HomeMy WebLinkAboutStaff Report 387-07City of Palo Alto
City Manager’s Repor-
TO:
ATTN:
FROM:
DATE:
SUBJECT:
HONORABLE CITY COUNCIL
FINANCE COMMITTEE
CITY MANAGER
OCTOBER 16, 2007
DEPARTMENT: ADMINISTRATIVE
SERVICES
CMR: 387:07
DISCUSSION OF COUNCIL’S TOP 4 PRIORITY "SUSTAINABLE
BUDGET"
RECOMMENDATION
Staff requests that Com~cit review the report and provide comments.
BACKGROUND
In the past decade the City of Palo Alto has faced an array of difficult budget challenges, raising
concerns and questions about the City’s long-term ability to support the variety and level of
services it currently provides. It is out of these financial trials that the concept of a "sustainable"
budget has emerged as a potential medium for solutions. Before reviewing these challenges, a
definition of a ’°sustainable" budget is necessary.
A budget, by definition, is a plan that is designed to keep an entity’s expenditures within its
available resources, i.e. spending w4thin your means. By adding the word "sustainable," the
fundamental issue of what services and programs can be supported over a prolonged period of
time is raised. In turn, this provokes questions such as:
¯What are the City’s basic program and spending priorities now and in the future?
¯How long can current expenditure patterns continue and what costs can be reduced or
eliminated to achieve a balanced budget?
¯Can current services and service levels be provided in a more efficient and cost-effective
marmer so as to maintain them?
¯What revenue sources can be counted upon now and in the furore and which are likely to
decline?
¯To what extent are the City and community able and willing to maintain and grow
revenue resources when needed?
CMR:387:07 Page 1 of 9
A sustainable budget can be considered a spending plan that meets the needs of the present
without compromising the ability to provide services to future generations. Such a budget would
meet the challenge of funding current operational costs while at the same time funding incurred
long-term liabilities.
Over the past 10 years, the City has faced several major financial challenges: These include:
¯Financing and rehabilitating the City’s aging infrastructure
¯Coping with the revenue shortfalls caused by the recession and dot-com bust of 2001
¯Fixing a structural deficit caused by ongoing expenditures, e.g., health care costs that are
rising at a greater rate than revenues
¯Addressing and funding the retiree medical liability incurred by the City
In addition to these issues, the City has had to contend with State takeaways of revenue; the
exodus of key revenue generators such as a hote! and car dealerships; growing competition from
the Internet and surrounding big box stores and malls; and legal and regulatory threats to its
revenue base.
The City has dealt with at least two major areas of liability that could have jeopardized a
sustainable budget: infrastructure rehabilitation and retiree medical obligations.
Historically overlooked due to a recession in the early 1990s and due to a heavy emphasis on
services in the operating budget, the City was compelled to ramp up infrastructure spending in
the late 1990s. A General Fund Infrastructure Management Plan (IMP) finished in 1997,
identified the need to spend $10 million ammally for the next ten years to address a growing
infi’astructure backlog. Without the necessary and ongoing improvements to the streets,
sidewalks, parks, buildings, and facilities, the ability of the City to deliver basic services would
have been put at risk. Essentially, the City recognized a structural imbalance in its spending
patterns and over the next ten years reallocated its resources.
Declaring infl’astructure as one of its top priorities for several years, the City made progress in
creating and funding a separate "Infrastructure Reserve" (IR) whose purpose was to sustain
capital funding over time. It developed a policy whereby year end operating budget savings
were channeled into the IR to keep it replenished. This policy helped to significantly increase
the amount of spending on IMP infrastructure since 2000 when the funding level was $7.4
million compared to $12.3 million in 2006-07. When faced in recent years with steep increases
in construction costs, expanding project scopes, and a draw on the IR for new projects, Council
directed staff to identify an additional $3 million for capital spending. This was a "Top 3
Priority" in 2006. This was achieved through a combination of expenditure reductions and
revenue enhancements and incorporated in the Adopted Budget for 2007-09. It is expected that
the City will need to grow the $3 million each year to keep up with the grown in project
construction costs.
