HomeMy WebLinkAboutStaff Report 6471
City of Palo Alto (ID # 6471)
City Council Staff Report
Report Type: Action Items Meeting Date: 4/4/2016
City of Palo Alto Page 1
Summary Title: Fiscal Years 2017 to 2026 General Fund Long Range Financial
Forecast
Title: Fiscal Years 2017 to 2026 General Fund Long Range Financial Forecast
(Continued from March 14, 2016)
From: City Manager
Lead Department: Administrative Services
Recommendation
Staff recommends that the Council review, comment, and accept the Fiscal Year 2017 to 2026
General Fund Long Range Financial Forecast.
Executive Summary
The base Forecast and alternate scenarios provided below differ from those delivered to the
Finance Committee (FC) on December 15, 2015 (Attachment A). This is a consequence of
several factors:
updated salary and benefit projections reflecting current estimates of negotiated
compensation and benefit packages
alternative assumption changes requested by the Finance Committee such as using a 3
percent cost increase for salaries in “out” years instead of 2 percent
revised revenue projections based on updated and currently tracked levels
most recent retirement assumptions provided by CalPERS
current valuation numbers provided by the City’s Actuary and prior forecast numbers
modified by staff
These modifications are explained in the relevant sections of the report.
The revised, base Fiscal Year (FY) 2017 to 2026 General Fund Long Range Financial Forecast
(Forecast) projects a General Fund (GF) deficit of $0.64 million in FY 2017, a $0.20 million deficit
in FY 2018, and a $0.08 million surplus in FY 2020. This contrasts with the December 5 Forecast
which showed a GF surplus of $0.09 million in FY 2017, a shortfall of $0.63 million in FY 2018,
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and a surplus of $0.9 million in FY 2020. The updated projection shows a financial shift
downward as the City embarks on the FY 2017 budget process.
The methodology utilized in December remains the same. Revenues have been updated to
reflect actual activity in FY 2016 and then are grown by the Compound Annual Growth Rates
(CAGR) recommended by the Finance Committee. Base expenditures reflect FY 2016 costs
changed for one-time items, midyear adjustments, and through any other actions taken by
Council this FY. Out year expenditures are modified according to the assumptions outlined in
this report.
The Forecast does not include:
New staffing and program requests that will be considered in the FY 2017 Proposed
Budget process
One-time expenditures of $3.0 million approved in the FY 2016 Adopted Budget
Cost implications that may arise in the FY 2017 Proposed Budget process such as: a
shortfall in reimbursement from Stanford University for Fire services; support for the
Parks Master Plan; and loans to the Palo Alto airport
A shift of $2.4 to $2.7 million in annual streetlight and traffic signal costs from the Electric to
General Fund as a consequence of State propositions
Since the new base Forecast reveals a projected deficit of $0.6 million in FY 2017, the addition
of costs without offsets to expenditures or new revenues will intensify the shortfall in FY 2017
and affect out year results.
In addition, there are a number of longer-term financial challenges the GF still confronts. These
include, for example:
Rising pension and health care costs
Funding long-term pension and retiree healthcare liabilities estimated at $439 million
city-wide, of which $293 million is the General Fund share
Funding Infrastructure Plan projects whose costs are rising above the original $126
million projection
Solid tax revenues and a strong local economy show a rebounding from the Great Recession.
The GF has experienced a series of year-end surpluses (primarily due to one-time events) and is
projected to end FY 2016 with a $3.1 million surplus. While these results are welcome, rising
benefit and other costs diminish a more positive outlook over the next 10 years.
Since the December forecast, which cited upbeat economic indicators, several clouds have
been hovering over the local, state, national and world economies making less clear the
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direction they will take. These include: a severe drop in world stock markets, a stronger dollar
weakening U.S. exports, further evidence of a slowing Chinese economy, sharply declining oil
prices, and increased uncertainty about global growth. Economists appear to be evenly divided
over the course of the economy with some citing strong employment data and rising wages
while others are concerned about weaker corporate profits, lower exports, and looming
interest rate hikes. Worried about the economy faltering, the Federal Reserve recently
postponed two expected rate increases in 2016.
Staff has added two scenarios requested by the FC to the LRFF that have adverse impacts on
the GF’s bottom line (see table below). These include: 1) a poorly performing PERS pension
portfolio which Bartel and Associates defines as returns of between 0.2% and 4.1%; and 2) a
scenario with 3 percent salary increases for out years. Compared to the base forecast, the PERS
scenario shows significant deficits in FYs 2020-22 and declining surpluses thereafter. By using a
3 percent inflator for salaries, and as expected, more and higher deficits occur compared to the
base year. The higher salary increase, however, is less onerous than the pension and recession
outcomes (see below).
Comparison of Bottom Lines for Poor PERS Performance, 3 Percent Salary, and Recession
Scenarios for Fiscal Year 2017-2026 LRFF
Net One-Time Surplus/(Shortfall)
Adopted
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
CalPERS Poor Investment Return 0 (642) 15 (668) (1,883) (2,051) (1,595) (46) 2,573 3,638 7,916
Cumulative Net Operating Margin 7,256
3 Percent Salary Growth 0 (642) (199) (118) (1,016) (732) 397 2,935 5,539 6,620 10,966
Cumulative Net Operating Margin 23,750
Base Forecast - 90 (632) 880 508 1,335 2,836 5,591 8,157 9,739 12,681
Cumulative Net Operating Margin 41,185
Staff does understand the difficulty of forecasting a recession, but historical trends show that a
downturn will occur during the term of this Forecast, especially since the country is nearly
seven years into a recovery. By virtue of a recession’s unpredictability, local jurisdictions tend
to react late to a downturn, so fiscal discipline and a focus on priorities is a recommended, pro-
active strategy.
For brevity purposes, staff has omitted much of the detailed background information that can
found in the December 5 report (Attachment A). Focus is placed, instead, on the changes
recommended by the Finance Committee, revised revenue and expense projections based on
recent data, key assumptions, alternate scenarios to the base Forecast, and the financial
challenges that lie ahead.
