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HomeMy WebLinkAboutStaff Report 116-06TO: FROM: DATE: SUBJECT: C ty Ma ager HONORABLE CITY COUNCIL 7 CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES JANUARY 17, 2006 CMR: 116:06 UPDATE TO LONG RANGE FINANCIAL PLAN FROM FINANCE COMMITTEE MEETING OF DECEMBER 6, 2005 RECOMMENDATION: After the Finance Committee reviewed the City’s 2005 update to the Long Range Financial Plan on December 6, it recommended: "The Finance Committee recommends to the City Council to review and comment on forecast of revenues, expenses and reserve levels .... " COMMITTEE REVIEW: Questions and issues raised during the Finance Conm~ittee’s review of the Long Range Financial Plan ranged from whether specific revenue category projections were realistic to how a declining infrastructure reserve could be replenished over time. For Council’s information, staff’s recommendation to the Finance Committee was that the Committee "review and comment on the attached forecast of revenues, expenses, and reserve levels before the City Council reviews the plan." ATTACHMENTS Attachment A: CMR 442:05 CMR:116:06 Page 1 of 2 PREPARED BY: JOSEPh SA~CIO Assistaht Director of Administrative Services DEPARTMENT HEAD APPROVAL: CARL YEATS Director, Admin Services CITY MANAGER APPROVAL: HARRISON Assistant City Manager CMR:116:06 Page 2 of 2 ATTACHMENT A City of Palo Alto City Manager’s Report TO:HONORABLE CITY COUNCIL ATTN:FINANCE COMMITTEE FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES DATE:DECEMBER 6, 2005 CMR: 442:05 SUBJECT:UPDATE TO LONG RANGE FINANCIAL PLAN REPORT IN BRIEF Attached to this report is the City’s updated General Fund Long Range Financial Plan (LRFP) for the years 2005-06 through 2015-16. The LRFP identifies key financial issues and will guide the upcoming 2006-07 budget process. The attached report contains a discussion of the following areas: National, state and local economic conditions Methodology and assumptions used to forecast future revenue and expenditure streams Analysis of City revenue and expenditure performance Results of long range forecast Financial challenges lying ahead Comparison of City forecasting model with alternative forecasting methods As a consequence of the community’s, Council’s and staffs "Strengthening the Bottom Line" efforts since 2001, the City has eliminated a long-term structural deficit. The current LRFP shows General Fund surpluses through 2010-11. Moreover, during this period, Council’s objective of contributing $1.0 million of surplus funds to the Infrastructure Reserve should be achievable. The most significant driver of balancing the budget and generating surpluses was the elimination of 70 General Fund positions since 2001. This difficult but necessary step was critical in achieving the results show in this forecast. Based on recent trends, the LRFP assumes a slowly improving economy in the near term, with revenue sources such as sales and transient occupancy taxes reviving. It also assumes, based on recent Public Employee Retirement System data and staff reductions, that increases in major benefit expenses such as health and pension will moderate in the near term compared to past, steep increases. CMR:442:05 Page 1 of 3 These positive trends, however, are not a ticket to passive management of the City’s finances. Instead, the following challenges demand Council’s and staff’s active attention: Building the Infrastructure Reserve to a level that sustains a $10 million annual rehabilitation effort Supporting major new facility needs such as a new police building, library improvements, rebuilding of several fire stations, and athletic fields and facilities at the Golf Course Maintaining a vibrant economic base that continues to generate significant sales and transient occupancy taxes Negotiating upcoming SEIU, Fire and Police union contracts Funding the City’s outstanding retiree medical liability Closing a major revenue gap starting in year 2012-13 when the landfill closes and refuse rent revenue declines To manage these challenges, the City will continue to seek opportunities to restructure the organization around staffing vacancies and retirements. Senior staffs upcoming review of the City Auditor’s Span of Control Report recommendations will aid this effort. Other cost containment efforts may be needed. With health care costs periodically rising at double-digit rates, employees may be called upon to contribute to premiums. To fund major new facilities, new revenue sources or a significant reallocation of resources may be necessary. CMR:442:05 Page 2 of 3 RECOMMENDATION Staff reconvnends that the Finance Committee review and comment on the attached forecast of revenues, expenses, and reserve levels before the full City Council reviews the plan. BACKGROUND AND DISCUSSION The attached document serves as background and discussion for the LRFP update. RESOURCE IMPACT As with any financial forecast, the fiscal impacts shown are estimates. Estimates of future deficits and surpluses, as well as the estimated costs of future financial challenges, are meant to guide future policy and budget decisions. POLICY IMPLICATIONS City Finances and the Long Range Financial Plan are one of the Council’s Top 5 Priorities. ENVIRONMENTAL REVIEW This report does not require California Environmenta! Quality Act (CEQA) review. ATTACHMENTS Attachment 1: Long Range Financial Plan (Chapters 1-4) PREPARED BY: JOE Deputy Di: :tor DAVID RAMBERG Budget Manager DEPARTMENTAL HEAD APPROVAL: CARL Direct, ¯ Administrative Services CITY MANAGER APPROVAL: ~E.~~/O-~~I~’~ HARRISON Assistant City Manager CMR:442:05 Page 3 of 3 LONG RANGE FINANCIAL PLAN Forecast 2006-2016 City of Palo Alto December 2005 Long Range Financial Plan STATE OF THE ECONOMY NATIONAL ECONOMIC OUTL O01~ The national economy has grown slowly but steadily over the past year and is expected to continue to do so through 2006. Real Gross Domestic Product (GDP) grew at an annual rate of 3.8 percent in the 3rd quarter compared to the 2nd quarter, which in turn had increased by 3.3 percent.~ UCLA Anderson Forecast, an often-cited economic outlook, projected economic growth in the 2 percent range over the next two years, but "an abrupt plunge in housing starts and housing prices - a bursting of the housing bubble - could still drive a slump.": In the fall, the two hurricanes in the Gulf Coast and continued high oil prices disrupted the g-rowth trend. Consumer confidence has dipped and consumer. spending is expected to decline. The University of Michigan Index of Consumer Sentiment, a measure of consumer confidence, fell from 89.1 in August to 76.9 in September, and further to 75.4 in October. In addi- tion, the Conference Board’s Consumer Confidence Index, based on a survey of household spending plans, fell to 86.6 in September from 105.5 in August, its big- gest drop in 15 years. Consumer confidence h~dicators are closely watched since two-thirds of economic out- put is driven by consumer spending.~ Although the hurricanes did not produce consumer spending cuts in Septem- ber, the consumer confidence indices indicate that "consumers are distressed," according to Robert Brusca, chief economist at FAO Econon~ics, a New York- based research firm, and therefore longer-term spending cuts are likely. STATE OF THE ECONOMY "The problem is the consumers are [still] spending all of their income. This is unsus- tainable," and energy prices will eventually take their tol! among lower- and middle- income consumers.; Personal saving as a per- cent of disposable income dropped below zero in the third quarter of 2005, to -1.1 per- cent compared to +1.2 percent a year earlier.~ This supports the notion that consumers are tapped out and may be unable to sustain their level of spending in the near future. EMPL 0 YMENT TRENDS Jobs have increased every month in the past year, except September. Over the 12 months ending in August, payroll employment g-rew by an average of 194,000 per month, and the unemployment rate trended downward. In September, the number of unemployed per- sons, 7.7 million, and the unemployment rate, 5.1 percent, rose, although they had been trending down in the previous months and remain lower than a year earlier.~ Hurricanes Katrina and Rita may cause larger, long-term job losses. The nonpartisan Cong-ressional Budget office estimated that the two hurricanes will ultimately cost the economy between 293,000 and 480,000 jobs] In addition, although total jobs have increased in the last year, job cuts have con- tinued. In June, U.S. corporations announced plans to cut 110,996 jobs- the highest monthly total in 17 months- and overall job cuts in 2005 reached 538,274 that month,s In July, workers at Eastman Kodak Co., Hewlett- Packard Co. and Kimberly-Clark Corp., among others, were warned about tens of thousands of layoffs. Hewlett-Packard announced a major reorganization that would cut 10 percent of its workforce, or 14,500 employees, by the end of 2006. This move closely followed a similar announcement by IBM, which also plans to cut 14,500 jobs. In late November, General Motors announced plans to cut 30,000 jobs and close nine plants. Merck and Co. then followed with planned reductions of 7,000 jobs and the shuttering of 5 plants. The technology sector is "one of the few areas of the economy that has failed to add jobs consistently over the last 12 months." In the last year, while the US economy has created nearly 2.2 million jobs, computer and commu- nications-equipment manufacturers have added a total of 6,000 workers. According to John Challenger, CEO of Chal- lenger, Gray and Christmas, a global out- FROM PAGE 1: 1 Bureau of Economic Analysis, "News Release: Gross Domestic Product," October 28, 2005 2 UCLA Anderson Forecast, September 28, 2005: "UCLA Anderson Forecast Continues to Warn of Slow Growth for National Economy" 3 Tom Abate: "Weak outlook for State seen," San Francisco Chronicle, 9/28/05 PAGE TWO: 4 Mark Glassman: "Inflation isn’t so bad for business," SmartMoney.com, t 0/14/05 5 Bureau of Economic Analysis, ~-~v.bea.gov, 10/28/05 6 wv~av.bls.go~5 Bureau of Labor Statistics of the U.S. Department of Labor, October 7, 2005: "Employ- ment Situation SummaD"’ 7 Mark Glassman: "September Payrolls Beat Expectations," SmartMoney.com, 10/7/05 quoting a state- ment issued by CBO Director Douglas Holtz-Eakin before the House Committee on the Budget 8 Ben Dobbin: "Thousands Losing jobs: Kodak, HE Kimberly-Clark start to worry analysts," San Fran- cisco Chronicle, 7/23/05 STATE OF THE ECONOMY placement firm, "The economy is growing at a healthy pace and employers are adding workers, but the tech sector...is strangely absent from the recovery.’’~ Challenger pointed to increased merger activity and outsourcing as the culprits. "Consolidation appears to be driving employment trends in the tech sector. Companies may be add- ing workers through the purchase of other firms...and even though outsourcing appears to have fallen off the front of the business pages as the hot issue of the day, the practice is sti]] wide]y used as a cost savings device...’