this account at the end of the year, the city records an overlay surplus, and the city can spend the money on any project. The city can decide to roll over the overlay surplus, so the account starts out the next year with a positive balance.
Eric Novinson has written articles on Daily Kos, his own blog and various other websites since 2006. He holds a Bachelor of Science in business administration from Humboldt State University.