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Forecast Discussion
As shown in the table below, the revised, base Fiscal Year (FY) 2017 to 2026 GF Long Range
Financial Forecast (Forecast) projects a deficit of $0.64 million in FY 2017, a shortfall of $ 0.20
million in FY 2018, and surpluses ranging from $0.24 to $12.1 million in the remaining years of
the Forecast (with a small exception in FY 2020). The bottom line results through 2021 could
easily move downward if additional expenses are added to the base or if revenues
underperform. As we move out from FY 2022, surpluses are more significant but are of less
predictive value. Over the term of this updated Forecast, a $31.7 million cumulative surplus is
projected.
This forecast does assume that the General Fund Budget Stabilization Reserve (BSR) is fully
funded at the City Council approved target level of 18.5 percent.
Fiscal Year 2017-2026 Long Range Financial Base Forecast
Adopted
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Total Revenue $185,672 $193,953 $202,919 $211,814 $218,393 $225,361 $232,916 $241,044 $249,421 $256,757 $265,564
4.5%14.7%9.2%7.6%6.4%6.7%7.0%7.1%6.5%6.5%
Total Expenditures $185,672 $194,594 $203,116 $211,035 $218,469 $225,124 $231,522 $237,091 $242,852 $249,079 $253,506
4.8%4.4%3.9%3.5%3.0%2.8%2.4%2.4%2.6%1.8%
Net One-Time Surplus/(Shortfall)$0 ($641)($198)$779 ($76)$238 $1,395 $3,953 $6,569 $7,678 $12,058
Cumulative Net Operating Margin (One-Time)$31,755
Net Operating Margin $0 ($198)$779 ($854)$313 $1,157 $2,558 $2,616 $1,109 $4,381
Cumulative Net Operating Margin $11,861
Assumes that the annual shortfalls are solved with ongoing solutions and annual surpluses are spent for ongoing expenditures.
The table above includes a calculation for the net operating margin which reflects the year over
year change of surpluses and shortfalls. With the net operating margin, it is assumed that each
shortfall is addressed completely with ongoing solutions in the year it appears, and that each
surplus is completely expended with ongoing expenditures. Based on these assumptions, the
cumulative net operating margin, or ongoing surplus, during the forecast period is
approximately $11.9 million, with the majority of these ongoing surpluses generated in the last
five years of the Forecast.
Consistent with the prior year’s forecast, the methodology for calculating changes from FY 2017
to FY 2026 are based on historical trends or using a Compounded Annual Growth Rate (CAGR).
This methodology is adjusted somewhat based on staff’s knowledge of known one-time events.
By using the historical average growth rate that incorporates the up and down cycles over the
past 10 or 20 years, there is no single year in which a downturn is depicted. Instead, past
downturns (e.g. dot com bust and Great Recession) have been factored into the CAGR used to
forecast future revenue streams. The CAGR approach tends to promote a positive forecast
outlook since revenues are growing at a steady pace. For this reason, staff has generated a
recession scenario (discussed below) beginning in the first half of Fiscal Year 2019.
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For the past several years, the City has generated healthy surpluses which mainly consist of
one-time items. In fact, staff is projecting a $3.1 million GF budget surplus for FY 2016. This
surplus incorporates City Council authorized budget amendments to date and includes higher
tax revenue estimates which are reflected in the 10 year Forecast. In addition, it contains all
known expense increases such as pension rates from PERS and salary and benefit increases that
have been authorized by Council for current negotiations with the City’s major bargaining units.
What the Forecast does not include, however, are the following potential impacts, which can
decrease or increase projected bottom line numbers in FY 2017 and beyond. They are:
1. Potential costs in excess of the Council approved $126 million Infrastructure Plan after
full design; prevailing wage requirements; construction costs; and operating budget
impacts from new facilities. The Public Safety Building and California Avenue Parking
Garage are expected to exceed original estimates by up to $30 million
2. Potential acquisition of the downtown Palo Alto Post Office with associated operating
expenses
3. Parks Master Plan expenditures to be determined in FY 2016
4. Operating and capital costs related to a new Junior Museum and Zoo facility
5. Capital costs related to City assets managed by non-profits such as Avenidas Senior
Center, the Palo Alto History Museum, and the Ventura Child Care Center
6. Cubberley Community Center Master Plan expenses in excess of the dedicated
Cubberley infrastructure funding as agreed to between the School District and the City
7. Construction and operating expenditure loans for the Palo Alto Airport
8. Potential loss in revenue from Stanford University for Fire services if there are no
offsetting cost reductions. In FY 2016, a one year extension of the contract was
approved at $6.5 million which reflected a $675,000 reduction in revenues as outline in
CMR # 6502.
9. The Cadillac Healthcare Federal Excise Tax which was delayed with an expected to
impact in calendar year 2020
10. Future changes to pension plan assumptions by CalPERS
11. CalPERS City contribution increases. This Forecast assumes CalPERS will meet its annual
investment return goal of 7.5%. An alternative Forecast which assumes a poor
investment return for the next ten years is provided below at the request of the FC
12. Higher Transient Occupancy revenues related to two new hotels opening on San
Antonio Road
13. Tax revenue alignment with updated Comprehensive Plan
14. Ongoing labor negotiation changes
15. Golf Course construction and operating cost updates (previous estimate was based on
2012 costs)
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16. Updated retiree medical annual payment and Unfunded liability (Bartel currently
updating)
Since the Great Recession, the City Council has approved various strategies to mitigate the
rising cost of salaries and benefits. These include:
1. Employees paying their own CalPERS contribution (between 6 percent to 9 percent of
salary) except for the members of the Fire Chiefs’ Association
2. Sharing future health plan cost increases
3. Creating a second pension tier that was followed by State implementation of a third tier
effective January 1, 2013
4. Reducing professional development expenses
5. Freezing cost of living freezes for four years
6. Terminating the Variable Management Compensation Plan
With the above actions, Council has reduced base costs and curbed the growth trajectory of
future costs related to pensions and medical care. The same, proactive stewardship may be
needed as the City deals with the potential costs cited above and a recession. A potential
solution is to have labor groups share in the cost of the City's or employer pension contribution.
Council has directed staff to explore options in the current labor negotiations.
The following sections present analysis and assumptions for the major revenue and expenditure
categories in the forecast. Based on new revenue data and input from the FC, staff has revised
several projections.
