HomeMy WebLinkAboutStaff Report 229-08City of Palo Alto
C ty Manager’s Report
TO:HONORABLE CITY COUNCIL
ATTN:FINANCE COMMITTEE
FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE
SERVICES
DATE:
SUBJECT:
MAY 6, 2008 CMR: 229:08
DIFFERENCES BETWEEN THE CITY OF PALO ALTO AND CITY OF
VALLEJO BUDGETS
RECOMMENDATION
This is an information repol~ and no Finance Committee action is requested.
BACKGROUND
During a Finance Committee meeting in February 2008, the Committee asked staff for
information comparing the budgets and financial conditions of the cities of Palo Alto and
Vallejo, in light of Vallejo’s recently publicized fiscal problems. On February 21, 2008, the San
Francisco Chronicle stated that, "Vallejo is on the bri~k of a dubious distinction - becoming the
first City in California to declare bankruptcy. The fiscal crisis, which comes more than tlnee
years after the state took over the city’s debt-ridden public schools, is a result of snowballing
police and firefighter salaries and overtime expenses coupled with plummeting tax revenue from
the weak housing market, officials say." (Source: x~vw.sf~ate.com. February 21, 2008 article by
Carolyn Jones).
Although Vallejo’s dire fiscal circumstances abruptly flashed across various news media this
year, underlying structural and financial issues had been emerging for some time. The recent
housing and credit crisis, which has severely affected Vallejo’s revenue stream, has exacerbated
those issues. As the Vallejo City Manager stated in his 2007-08 budget transmittal letter: "...for
over a decade the City has x~estled with severe financial difficulties. Year after year we have
asked the employees for give-backs, used one-time monies, or reduced services. This year the
situation was even worse."
From these unfortunate circumstances, cities may glean information to prevent or mitigate
similar occun’ences.
CMR: 229:08 Page 1 of 10
DISCUSSION
Staff has reviewed Vallejo’s budget documents, Comprehensive Annual Financial Repol~s, and
other publicly available sources such as newspaper articles, to analyze events and trends causing
Vallejo’s General Fund (GF) financial dilemma. Unfortunately, and undoubtedly due to the
gravity of its financial situation, calls to Vallejo staff for additional and more helpful, detailed
information were not returned. This has resulted in a generally high level colaparison with a
number of inferences from available information.
Economic Base and Revenue Issues
A number of factors have caused Vallejo’s economic base to erode. These include:
¯The closure of the Mare Island Naval base in 1996 which provided well-paying jobs and
a vital economic foundation.
The inability of Vallejo to replace the economic benefits of the shipyard with other
commercial or industrial tax generators such as malls or tectmology companies.
The City’s predominant focus on residential development which has performed poorly
due to current economic events in the real estate market.
¯The failure to keep big-box stores like Wal-Mart or high end supermarkets with the
consequent result of sales tax leakage to surrounding jurisdictions.
Recent plans to integrate the downtown and waterfront with a mixture of restaurants,
offices, and condominiums forestalled because of the credit crisis.
In addition, other economic conditions have contributed to a decrease in GF revenue sources,
including:
The prope~y transfer tax declined fi’om a peak of $5.5 million in 2004-05 to an estimated
$3.7 million in 2007-08, a $1.8 million or 33 percent decline. This is a consequence of
the slmnping housing and connnercial real estate market.
A significant decrease in building, planning and other permit fees fl’om $5.2 million in
2004-05 to an estimated $2.7 million in 2007-08, a $2.5 million or 48 percent decline.
Sales tax revenues have declined slightly since 2005-06.
Properb~ taxes have remained relatively flat since 2005-06
Other revenue source declines from 2005-06 through 2007-08 such as Marine World
receipts and transfers which total $3.7 million.
These revenue drops represent $8 million or nearly 10 percent of Vallejo’s sources of funds.
CMR: 229:08 Page 2 of 10
Expense Issues
On the expense side, particularly in the area of salaries and benefits, Vallejo has experienced
considerable pressure:
Salaries and benefits have comprised approximately 78 percent of Vallejo’s total GF
expenses since 2003-04 until its recent efforts to reduce staffing.
Total GF salary and benefit increases from 2004-05 through the adopted 2006-07 budget
grew at a compound a~mual growth rate of 10.2 percent.
Police and Fire expenses totaled 73 percent of total budgeted expenses (before
reductions) in 2006-07, leaving little flexibility in reducing other expenditures. Public
safety minimum staffing requirements, overtime, and relatively high salaries have
severely strained Vallejo’s resources (see discussion below).