~° Tech-sector job cutting through the third quarter was nearIy 20 percent ahead of 2004 tech employment cuts for this same period. In the first three quarters of 2005, tech job cuts totaled 140,696, compared to 118,427 in the same three quarters of 2004. Continued outsourcing worries tech indus- try employees. EE Times, a trade publica- tion, conducted a survey of 150,000 Cherry Pie Graphics Santa Clara 2,000 Chordiant Software Cupertino 35,000 Fairchild Imaging Milpitas 10,000 Finisar Sunnyvale 50,000 GE Healthcare Sunnyvale KLA Tencor Milpitas 60,000 Kulicke & Soffa Ind.Santa Clara 75,000 Mercury Interactive Mountain View 132,000 SGI Mountain View 50,000 Spherion Cupertino 10,000 Veritas Software Mountain View RIF: Reduction in Force Source: NOVA Workforce Board, "Workforce Review. July 2005~ engineers. Among the 4,000 respondents, competition from overseas engi- neers was of fore- most concern, with nearly half of the respon- dents saying their companies "had sent elec- tronics design work offshore." In addition, only I in 10 respondents felt that "the US will always maintain its tech- nology leadership position." Only 16 per- cent of survey respondents termed their job security "good." More than half said they were "concerned" about outsourcing. And 10 percent said they had either lost or were in danger of losing jobs because of it. In addition, an October report published by the National Academies, a top science and technology policy group, stated that India and China toge,ther trained more than 13 times as many engineers last year as did the United States. "For the costR.IF RIF of...one engineer in the R.IF United States, a company RIF can hire about...11 engi- RIF neers in India," the report Closure said.:~ This trend is signif-RIF icant to the local econ-RIF omv, as discussed in theClosure RIF State and Local Economic Outlook section below. 9 "Hewlett-Packard to Slash 14,500 Jobs, After IBM Move," Spacedaily.com 7/19/05 10 T.K. Maloy: "Tech-Sector job Cuts up 20 percent," Spacedaily.com; 10/18/05 11 Tom Abate: "Tech engineers fear US is falling behind," San Francisco Chronicle, 11/14/05 STATE OF THE ECONOMY September also saw additional planned layoffs in the airline and auto indus- tries and consol- idation in the retail industry- for a total of 71,836 planned layoffs in September (a rise from August’s 70,571). At the same time, planned hirings fell to 15,666 in September.,. from August’s 27,581- breaking three consec- utive months of increases in announced hir- ingsi: Despite overall gains in the number of jobs, real wages are down 2.3 percent since 2004.:~ Although this national trend does not apply to Silicon Valley, this means working families are having a harder time paying their bills. STATE AND LOCAL ECONOMIC OUTLOOK Like the nation, California experienced gTad- ual, broad-based growth in the past year. Gross State Product increased 7.3 percent in 2004 to $1.54 billion, compared to the 2003 increase of 5.5 percent over the prior year. Each of the state’s eleven industry sectors showed a year-over gain in September, with the largest job increase in construction (58,600 jobs), followed by professional and busines~ services (41,100 jobs). California’s unemployment rate continued to drop more steeply than that of the nation as a whole. The state unemployment rate fell 1.0 percent over the last year, to 5.2 percent, and by 1.7 percent over the last 2 years. In con- t~ast, the U.S. unemployment rate fell by just 0.3 percent over the last year and by 1.0 per- cent over the last 2 years. ~ Economic analysts seem to be most worried by the over- inflated housing market. According to the National Association of Realtors, last year’s quick rise in housing prices, along with the longer sales times seen this fall, are ~,pical signs foreshadowing a market slow-down/’ The impacts of a slowed-down housing market are dis- cussed in gTeater detail in the section below. Unernployrrent Rates 2000-04 9% 6% 5°/o 2% 2000 2001 2002 2003 2004 4.0%4.7%5.8%6.0%5.5% 5.0%5.4%6.7%6.8%6.2% 3.1%5.1%8.5%8.5%6.6% 1.5%2,5%4.3%4.3%3,3% Sources: Bureau of Labor Statistics and California Employment. Development Department !1 SCC = Santa Clara County 12"Airlines~ autos and retail lead September layoffs," Reuters: 10/5/05, w~v.msnbc.msn.com 13Jared Bemstein: "Economy continues to expand, while real average wages experience fastest decline on record," Economic Policy Institute, Oct. 28, 2005 14"Slowing is seen in housing prices in hot markets," New York Times, 10/4/05 15~s~av.labormarketinfo.edd.ca.gov 10/24/05: "California Employment Highlights- September 2005 STATE OF THE ECONOMY However, the healthy image may be skin- deep. According to Christopher Thorn- berg, an economist with UCLA Anderson Forecast, "’the forecast for California is mediocre at best."~ Of concern to Thorn- berg and other economists is the inevitable cooling of the superheated housing market and its effect on the state. Scott Anderson, Northern California economic specialist for Wells Fargo, commented, "The job recovery in the nation as a whole, but in California especially, has been tremendously depen- dent on housing and remodeling." 12.3 per- cent of all net payroll growth nationwide from August 2004 to August 2005 came directly from construction. In California, it was 27.3 percent.~; In addition, the housing sector has been strongly linked to consumer spending. Consumers borrow against their home equi .ty to finance remodeling projects and other spending. A recent San Jose Mercury News article describes it this way: "...buyers today are willing to take on diz- zying debt to get into a home. Once in, many borrow heavily against their rising property values, taking out equity loans to pay for college tuition or to buy a new car. Because recent history tells them Silicon Valley real estate values go ever upward--with many houses now worth 30 times what they cost 30 years ago-- many homeowners assume there will be enough equity left over to pay for retire- ment, too.’’~ With mortgage interest rates rising, "home prices could flatten or fall, in which case construction employment would probably be hit within three to six months," accord- ing to economist Joe Hurd, with Rosen Consulting.Group in Berkeley.~ According to an August Field poll, Califor- nians are aligned with the national down- ward trend in consumer confidence. For the first time since 2001, more Californians pre- dict the economy will worsen over the next 12 months than think things will improve. Thirty percent foresee a decline; 22 percent predict improvement. In contrast, last year the survey showed 44 percent thought 4% 1% (2%) (8%) (~%) ( ~4 %) (~7%) (20%) Percent Change in Employment and Number of People Unemployed From 9104 to 9/05 2.8%T-----271%1.8% ]C~li~S~Di~ ...................... I~1% Chg. in Employment E]%Chg. in # of People Unemployed Source: California Department of Finance 16 UCLA Anderson Forecast: "UCLA Anderson Forecast Continues to Warn of Slow Growth for National Economy," September 28, 2005 17 Tom Abate: "Weak outlook for state seen," San Francisco Chronicle, 9/28/05 ! 8 Sue McAllister: How the Boom Has Hit Home," San Jose Mercury News, 10/3/05 19 Tom Abate: "State’s job picture brightens," San Francisco Chronicle, 9/17/05 STATE OF THE ECONOMY things would improve, and just 14 percent predicted a decline in the state’s economy.> Within a State with consistent job growth, dis- tinct regional variations were evident. In the Bay Area, although unemployment declined more steeply, job creation was the softest in the State for the first half of 2005.:~ Silicon Valley is, in turn, the slowest growing area within the Bay Area economy. Palo Alto’s unemployment rate declined from 3.1 percent to 2.7 percent between August 2004 and August 2005.2~ The Valley’s unemployment rate slipped to 5.2 percent in September, down from a revised 5.4 percent in August and 6.0 percent a year ago. But it’s still higher than the rest of the State. Without Santa Clara County, the Bay Area would post year-over- year job growth through August of 1.34 percent, which beats Southern California’s 1.23 percent, according to Gary Schlossberg, senior econ- omist at Wells Capital Man- agement. Throw in Silicon Valley, and growth slows to 0.85 percent?> Bay Area executives’ confi- dence in the local economy has also declined. The Bay Area Business Confidence Survey, conducted by the Bay Area Council, a business-backed public policy group, con- ducted a survey in October showing the "gloomiest assessments on the Bay Area Council’s business confidence index in nearly three years." 20 percent of Bay Area executives surveyed expected the local econ- omy to worsen over the next six months. In July, only 7 percent were downbeat in their six-month outlook. "That’s a pret-ty big drop" in mood, said Jim Wunderman, chief execu- tive for the Council.:~ The fact that the survey was taken in October may indicate that the hurricanes in the Southeast had an effect o~ the results. In interviews with 517 Bay Area business leaders representing a mix of firms by size and industry, the survey determined that 33 percent expected to hire workers over the next six months, while 10 percent planned layoffs. Santa Clara County (SCC) execs have typi- Bay Area Business Confidence Index* 50 ~ ............................................................................. 40 ~ 39 35 ~- "The Index value is the average of the percent of positive responses to the ques- tions in the su~ey. An Index above 50 means there are more positive than negative responses. Source: Bay Area Council, ~.mercuwnews.com/business 1%15-05 209/21/05 AP: "Poll: Californians .grow pessimistic on economy, inflation" (Poll drawn from polls to 465 registered voters of a 10-day period ending Aug. 29.) 21 Department of Finance Bulletin, July ’05 22California Employment Development Department 23 Nicole C. Wong: "Valley makes job gains," San Jose Mercury News, 10/22/05 24Matthai Chakko Kuruvila: "Execs say Bay Area economy ’weaker’," San Jose Mercury News, 11/15/05 STATE OF THE ECONOMY cally been the most pessimistic in the nine- county Bay Area, but the gap was slightly less this time around. Twenty-two percent of SCC executives believed the economy was worse in October than it was six months prior, compared to 17 percent Bay Area-wide.~ The slower job growth- and greater pessi- mism- in the Valley may be due to the changing nature of the high tech industry. According to the Silicon Valley Leadership Group in its 2006 Projections report: "Technology company payroll growth will continue to be held back by the high cost of doing business and the structural changes occurring in the technology industry... [As the tech industry has become more global since 2000,] major technolo~, bellwethers like Intel have announced their intention to do much of their future hiring outside the United States, closer to where their fastest growing markets and an increasing share of their customers now reside."