Revenues
City of Palo Alto tax revenues continue to parallel a strong local economy. Robust residential
and commercial property values, business driven transient occupancy and daily rates, and the
emergence of new hotels have propelled key revenue sources upward since Fiscal Year 2013.
Economic drivers such as low unemployment, strong incomes, vibrant business activity, and
demand for Palo Alto property should continue to buttress revenue in the near future.
The tables below highlight annual revenue projections and year over year percentage increase
assumptions in the Forecast. Compared to FY 2016 Adopted Budget total sources of revenue
are expected to increase by 4.1 percent or $7.8 million in FY 2017. Principal contributors to this
growth come from property and transient occupancy taxes.
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Fiscal Year 2017-2026 Long Range Revenue Forecast
Revenue & Other Sources
Adopted
2016
Projected
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
CAGR 10
Years
Sales Taxes $27,630 27,850 $28,668 $29,396 $29,912 $30,667 $31,448 $32,234 $33,062 $33,932 $34,851 $35,820 2.5%
Property Taxes 35,067 35,074 37,853 40,343 42,970 45,655 48,375 51,064 53,837 56,680 59,582 62,583 6.0%
Transient Occupancy Tax- General Purpose 13,766 15,317 15,137 15,648 16,190 16,761 17,363 17,979 18,607 19,249 19,909 20,582 3.0%
Transient Occupancy Tax- Infrastructure 5,025 9,232 7,997 8,266 8,553 8,854 9,173 9,498 9,829 10,169 10,518 10,874 1.7%
Documentary Transfer Tax 6,852 7,050 7,532 7,971 8,452 8,995 9,580 10,135 10,706 11,296 11,902 12,503 5.9%
Utility Users Tax 11,189 10,495 11,209 11,811 12,147 12,423 12,581 12,782 13,097 13,531 13,986 14,393 3.2%
Other Taxes and Fines 2,180 2,180 2,022 2,122 2,181 2,242 2,304 2,367 2,433 2,500 2,568 2,639 1.9%
Subtotal: Taxes 101,709 107,198 110,418 115,557 120,405 125,597 130,824 136,059 141,571 147,357 153,316 159,394 4.0%
Charges for Services 17,576 17,576 16,714 18,220 20,496 21,130 21,785 22,460 23,159 23,881 24,627 25,403 3.8%
Stanford Fire & Dispatch Services 7,823 6,893 8,981 9,425 9,766 10,119 10,483 10,860 11,250 11,654 12,072 12,501 6.1%
Permits and Licenses 8,211 8,211 8,670 8,896 9,128 9,365 9,609 9,859 10,116 10,379 10,649 10,926 2.9%
Return on Investments 824 824 840 857 876 896 917 940 964 990 1,019 1,050 2.5%
Rental Income 15,296 15,296 15,015 15,631 15,895 15,033 14,510 14,879 15,257 15,646 14,721 15,095 -0.1%
From Other Agencies 373 373 333 337 341 345 349 354 358 363 367 372 0.0%
Charges to Other Funds 11,930 11,930 11,550 12,123 12,593 13,153 13,686 13,863 14,282 14,618 15,001 15,388 2.6%
Other Revenue 1,609 1,609 1,344 1,382 1,420 1,456 1,494 1,532 1,571 1,611 1,652 1,694 0.5%
Total Non-Tax Revenue 63,642 62,712 63,447 66,870 70,514 71,497 72,833 74,747 76,957 79,140 80,109 82,430 2.8%
Operating Transfers-In 18,589 18,589 20,088 20,491 20,895 21,299 21,704 22,110 22,517 22,924 23,332 23,740 2.5%
BSR Contribution (One-Time)1,732 1,732
Golf Operating Loss Reserve Liquidation
Total Source of Funds $185,672 $190,231 $193,953 $202,919 $211,814 $218,393 $225,361 $232,916 $241,044 $249,421 $256,757 $265,564
Revenue & Other Sources
Adopted
2016
Projected
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Sales Taxes 0.8%2.9%2.5%1.8%2.5%2.5%2.5%2.6%2.6%2.7%2.8%
Property Taxes 0.0%7.9%6.6%6.5%6.2%6.0%5.6%5.4%5.3%5.1%5.0%
Transient Occupancy Tax- General Purpose 11.3%-1.2%3.4%3.5%3.5%3.6%3.5%3.5%3.5%3.4%3.4%
Transient Occupancy Tax- Infrastructure 83.7%-13.4%3.4%3.5%3.5%3.6%3.5%3.5%3.5%3.4%3.4%
Documentary Transfer Tax 2.9%6.8%5.8%6.0%6.4%6.5%5.8%5.6%5.5%5.4%5.0%
Utility Users Tax -6.2%6.8%5.4%2.8%2.3%1.3%1.6%2.5%3.3%3.4%2.9%
Other Taxes and Fines 0.0%-7.2%4.9%2.8%2.8%2.8%2.8%2.8%2.8%2.7%2.7%
Subtotal: Taxes 5.4%3.0%4.7%4.2%4.3%4.2%4.0%4.1%4.1%4.0%4.0%
Charges for Services 0.0%-4.9%9.0%12.5%3.1%3.1%3.1%3.1%3.1%3.1%3.2%
Stanford Fire & Dispatch Services -11.9%30.3%4.9%3.6%3.6%3.6%3.6%3.6%3.6%3.6%3.6%
Permits and Licenses 0.0%5.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%
Return on Investments 0.0%1.9%2.0%2.2%2.3%2.3%2.5%2.6%2.7%2.9%3.0%
Rental Income 0.0%-1.8%4.1%1.7%-5.4%-3.5%2.5%2.5%2.5%-5.9%2.5%
From Other Agencies 0.0%-10.8%1.2%1.2%1.2%1.3%1.3%1.3%1.3%1.3%1.3%
Charges to Other Funds 0.0%-3.2%5.0%3.9%4.4%4.1%1.3%3.0%2.4%2.6%2.6%
Other Revenue 0.0%-16.4%2.8%2.8%2.6%2.6%2.6%2.6%2.6%2.6%2.6%
Total Non-Tax Revenue -1.5%1.2%5.4%5.4%1.4%1.9%2.6%3.0%2.8%1.2%2.9%
Operating Transfers-In 0.0%0.9%2.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%
BSR Contribution (One-Time)0.0%-100.0%
Golf Operating Loss Reserve Liquidation
Total Source of Funds 2.5%2.0%4.6%4.4%3.1%3.2%3.4%3.5%3.5%2.9%3.4%
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The graph below depicts historical performance and base model projections for the five major
General Fund tax revenues. It includes 10 years of actual revenue history; projections for FY
2016 based on actual year-to-date data; and projections for FY 2017 through FY 2026.