Another long-term liability is the unfunded but earned retiree medical benefit. GASB 45
requires that local jurisdictions recognize, and hopefully fund, the costs of retiree medical
benefits as they are incurred rather than when the premiums must be paid. Based on investment
CMR:387:07 Page 2 of 9
of funds in a trust, an actuary has estimated the City’s liability at $82.6 million. GASB 45’s
put’pose is to avoid having an operating budget’s services and programs suffocated by the
growing and sizeable expense of a post employment benefit. The City of Palo has dealt with this
major issue by developing a healthy retirement medical reserve and by indentifying funding in its
operating budget to meet its atmual required contribution. Moreover, the City is near to
investing its reserve and contributions in a trust fund ",hose rate of return mitigates the impact of
the overall liability.
In addition to long-term threats, there are short-term and cyclical events that endanger City
resources or revenues. These range from the economic cycle to the exodus of major revenue
generators, as well as State ~takeaways" of revenue sources. Typically, the City deals with these
occun’ences by reducing expenditures to match lower revenue expectations. During the dot-corn
downturn, for example, the City’s sales and transient occupancy taxes, which totaled $35.2
million in 2001-02, fell by a substantial $11.9 million or 33.8 percent over a ~o year period.
This revenue swing represented a 9.5 percent drop of total budgeted revenues. The downturn,
combined with a later realization that expenses such as health care were increasing at a faster rate
than revenues, led to a series of painful and prolonged expenditure reductions. Since 2001, the
City has pared its expenses by $20 million. This included the elimination of 70 positions.
DISCUSSION
The examples above provide evidence that the City has dealt with long-term, sustainable budget
issues and that it is in the City’s best interests to forecast and address long and short-term
dislocations welt in advance of their occut-rence. To a considerable degree, the City’s Long
Range Financial Forecast (LRFF) identifies the principal expense and revenue trends and risks
facing the City. It includes, for example, mention of increases in medical premiums and health
care costs that are growing at a rate faster than inflation; anticipated losses of revenue such as
rent when the landfill closes; and the potential impact of a recession. Although the LRFF cites
opportunities and efforts underway to maintain and enhance the City’s revenue base, it does not
recommend strategies or a plan to maintain a viable, sustainable budget over the next decades
given what is known today. Before outlining potential steps to develop a sustainable budget, a
discussion of some major expense and revenue trends is important.
Expenditure Trends
Of all the expense trends facing the City, past and anticipated increases in health care costs are
the most disquieting, as depicted in the graph below. As the LRFF states, ~Medical premiums
are expected to double by 2015, having grown by nearly 60 percent over the past seven years to
$12.2 million." In 2006-07, health care costs represented 9.3 percent of the City’s budget; by
2015 it is expected to grow to 14.9 percent of total expenses. With health care costs constituting
a greater and greater share of national Gross Domestic Product, a similar and unsustainable
development is occurring within the City.
CMR:387:07 Page 3 of 9
Healthcare Expenses
$24
$21
$18
$15
$12
$9
$3
SO
~0 0 0 0 0 0 0 0 0 0 0~ ~ ~ ~0 0 0 0 0 0 0 0 0 0
~ ~ ~ 6 6 6 6 o o o 6 6 6 .......
0 0 0 0 0 0
¯ Active Employees []Retirees [] Retiree Medical Liability
The City has taken steps to address this rising cost. Being one of the few remaining jurisdictions
to fully fund employee health insurance premiums and retiree medical costs, the City has placed
a limit on its contribution to medical premiums for both active and retired employees. In
addition, the City has raised its vesting requirement from 5 to 20 years to obtain health care
coverage upon retirement. Given expected steep increases in health care costs, however, the City
will need to curb expenses further. To achieve a sustainable budget, additional measures to share
rising medical expenses with employees are necessary. Other jurisdictions are moving toward
employee premium contributions and this practice is common in the private sector.
As the graph below shows, benefits costs in real terms have increased over the past five years.
Salaries have fallen over the same period due to the reduction of positions.
