HomeMy WebLinkAboutStaff Report 467-08City of Palo Alto
C .ty Manager’s Report
TO:HONORABLE CITY COUNCIL
ATTN:FINANCE COMMITTEE
FROM:CITY MANAGER
DATE:DECEMBER 16, 2008
REPORT TYPE: Discussion Report
SUBJECT:
DEPARTMENT: ADMINISTRATIVE
SERVICES
CMR: 467:08
UPDATE TO _LONG RANGE FINANCIAL FORECAST
EXECUTIVE SUMMARY
Attached to this report is the City’s updated General Fund Long Range Financial Forecast
(LRFF) for fiscal years 2009 through 2019. The LRFF’s primary purpose is to identify key
financial issues that will guide the upcoming Fiscal Year (FY) 2010 and 2011 budget process
and that affect the City’ s long-term financial condition.
RECOMMENDATION ,
Staff recommends that the Finance Committee review and comment on the attached forecast of
revenues, expenses, and reserve levels and forward it to the full Council.
DISCUSSION
As newspaper articles state repeatedly, the nation is facing its worst financial and economic
crisis since the Great Depression. The National Bureau of Economic Research recently
pronounced that the nation has been in a recession since December 2007. Rising unemployment,
plummeting home sales and property values, credit tightening, and failing banks and businesses
all point to a protracted and perhaps deep recession. In November 2008 alone, approximately
533,000 jobs were cut by employers nationwide, the highest number in 34 years. The nationa!
unemployment rate has risen to 6.7 percent.
Similarly, the State of California is mired deeply in financial crisis and economic disarray.
Unemployment in the State has risen to 8.2 percent and is likely headed higher. The Governor
and Legislature have a $28 billion deficit to solve. States and local jurisdictions throughout the
country are struggling with sharply declining revenues and the need to reduce expenditures.
Retirement portfolios have experienced steep losses posing potential, future increases in
employer contributions. The City of Palo Alto and surrounding jurisdictions are not immune
from the economic headwinds. As Stephen Levy, a prominent local economist, stated in the Palo
Alto Weekly (October 17, 2008), "The idea that Palo Alto and Silicon Valley are protected from
CMR:467:08 Page 1 of 4
the worldwide economic meltdown is poorly reasoned. Our local economy’s fate is connected to
the fate of the national and world economies and financial markets." This observation is proving
accurate.
City of Palo Alto revenues, as well as thosein nearby jurisdictions, are showing definite signs of
stress. For example, hotel stays during the first quarter of FY 2009 were nearly 12,000 days
below that of the prior year; automobile sales in the first quarter of FY 2009 were 12 percent or
$230,000 lower than the prior year period; and documentary transfer taxes have been trending
lower since the beginning of the fiscal year. In addition, county wide data shows a sharp
slowdown in the rate of property value growth.
These developments and general economic conditions have led staff to lower General Fund
revenue targets in the LRFF for this fiscal year and in FY 2010. Compared to the FY 2009
adopted budget, staff believes that total revenues must be adjusted downward by $2.8 million.
The consequence of the revenue revisions is that a deficit of $2.6 million is anticipated this year,
a deficit of $5.3 million in FY 2010, and consequent deficits could recur through FY 2014.
Unless expenditure reductions or new revenues are added, the Budget Stabilization Reserve
would fall to 9.7 percent of expenditures by the end of FY 2010, well below the minimum policy
level of 15 percent. Staff is ir~ the process of developing a plan to address these shortfalls which
it intends to discuss with the Council shortly. Already the City Manager is instituting an
aggressive position control process regarding new hires and has instructed departments to come
up with budget reductions to close the FY 2009 budget gap.
After recently having reduced the General Fund budget by $20 million and 70 FTE during the
dot.com bust, it is expected that upcoming reductions will be difficult. In light of the many
challenges the City faces such as growing infrastructure rehabilitation needs; funding, staffing
and maintaining new facilities; and rising benefit and labor costs, paring expenditures will
require priority setting and a discussion of a Sustainable Bud, get.