Per 2013 Finance Committee discussions and recommendations, staff has used historical, CAGR
data to forecast revenues. The rates utilized are shown at end of table above and discussed in
the tax revenue categories. In addition, analysis of other major revenue sources is presented.
Sales Tax
Sales taxes have risen from a low of $17.9 million in FY 2010 to a projected level of $28.4
million in FY 2016. Staff has factored into the forecast weakening receipts over the past several
years from a few key generators as well as a drop-off in one-time use tax receipts from the
Stanford Hospital construction projects. The latter change was discussed during the December
5 Finance Committee meeting.
Staff remains concerned about the ongoing movement of tangible good purchases from brick
and mortar stores to online vendors. This poses an important long-term threat. Evidence of
this erosion was reported in a December 1, CNBC article, “According to the Adobe's Digital
Index, total online sales on Cyber Monday rose 16 percent compared to last year, to $3.07
billion.” The article goes on to say that in-store data “showed sales were down an estimated
10.4 percent over Black Friday weekend” compared to the prior year.
As reported to Council, there was a one-time tax windfall from one vendor in FY 2014 and a
Government Accounting Standards Board tax accrual adjustment in FY 2015. In each year, sales
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tax was reported at $29 million. As shown below, the FY 2016 and FY 2017 projections return
to a more realistic level in 2017. Restaurant and auto sales are trending higher, while
department store and electronic firm sales are trending lower. The State will terminate its
“triple flip” program this Fiscal Year so the City will receive more timely payments.
TABLE 1: SALES TAX REVENUE BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $22.0 $25.6 $29.4 $29.7 $28.4
$28.7
The CAGR applied to the period FY 2016 through FY 2025 is 2.5 percent which is in line with
historical growth rates.
Property Tax
As the table below shows, since FY 2012 property taxes have risen substantially. Staff projects
this source to grow at a 6.0 growth rate next ten years which is in line with historical trends.
Recent and large purchases along Page Mill Road and in the Stanford Research Park as well as
an acquisition of Epiphany Hotel ($71.6 million) evidence a compelling commercial real estate
market. Other contributing factors include: single family home sales that have exceeded asking
prices and the unleashing of latent property values from the sale of long held homes that were
“shielded” from assessed value appreciation by Proposition 13.
TABLE 2: PROPERTY TAX REVENUE BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $26.5 $28.7 $30.6 $34.1 $36.0 $37.9
The City’s property tax estimate for FY 2016 is based on quarterly information from the Santa
Clara County Assessor’s Office. Projections beyond FY 2016 are based on a 5.7 percent growth
rate consistent with the CAGR derived from historical data. Of note are the recent one-time
payments of excess ERAF funds to the City amounting to some $0.9 million in FY 2015 and an
estimated $0.9 million FY 2016. These are anticipated to end when property value increases
are less heated.
In FY 2015, the Administrative Services Department contracted with a firm to produce detailed
reports on property taxes. The consultant’s reports have provided key insights into Palo Alto’s
real estate market that supports property taxes growing at around 5-6 percent per year,
including:
Transient Occupancy Tax (TOT)
Transient Occupancy Taxes continue to perform exceptionally well. Average daily room rates
and occupancy levels continue to demonstrate considerable strength since FY 2011. Generally,
occupancy levels between 80 and 85 percent indicate full occupancy. Current, average room
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rates have reached an elevated level. A vibrant business environment has led to a surge in
hotel bookings from San Francisco down through the Peninsula to San Jose.
TABLE 3: TRANSIENT OCCUPANCY TAX BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016* 2017
General Purpose Revenue $9.7 $10.8 $12.3 $13.4 $14.3 $15.1
Infrastructure Revenue N/A N/A N/A $3.3 $7.7** $8.0**
TOTAL $9.7 $10.8 $12.3 $16.7 $22.0 $23.1
Average Daily Room Rate $165 $182 $208 $208 $250 N/A
Average Occupancy (percent) 79% 80% 79% 79% 75% N/A
* Projected revenue based on trend and FY 2016 year-to date-data. Average Daily Room and
Occupancy rates are year-to-date through January 2016.
**These revenue figures are lower than in the December 5 Forecast due to a miscalculation. The new
and lower numbers are reflected in the Forecast.
This forecast includes estimated revenues for the Epiphany, the two new Hilton hotels, and the
Westin Annex expected to open sometime this Fiscal Year. Revenues from the two new hotels
planned for San Antonio Road are not incorporated.
Receipts from the 2.0 percent TOT increase and from new hotels dedicated to infrastructure are
shown as a combined line item in the table above. The CAGR applied to the period FY 2016
through FY 2026 is 3.0 percent which is lower than the 4.5 percent used in prior forecast. Staff
believes that the current, elevated occupancy and room rates have resulted in a revenue base
that will be difficult to grow by 4.5 percent in out years.
Documentary Transfer Tax (DTT)
After two solid years of unusually strong performance, the Documentary Transfer Tax will likely
regress toward more normal levels in FY 2016. Although mid-January 2016 receipts are running
8.1 percent above the prior year, it is unlikely remaining revenue streams will equal the sizable,
one-time transactions in the second half of last FY. During that period, there were $1.4 and
$3.6 million receipts, primarily due to Hudson Pacific purchases of office space along the Page
Mill corridor. Such acquisitions are unlikely to be duplicated in FY 2016.
Based on current activity, staff expects $7.1 million in FY 2016 with a mild uptick in FY 2017 to
$7.5 million.
TABLE 4: DOCUMENTARY TRANSFER TAX BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $4.8 $6.8 $8.1 $10.1 $7.1 $7.5
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The CAGR applied to the period FY 2016 through FY 2026 is 5.9 percent, again, in line with prior
year CAGR trends.
