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The City of Buffalo closed the books with a $3.3 million operating surplus for the fiscal year that ended in June, City Comptroller Anthony R. Nanula disclosed Tuesday.

But the fiscal outlook for this year is not nearly as rosy. The city faces a deficit that could approach $42 million, according to Budget Director James B. Milroy. The projected gap has increased by about $4 million since Milroy issued his last financial outlook three months ago.

One of the biggest hits will come from the city's continuing revaluation, which is expected to result in the loss of more than $18 million in property tax revenue.

"The surplus is good news, because no one wants to close with a deficit," Milroy said. "But we're still facing some major challenges."

City officials are hoping that the state will help close the projected gap by agreeing to provide more than $18 million in "spin-up" aid.

Milroy said the city's options for dealing with the shortfall are somewhat limited, given that it is already close to its constitutional taxing limit. Some City Hall sources are predicting there could be cuts in Mayor Anthony M. Masiello's budget proposal, which must be sent to the Common Council by May 1.

City budget surpluses can be used to offset costs in future years. The city has posted surpluses ranging from $2.1 million to $5.5 million in three of the past four years.

In the year that ended in June, revenues from real property taxes decreased by $6.3 million, to $138.9 million. But the loss was offset by a $4 million increase in sales tax revenue and a $7.5 million increase in state aid.

Though Nanula acknowledged that there is "much work to do," he described the year-end figures as a sign that the city is on a "positive track." He noted that the city posted a $905,000 deficit in the 1998-99 fiscal year.

"I think we're headed in the right direction," Nanula said, "but it's clear that we'll need to rely on Albany to help us weather the storm in the next fiscal year."

Significant increases in state aid also enabled the Board of Education to close its fiscal year with an $8.8 million surplus, according to Tony Farina, Nanula's executive assistant. Farina said the school district received an additional $40 million in state aid, including increases in basic formula funding, lottery aid and funding for textbooks.

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