Comparing Palo Alto and Valle_io
In general, contrasting the budgets of two cities is fraught with many difficulties. An "apples to
apples" comparison for GF services is made complex by the type and level of services provided
as well as how those services are funded. Unlike Palo Alto, Vallejo does not have locally
provided library or recreational services. Instead, Vallejo makes direct and comparatively
modest contributions to the Solano Count3~ library system a~d to a Greater Vallejo Recreation
District. Vallejo’s payments to the county for library services in 2005-06, for example, were
$0.4 million whereas Palo-Alto’s library services in the same year cost $5.7 million. Other
operations, such as animal control and shelter se~wices, are provided by separate agencies to
which the City also makes contributions. Another important difference between the cities is that
Vallejo has a number of redevelopment districts that can fund, through incremental property
taxes, capital and other improvements. Palo Alto does not have any redevelopment district areas
and implements capital work using General Fund resources.
Recognizing the dissimilarities in the way services are delivered to the public by each city, some
background infotnnation is helpful in comparing Palo Alto and Vallejo. In 2006-07, Palo Alto
had a population of 62,615 while Va!lejo had a population of 121,425. Palo Alto has a land area
of 29.9 square miles and Vallejo has 25.6 square miles. Excluding Palo Alto’s Community
Services and Library departmems, it had 508.9 Full Time Equivalents (FTE) while Vallejo had
463.4 FTE. Once again, programs and levels of service differ from jurisdiction to jurisdiction so
comparisons must be made carefully.
Although there are significant economic, geographic, demographic, and budget differences
between the cities (see attachment 1 for comparative data), informative comparisons and
conclusions can be drawn. In particular, Vallejo’s current fiscal situation highlights issues raised
in a recent City of Palo Alto report on maintaining a sustainable budget (CMR: 387:07).
CMR: 229:08 Page 3 of 10
Economic Base
A fundamental cause of Vallejo’s budget dilemma is the erosion of its economic base. The loss
of Mare Island’s economic benefits; the strong emphasis on residential development; and the
weak retail sector have undermined Vallejo’s ability to maintain and generate revenues. The
City was aware of these issues, but has been unable to surmount them. Its latest effort at mixed
development in its waterfront area to stimulate retail sales and commercial development has
suffered as a consequence of the credit and housing crunch. Vallejo could not have a~ticipated
the credit bubble and the consequent housing crisis, but it did need to resuscitate and diversify its
economic base stating in 1996.
The reality of a California local jurisdiction’s financing structure and the legal requirements
surrounding it make it imperative to pay ongoing attention to funding sources. Without hotels, a
diversified property tax base (residential and con~-nercial), and strong retail activity generated by
shopping centers, automobile dealerships, business to business activity, local goverm~ents
cannot maintain or enhance services in the long-term. Palo Alto’s efforts in this area such as:
wor-king to maintain the Honda and Toyota dealerships, changing zoning to allow ground floor
retail, increasing business through efforts like Destination Palo Alto, and working with Stanford
to expand the shopping center and build a new hotel will help the City to avoid circumstances
occurring in Vallejo. Although the economic cycle makes these revenue som’ces volatile, they
are essential to a local jm’isdiction’s financial health whether it is Vallejo or Palo Alto.
Revenue Structure
As the pie charts below reveal, Vallejo’s revenue sources are more highly concentrated than Palo
Alto’s. Their top 4 categories (property tax, sales tax, utility users tax, and prograna revenues)
constitute 70 percent of total sources, while Palo Alto’s top 4 (property tax, sales tax, charges for
services, and operating transfers) total 57 percent. Palo Alto’s remaining revenue categories are
more diverse and more robust than Vallejo’s. Transient occupancy and rental income, for
exan~ple, are important revenue sources that provide additional depth and breadth to Palo Alto’s
revenue base. \Vhereas no one source for the City exceeds 15 percent of total revenues,
Vallejo’s property, sales and utility user taxes constitute 23, 16, and 16 percent, respectively.
CMR: 229:08 Page 4 of 10
2007-08 Vallejo Adopted Budget Revenues
Program
Revenues
15%
Sales Tax J
16%
Utility Users
~’- Tax
k, btor Vehicle
License Fees
12%
Property
~nsfer Tax
4%
Franchise
Fees
5%
Property Tax ," ,~ Other
23% - 9%
2007-08 Palo A!to Adopted Budget Revenues
Other Revenue
1%
Charges to
Other Funds-
8%-.,
From other
Agencies
Rental Income~9%
Return on
Investment--""/
2%Permits &
Ucenses
4%
Operating Pro perty
Transfers In Tax12%"5%
Sales Tax
"5%
Transient
- Occupancy Tax
5%
Utility Users
Tax
7%
Other Taxes andCharges for ,_FinesServices6%"5%
CMR: 229:08 Page 5 of 10
With 23 percent of total revenues derived from property taxes, Vallejo is much more vulnerable
to real estate downturns, particularly in the residential sector it has sought to build out. Related
to this, Vallejo has experienced a sharp decrease in its property transfer tax and in building,
plam~ing and permit fees. This has been a consequence of plummeting home sales. In contrast,
Palo Alto’s property tax revenues equal 15 percent of General Fund resources. Palo Alto is
fortunate to have less volatility in real estate prices and more diversity in its residential and
commercial property mix. Both of Palo Alto’s property and transfer tax revenues are roughly
split between the residential and commercial sectors at 63 percent and 37 percent, respectively.