Utility Users Tax (UUT)
The Utility Users Tax forecast includes a 5 percent tax on water, gas and electric usage and a
4.75 percent tax on telephone activity. In FY 2015, the step down tax for large users of utilities
was eliminated.
Receipts anticipated from the UUT are based on the Utilities’ five-year revenue and rate
projections. These estimates can change as the department presents its proposed rate plan to
the Finance Committee and City Council during the budget process. With the drought and
heightened water conservation efforts as well as lower gas prices and consumption, the utilities
UUT is expected to decline from FY 2015 to FY 2016. Revenues in FY 2015 registered at $7.6
million and these are expected to drop to $7.1 million in FY 2016. Upward movement in
revenues to $7.8 million is anticipated in FY 2017 with proposed rate increases.
Telephone receipts have been increasing marginally since FY 2014 and are expected to continue
the same trend despite the drop of 0.25 percent in the telephone UUT. Starting January 1,
2016, the City will be collecting new UUT revenue on pre-paid wireless cards and phone plans.
This effort is being implemented via a State program. With no actual data, a modest revenue
guesstimate has been included in the Forecast. Telephone revenue is expected at $3.4 million
in FY 2016 and to move slightly higher in 2017.
Total UUT revenues are projected at $10.5 and $11.2 million in FY 2016 and FY 2017,
respectively.
Other Taxes & Fines
Based upon a review of historical collection patterns, budgeted revenue estimates will need to
be reduced as part of the FY 2017 Proposed Operating Budget. As such, this forecast assumes a
reduction of 7.2 percent, primarily attributable to lower parking violations and library fines. In
the remaining years of the forecast, revenues are anticipated to increase between 2.7 and 4.9
percent.
Charges for Services
For FY 2017, total revenues in this category (excluding Stanford Fire & Dispatch Services) will
decrease by 4.9 percent or $0.9 million compared to the FY 2016 Adopted Budget of $17.6
million. Factored into the revenue projection are one-time adjustments approved as part of the
FY 2016 Adopted Budget. In addition, major components of this category are Golf Course
receipts, Development Services fees, and outlined below are payments from Stanford
University for fire and dispatch services of which a number of these areas present financial
issues.
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Golf Course revenues are decreased by approximately $0.6 million from the FY 2016 Adopted
budget due to an anticipated closure for renovation beginning in FY2017 and returning to full
operational status by FY2019. This significant change from a reduction in revenues to sizeable
increases is a direct reflection of the anticipated opening of the golf course with growth of 9.0
percent in FY2018 and 12.5 percent in FY2019. These declines and subsequent increases in
revenues are offset by changes in contract services expenses associated with operating the Golf
Course. Since the State Water Board has not issued a required permit, it is unknown when
construction on the course will begin, however, at the time of the printing of this report it is
anticipated July 2016. As more information is refined, the anticipated revenue and expenditure
implications will be factored into the development of the FY 2017 Proposed Operating Budget.
Additional significant changes from the FY 2016 Adopted Budget reflect the technical correction
of removing $0.3 million in estimated revenue for Fire Department plan check permits. As part
of the FY 2015 Budget when the Development Services Department was created, these
revenues were inadvertently budgeted both as part of the Development Services Department
as well as the Fire Department. This change to eliminate the double budgeting of these
revenues was also reflected in the FY 2016 Mid-Year Budget Review.
Stanford Fire and Dispatch Service Charges
On October 8, 2013, the City received a Notice of Termination letter from Stanford with the
intention to terminate the contract with the City no sooner than one year and no later than two
years from the date of the notice. During the termination period as well as in the past few
months, the City continued to negotiate with Stanford to settle on a service level and cost. As
outlined in CMR #6505 Stanford Fire Agreement 3rd Amendment, the Third Amendment
provides for continuation of fire services for one year at a fixed fee of $6.5 million, while
allowing the time needed to facilitate negotiation of financial terms for a new long term
agreement. This Forecast assumes a Stanford payment at $8.3 million for Office of Emergency
Services and fire services (excluding both Capital and vehicle reimbursements) and $0.7 million
for Public Safety Dispatch Services a net reimbursement of $9.0 million. The $8.3 million
reimbursement assumes the previous contract calculation, of 30.3% of the operating budget.
Stanford and the City are in a mediation process to determine appropriate reimbursement for
City fire services. Depending on the outcome of mediation significant adjustments to the
assumed reimbursement level of fire services in the General Fund may be necessary.
Permits and Licenses
Revenue from permits and licenses has experienced consistent growth over the past several
years. This results from increased development activity in the City. Based on year-to-date
estimates, FY 2016 revenues are projected to reach the Adopted Budget revenue estimate of
$8.2 million. In FY 2017, revenues in this category are expected to increase 5.6 percent. This is
consistent with projected increases in salary and benefits which are a major component of the
fees and cost recovery. Remaining years in the forecast assume 2.6 percent cost growth
annually, consistent with the modeled growth in personnel costs. As stated in the FY 2016
Adopted Budget, the Planning and Community Environment and Development Services
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departments are reviewing their cost recovery levels. Upon completion of this analysis, staff
will evaluate changes in fees and then recommend adjustments to Council.
Rental Income
The largest source of rental income comes from the City’s Enterprise Funds and the Cubberley
Community Center. Compared to the FY 2016 Adopted Budget, rental income will decrease
from $15.3 million to 15.0 million in FY 2017. The decrease includes a projected loss of
$500,000 in rental income due to Foothill College’s departure from Cubberley, however, at the
time of the printing of this report, it is anticipated that the departure timeline will be slightly
accelerated compared to these assumptions. Staff will pursue and recommend replacement
tenants to offset this significant loss. The Forecast does assume that by Fiscal Year 2018
Cubberley will have new, paying tenants that increase income by $200,000. The Forecast’s out
years assume 2.6 percent growth for all rental properties except for Refuse Fund rent which has
been set by Council until FY 2021 to cover closing costs.