> F Yet even this sobering report pre- dicts a solid if slow-growing future: "On balance the Silicon Valley’s economic recovery continues to broaden and sustainabili .ty is likely...Employment is expected to grow by 1.6 percent in 2006, adding approximately 21,282 jobs. Yet longer-term, employment growth through 2016 will likely average far below the rates experienced from 1993 to 2000, as the evolving struc- ture of supply and demand in the tech- nologT industry creates a growing share of the employment growth over- seas.":~ Brightening that outlook is the fact that high tech jobs, if relatively scarce, are pay- ing increasing wages. Wages earned in Santa Clara Count, were 6 percent higher in 2004 than in 2003. First quarter 2005 wages were 3.5 percent higher than first quarter last year. As Stephen Levy of the Center for Continuing Study of the Califo> nia Economy stated, "It’s possible to have increased revenues without job growth," due to the relatively healthy and increasing salaries provided in the technology sector. The key to the region’s long-term economic health, according to Levy and many others, is its continued desirability as a place in which businesses can incubate. As evidence that the Valley continues to fulfill that role, venture capital (VC) investment increased $66.104 Annual Wages in Santa Clara County $57,096 $56,088 $59,435 2001 2002 2003 2004 Source:U.S. Dept, of Labor/BureauofLaborStatistics 25Matthai Chakko Kuruvila: "Execs say Bay Area economy ’weaker’," San Jose Mercury. News, 11/15105 26Silicon Valley Leadership Group, "2006 SVLG Projections," page 2 27Silicon Valley Leadership Group, "2006 SVLG Projections," pages 2-3 for the first time in three years, from $6.5 billion in 2003 to $7.7 billion in 2004, an increase of 18 percent. VC investment peaked in 2000 at $34 billion. Since that time, venture capital investment in Silicon Valley has declined by about 80 percent, but the Val .... ley’s share of national venture capital invest- ment has g-rown every year since 1995, rising from t4 percent that year to 35 percent by 20042~ Technology executives have expressed con- cern that certain government policies and pro~ams are detracting from the region’s competitive assets. At a TechNet conference in San Jose on November 16, executives blamed medi- ocre public education, federal regulations, and restrictive immigTation policies for weakening Silicon Valley competi- tiveness. They urged additional spending on math and science educa- tion and a review of the post-9/11 immigTation procedures, which are restricting scientific exchanges involving international scholars, researchers and students2~ The Bay Area Science and Innovation Consor- tium (BASIC) pointed out in a recent report that "In an era of g-rowing competition for jobs, investment and economic leadership, the abilit%, to attract and retain this human capital constitutes a key competitive advantage." Regulations and immigration policies are worth noting as they negatively affect the reg-ion as a destination for worldwide techni- cal entrepreneurs and workers. In summary, both national and local eco- nomic outlooks are brighter than the?, were a year ago. However, the trends are not over- whelmingly positive. The local economy, as well as the national economy, is likely to con- tinue a slow, bumpy ascent towards-stability. $32 Total Venture Capital Financing in Silicon Valley Firms Source: PricewaterhouseCoopers MoneyTreeTM Survey as graphed by Joint Venture. Silicon Valley Network’s "2005 Index of Silicon Valley" 28Joint Venture Silicon Valley: 2005 Index of Silicon Valley; PriceWaterhouseCoopers Mon- eyTree survey, www.pwcmoneytree.com 29 Verne Kopytoff: "Tech leaders say Silicon Valley’s edge is ~owing duller," San Francisco Chronicle, l 1/17/05 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES FORECAST The ten year forecast of revenues and expenditures (Exhibit I) for the Long Range Financial Plan can be found at the end of this chapter. The forecast is followed by the assumptions or percentage changes for each revenue and expense category (Exhibit 2) and by a table summarizing the effects of the forecast on reserves (Exhibit 3). The intervening text describes how staff arrived at the forecast presented in this report and highlights important facts, issues and trends. FORECASTING METHODOLOGY: REVENUES As in past Long Range Financial Plans, it is assumed that the compound annual rate of g-rowth (CAGR) for economically sensitive revenue sources between 2005-06 and 2015- 16 will be roughly similar to that between the years 1994-95 and 2004-05. For example, the CAGR for sales taxes between 1994-95 and 2004-05 was 2.7 percent. The forecast for 2005-16 assumed a 2.7 percent g-rowth rate, implying that future g-rowth will mimic that of the past decade. Using the CAGR methodolo~ produces a somewhat conservative growth rate, since it does not recognize the extraordinary reve- nue gains of 1999-00 and 2000-01. Similarly, if a dip in revenues had occurred in the last ten years, the CAGR methodolo~ would even that out by averaging the growth rate. A drawback in this methodology is it does not account for structural changes in reve- nue generation, such as the departure of automobile.dealerships or the addition of new electronics businesses. In these types of events, staff adjusts base revenues before developing a projection. On balance, staff believes that using the CAGR methodology. and adjusting the revenue base up or down, ~ven specific information and events, is a sound approach to forecasting. The forecast assumes that the City wilI channel any revenue windfalls into reserves or one-time capital improvements. In this way, the City may avoid committing resources to new, ongoing operating pro- g-rams or labor commitments in flush times, only to see them cut or under-funded when revenues retreat to more normal levels. Included in the forecast is a projected eco- nomic downturn that begins in approxi- mately six years, around 2011. Most economists will say that timing the next recession comes down to guesswork, but incorporating a two-year downturn is use- ful due to the following: °In the past, California has experienced a recession approximately once per decade. o Planning for a two-year downturn in the next ten years encourages prudent planning and fiscal management. The downturn projected in years 2010-11 and 2011-12 is relatively mild compared to PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES that experienced from 2001-02 through 2004- 05. A deficit of $1 million emerges in 2011-12. Staff does not believe the Ci~, needs to take any corrective action at this time. If no reces- sion occurs in this time period, the City will be in a better-than-projected position. I~A CKGROUND FORECAS T: REVENUES State Budget Actions and Revenue Changes The forecast continues to incorporate city rev- enue source changes included in the 2004 State budget-balancing package. These include the "triple-flip" and "ERAF III" adjustments involving sales tax, vehicle license fees, and property taxes. The "triple-flip" is a swapping of revenue sources to allow the State to issue bonds with- out voter approval. The State will pay directly to local jurisdictions three quarters of the one percent of sales tax due to them. The remain- ing quarter percent will be paid to localities via property tax remittances from the coun- ties. While it is anticipated the City will even- tually receive the full one percent of sales taxes, the timing of the quarter percent pay- ments affects cash flow and interest income earned. The City’s General Fund (GF) will lose a little over $71,000 in interest earnings per year from this change. Once the "triple- flip" bonds are repaid (estimate is 10 to 20 years), direct payment of the full one percent should resume. As part of the State budget compromise, the Cit%,, of Palo Alto lost $1.543 million in annual vehicle license fee (VLF) revenue in 2004-05 and in 2005-06. This revenue loss was "offered" in exchange for legislative and gubernatorial support for Proposition 1A, and will not be repaid. The State is to resume full VLF payment in 2006-07, and this expec- tation is reflected in the forecast. In the future, most of the VLF revenue will be paid via property tax remittances. This is known as the "In-Lieu VLF payment." The In-Lieu VLF payment will increase over time according to the gTowth in the property tax roll. In a rare piece of good news from the State,. the $1.03 million "borrowed" by the State in 2003 (known as the "VLF Backfill Loan Gap") has been repaid a year early. This revenue, anticipated for receipt in 2006-07, will be booked in 2005-06, improving this year’s bud- get projection. Impact of Recent Economic Trends on Revenue As Chapter One discusses, there is slow but steady economic g-rowth at the Iocat, State, and national levels. Correspondingly, after stabilizing in the latter half of 2004-05, sales and transient occupancy taxes have turned modestly upward. The local economy appears to be on firmer g-round, but causes for concern continue to be: ¯Higher energT costs and rising interest rates have eroded consumer spending power °Modest job growth on the Peninsula ¯The continuing exodus of high-paying tech- nolo~, jobs overseas ¯Competition from malls, discount chains, and hotels in surrounding communities ¯The potential exit of automobile dealerships from Palo Alto Local resistance to economic development ini- tiatives such as those at the Hyatt Rickey and Alma Plaza sites PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES These factors impact primarily sales and transient occupancy taxes, which comprise 21 percent of GF resources. Because of the concerns cited above, staff has assumed a lower rate of ~owth in the next ten years than occurred in the past decade. Total rev- enues in the forecast have a CAGR rate of 2.8 percent from 2005-06 through 2015-16, in comparison to 1994-95 through 2004-05 when the CAGR was 5.1 percent. DISCUSSION OF SPECIFIC REVENUE PROJECTIONS IN THE FORECAST Sales Tax Sales tax revenues rebounded in 2004-05, and early data for 2005-06 indicate increases for this year will be in the range of 3 to 4 percent. Recent concerns about con- sumer spe.pding during the holiday season, rising interest rates, and a potential burst of the housing bubble suggest a ~owth rate slightly below that range. Therefore, the S26 ~ Sales Tax $24 $22 $2O $18 1996-1997-1998- 97 98 99 $18.3 $20.0 $20.2 2,1%9.5%1.1% $0.4 $1.7 $0.2 ITotal ~1% Change iS Change Transient Occupancy Tax 1999-2000-2001-2002-2003-2004-2005- O0 01 02 03 04 05 06 $22.9 $25.8 S20.1 $18,0 $t8.2 $19,3 $20.0 13,1%12.8%(22.1%)(10.2%)0.6%6.4%3.7% $2.6 $2,9 $(5.7) $(2.0)$0.1 $1,2 $0,7 2006-2007-2008-2009- 07 08 09 t0 $20.8 $21.7 $22.5 $23.2 4.0%4,1%3.7%3.2% $0.8 $0.8 $0.8 $0.7 $ 10 $9 ¢"$8._o "=$7 $6 $5 19~-6-1997-1998-1999-2000-2001-2002- 2003- 2004-2005- 2006-2007- 2008-2009- 97 98 99 O0 01 02 03 04 05 06 07 08 09 10 Total $5.t 55.8 $6.6 $8.3 S9,5 $6.6 $5,3 55.5 55,7 $6.2 $6,4 $6.8 57.1 57,5 % Change i 19.4%14.5%12,1%26.6%14.1%(30,1%(19.4%2.9%3.6%8,6%4.5%5.1%5.4%5.5% i 50.8 S0.7 S0.7 $1.7 $1.2 S(2,8)5(1.3)50,2 S0.2 S0.5 S0.3 S0.3 50.4 50,4$Change PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES 1994-2005 CAGR of 2.7 percent was used for sales tax projections through 2015-16. Key economic seg-ments that displayed weak- ness in 2004-05 were business services and computer retail sales. Automobile sales-gen- erated revenues have been flat at 10 percent of total sales tax revenues. Service stations, elec- tronic equipment, and drug store seg-ments have shown sales growth. (See Sales Tax chart on page 11.) Transient Occupancy Tax Following a 40 percent decline since 2001, transient occupancy tax (TOT) revenues improved toward the end of 2003-04 and improved further in 2004-05. During the first quarter of 2005-06, TOT revenues ran $0.09 million or 6.1 percent higher than last year. Occupancy rates have exceeded 60 percent on a regular basis and daily room rates have risen. It is expected that TOT revenues will be on budget in 2005-06; however, the emer- gence of high-end hotels in Los Altos, Menlo Park, and East Palo Alto means competition for hotel taxes will stiffen. In addition, although other Palo Alto hotels will absorb part of Hyatt Rickey’s business, it is antici- pated that a good portion of Hyatt TOT reve- nue will be lost. This loss has been factored into the Long Range Financial Plan (LRFP). The forecast includes a CAGR of 3.7 percent in TOT receipts over the next ten years com- pared to 4.6 percent in the past 10 years. (See Transient Occupancy Tax chart on page 11.) Property Taxes Property tax revenues were healthy in 2004.