Expense Structure
On the expense side, recent articles have stressed two causes for Vallejo’s budget dilemma:
salaries/benefits and the costs of public safety. The former constituted 78 percent of Vallejo’s
2007-08 budget while the latter absorbed 73 percent of resources. Palo Alto’s respective shares
of these same expense categories in the 2007-08 budget were 65 percem and 52 percent.
Although the proportion of Vallejo’s budget for salaries and benefits is much higher than the
average jurisdiction, there are several explanations. To address its long-term issues, Vallejo did
cut capital, supplies and materials, and transfer (e.g., transportation subsidy) expenses -the usual
reductions most jurisdictions make to maintain services until the budget rebounds. To place the
above percentages in perspective, this cost cutting approach has the effect of raising salaries and
benefits as a percentage of the budget over time. Nevertheless, Vallejo does have higher salaries
(public safety) and a more_generous employee benefit package (retiree medical) compared to
other jurisdictions.
Vallejo’s employee benefits package has been ample. It pays all current employee and
dependent health care premiums for its PERS health care plans. It continues to provide PERS
Care, the most expensive plan available and which Palo Alto has discontinued. With the
exception of a 5 percent monthly share of premium costs for spouse coverage, all retiree medical
premium costs are paid by Vallejo. Retirement plans are similar to Palo Alto’s with 2.7 percent
at 55 for miscellaneous employees and 3.0 percent at 50 for public safety personnel. In contrast
to Palo Alto, Vallejo requires that the employee share of their retirement plans is paid entirely by
employees. Begim~ing in 2007-08, miscellaneous employees in Palo Alto began to pick up 2
percent of the employee share. The remaining benefits package consisting of dental, vision,
employee assistance program, and life insurance is fairly similar to Palo Alto’ s.
Given the last decade’s double-digit increases in health care costs and the provision of all PERS
health plans (including PERS, this line item must be exerting considerable pressure on Vallejo’s
budget. Although Vallejo makes reference to its retiree medical liability and intended to devote
an additional $1.0 million to this cost in 2008-09, their financial condition likely will not allow
this. In March 2008 Palo Alto transfen’ed $30 million to a PERS retiree medical trust toward its
liability. There has been little indication in the newspapers or in public docmnents that Vallejo is
contemplating changing its benefit structure. It has focused mainly on salary reductions which do
have the effect of reducing retirement payments. As it has with contributions toward retiree
health premiums, one option for Vallejo is to negotiate cm~’ent employee payments toward their
premiums.
CMR: 229:08 Page 6 of 10
According to the newspapers, Vallejo’s salary structure is in excess of average municipal
compensation, specifically in the public safety area. As one newspaper reported, "Vallejo’s base
pay for firefighters is more than $80,000 a year. Last year, 21 of them topped $200,000 in salary
and overtime, according to city payroll records." Indeed, starting in 2007-08, the base pay for a
firefighter was $80,300 and for a police agent $83,700. It appears that an agreement was reached
recently with public safety unions to cut salaries by 6 percent, reducing salaries to $75,800 for a
firefighter and $78,900 for a police officer. Vallejo’s public safety salary levels, particularly for
firefighters, are at a premium.
2007-08 Vallejo Adopted Budget-Expenditures by
Department
Public Works
6%
Non-Administration
Departmental 5%
10%
"-.,Community
Development
5%
Fire
28%
Police
46%
2007-08 Palo Alto Adopted Budget
~ Expenditures by Department
Operating
Transfers Out-,
8%
Library
5%
Non-
Departmental
7%Administration
~12%
Ranning
7%
Community
Services
15%
Police
2O%
Public Works
10%Fire
16%
CMR: 229:08 Page 7 of 10
As of July 1, 2007 the base pay for a Palo Alto firefighter was $63,900 and for a police officer
$76,100. Prior to the 6 percent reduction in pay, Vallejo’s firefighters were earning $16,400 or
26 percent more than Palo Alto’s. Police officers were earning nearly $7,500 or 9 percent more
than our officers. It appears that from 2003-04 through the 2006-07, public safety salary and
benefit costs were rising at a compound annual growth rate of between 8 and 9 percent. This
unsustainable growth rate combined with a sha-p decline in revenues are clear reasons why
public safety costs represent 73 percent of Vallejo’s budget and why the city is on the bri1~k of
bankrnptcy. As one of Vatlejo’s council members concluded, "The root of the problem is the
contracts the city simply cannot afford." (S.F. Chi’onicle, April 21, 2008). As of April 22, the
date by which a declaration of bankruptcy was anticipated, the City was still in negotiations with
its unions.