Toward this end, staff has resurrected a report sent to the Finance Committee on a Sustainable
Budget for discussion in October 2007 (CMR: 387:07). A copy of this report is attached to the
LRFF and a summary of key points is provided below and in the LRFF document.
After the "dot.com" economic downturn, Council was concerned that the City could not continue
to fund: the variety and level of services provided, a rising infrastructure backlog, the emerging
need for new facilities, and growing employee benefit costs. When combined with the
uncertainties of the economic cycle that can swiftly erode revenues, the necessity of creating and
maintaining a sustainable budget became more urgent. Examples of expenditure trend data cited
in the report supported the need to re-examine the City’s priorities. The report stated that
"medical premiums are expected to double by 2015, having grown by 60 percent over the past
seven years to $12.2 million." It showed that as a consequence of eliminating a $20 million
structural deficit caused by the dot.com collapse, administrative department expense "dropped in
real dollar terms from $17.5 million in 2003 to $13.1 million in 2007." In turn, this suggested,
"that there will be less flexibility in the future to pare expenses in these departments." As
administrative expenses decreased, the services the public and Council view as basic services -
police, fire and community services - grew as a percentage of the budget in real dollar terms.
CMR:467:08 Page 2 of 4
They increased from 58.3 percent in 1997 to 61.5 percent in 2007. Reducing expenditures in
these areas has proved difficult in the past, but may need to be considered in the future.
Implementing a sustainable budget raises a series of difficult questions and policy choices.
Some of those raised in the 2007 report include:
¯What are the City’s core non-discretionary services?
¯What are the City’s discretionary services and how will they be prioritized?
¯Can tliese services be delivered in an alternative, cost-efficient manner that is equally or
near to equally effective?
What degree of risk is the City willing to incur as it seeks to control expenses,
particularly in the public safety budget?
¯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?
¯To what extent is the community 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?
¯What opportunities does the City have to maintain and expand revenue sources wlien
necessary?
Can a meaningful dialogue be initiated with City employees and unions on sharing
benefit expenses?
In conclusion, the current economic environment is exerting downward pressure on the General
Fund’s revenue resources. Although staff believes its revenue forecast is relatively conservative
and reasonable, the severity of this recession may present additional challenges in the future. To
prepare for this and other contingencies, corrections to this year’s budget and movement toward
a sustainable budget for the future is recommended.
RESOURCE IMPACT
As with any financial forecast, the fiscal impacts shown are estimates. Projections of future
deficits and surpluses, as well as the estimated costs of future financial challenges, are meant to
guide future policy and budget decisions.
Staff will report on the first series of recommended budget reductions and other adjustments to
the Finance Committee in February 2009 at the Midyear review, and continue with the FY 2010
and 2011 proposed budget process.
POLICY IMPLICATIONS
The Long Range Financial Forecast is a tool for Council’s use in making policy decisions
regarding the allocation of resources.
ENVIRONMENTAL REVIEW
This report does not constitute a project under Section 21065 of the California Environmental
Quality Act (CEQA).
CMR:467:08 Page 3 of 4
PREPARED BY:
JOE SACCIO
Deputy Director
DEPARTMENTAL HEAD APPROVAL:
and SHARON BOZMAN
Budget Manager
LALO PEREZ
Director, Administrative Services
CITY MANAGER APPROVAL:
City
ATTACHMENTS
Attachment 1" CMR 387:08
Attachment 2: Long Range Financial Forecast.
CMR:467:08 Page 4 of 4
ATTACHMENT 1
City of Palo Alto
City Manager’s Report
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 Council 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 o£ 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 within 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 mad 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
malmer so as to maintain them?