- 05, with secured taxes rising 9.1 percent or $1.1 million over 2003-04. This is attributed to a robust residential market, as well as to a few high-worth commercial transactions. The remainder of the increase in 2004-05 was derived from the State payment of the $1.7 million Vehicle License Fee (VLF) Backfill through property taxes (discussed earlier). In 2006-07, there is a significant increas~ over 2005-06 due to the cessation of the $1.5 mil- lion ERAF Ill takeaway (also discussed ear- lier). The ~aph on page 13 titled "Property Taxes and ERAF" depicts the State Educational Rev- enue Augmentation Fund (ERAF) takeaways from the City of Palo Alto since 1991-92. The State has used these monies to solve its Property Tax Total $ 7.7 $ 8.9 $ 9.5 % Change I (1.1%)14.6%7.4% I$ Chanae i $(0.1)$1.!$0.7 $24 Projected . . i" " [] $!5 ~ 12 86 1996- 1997- 1998- 1999-2000-2001-2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 97 98 99 00 01 02 03 04 05 06 07 08 09 10 $10.8 $12,1 $t3.2 513.8 $13,7 $16.7 $18,0 $20.4 $21.3 $22.3 $23.4 13.1%12.4%9.2%4.4%(0.7%)21,5~/~7.9%13.3%4.6%4.8%4.9% $1,2 S1.3 ~1,1 $0.6 S (0,1)$2,9 $1,3 $2.4 $0.9 $1,0 ~1.1 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES unceasing budget problems--monies that could have been used by the City to fund its infrastructure needs. To date nearly $42 million has been taken from the City. Utility Users Tax The Utility Users Tax is based on telephone usage and sales of water, gas, and electric- ity. UUT forecasts utilize the Utility Depart- ment’s long range forecasts which take into account commodity, operating and capital costs as well as necessary reserve and rate changes. The UUT CAGR for the past ten years has been 2.9 percent, and staff is pro- jecting revenues will grow by an average rate of 3.8 percent. The higher growth rate is attributable to planned water, gas and electric rate increases. The high overall rate is offset by lower growth (2 percent) in tele- phone UUT revenues. This results from a concern over the emerging Voice-Over Internet Protocol (VOIP) which staff believes will slowly chip away at telephone UUT receipts. $21 S18 $15 $12 $9 $6 $3 Property Taxes and ERAF -~ ERAF tax losses i. since 1992-93 total i $41.6 m illion SO r~Tax Receipts ~ERAF Utility Users Tax i.TotaIi.% Change iS Change $11 s~0 ~Projected................... .~ ....,~ ~ $9 . 1996-1997-1998-1999- 2000- 2001-2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 97 98 99 00 0! 02 03 04 05 06 07 08 09 10 $5.5 $5.8 S6.0 $5.9 $6.7 $6.5 $7.1 $7.2 $7.3 58.5 $9.4 $10.1 $10.2 $10.2 8.1%4.9%4.5%(2.9%)t5.0%(4.2%)9,5%1.3%1.6%17.2%10.4%7.0%0.9%0.7%[ $0.4 $0.3 $0,3 $(0.2)$0.9 $(0~3)50.6 $0.1 $0.1 $1.3 $0.9 $0.7 $0.1 $0.1 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES Documentary Transfer Tax Documentary Transfer Tax revenue is acutely sensitive to the volume and size of property sales and the mix of residential and commer- cial transactions, and it varies widely from year to year. In 2003-04, it jumped to $5.6 mil- lion due to a one-time Stanford Shopping Center lease transaction. Then, in 2004-05 it reached $5.1 million, as a result of the all-time low interest rate environment and the high demand for local housing. Growth is pro-., jected at 5.4 percent (compared to the CAGR of 13.8 percent for the past ten years), assum- ing a softening in the housing market, as dis- cussed in Chapter One. $7 $6 $5 S4 S3 Documentary Transfer Tax $2 $I i Total Change Change 1996-1997-1998-1999-2000-2001-2002-2003-2004- 2005-2006- 2007-2008- 2009- 97 98 99 O0 01 02 03 04 05 06 07 08 09 10 $2.0 $3,0 $3.1 $4,4 $3.8 $2.9 $3,5 $5.6 $5.1 $4.0 $4,6 $5.1 $5,7 $6.2 4%52%3%42%(14%)(25%)22%59%(8%)(22%)14%12%12%9% $0.1 $1.0 $0.1 $1.3 $(0.6)$(0.9)$0.6 52.1 $(0.5)$(1.1)$0.6 $0.5 $0,6 $0.5 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES Interest Income As a consequence of the transfer of the Infrastructure Reserve (IR) from the Gen- era] Fund (GF) to the Capita] Fund, interest income declined by $I million in 2004-05. Over the past two years, average yields on the City’s portfolio decreased from 4.29 per- cent at the end of 2003-04 to 4.17 percent at the end of 2004-05. Yields declined further to 4.13 percent in the first quarter of 2005-06 as older, higher yielding investments con- tinued to mature. Yields are anticipated to gTadual]y increase for the remainder of 2005-06 as the Federal Reserve pushes inter- est rates higher. The forecast shows General Fund (GF) interest income stabilizing at $2.2 mi]]ion in 2005-06. (See Interest Income chart on page 16.) Based on an arunual investment survey con- ducted by the City of San Mateo, staff is proud to report that for the past three years the City of Palo A]to’s portfolio yield has been at least a half percent higher than the next highest city - Mountain View. Based on the City’s $350 million portfolio, this half percent translates into an additional $1.8 million in interest earnings ($0.26 million for the General Fund). Cities in the survey included San lose, Mountain View, Red- wood City, Alameda, and San Mateo, among others, Fines and Penalties, Service Fees and Permits, and Joint Service Agreements These categories include: ¯Fines and Penalties: parking violations, libraD, fines, administrative citations, and other fines and penalties Service Fees and Permits: service and per- mit revenues generated from golf course fees, class re~stration and admission fees in Communi~, Services, permit, plan check and zoning fees in the Planning and Com- muni~ Environment Department, and paramedic service fees in the Fire Depart- ment ¯Joint Service AgTeement: the contract with Stanford Universib, for fire and communi- cation services Fines and Penalties declined by $0.7 million in 2004-05 and are projected to increase by 18 percent in 2005-06 due to the Police Department’s commitment to traffic safety. Parking violations account for $1.9 million or 77 percent of total fines and penalties revenue in 2005-06. Service Fees and Permits revenue is expected to increase by 12.7 percent in 2005-06 but level out over the remaining nine years to approximately three percent annually. Early data for 2005-06 indicate strong gTowth in new construction permits. Staff also expects incremental paramedic revenue from the newly implemented Basic Life Support (BLS) ambulance progTam. This program allows paramedics on the scene to relegate non-emergency, lower- level medical calls to be transported by the BLS unit, increasing the availability of Advance Life Support (ALS) units for prior- ity calls. The Community Services and Planning and Community Environment Departments have also increased some of their fees to maintain cost recovery levels. The Joint Service AgTeement with Stanford funds 30 percent of the Fire Department budget. In 2004-05, revenue increased by $0.8 million due to increasing healthcare and retirement pension costs along with ris- ing fuel costs. In 2005-06, staff expects a PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES Interest Income $5.0 $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 P roj e cte d 1996-1997-1998-1999-2000-2001-2002-2003-2004-2005-2006-2007-2008-2009- 97 98 99 00 01 02 03 04 05 06 07 08 09 10 .Total $2.7 $3.3 $3.6 $4.2 $4.2 $4.4 $3.9 $3.5 $2.1 $2.1 $2.2 $2.3 $2.5 $2.6 ’,% Change 1.5%20.8%9.2%17.5%(0.8%)3.6°/,(10.3%111.1%)(38.3%(1.4%)5.3%5.3%5.5%5.0% iS Change S0.0 $0.6 $0.3 $0.6 $(0.0)’$0.2 $(0.4)$(0.4)$(1.3)$(0.0}$0.1 S0.~$0.1 $0.1 S19 Fines & Penalties, Service Fees & Permits, Joint Service Agreements $17 $15 $13 $11 $9 $7 $5 $3 $1 i iFines and Penalties t iSvce Fees & Permits l,~Joint Svc Agreement ~"’~"~=i~s S~d F e~isities Projected ~1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 99 O0 01 02 03 04 05 06 07 08 09 10 1.5 $1.7 $1.9 $2.2 $2.1 $2.9 $2,1 $2.5 $2.6 $ 2.6 $2.7 $2.8 8.7 $12.3 $12.6 $13.1 $13.8 $12.8 $13.8 $15.6 $16.4 $16.9 $17.6 $18.3 4.8 $ 5.1 $5.5 $ 6.4 $ 6.1 $ 6.0 $6.8 $6,6 $6.7 $7,0 $7,4 $7.8 Reimbursements and Transfers $18$17 ~ .............................................P[oJe#~t~d .......~.. [] $16 ....f~n-s~s .........." ..................... 1 ....................................................................... i i .........$ 12 .................. -- S los9 ~~ " "~- - I- " ~ " "~ " S8 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 99 O0 01 02 03 04 05 06 07 08 09 10 $8.9 $9.2 $9.5 $11.8 $11.5 $9.1 $9.4 $8.9 $9.0 $9,4 $9.7 $10.1 $ 12,9 $ 12.9 $ 14.2 $ 13.8 $ 15.3 $ 17,9 $ 15.4 $ 15.1 $ 15.6 $ 16.3 $ 16.8 $ 17.5 i [ Reimb.i~T_ ransfers PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES decrease of $0.2 million dUe to a staffing reduction in the Fire Department. Since the- majority of fire service expenses consist of staffing, the growth of this revenue stream is directly related to the Department’s per- somael expenses. and Electric). The growth of this funding source is budgeted at 3 percent per year-- the growth rate incorporated into the equi~ transfer methodolo~,. Other Revenues Reimbursements and Transfers Reimbursements are payments to the Gen- eral Fund (GF) for services rendered to the Enterprise Funds such as accounting, pay- roll, purchasing, human resources, and legal advice. In 2005-06, reimbursements to the GF are expected to be $8.9 million, a 4.8 percent decrease from 2004-05. Reimburse- ment revenues are projected to grow at a 2.5 percent average annual rate over the next ten years. Transfers between funds are a common means, within governmental fund account- ing, of moving resources for general opera- tions and capital projects. The main component of this category is the equity. transfer from the Enterprise Funds ($14.2 million), which represents a return on the City’s original capital investment in the Ut-ili~T Department operations (Water, Gas, $17 $16 815 $14 s 13 $12 $1t $ !o $9 Totali% Change i(2%) $ Change 15(0.2 Other revenues comprise 13 percent of the total sources of General Fund revenue in 2005-06. A significant component of this category is the rental of land and facilities by Utilities and Public Works Enterprise Funds. About half of this rental revenue, or $4.3 million, is paid by the Refuse Fund and will cease with the closure of the landfill. A new revenue source or expense reduction must be identified before 2013. The spike in 2005-06 is due to $2.6 million in grants received for the purchase of the Bressler Open Space property. FORECA STING ME THOD OL 0 G Y: EXPENDITURES Expenditure projections, like revenue pro- jections, are based on a combination of his- torical trends, assumptions about future growth rates, and other judgments deemed appropriate. Salary projections are based Other Revenues i ’ ’ Projected4.’ ’.,,.-[] 1995-1996-1997-1998-1999-2000- 200%2002-2003-2004-2005-2006-2007-2008-2009- 96 97 98 99 O0 01 02 03 04 05 06 07 08 09 10 $10.6 $10.7 $11.6 $11.8 $14.9 $15.2 $13.3 $16.8 $13,8 $14.2 $14.6 $15.0$12.3 $12.2 $9.7 !%15%(5%)1%4%22%2%(36%)37%26%(18%)3%3%3% S0.1 S1.6 $(0.7 $0,2 $0.4 $2.7 $0.3 $(5.5 S3.6 $3.5 $(3.0 $0.4 $0.4 $0.4 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES primarily on-previously negotiated labor agreements. For timelines beyond those con- tracts, salary growth is projected by using a weighted average of historical trends and regional labor cost increases. Because healthcare and pension costs have grown so rapidly over the past several years and indications are that rates are moderating, these costs are projected to slow to a 5 to 8 percent g-rowth rate over the next ten years. The City will continue to seek controls on the ~owth of these expenses, but such controls are not assumed in the plan. Operating transfers are primarily a function of capital work. The five-year capital plan is the basis for the first half of the LRFP capital transfers, and the last five years are estimated based on historical spending patterns. BACKGROUND FOR FORECAST OF EXPENDITURES The City’s broad range of community pro- g-rams and services has a direct impact on staffing levels, which in turn affect the main component of expenditures: salaries and ben- efits. The graph below depicts the projected trend lines for salaries, benefits, non-salary expenses, and transfers. Please note the following regarding that graph: ¯Salaries remain at about 45 percent of total expenditures from 2005-06 through 2015-16 ¯Benefits increase from 20 to 24 percent of total expenditures from 2005-06 to 2015-16 ¯The average annual increase in total expendi- tures from 2005-06 to 2015-16 is 3.4 percent ° Non-salary expense and transfers represent about one-third of General Fund expenditures ¯Reimbursements for General Fund expendi- tures total $15.5 million. These reimburse- ments include payments related to the Stanford Fire agreement, external IT-services, health and human service agreements, utilities tree line clearing, animal control services, and services rendered to the Enterprise Funds. Another salient point about General Fund expenditures is that the two largest functional areas of the budget are public safety (police and fire) and community services. The former comprises 36 percent of total expenditures in Expenditures by Category $801 $40 ~ $20 $0 +Salaries ---I~--- B erie fits --It-- N o n-S ala ry ---~T ransfers PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES 2005-06 and the latter 16 percent. Together these services comprise 52 percent of City expenditures: The pie chart below shows $15.1 million in expenditures for "ASD, CAO, and HR." T!~is category includes Administrative Ser- vices, the City Attorney, City Auditor, City Clerk, City Council, City Manager, and Human Resources. The Enterprise Funds reimburse the General Fund for administrative services in the amount of $7.6 million. DISCUSSION OF SPECIFIC EXPENDITURE PROJECTIONS The City of Palo Alto is a labor- intensive and service-driven organization; hence the salaries and benefits category represents approximately 66 percent of the General Fund budget in 2005-06. In the past several years, the City has undergone multiple restruc- turing efforts to contain the rising costs of salaries and benefits. As a 740 Public $11.5 result of "Strengthening the Bottom Line" efforts, projected annual growth for salaries and benefits over the next ten years has declined from 5.0 percent (1996-2006) to 3.5 percent, an annual savings of $1.5 million. This is primarily due to the reduction of 30 positions in the General Fund during the 2005-07 budget process, which followed the reduction of 40 positions in prior years. (See General Fund Staffing chart below.) 2005-06 Expenditures by Function Transfers Library Out $6.6-~ ...../- $5.6/ Planning Public $8.8 Safety $44.5 Non-Dept_/ $12.7 ASD, CAO_i $15.1 General Fund Staffing 3ommunity Services $19.6 720 700 680 660 640 ~98-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES Other factors contributing to slower growth in salaries and benefits include: Slowing healthcare cost increases Slower g-rowth in pension expense due to higher PERS portfolio returns and rate smoothing Salaries and Benefits For the next ten years, salary and overtime expense is projected to grow by 2.9 percent per year--declining from a 4.4 percent rate during the prior ten years. The slower growth trend is a result of staff reductions and an anticipated loosening in the labor market. It is possible, however, that prevailing labor mar- ket differentials may surface over the next few years as comparisons are made with bench- mark cities. This will lead to complex labor negotiations as budget-balancing efforts weigh against regional wage standards. Spe- cific labor negotiations anticipated include: contracts for classified and hourly units under the Service Employee’s International Union (SEIU), International Association of Fire Fighters (IAFF), and Fire Chiefs’ Association (FCA), scheduled to expire in 2006; and the union contract for Palo Alto Peace Officer’s Association (PAPOA), set to expire in 2007. Salaries and Benefits The City will continue to seek opportunities to restructure the organization around staff- ing vacancies and retirements. An important goal of the restructuring effort will be to bal- ance and increase managers’ spans of control. ~o I 75 ~ 2000-01 2001-02 2002-03 ! ~Salaries 2003-04 2004-05 E3 Benefits J 2005-06 2006-0"/ The rise in benefit costs is primarily responsi- ble for the swelling of salaries and benefits, as a proportion of total expenses, from 63 to 69 percent over the period 1995 through 2015.- The average gTowth rate in benefit expense is projected to be 4.7 percent annually over the next 10 years. Healthcare and pension cost growth is be~nning to slow after several years of double-digit increases. However, these two components continue to be the main source of benefit cost increases. Pension Expense: The single largest ~hallenge on the expense side of this long-range plan is the pension costs from the statewide CalPERS retirement system. Annual General Fund expense in this area has more than doubled since 2003-from $5.7 million to $12.4 million due to significant negative stock market returns. In 2005, the CalPERS Board enacted a new rate policy with the goal of stabilizing rates over the long term. With the new stabili- zation policy, market gains and losses are spread over 15 years rather than over three years when calculating the value ", of assets. The impact of this pol- icy is appearing for the first time, in 2006, with rates reduced by 3-4 percent compared to the prior year. Pension expenses are expected to flatten out in the upcoming years: from 2000-2005, the average annual growth was approximately 37 percent; in 2006-2016, an average armual growth of 5 percent is forecasted. PROdEOTION N L¥SIS 07 REVENUES AND EXPENDITURES Healthcare Costs: Having grown by more than 50 percent over the past five years to $11.4 million in 2006, medical premium expense is expected to double by 2015. Pre- mium increases in the range of 7-10 percent indicate cost inflation three to four times that of general consumer price increases. Retiree premium expense is projected to gTOW at a slightly faster rate than that for active employees; in the long term, this will be partially offset by 20-year retirement medical benefit vesting requirements for all new employees, including those repre- sented by PAPOA (as of November 2005). The City has taken steps to solve these fiscal challenges. This includes capping City medical contributions and the 20-year vest- ing requirement. These steps have helped lower the City’s healthcare expense. The City of Palo Alto is one of a few jurisdic- tions that completely funds all employee health insurance plans and a retiree medi- cal plan. (See Healthcare Expenses chart on page 22.) Non-Salary Expenses Non-salary expenses represent 29 percent of the General Fund budget in 2005-06. These expenses include contract services, supplies, general expenses, rents and leases, and allocated charges. Consistent with the prior year’s LRFP, this plan assumes no prog-ram gTowth beyond gen- eral cost inflation over the next ten years. The pie charts on page 22 show the break- down of non-salary expenses. Included in general expense is the lease payment of $6.1 million to the Palo Alto Unified School District (PAUSD) for the Covenant Not to Develop surplus school facilities. From 2002-03 to 2005-06, this pay- ment is projected to increase by 9.1 percent. This contract requires CPI adjustments to the annual lease payment, with a projected ~owth rate for the next ten years of 2.8 per- cent. (See 2005-06 Non-Salary Expenses chart on page 22.) Interfund Allocated Charges The General Fund receives a number of ser- vices from the City’s Internal Service Funds (ISF) and from the Enterprise Funds such as electric, gas, and water service, vehicle maintenance and replacement, printing and mailing, and techi~olog%,. These costs are distributed to all funds citywide based on a usage methodology. The Technology Fund’s allocation of costs are once again being charged back to the General Fund over a three-year period, starting in 2005- 06, until their full allocation is achieved. These allocations were reduced by $3.5 mil- lion in 2004-05 as part of General Fund bud- get-balancing efforts. (See Breakdown of Allocated Charges chart on page 22.) Transfers to Other Funds The General Fund (GF) has obligations to other funds such as the Capital Project Fund and Debt Service Fund. These trans- fers provide the necessary resources for capital expenditures and debt service pay- ments. The LRFP includes four main cate- gories of transfers: Infrastructure Management Plan (IMP) capital projects, non-IMP capital