Charges to Other Funds
Approximately 86 percent of this category is General Fund administrative cost plan charges to
the Enterprise and Internal Service Funds. Internal support departments such as ASD, HR, and
Council Appointees provide services to these funds. The charges for Fiscal Year 2017 are
determined based on actual services provided in Fiscal Year 2015. The FY 2017 projected
amount is $11.5 million, a decrease of 3.2 percent, from the FY 2016 Adopted Budget. This is
attributable to internal support departments providing more support to General Fund
departments in Fiscal Year 2015. The forecast includes increases ranging between 2.6 to 4.9
percent each year based primarily on assumed increases in salary and benefit costs.
Operating Transfers In
Operating Transfers principally consist of equity transfers from the Electric and Gas funds. In
accordance with a methodology approved by Council in June 2009, the equity transfer is
calculated by applying a rate of return to the capital asset base of the Electric and Gas funds.
Using the Utility Department’s projections from the Electric and Gas Five Year Financial
Forecasts, the equity transfer from the Electric and Gas funds are projected to increase from
$17.3 million in FY 2016 to $18.8 million in FY 2017 (8.4 percent); and then increase annually by
2.3 percent over the forecast period. The higher increase in FY 2017 reflects updated Gas Fund
capital asset data while the subsequent years reflect the average annual adjustment in the
equity transfer since 2009. Overall Operating Transfers are estimated to increase to $20.1
million in FY 2017, an increase of $1.5 million from the 2016 Adopted Budget level of $18.6
million.
Expenditures
In developing the FY 2017 Forecast expenditure budget, expenditure categories have been
adjusted by removing FY 2016 Adopted Budget one-time expenditures and updating major cost
elements such as salary and benefits costs. The tables below display the General Fund expense
City of Palo Alto Page 14
forecast. Compared to FY 2016 Adopted Budget, FY 2017 expenditures are estimated to
increase by $8.4 million or 4.5 percent. This is due to increased salary and benefits, an
increased transfer to infrastructure, and allocated charges costs from Enterprise Funds and
Internal Service Funds.
Fiscal Year 2017-2026 Long Range Expenditure Forecast
Expenditures & Other Uses
Adopted
2016
Projected
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
CAGR 10
Years
Salary 56,015$ 55,677$ 70,971$ 73,686$ 75,903$ 78,034$ 80,056$ 81,876$ 83,711$ 85,559$ 87,429$ 89,321$ 4.8%
Benefits 56,633 56,296 48,550 51,273 54,844 58,517 61,026 63,427 65,188 66,806 68,808 68,927 2.0%
Subtotal: Salary & Benefits 112,648 111,973 119,521 124,959 130,747 136,551 141,082 145,303 148,899 152,365 156,237 158,248 3.5%
Contract Services 17,362 17,362 14,474 15,739 16,252 16,653 17,069 17,497 17,937 18,387 18,850 19,324 1.1%
Supplies & Material 3,664 3,664 3,595 3,698 3,814 3,913 4,014 4,118 4,225 4,335 4,447 4,562 2.2%
General Expense 4,725 4,725 4,718 4,835 4,957 5,083 5,211 5,343 5,478 5,616 5,759 5,905 2.3%
Cubberley Lease 5,584 5,584 5,751 5,924 6,101 6,284 6,473 6,667 6,867 7,073 7,285 7,504 3.0%
Debt Service 431 431 432 432 431 0 0 0 0 0 0 0 -100.0%
Rents & Leases 1,493 1,493 1,531 1,571 1,611 1,653 1,696 1,739 1,784 1,830 1,878 1,927 2.6%
Facilities & Equipment 622 622 497 511 524 538 552 566 581 596 612 628 0.1%
Allocated Charges 16,433 16,433 18,028 18,526 18,997 19,489 19,993 20,511 21,012 21,557 22,115 22,689 3.3%
Total Non Sal/Ben Before Transfers 50,314 50,314 49,027 51,236 52,689 53,613 55,009 56,442 57,884 59,395 60,946 62,538 2.2%
Operating Transfers-Out 1,834 1,834 1,834 2,094 2,129 2,169 2,204 2,239 2,045 2,085 2,126 2,168 1.7%
Transfer to Infrastructure - Base 15,852 15,852 16,216 16,563 16,918 17,283 17,657 18,041 18,435 18,839 19,254 19,679 2.2%
Transfer to Infrastructure - TOT 5,025 9,232 7,997 8,266 8,553 8,854 9,173 9,498 9,829 10,169 10,518 10,874 1.7%
Total Use of Funds $185,672 $189,204 $194,594 $203,116 $211,035 $218,469 $225,124 $231,522 $237,091 $242,852 $249,079 $253,506 3.0%
Expenditures & Other Uses
Adopted
2016
Projected
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Salary N/A -0.6%27.5%3.8%3.0%2.8%2.6%2.3%2.2%2.2%2.2%2.2%
Benefits N/A -0.6%-13.8%5.6%7.0%6.7%4.3%3.9%2.8%2.5%3.0%0.2%
Subtotal: Salary & Benefits N/A -0.2%3.6%4.8%4.1%3.9%3.9%3.8%3.8%3.8%3.8%3.8%
Contract Services N/A 0.0%-16.6%8.7%3.3%2.5%2.5%2.5%2.5%2.5%2.5%2.5%
Supplies & Material N/A 0.0%-1.9%2.9%3.1%2.6%2.6%2.6%2.6%2.6%2.6%2.6%
General Expense N/A 0.0%-0.2%2.5%2.5%2.5%2.5%2.5%2.5%2.5%2.5%2.5%
Cubberley Lease N/A 0.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%
Debt Service N/A 0.0%0.3%0.0%-0.3%-100.0%N/A N/A N/A N/A N/A N/A
Rents & Leases N/A 0.0%2.5%2.6%2.6%2.6%2.6%2.5%2.6%2.6%2.6%2.6%
Facilities & Equipment N/A 0.0%-20.1%2.8%2.6%2.6%2.6%2.6%2.6%2.6%2.6%2.6%
Allocated Charges N/A 0.0%9.7%2.8%2.5%2.6%2.6%2.6%2.4%2.6%2.6%2.6%
Total Non Sal/Ben Before Transfers N/A 3.1%-7.6%3.9%2.4%2.6%1.7%2.6%2.6%2.6%2.6%2.6%
Operating Transfers-Out N/A 0.0%0.0%14.2%1.7%1.9%1.6%1.6%-8.7%1.9%2.0%2.0%
Transfer to Infrastructure - Base N/A 0.0%2.3%2.1%2.1%2.2%2.2%2.2%2.2%2.2%2.2%2.2%
Transfer to Infrastructure - TOT N/A 83.7%-13.4%3.4%3.5%3.5%3.6%3.5%3.5%3.5%3.4%3.4%
Total Use of Funds N/A 1.9%2.8%4.4%3.9%3.5%3.0%2.8%2.4%2.4%2.6%1.8%
Salary and Benefits
The table above depicts the salaries and benefits costs for the next ten years. Over the
Forecast period, the salaries and benefits cost gradually increase as a percentage of the total
expenditure budget. In FY 2017, salaries and benefits costs represent 61.3 percent of the total
use of funds budget while in FY 2026, the same costs represent 62.4 percent of the budget.