Palo Alto’s labor philosophy and strategy has been to track average Bay Area compensation
while recognizing competitive market conditions for specific personnel. Vallejo exceeded this
benclmaark at a time when it could ill afford to do so. According to one source, Vallejo had not
conducted a fire departmem salary survey in 20 years. Palo Alto conducts a salary survey with
each new contract negotiation.
Reserves
During economic downturns and when revenues are falling, the City of Palo Alto has resorted to
expenditure reductions to.balance its budget. The question often arises, particularly from the
City’s labor unions, as to why reserves are not used to cushion negative impacts on the budget.
Vallejo’s experience is instructive. At the begimaing of the 2006-07 fiscal year Vallejo’s GF
balance was $10.9 million. Within less than two years this balance was depleted. The use of
one-time monies is not a solution for an ongoing and deep structural deficit. Expenses must be
brought imo alignment with revenues to stabilize the budget and prevent imbalances moving
forward. By the end of 2007-08, the City of Palo Alto is expected to have a Budget Stabilization
Reserve of $25.8 million.
Conclusions
Vallejo has used all of its General Fund reserves, will not have adequate cash flow after June 30,
and is facing a $13 million deficit for fiscal year 2008-09. The City’s financial situation is dire.
It is important to note, however, that many jurisdictions, though not to the same degree, face
challenges similar to Vallejo’s: increasing health care costs; retiree medical liabilities; revenue
sources extremely sensitive to economic cycles; union pressures al~d agreements limiting
flexibili~ to reduce costs (e.g., minimum staffing requirements that require overtime); and legal
and regulatory constraints. Although Vallejo has experienced a "perfect storm" of negative
events, their intractable dilen~una does provide instruction that may help jurisdictions weather
similar storms. Some of these insights were raised in the sustainable budget discussions held in
the past yea" with the Finance Committee. They include:
¯Maintain a vibrant economic base that can generate solid revenue streans over time.
¯Diversify the revenue base to reduce exposure to the economic cycle and over
dependence on any one source.
¯Maintain a balance between residential and commercial development so as to retain the
resources that meet expected service levels.
CMR: 229:08 Page 8 of 10
Have a program priority plan determining core versus discretionary services so as to
reduce costs in the evem of a major revenue downturn.
Examine services that can be provided in an alternative, cost-efficient maimer that is
equally or near to equally effective e.g., regional service agreements.
Determine the degree of risk the City is willing to incur as it seeks to control expenses.
Open a dialogue with employees and unions on how to share steeply rising medical
costs.
Maintain strong rese~wes (Vallejo depleted a high level of reserves rapidly) and the
policy of reducing expenditures as structural deficits emerge.
Continue annual updates to the City’s Long Range Financial Forecast.
Fortunately, the City of Palo Alto is fairly far removed from the extreme fiscal conditions
Vallejo faces. Nevertheless, it is important to monitor revenue and expenses carefully. Public
safety, co~rmmnity, and library services are high priorities in Palo Alto. As CMR: 387:07
showed, these services have grown from 58.3 percent of the budget in 1997 to 61.5 percent in
2007. Since 2003 mad in real dollar terms, public safety expenses have risen by $2.4 million
while community and library services have remained constant. Collectively, all other City
depa’tments and services have declined. Given current capital plans for police, library and
recreational facilities, it can be expected that operating, equipment, and maintenance costs will
increase for these facilities and consume a larger slice of the City’s resources.
In light of these initiatives, a $455 million infrastructure backlog, ongoing benefit cost pressures,
a souring national and state economy, mad other new and yet-to-be-determined prograns, the
City may want to establish a prioritization plan for its resources. As the Finance Committee
stated during its review of a sustainable budget on October 16, 2007, engaging the connnunity in
a discussion of resources and program priorities is a necessary first step in a complex endeavor.
It also is a step that helps to avoid some of the pitfalls that have beleaguered Vallejo.
RESOURCE IMPACT
This report is for informational purposes and does not have a resource impact.
POLICY IMPLICATIONS
This report is consistent with Council policy direction and requests.
ENVIRONMENTAL REVIEW
Discussion of this general topic does not represent a project under California Enviro~maental
Quality Act (CEQA).
CMR: 229:08 Page 9 of 10
PREPARED BY:
DEPARTMENT H2EAD APPROVAL:
JOSEPH ~’ACCIO
Deputy Director, Admlmstratlve Services
LA-L-4~P-E~
Director, Administrative Services
CITY MANAGER APPROVAL:
STEVE EMSLEE and KELLY MORARIU
Deputy City Managers
CMR: 229:08 Page 10 of 10