projects, debt service, and other transfers. IMP Capital Pro]ects: The IMP, also known as "CityWorks," began in 1999-00 as a 10- year, $100 million plan, designed to elimi- nate the City’s backlog of infrastructure rehabilitation projects. The GF has a base PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES Healthcare Expenses $21 $18 $15 $12 $9 $3 $0 [] Active Employees [] Retirees Supplies & M ate rials 8.7% 2005-06 Non-Salary Expenses Rents & Leases 12.7% Contract Services 25.9% Allocated Charges 27.9% General Expenses 24.8% Breakdown of Allocated Charges Technol Vehicles 6.5% Other 11.4% P rinting & M ailing 2.2% Breakdown of General Expenses PAUSD 16.8% Other 8.0% PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES con~-nitment to transfer ~$~.6 million a]mu- ally to fund these projects. It is now antici- pated that the "City Works" commitment will continue for the foreseeable future as the City continually reinvests in infrastruc- ture. Non-LVIP Capital Projects: Transfers for non-infrastructure projects, including those for traffic calming and technolo~,, are esti- mated to increase by an average rate of 4 percent annually over the next ten years. Debt Service: Total current outstanding debt is $11.5 million, one of the lowest debt lev- els of any city in the Bay Area. The model assumes that no new GF-funded debt will be incurred in the next ten years. The pro- jected transfer to the Debt Service Fund until 2010-11 will remain near an annual average of $1.2 million. Starting 2012-13, the transfer will decrease to $0.7 million due to the retirement of the 1992 Civic Cen- ter Certificates of Participation. Other Transfers: Through a mail ballot in April 2005, property owners approved an increase of the monthly Storm Drainage Fee, thereby alleviating the need for contin- ued supplemental funding from the Gen- eral Fund. In order to accelerate construction of capital improvements, the plan reflects the pre-payment of the Storm Drainage Fees attributable to City-owned General Fund properties for twelve years. These advance payments are shown from 2005-06 through 2007-08. The fee increase will expire after twelve years due to a sun- set provision in the approved ballot mea- sure. nue declines, state take-aways, and escalat- ing healthcare and pension costs. As shown in the 6 Year Trend - Before chart on page 24, expenditures were on pace to exceed revenue on an annual basis. The projected deficits would have depleted the General Fund Reserve by 2010 if steps had not been taken to deal with the imbalance. Over the past five budget cycles the City has reduced General Fund expenditures by approximately $20 million, including $5.2 million in 2005-06. These cuts have included the elimination of a total of 70 positions from the City’s payroll. In the 2005-07 budget, the City met the challenge by reducing the expense base by $4.2 mil- lion on an ongoing basis. In the past several years, the reduction included the elimina- tion of 30 positions among other depart- mental reductions. The City has addressed the structural deficit through numerous restructuring and cost-saving efforts. As shown in the 6 Year Trend - After chart, revenue and expenditures are trending upward evenly. One of Council’s top priorities is to restore the Infrastructure Reserve (IR). The IR is devoted to funding infrastructure projects related to streets, sidewalks, parks, librar- ies, fire stations, and other facilities. This year’s forecast assumes $1 million annual contributions to the Reserve. However, the City must find other ways to fully fund the IR. (See Chapter 3, Financial Challenges, for further discussion of the IR.) THE BOTTOM LINE In the past five years, the City has faced unprecedented challenges due to tax reve- PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES $134 $128 =" $122 $116 6 Year Trend - Revenues/Expenditures (Before) $110 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 6 Year Trend - Revenues/Expenditures (After) $134 $128 $122 $116 $110 - 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES EXHIBIT 1 - Base Forecast 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011.12 2012-13 2013-14 2014-15 2015-16 ,Ac ,Dai Adjusted Revenues Sales Taxes Prope~, Taxes UtJii~, User Tax Transient Occupancy Tax O~qer Taxes, Fines & Pena!~es Subtotal: Taxes Sewice Fees & Permi~ Joint Sewice Agreements (Stenford University) n~.erest Earnings Q~qer rev enues 19,308 20,020 20,815 21,662 22.467 23,190 22,893 22,142 22,826 23.550 24.425 25,395 16,657 17,968 20.360 2!,297 22,321 23,417 23.373 23,096 24.5~25,972 27,627 29.499 7,269 8.522 9,412 10.067 10.156 I0,229 ,,10,289 10,772 11.300 11,584 il,995 12,378 5,686 6.173 6,449 6,774 7.137 7,528 7.419 7,238 7,629 8,0!7 8,442 8.894 7,678 7,975 7.551 8.178 8.874 9.476 9.556 9,495 9,508 9,512 9,982 10,542 56,598 60,658 64,587 67,978 70,955 73.840 73,530 72,743 75,807 78,635 82,471 88,708 13,801 15,556 16,396 16,948 17.598 18.~8 18,555 18,740 18,827 19,373 20.135 20,926 6,772 6.587 6.659 6,961 7,428 7,757 7.992 8.204 8,599 9,113 9,618 10.092 2.146 2.116 2,227 2,346 2,474 2,598 2.559 2,495 2,601 2,715 2,85!2.998 13,286 16,805 13,788 14.202 14,628 14,993 15,293 !5,676 13,886 i4.303 12,575 12,952 Reimbursements ~orn ~her Funds 9,385 8,934 8,979 9~382 9,707 10,084 10,333 10,468 i0=659 11,039 11,478 11,914 Total Revenues 101,988 110.656 112,636 117,617 122,790 127,620 128.262 128,326 130,379 135,176 139,128 145,590 Transfers from Other Funds I5.425 15,108 i5.584 16,284 16,848 17.502 17~934 i&168 18.499 i9,159 19.92t 20:677 TOTAL SOURCEOF FUNDS 117,413 125,763 128,220 134,101 139,638 145,!22 146,196 146,494 148,878 154,337 159,049 166,267 Expenditures Saiaries & Benef,,~ Contact Sew ices Supplies & Materiais General Expense Ren~, Leases. & Equipmen! Aliocated Expenses Total Expenditures Transfers to Other Funds 79.548 8i,573 83,470 86,695 91.106 95,033 97.536 99.237 t01,648 106,036 11!,007 1t5.894 9,063 9,~i 9,360 9.669 9.984 10,333 10,566 10618 10.671 10,831 it,i35 11,406 2,989 3.130 3.134 3,237 &343 &460 3.537 3,555 3,573 3.627 3,728 3.819 8,103 8,972 9.035 9.299 9,569 9.855 10,126 10,372 10,632 10.9t6 1i,223 1i,476 924 4,591 i.009 1,042 1:076 1.113 1.139 i,i~4 1,!50 I~167 i,200 1,229 9,194 10080 13.078 15.009 i5,497 t6,039 16,400 i&482 16.565 16,979 17,488 17~982 !09,821 117,687 119,086 124,95t 130,575 135,833 139,303 141,409 144,239 149,556 155,781 161,806 GF tansfer for non-IMP capit~ project~903 950 950 1,348 1,390 1,433 i.471 1,507 1,544 1,590 1.645 1,645 GF transit for t~,~P capi~! projects 3,855 3.988 4,127 3,600 3.600 3,600 3,600 3.600 3.600 3,600 3:600 3,600 Debt Ser,:ice 1,208 1.!68 i,172 1.172 1.171 !.177 1.173 929 752 749 649 763 Oher 737 547 1,155 1.097 13 13 I4 14 15 15 i5 15 TOTAL USEOF FUNDS 116,524 124,339 126,490 t32,168 136,749 142,056 145.561 147,459 150,149 155,510 161,690 167829 Net Operating Surplusf(Deficit)889 1,424 1,730 1,933 2,889 3,066 634 (966)(1,272)(1,173)(2,642)(1,563) Transier to/nfrastr~clure Reserve (1,000,)(1 0001 1 000)(1:000)(1,000)(I.0001!(i,000!(1,000}(1:000)(1.000)I1 000} Net of Reserve Transfer 889 424 730 933 1,889 2,066 (366)(1,966)(2,272)(2,173)(3,642)(2,563) PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES EXHIBIT 2 2004-05 2005-06 2006-07 2007-08 2008-09 2009.10 2010-11 2011-12 2012-13 2013-14 2014-15 2015.16 %%%%%%%%%%%% Change Change Change Change Change Chang Change Change Change Change Change Change Revenues Sales Taxes 6.37%3.69%3,97%4.07%3.72%3.22%(1.28%)(3.28%)3.09%3.17%3,72%3,97°/~ Prope~ Taxes 21.52%7.87%13.31%4.60%4,81%4.91%(0.19%)(1.I9%)6.27%5.82%6.37%6.78°A U~Jlity User Tax 1.58%17.24%10,44%6,96%0.88%0,72%0.59%4.69%4.90%2.51%3.55%3.19% Transient Occupancy Tax 3.59%8.56%4.47%5.04%5.36%5.48%(1.45%)(2.44%)5.40%5.09%5,30%5,35% Other Taxes, Fines & PenaliZes (32,02%)3.87%(5.32%)8.30%8.5t%&78%0,84%(0.64%)0.14%0.04%4.94%5.61%, Subtotal: Taxes 1.44%7,17%6.48%5.25%4.38%4.07%(0.42%)(1,07%)4.21%3.73%4,88%5,14% Service Fees & Permi’ts Joinl Serv ice Agreements (Stanford Univ ersity ) thleres~ Earnings Other rev enues Reimbursements from Other Funds Total Revenues Transfers fTom Other Funds FUNDS Expenditures Salaries & Benefits Contact Sew ices Supplies & Materials General Expense Rents, Leases, & Equipment Allocated Ex penses Total Expenditures Transfers to Other Funds GF ~ansfer for non-IMP capital projects GF transfer for IMP capital Debt Serv ice Other TOTAL USE OF FUNDS Surplus/(Deficit) 7.57%12,72%5.40%3.37%3,84%4~26%1.13%1.00%0.46%2.90%3,93%3.93%! 12.68%(2.73%)1,09%4.54%6.71%4.43%3.03%2.65%4.81%5,98%5.54%4.93% (38.28%)(1.40%)5.25%5.34%5.46%5.01% (1,50%)(2.50%)4.25%4.38%5,01%5.16% 37,24%26.48%(17.95%)3,00%3.00%2.50%2.00%2.50%(11.42%)3.00%(12.08%)3.00% 2.57%(4.80%)0.50%4.49%3.46%3.88%2.47% 5.20%8.50%1,79%4.60%4.22%3.93%0.50% (13.77%)(2.06%)3.15%4.49%3.46%3.88%2.47% 2.25%7.11%1.95%4.59%4.13%3.93%0.74% 1.30%1.82%3.57%3.97%3.80% 0.05%1.60%3.68%2.92%4.64% 1.30%1.82%3.57%3.98%3.79% 0.20%1,63%3.67%3.05%4.54% 10.00%2,55%2.33%3.86%5.09%4.31%2.63% (0.52%)3.07%0.20%3.30%3.26%3.50%2.25% 0.71%4.72%0.13%3.29%3.27%3.49%2.25% (4.52%)10.72%0,70%2.92%2.g0%2.99%2.75% (7.69%)396.86%(78.02%)3.27%3.26%3.49%2.25% (18.39%)9.64%29.74%14.77%3.25%3.50%2.25% 4,44%7.16%1,19%4.93%4.50%4.03%2.55% 1.74%2.43%4.32%4.69%4.40% 0.50%0.50%1.50%2,80%2.44% 0.50%0,50%1,50%2,80%2.44% 2.43%2.50%2.67%2.82%2.26% 0.50%0.50%1.50%2.80%2.44% 0.50%0.50%2.50%3,00%2.82% 1.51%2.00%3.69%4.16%3.87% 100.00%5.21%0.00%41.89%3.12%3.09%2.65%2.45%2,46%2.98%3,46%0.00% (30.55%)3.45%3.49%(12.77%)0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00% 22.93%(3.38%)0.34%0.06%(0.11%)0.50%(0.29%)(20.84%)(19.07%)(0.40%)(13.34%)17.54% (55.26%)(25.79%)111.31%(5.02%)(98.81%)2.82%2.82%2.82%2.82%2.82%2.82%0.00% 1.92%6.71%1.73%4.49%3.47%3.88%2.47%1.30%1.82%3.57%3.97%3.80% 76.06%60.17%21.50%11.72%49.48%6.11%(79.31%)(252.20%)31.70%(7.78%)125.27%(40,84%) PROJECTION AND ANALYSIS OF REVENUES AND EXPENDITURES EXHIBI T 3 Budget Stabilization Reserve Beginning Balance Net OperaSng Surplusi(Deficit) Yearly BAOs Year End Savings Target 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 Ac~Jal Adjusted 21,467 2t ,066 2i ,759 23,401 24.451 25.299 26.280 26.929 27.280 27,778 28,769 29,9t3 889 1,424 1,730 !,933 2,889 3,066 634 (966)(1,272)(1.I73)(2.642)(i.563) (1,290)(I,t10)0 0 0 0 0 0 0 0 0 0 0 i.000 1,000 1,000 1,000 1.000., 1,000 1,000 1,000 1,000 i,000 1.000 Subtotal BSR Balance 21,066 22,380 24,490 26,334 28,340 29,364 27.915 26,963 27,008 27,605 27,128 29,350 Transfer to tR" 0 621 1,089 1.882 3,042 3.084 986 (317) (769) (1,164) i2,785) (1,699) Ending Balance 21,066 21,759 23,401 24,451 25,299 26,280 26,929 27,280 27,778 28,769 29,913 31,048 "D~Je to the purchase of the Bressler prope~, in 2005-06. the BSR is projected to be t7.5 percent of total use of funds, sligh~y below lhe 18.5 percent target. FINANCIAL CHALLENGES AND ACCOMPLISHMENTS As the long range forecast shows, the City’s "Strengthening the Bottom Line" (SBL) effort was successful in aligTLing expenses with rev- enues. This major undertaking has placed the City in a better position to meet future ., expense and revenue challenges