° What revenue sources can be counted upon now and in the future mad 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
witho~ft 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 maj or financial challenges. These include:
Financing and rehabilitating the City’s aging infrastructure
Coping with the revenue shortfalls caused by the recession and dot-corn bust of 2001
Fixing a structural deficit caused by ongoing expenditures, e.g., healthcare costs that are
rising at a greater rate than revenues
Ad&essing 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 hotel and car dealerships; growing competition from
the Internet and surrounding bigbox 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 annually for the next ten years to address a growing
infrastructure 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 infrastructure 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 growth 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
purpose is to avoid having an operating budget’s services and programs suffocated by the
growing and sizeable expense Of a post emp!oyment benefit. The City of Palo has dealt with this
maj or issue by developing a healthy retirement medical reserve and by indentifying funding in its
operating budget to meet its annual required contribution. Moreover, the City is near to
investing its reserve and contributions in a trust fund whose 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 econom{c cycle to the exodus of major revenue
generators, as well as State "takeaways" of revenue sources. Typically, the City deals with these
occurrences 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 two 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_S20 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 well in advance of their occurrence. 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
$24
$21
$18
$15
$12
$6
$3
$0
Healthcare Expenses
l []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
$70,00O
$60,000
$50,000
$40,000
$30,000
$20,000
$1o,oo0
$o
General Fund Operating Expenditures:
Last Five Years in 2003 Dollars (in $000s)
2003 2004 2005 2006 2007
+ Salaries ~ Benefits ~ Contract Services
---x--- Supplies + General Expense ~ Rents/Leases--F-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 over,head, have dropped in real dollar terms from $17.5 million in 2003 to $13.1
million in 2007. This significant drop occurred since most bf the cost reductiong 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 future to pare expenses in these departments.
CMR:387:07 Page 5 of 9
General Fund Operating Expenditure.s:
LastFive Years in 2003 Dollars (in $000s)
$25,000
$20,000
$15,000
$10,000
$5,000
$0
?,X
2003 2004 2005 2006 2007
’="~- A drrinis tr alio n ~ PuNic Works ~ Ranning and Corrrn Env ~ Police ~ CSD and Library ~ Fire
In comparison, the public safety departments, Police and Fire, and community services (defined
as the Community 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
Safety
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 pubiic
safety building and library/community center facilities. In addition to the capital costs expected
to be paid from General Obligation bonds, there will be incremental equipment, maintenance,
and operating costs associated with these new facilities.
Revemle Trends
The City of Palo Alto is fortunate to have a diverse and well-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 ~re 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 Million/A dopted 2007-08
Charges to other Funds
8%
Other Revenue
1o/.
Operating Transfers-In
12%
Sa/ee T~
15%
From other Agencies
Less than 1%
Rental Income
9%
Return on Investment
2%
Transient Occupancy
5%
Permits & Licenses
4%Charges for Services Ot her Taxes and Fines
15%6%
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
annual 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 emhancing 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 informationon 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, ~nd
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 programs 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 th4 City control expenditures growing at greater than inflation rates yet preserve
core services?
What opportunities does the City have to maintain and expand revenue sources when
necessary?
To what extent is the community 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?
What 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 soiutions 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, planning, fiscal discipline, establishing priorities, and a long-term vision.
Next Steps
This report presents initial concepts for consideration by the Finance Committee. Staff is
requesting input from the Finance Cormnittee on possible next steps to achieve a sustainable
budget plan. With this input staff wilt further develop the concepts and components of a
sustainable budget and include them in the Long Range Financial Forecast (LRFF). The LRFF
will be reviewed with the Finance Connnittee 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 will 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 issues does not represent a project under California
Environmental Quality Act (CEQA).
PREPARED BY:
J~£ SACCIO
Deputy Director
PREPARED BY:
DEPARTMENT HEAD APPROVAL:
DAVID RAMBERG
Budget Manager
CITY MANAGER APPROVAL:
~EMILY HARR~S’~N
Assistant City Manager
CMR:387:07 Page 9 of 9