During the same period, benefit costs as a percentage of total salaries and benefits costs
increase from 40.4 percent in FY 2017 to 43.6 percent in FY 2026. This is compared to the
FY2016 Adopted Budget which reflects benefits of 50.3 percent of total salaries and benefits.
Over the Forecast period (from FY2017 to FY2026), salaries and benefits are projected to grow
approximately an average of 3.5 percent annually. This compounded growth is less than that
estimated in the prior year Forecast due to lower estimated City pension contributions in the
out-years of the Forecast. The reason for this change is discussed in more detail below. The
following sections describe the assumed increases in salary and benefits costs and depict the
reasons for the faster increasing benefits versus salaries costs.
City of Palo Alto Page 15
Salary
The City is currently in negotiations with all of its major labor units. The base Forecast includes
projected costs for salary and benefits increases reflecting the current status of negotiations
and by 2 percent in the out years. The Forecast also assumes step increases consistent with
applicable MOUs and merit increases for Management and Professional employees. AS
requested by the Finance Committee a scenario with 3 percent growth in the out years can be
found later in this report.
Benefits
Pension
The Forecast includes pension rates from CalPERS as of the June 30, 2014 valuation for the
City’s Miscellaneous and Safety plan and as updated by Bartel Associates (Bartel), the City’s
actuary. Staff asked Bartel to update the pension rates based on the latest available
information from CalPERS based on the actuarial valuations as of June 30, 2014 which became
available at the start of the year. CalPERS releases the latest valuation, staff updated the
pension costs for the Fiscal Year 2017 through FY 2022 budget and in the out years of the
forecast period used Bartels assumed rate of growth on CalPERS rates. In the December 2015
Forecast, staff relied on the figures from Bartel based on the latest information at that time.
Once
As shown in the table below, the FY 2017 pension contribution rates for the Miscellaneous and
Safety plans, increased from the current year. For the Miscellaneous Plan, the projected
pension contribution rate increase is 1.2 percentage points from the FY 2016 rate of 27.7
percent to a FY 2017 rate of 28.9 percent reflecting growth of approximately 4%. For the Safety
Plan, the projected pension contribution rate increase is 3.5 percentage points, from the FY
2016 rate of 41.9 percent to a FY 2017 rate of 45.4 percent. The table below shows the pension
contribution rates from FY 2018 through FY 2026.
TABLE 5: PENSION RATES BY PLAN (FISCAL YEAR)
Pension Plans 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Miscellaneous 27.7% 28.9% 31.0% 33.1% 35.2% 35.9% 36.4% 36.2% 36.0% 35.8% 32.6%
Safety 41.9% 45.4% 48.8% 52.1% 55.5% 56.4% 57.3% 56.9% 56.5% 56.0% 55.7%
The City pension contribution rates assumed in this Forecast are substantially lower for the last
few years of the Forecast period than assumed in the prior year Forecast due to a change in
methodology for projecting the rates. Last year, staff used a linear extrapolation of rate
increases provided by CalPERS during the first four years (CalPERS only provides rates for five
fiscal years). This year, staff asked Bartel and Associates to provide a projection of the City
Contribution rates as presented to the Finance Committee in November. To illustrate the
impact of this change in methodology, the last Forecast assumed for FY 2025 a 42.6% City
contribution rate for Miscellaneous employees and a 64.3 % City contribution rate for Safety
City of Palo Alto Page 16
employees. The lower City contribution rates for this Forecast resulted in lower overall
projected benefits costs.
The CalPERS Board recently approved a “de-risking” policy of its investment portfolio in order
to reduce the assumed investment return of 7.5 percent to 6.5 percent over a 20 year period.
With this policy, CalPERS will only reduce the investment return assumption in years with
investment returns higher than 11.5 percent in intervals and with annual caps. The Board,
however, is scheduled to revisit this policy in February 2018. Whenever the assumed
investment return is lowered, it typically results in higher City contribution rates and costs.
Retiree Healthcare
This Forecast includes the Annual Required Contribution (ARC) per the May 2014 actuarial
valuation based on information as of June 30, 2013, (accepted by the City Council on June 9,
2014) for the City’s retiree healthcare plan and as updated by Bartel. Bartel’s update to the last
actuarial valuation assumes the latest CalPERS mortality rate assumptions, incorporates the
investment gain for the Retiree Healthcare Trust Fund as of June 30, 2015, and assumes a
lowering of the assumed investment return assumption from 7.61% to 7.25%. Currently, Bartel
is preparing the Retiree Healthcare valuation as of June 30, 2015. Staff will incorporate the
findings of the valuation as part of the FY 2017 Proposed Budget as appropriate.
The table below details Bartel’s estimate for the City’s annual Retiree Healthcare contribution
by the General Fund and all other funds for the next ten years.