discussed below. A consequence of SBL was the elimi- nation of 70 full-time positions. This reduc- tion has had an impact on existing staff workload and a modest effect on the delivery of services. Should additional reductions be required in the future, it is expected that ser- vice impacts would be more severe. There is an inextricable link between reve- nues and services, as illustrated by the table below. Declines in revenue due to a soft economy, key revenue-generating businesses leaving town, or a declining shop- ping area mean that expenses and services must be cut unless new revenues are generated. The City must carefully protect and enhance its Open Space revenue base to improve its position in facing such challenges. have identified con- cerns businesses have with regard to the City and, where feasible, have implemented solu- tions. These include forming City staff or "red" teams to reach out to busi- nesses; providing information and assistance to businesses to Pa]o Alto; improving sig-nage to facilitate business traffic; and identifying potential sites for automobile dealerships. The ultimate goal of the committees is to maintain and attract businesses that generate revenues to support City services. Toward this end, the Council and its Mayors have formed a series of ad hoc committees to reach out to the business com- munity. These committees interested in locating Police Investi~tion & Crime Prevention Sec,,ices Children’s Performing Arts Fire Suppression Ser~,ices and Hazardous Materials Trees Visua! Arts $3,194.000 $1,852.000 $1.218.000 $2,042.000 $2,122.000 $3,000,000 $1,900,000 $1,310,000 82,000,000 $2,198,000 One half of City’s Transient Occupancy Tax Sales tax from all new automobile vehicle sales Sales tax from all City apparel stores One half of the City’s documentary transfer tax Sales taxes from all restaurants within the City $1,158.000 $I.I00.000 One half of General Fund’s interest income earnin~ FINANCIAL CHALLENGES AND ACCOMPLISHMENTS CHALLENGES Infrastructure Reserve Funding One of Council’s major priorities is to restore and maintain the City’s General Fund infrastructure. To deliver services, the City must devote continuing resources to its public safety buildings, streets, side~ walks, parks, libraries, and a host of other facilities. An Infrastructure Reserve (IR), currently valued at $25.2 million, was cre- ated to address this top priority and to ensure future project funding. Council directed staff to replenish the IR annually by $2 million. Half of the goal was achieved by moving the IR into the Capital Fund and allowing interest to accrue to the fund. The remaining $1 Sources million was to be achieved through General Fund sur-uses pluses at year end, and the current LRFP forecast indi- cates this will occur through the year 2009-10. When the Infrastructure Mas- ter Plan (IMP) was initiated nearly ten years ago, it was estimated the City needed to devote $10 million annually to both eliminate an infra- structure backlog and main- tain existing infrastructure into the future. The table and chart Infra- structure Reserve Balance show the ending balance of the infrastructure reserve through 2009-10. The table does include after-surplus transfers from the General Fund as projected in the LRFP. Based on the projection below, staff expects the IR to be depleted by 2011-12. If the transfers from the General Fund are increased, the reserve may deplete at a slower rate. However, a contribution to the IR in the range of $3 to $5 million annually is needed to increase the reserve to sufficient levels to complete the original IMP. The need for this increased contribution to the IR is a result of the ori~nal cost of the IMP having increased ’due to inflation and the use of the IR for projects not originally identified in the IMP. $10,516 $9,836 $6,317 $5,947 (15,585) (15,901) (11,079) (10,544) Surplus (shortfall) of Sources over Uses $5,847 (7,444) (1,597) 4,023 Infrastructure Reserve (IR) Balance $25 38 $10$5 J’ ......................................................................... $8.62 2.40 $0 2005-06 2006-07 2007-08 2008-09 2009-10 (5,069) (6,065) (4,762) (4,597) Infrastructure Reserve Balance, beNnning 24,516 19,447 13,382 8,620 Infrastructure Reserve Balance, ending S19,447 $13,382 $8,620 S4,023 $2,426 FINANCIAL CHALLENGES AND ACCOMPLISHMENTS Should the City be unable to replenish the IR through sav- ings alone, Council may want to con- sider a new or enhanced reve- nue source, such as a Business License Tax or an increase in the Transient Occupancy Tax, specifically targeted for the IR. Another alter- native is to reallocate resources from an oper- ating program to infrastructure improvements. Retiree Medical Liability Government Accounting Standards Board (GASB) Statement 45 requires employers to measure and report the long-term costs of retiree health benefits for employees still working. Under current practice, cities are not required to book the accrued liabilities and are simply required to report the current-year premium expense which the City of Palo Alto pays al-unually. Under the GASB ruling, the accrual of these liabilities must be recog-nized by the City beginning with fiscal year 2007-08. As part of these requirements, cities must per- form an actuarial valuation of the retiree medical liability every two years. The City of Palo Alto has hired an actuarial firm to do the valuation, which should be complete in December 2005. Once the valuation is fin- ished, financial strategies will be developed to reduce and pay the accrued liability. The results of the report and management recom- mendations will be presented to the Finance Committee in early 2006. It should be noted that the City has funded a Retiree Health Benefit reserve to help pay for its accrued retiree medical liability. As of June 30, 2005, the unrestricted balance of this reserve totaled $18.3 million. Compared to other jurisdictions, the City is unique in hav- ing the foresight to set aside funds to meet this obligation. Major New Facility Projects The City is considering several major new facility proposals. These include realignment of the Golf Course to accommodate athletic fields and facilities; the replacement or re-sit- ing of the Municipal Services Center to accommodate an auto center; a new or expanded police building; rebuilding of exist- ing fire stations; and new or enhm~ced library buildings, among other proposals. As a consequence of Council policy,the con- straints of the current budget, and the mild surpluses identified in the current LRFP fore- cast, new funding sources need to be identi- fied for new infrastructure efforts. New revenue sources such as a Business License Tax are currently being explored with the Council and could be used toward financing one of these projects. Laborlssues Like most other Bay Area cities, Palo Alto is highly unionized. Approximately three-quar- ters of total employees are represented by union contracts. In 2005, over 100 temporary employees formed a new hourly bargaining unit. In 2005-06, some Management and Pro- fessional employees initiated an organizing effort and an election in an attempt to form a new Managers and Professional Association. In 2006-07, the City will face a number of issues relating to organized labor. These include the renegotiation of the IAFF, FCA, FINANCIAL CHALLENGES AND ACCOMPLISHMENTS and SEIU (classified and hourly) contracts. Depending on the results of the Manage- ment and Professional election, another contract may need negotiation. Labor negotiations in 2006 may be challeng- ing, as prevailing standards in labor market compensation are reconciled with the eco- nomic realities of the City’s financial condi- t-ion. Although the local economy and revenue sources are improving somewhat, the City does not have the fiscal flexibility to meet all the demands of the labor market in which it operates. For example, an expected proposal from SEIU will be a new retirement plan calling for 2.5 or 2.7 percent at 55. The union will state that Palo Alto is one of the few remaining cities in the Bay Area that does not offer this benefit. The cost of this change is over $6 million per year, representing a sig-nificant issue for City finances. City’s Economic Base The following statistics demonstrate the sensitivity of City revenues to business and to a relatively small number of enterprises within the City: °Approximately 55 percent of City revenue is associated with business activity ¯The top 25 sales tax generators yield 50 per- cent or $9 million in sales tax Auto dealerships generate just under $2.0 million annually The Stanford Shopping Center department stores and a major electronic retail outlet generate around 21 percent or $4 million of sales tax revenue In addition to the City’s dependence on key businesses, there are significant competitive pressures on these and other busi- nesses, including: Retail competi- tion from regional shop- ping centers such as Valley Fair and Santana Row ¯The competition of big-b.ox stores such as Best Buy, Home Depot, Costco, REI, and supermarkets in Mountain View and East Palo Alto ¯The emergence of high-end hotels in Los Altos, Menlo Park and East Palo Alto The transformation of the Stanford Research Park from firms producing taxable sales to those providing non-taxable research and administration and business services °Opposition to business development within the Ci~, ¯Lack of adequate space for automobile deal- erships and the efforts of nearby cities to lure dealerships from Palo Alto While the City has made important strides in understanding the needs of businesses, it must enhance its efforts to maintain a sound economic base. The direct link between revenues and the provision of ser- vices must be considered as the City consid- ers other policy goals such as the provision of housing, controlling traffic, and regulat- ing gTowth. FINANCIAL CHALLENGES AND ACCOMPLISHMENTS Voice Over Internet Protocols (VOIP) and Telecommunications Regulatory Challenges VOIP is an emerging technology that will impact telephone UUT revenues. Since the City will not have the capacity to tax this ser- vice based on the passage of a recent Federal Cormnunications Commission ruling, this $2 million revenue source will probably erode over time. The extent of the negative impact will not be known until VOIP ,,. matures as a technology and as a product. In addition to the VOIP threat, there are initiatives at the Fed- eral level to limit the ability, of localities to charge franchise fees to cable providers. The cable and telecommunications industries bridle at local taxes and controls and are actively pursuing state and federal legislation to eliminate them. The success of such opposition will translate into revenue threats to the City. The City cur- rently receives $0.4 million in franchise fees. Landfill Closure and Loss of Refuse Rent The General Fund (GF) receives rent pay- ments of approximately $4.3 million annually from the Refuse Fund. The rent payment is expected to decrease by $2.2 million in 2012- 13 and by an additional $2.1 million in 2014- 15. The loss of these funds is included in the current forecast. Staff will present this issue to Council for consideration in December 2005. State’s Financial Condition Although Proposition 1A, which protects local revenues, was passed by voters, the State still faces budget issues and could be tempted to raid local coffers. If a fiscal "emer- gency" were declared, the protections of 1A could be reversed. Until this fiscal year, California outlays have exceeded revenues every year since 2000. In 2005-06, the state will have ~n unexpected $5.2 billion sur- plus, but in 2006-07 it expects to run a $4 billion deficit. Fur- thermore, California has dou- bled its debt load in the past five years and has the lowest bond rating of the 50 states. The recent defeat of_the Gov- ernor’s proposition to limit state spending and allow him g-rearer veto power portends additional conflict in resolv- ing budget deficits. Whether the state can make the structuraI changes nec- essary to stabilize state and local revenues remains to be seen. In addition to the possibility of State revenue raids, there are annual efforts to change the local fisca! structure. Bills have been pro- posed, for example, to redistribute proper~ and sales tax revenues on a regional rather than local basis. Such efforts are IikeIy to be . detrimental to cities like Palo Alto which have the advantage of strong retail outlets like the Stanford Shopping Center and vibrant down- town areas. A CCOMPLISHMENTS The City has emerged successfully from a grueling economic downturn with a ba!