CMR:387:07 Page 4 of 9
$70,000
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$o
General Fund Operating Expenditures"
Last Five Years in 2003 Dollars (in $000s)
2003 2004 2005 2006 2007
+ Salaries ,-.i.- Benefits ~ Contract Services
~ Supplies ~ General Expense ~ Rents/Leases
--+-- Allocated Expenses
Another way to approach expenditure growth is by analyzing expense trends by department. The
graph below depicts the change in department expenditures in real dollars over the past five
years. It shows that expenses in administrative departments (Administrative Services, Human
Resources, City Manager, City Attorney, City Clerk, and City Auditor), or what is commonly
termed City overhead, have dropped in real dollar terms from $17.5 million in 2003 to $13.1
million in 2007. This significaaat drop occurred since most of the cost reductions made over the
past five years have been in administrative areas and management positions. This also suggests
that there will be less flexibility in the furore to pare expenses in these departments.
CMR:387:07 Page 5 of 9
General Fund Operating Expenditures:
Last Five Years in 2003 Dollars (in $000s)
S25,000
S20,000
$15,000
$10,000
$5,000
SO
2003 2004 2005 2006 2007
~Ad~n~a~on ---=-- ~b~c ~~ Rann~g and Corrrn ~v .--I.i-.-Po~ce --~-.-CSD and Ubra~~ ~e ~
In comparison, the public safety departmems, Police and Fire, and community services (defined
as the Cormnunity Services and Library departments) have grown or stayed constant in real
dollar terms. In real dollars, the Police Department expenses have grown from $19.7 million in
2003 to $21.4 million in 2007, while the Fire Department expense has risen from $16.8 million
to $17.8 million. The provision of community services has remained steady from $19.8 million
in 2003 and $19.8 million in 2007.
The table below indicates the rate of change of functional expenditures over the last decade.
Expenditures for public safety exhibit the most significant growth, while expenditures for
administration show the most significant decline.
From 2004 to 2007
From 2001 to 2007
From 1997 to 2007
Admin
-1.0%
-5.2%
-0.8%
Public
Works
1.9%
-1.9%
-0.5%
Planning
-1.5%
1.3%
3.2%
Public
Safer3’
4.2%
1.5%
1.5%
CSD
and
Library
0.2%
0.6%
1.3%
As a proportion of the City’s budget, the public safety and community service functions have
grown from 58.3 percent of the total in 1997 to 61.5 percent in 2007. These numbers make sense
in light of the reductions made in the administrative departments, but it shows that if the City is
to sustain its budget, difficult decisions may be necessary in areas that the public and Council see
CMR:387:07 Page 6 of 9
as "basic" services. This is especially important as the City endeavors to fund a new public
safety building and library/conmmnity center facilities. In addition to the capital costs expected
to be paid from General Obligation bonds, there wilt be incremental equipment, maintenance,
and operating costs associated with these new facilities.
Revenue Trends
The City of Pale Alto is fortunate to have a diverse and welt-balanced portfolio of revenue
sources. As the following chart shows, no one revenue source exceeds 15 percent. The main
sources of total City revenues are: sales tax at 15 percent; property taxes at 15 percent; charges
for services (such as the Stanford fire contract) at 15 percent; operating transfers at 12 percent
(including Utility equity payments); and rental income at 9 percent. Many jurisdictions rely
heavily on a single source of revenue such as property, sales, or business license taxes, exposing
them to extreme volatility when economic dislocations occur.
$139.7 Milfion / Adopted 2007-08
Charges to ot #~r Funds
8%
Ot t’~ar R evenu~
Operating Transfers-In
~ %
Sales Tax
From otk~r, A g encies
Less than 1%
Return on Investrne~
2%I
l!iI
Permit s & Licenses
4%Charges for Services Ot her Taxes and Fines
I5%6 %
Properly Tax
15%
TransieN Occqaaney
5%
"~i Utility Users Tax
7%
An economic downturn can result in a swift and steep decline in sales and TOT revenues.
Events such as the current credit crisis and housing bubble can easily ripple down to the local
economy, threatening consumer and business spending essential to the City’s revenue base.