- anced budget. While navigating through the economic slump of the past four years, the City achieved several financial mile- stones. The City has man- aged to maintain its Triple-A credit rat- ing from Standard and Poor’s and Moody’s. Both the City’s Budget Doc- ument and Com- prehensive Annual Financial Reports continue to receive awards and recog- nition from State and national associations for their excellence. In the annual reports to the City’s Finance Committee, the City’s Outside Auditor commended the City for the quality and accuracy of its financial statements. The final evaluation of how the City is per- forming should come from the community. In the 2003-04 Service Efforts and Accom- plishments Report, the am~ual Citizen Sur- vey revealed that "90 percent rated the overall quality of City services good or excellent .... This included 33 percent rating the overall quality of services as excellent, 57 percent good, 9 percent fair, and only 1 percent poor." Based on projections in this report, the overall community should con- tinue to expect the quality of services it so resoundingly endorses. FINANCIAL CHALLENGES AND ACCOMPLISHMENTS STATISTICAL ANALYSIS METHODOLOGY RESEARCH BACKGROUND As a foundation for last ),ear’s Long Range Financial Plan, staff researched existing meth- odologies for projecting revenues and expen- ditures. This research is summarized in the. 2004 Long Range Financial Plan. This report replicates the quantitative analy- sis of variables performed in 2004, in addition to staff’s primary forecasting methodology- i.e., the CAGR as a base from which specific events and trends are added or subtracted. The purely quantitative forecasts were then compared to the more qualitative forecast contained in the model. Results are discussed below. INFLUENCE OF KEY ECONOMIC INDICA TORS: USING "EXPER T PREDIC TIONS ~; The 2004 analysis showed that the key indica- tors correlating with growth in City revenues are State per capita resident income, Gross State Product (for California), and number of employed Santa Clara County residents. Charts 1, 2, and 3 show the correlation between each of these indicators and General Fund Revenue. Chart I illustrates the rela- tionship between Gross State Product and General Fund revenues, and shows the R2 or degree of correlation between the two vari- ables. An R2 of 1.0 would indicate a 100 per- cent correlation. In addition, the charts show the regTession equation -- showing the rela- tionship between the two variables, tn the case of Chart 1, General Fund Revenues (not including reimbursements or transfers) for a ~ven year equal the Gross State Product for that year times.0663 plus 428.37. We use these regression equations later in the document to explain what the experts predict for the State means for City revenues and for our forecast. Charts 2 and 3 illustrate, respectively, the relationship between the number of employed Santa Clara County residents and General Fund revenues, and the relationship between California per capita income and General Fund revenues. (Please note that all General Fund revenues referenced in this Chart 1: Gross State Product v. General Fund Revenues G~oss State Product (Millions) $0 Chart 2: No. Employed in SCC v. General Fund Revenues Employment STATISTICAL ANALYSIS chapter exclude reimbursements and oper- ating transfers.) The high degree of correlation between the above three variables and General Fund revenues provides another point of refer- ence with which to evaluate our model forecasts. Using "expert forecasts" for any of the three variables, we can use the regression equations above to predict Gen- eral Fund revenues in the future. Then we can compare this with the model’s fore- casted revenues. The Center for Continuing Study of the Cal- ifornia Economy (CCSC) predicted a state per capita income of $43,297 -- as a moder- ate projection -- in 2012. Plugging that into the regression equation from chart 3 below, we derive total General Fund revenue of $126.1 million in 2012. That is 7 percent $ 20,000 Chart 3: Calif. Per Capita Income v. General Fund Revenues SO S13.08@ $~’5.’~3.9 820.000 825.0C© $30.,~0~0 S35,0©© $40.000 Per Capita Income ¯ above the Long Range Financial Plan model’s projection of $117.9 million. If we use CCSC’s low projection or $40,043, we get $115.0 million in General Fund revenue in 2012, or 2.5 percent below the revenue forecasted in the model. (See 2012 General Fund Revenues chart below.) Applying these expert forecasts as a frame of refer- ence, the revenues forecasted in our model fall within the conservative-to-moderate USING HISTORIC PROJECTIONS TO FORECAST FUTURE REVENUE Historic revenue data were used to forecast future revenues in two distinctly different approaches -- a straight-line approach and a weighted data approach. In the first approach, all data were weighted equally -- that is data from 1981, for example, were weighted equally with data from 2003. This -,, approach de-emphasizes the intervening boom or bust periods. The second approach, called "Crystal Ball" after the software used to do the regressions, used weighted data, placing greater emphasis on more recent periods and less weight on earlier periods. This had the effect of emphasizing the recent large fluctuations in the economy. Neither approach is necessarily more accurate or correct, but the two sets of results pro- vide a range of possible outcomes. F 2012 General Fund Revenues: 3 Sources ccsc-i~$126.1Moderate i !~$117.9LRFP ccsc- o , I"o 0 50 10 O The following four charts compare the projections in the model with (a) the non-weighted trend-based projections and (b) the weighted historical-based projections. Chart 4 shows Sales Tax Revenue pro- jected three different ways: by a trend line, by the weighted "Crystal Ball"150 STATISTICAL ANALYSIS method, and by the Long Range Financial Plan model. The fact that the linear trend line is consis- tently above the projections of the other two methods shows how drastic the changes have been since 2001. Crystal Ball gives more weight to the recent declines in sales tax rev- enues, and so does the staff model. Further- more, the modePs forecast dives below the Crystal Ball forecast in the out years, due to the assumed recession beginning 2011. - Chart 5 maps out the three types of projec- t-ions on Property Tax Revenues. The model forecast exceeds both the linear trend line and the weighted forecast in the early years - due to the soaring home prices and the ces- satioh of ERAF III state takeaways. After 2010 it goes between the other two forecasts. This chart illustrates the advantage of insert- ing qualitative information into a forecasting model: the recent irregularities due to state budget-balancing measures and trading of revenue sources, among other phenomena, are impossible for a strictly quantitative model to capture. Chart 6 illustrates that TOT revenues will rebound more quickly according to the non- weighted analysis. Staff’s forecast falls some- where between the two, as staff believes that the recent upturn will continue. Chart 7 shows a wide range between UUT revenues projected by staff and those pro- jected by the weighted and trend-line meth- odologies. This is due to the rate increases being implemented by Utilities to cover ris- ing water, gas, and electric commodity costs. The strictly quantitative analyses could not take that known change into account. Chart 8 shows a 30 percent difference between the weighted forecast and the Long Range Financial Plan model in 2015. The model follows the trend line fairly closely, rather than predicting low or fiat revenues /"Chart 4. Sales Tax Revenue Projections $ 30 000 ~S25,000 .................................... ~ s2o,ooo "~ ~ ~.000 ] £75 ~84 1992 2001 20!0 ! + Historic Data +CB Projections ~i ~ LRFP Model -- Linear (Historic Data) Chart 5. Property Tax Projection~ 535,000 $ 30.000 525000 $20000 S "5.000 $ "0.000 55,000 070 ~80 £90 2000 20 £2020 {+Historic Data -.--I!~-- CB Projections ~LRFP Model ~Linear (Historic Data)[ Chart 6. TOT Revenue Projections ""] ~ ~ 000 $4,000 i $2000 i 970 ~80 ".qg0 2000 20!3 2020 I + Historic Data ~ CB Projections i ----~-- LRFP Model ~Linear (Historic Da a)! STATISTICAL ANALYSIS mirroring those of the past few },ears. The expert predictions discussed earlier vali- date staff’s assumption of future moder- ate ~owth in revenues. In conclusion, the alternative quantitative forecasting methods enabled a critical review of the model’s forecast. It caused staff to check assumptions used in the model. By and large, the judgments incor- porated into the model’s forecast seemed reasonable and explained the variations from the quantitative forecasts. $ ~,000 S ~,000 d ~-o,ooo $ 8,000 $ 6,000 $ 4,000 r~ Chart 7. UUT Revenue Projections¯ S 2.000 ....... ~85 "990 ~95 2000 2005 2013 2015 2020 ! -~-- Historic Data ~ CB Projectio ns I~ LRFP M odel ~Linear (Historic Dala)~ Chart 8. General Fund Revenue Projections 1D3,090 -jS80.COO S40.G70 s2o,ceo i 1970 ~gSO 1~90 201)3 20"0 2020 i "-’@-- Histodc Data ~ CB Projections ~ LRFP Model ~ Unear (Historic Data)i Tt-tis page is intentionally left blank. Staff thanks City Manager Frank Behest and Director of Administrative Services Carl Yeats for their careful review and support in writing this document. In addition, thanks to Debra Remley for her conscientious administrative support. Contributors Graphics Nancy Nagel Tarun Narayan David Ramberg Joe Saccio Dale Wong DaveYuan Cherie McFadden