Long-term threats such as increasing Internet sales (which are not taxed), the aversion to
commercial growth and resulting traffic in the community, and retail competition are areas of
concern. Legal and regulatory challenges such as telecommunication company objections to the
CMR:387:07 Page 7 of 9
utilities users tax being paid on national plans could significantly erode over $2.4 million in
ammal revenue. The City must be agile in maintaining and enhancing its revenue sources just as
it must be vigilant in managing its expenses.
Sustainable Budget Suggestions/Options
The City has been proactive in attempting to solve budget problems. City mayors have been
active in maintaining and attracting businesses to Palo Alto. Significant efforts have been made
to maintain automobile dealerships in Palo Alto; to make Palo Alto a destination point for
business travel and tourism; and to work in concert with Stanford University to expand the
Stanford University Shopping Center. The City also has engaged the business community in
discussions about enhancing revenue sources such as the TOT by adding another 2 percent to the
existing tax rate, which will generate additional revenue for the General Fund if approved. There
has been very preliminary discussion of a Business Registry Fee and a Business License Tax
(Palo Alto is one of the few cities in California that does not have this tax) that could lead to
additional revenues either by expanding information on businesses within the City or a new tax.
In terms of expenditures, the City typically has taken a conservative approach to issuing debt and
to new program spending. General Fund debt is low compared to other jurisdictions.
From a staff perspective, the following complex issues need further analysis, discussion, and
action:
¯What are the City’s core non-discretionary services?
¯Can these services be delivered in. an alternative, cost-efficient manner that is equally or
near to equally effective?
¯What are the City’s discretionary services and how will they be prioritized?
¯What framework will the City use to evaluate and fund new pro~ams versus ongoing
services?
¯What is the optimal balance between infrastructure and operating expenses that will
sustain the delivery of services?
¯Should the City incur more debt for capital projects so as to spread the cost burden of
improvements over current and future users? The City has generally used a conservative,
pay-as-you go approach for capital projects.
¯How can the City control expenditures ~owing at greater than inflation rates yet preserve
core services?
¯\Vhat opportunities does the City have to maintain and expand revenue sources when
necessary?
¯To what extent is the conmaunity willing to balance its desire for services and the
revenues that support them with its desire to restrict business growth and its associated
traffic impacts?
¯~q~at degree of risk is the City willing to incur as it seeks to control expenses?
¯Can a meaningful dialogue be initiated with City employees and unions on sharing
medical premium expenses?
These questions need serious attention to develop a sustainable budget plan.
CMR:387:07 Page 8 of 9
There are no easy solutions to develop a sustainable budget. The City is in a sound financial
position, but it faces numerous challenges. The "easy" reductions have been made in the first
half of this decade; the difficult ones can be expected in the second half. Similar to the
rebalancing of resources and priorities that the infrastructure effort required, a sustainable budget
requires analysis, plamaing, fiscal discipline, establishing priorities, and a !ong-tenn vision.
Next Steps
This report presents initial concepts for consideration by the Finance Committee. Staff is
requesting input from the Finance Committee on possible next steps to achieve a sustainable
budget plan. With this input staff will further develop the concepts and components of a
sustainable budget and include them in the Long Range Financial Forecast (LR~F). The LRFF
will be reviewed with the Finance Committee in December and with the full Council in January.
Based on this discussion with Council, elements of a sustainable budget can be included in the
proposed 2008-09 budget that wilt be reviewed with the Finance Committee in May 2008.
RESOURCE IMPACT
This report is for informational purposes and does not have a resource impact.
POLICY IMPLICATIONS
This report addresses a Council "Top 4" Priority.
ENVIRONMENTAL REVIEW
Discussion of these general policy
Environmental Quality Act (CEQA).
issues does not represent a project under California
PREPARED BY:sxccio
Deputy Director
PREPARED BY:
DEPARTMENT HEAD APPROVAL:
DAVID RAMBERG
Budget Manager
~S
Director ~,ices
CITY MANAGER APPROVAL:
LEMILY HARR~Si~N"
Assistant City Manager
CMR:387:07 Page 9 of 9