TABLE 6: RETIREE HEALTHCARE ANNUAL REQUIRED CONTRIBUTION (IN MILLIONS BY FISCAL YEAR)
Fund 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
General Fund $10.0 $10.9 $11.2 $11.6 $12.0 $12.4 $12.8 $13.2 $13.6 $14.0 $14.5
Non-General
Funds
$4.8 $5.2 $5.4 $5.6 $5.8 $5.9 $6.1 $6.3 $6.6 $6.8 $7.0
TOTAL $14.8 $16.1 $16.6 $17.2 $17.8 $18.3 $18.9 $19.5 $20.2 $20.8 $21.5
On June 9, 2014, City Council accepted the Retiree Healthcare Plan GASB 45 Actuarial Valuation
as of June 30, 2013 and approved full funding of the Annual Required Contribution (ARC) for
Retiree Healthcare for FY 2015 and FY 2016. As documented in the report (CMR #4891), which
recommended approval of full payment of the ARC, the primary reason for the increased ARC
was the inclusion of a new actuarial standard regarding the implied subsidy of healthcare
premiums of active employees in relationship to healthcare premiums for retirees. The implied
subsidy for FY 2015 was $1.9 million for all funds.
In preparing the FY 2015 CAFR, staff worked closely with the City’s actuary, the managers of the
City’s trust fund for Retiree Healthcare, and the City’s external auditor concerning the implied
subsidy in the Retiree Healthcare Fund. After many discussions, staff realized that the implied
subsidy budgeted in the Retiree Healthcare Fund should have been budgeted as a contribution
from the City’s healthcare premiums for active employees. However, the FY 2015 budget had
fully funded the City’s healthcare premiums of approximately $17.4 million for active
City of Palo Alto Page 17
employees. Therefore, the cost of healthcare premiums related to the implied subsidy in the
amount of $1.9 million was inadvertently budgeted in two places.
For FY 2015, the savings of healthcare premiums related to the implicit subsidy remained in the
General Benefits Fund for future use. For FY 2016, staff brought forward recommendations in
the FY 2016 Midyear Budget Review report to correct departmental budgets regarding the
implied subsidy. Starting with this Forecast and the FY 2017 Budget, staff correctly budgeted
for the implied subsidy for active employees healthcare premiums.
Healthcare
Consistent with the previous Forecast and as a result of the last labor agreement between the
City and the Service Employees International Union (SEIU), the City’s contribution amount
towards medical costs for SEIU employees is based on a flat contribution from the City with the
employee contributing towards the remaining medical plan premium. This flat contribution
towards medical costs also is used for the Management and Professional employees.
All other labor groups eligible for medical benefits will remain on the 90/10 contribution
structure until new agreements are reached. This Forecast assumes an annual health care cost
inflator of 8 percent for the labor groups on the 90/10 medical benefit structure, and a 4
percent annual health care cost inflator for the labor groups on the flat rate contribution
structure. Consistent with the previous Forecast and with historical trends, the 2017-2026 LRFF
assumes a 4 percent increase for dental and vision costs for the out-years.
Contract Services
The FY 2016 Adopted Budget included $17.4 million to fund contract services of which
approximately $2.4 million was for one-time items. These items include: $0.3 million for trash
receptacles on University Avenue; $0.3 million for the Fry’s Master Plan; and $0.3 million for
the continuation of services at the Palo Alto Animal Shelter as well as the Shelter’s transitioning
its operations to a non-profit.
In addition, the FY 2016 Adopted Budget assumed the Golf Course would be closed during the
second half of the fiscal year. Due to continued delays, however, in securing the required
permits to begin the Golf Course Reconfiguration Project (detailed in CMR #6335), this Forecast
assumes the project will begin in early FY 2017. As a result, contractual expenses related to the
Golf Course are anticipated to be reduced by approximately $0.5 million from the FY 2016
Adopted Budget level. This reduction in Golf Course expenses is offset by a reduction in
Charges for Services of approximately $0.6 million. In FY 2018, upon the assumed completion
of the Golf Course Project, contractual expenses will increase by approximately $0.9 million
along with estimated revenues. As noted in the discussion of General Fund revenues, staff is
currently undergoing an revised analysis of the impacts of the July 2016 anticipated closure
date and will provide updated adjustments as appropriate as part of the FY 2017 Proposed
Budget process.
City of Palo Alto Page 18
As discussed with the Finance Committee in October, staff continues to look for implementing
alternative service delivery models such as partnering with a non-profit agency to provide
animal services or identifying a partner for the City’s swim program. For the FY 2017 Forecast
Budget year, $0.1 million has been added for the maintenance of the Magical Bridge
playground and parkland maintenance. In the out-years of the Forecast, a 2.6 percent growth
factor for contract services is assumed. This is aligned to the 20 year historical average of the
San Francisco Metropolitan Statistical Area Consumer Price Index – All Urban Consumers of 2.6
General Expense
This category includes costs for travel and meetings, telephone and non-City utilities,
contingency accounts, subsidies and grants provided through the Human Services Resource
Allocation Process (HSRAP), and bank card service charges. These costs remain flat over the
near future at 4.7 million. Except for the Cubberley lease, annual increases of between 2.5 and
2.6 percent.
On January 1, 2015, the City and Palo Alto Unified School District (PAUSD) agreed to an
extension of the Cubberley Lease for five years. As part of the lease agreement, the City Council
approved creation of a fund for Cubberley infrastructure improvements. The lease called for
$1.9 million to be transferred to the Cubberley Property Infrastructure Fund. Therefore, the
$1.9 million is classified as an Operating Transfer Out (discussed below).
The FY 2017 Forecast Budget includes $5.8 million for Cubberley Lease payments. In
accordance with the lease agreement, a 3.0 percent annual CPI increase for the lease payments
to the PAUSD is projected. Although the lease agreement is five years, for planning purposes
this Forecast assumes the agreement will continue through FY 2026.
Rents & Leases
Rent and Lease expenses for FY 2017 are estimated to increase by $38,000 from the FY 2016
adopted level of $1.5 million. The largest expense in this category is $1.1 million for the
Development Services Center (DSC). From FY 2018 forwards, this expense is expected to
increase by 2.6 percent per year. The continued availability of the current space for the DSC
will be revisited in the next year and, depending upon the potential acquisition of the
downtown post office, the lease cost could change.
Facilities & Equipment
Facilities and Equipment expenses for FY 2017 are projected to decrease by 20.1 percent, or
$0.1 million, as compared to the FY 2016 Adopted Budget, due to the elimination of one-time
funding. One-time items funded during FY 2016 include the purchase of 30 AEDs ($50,000),
community center furniture replacement ($25,000), and the build out of office space at the
Development Center ($20,000). After eliminating one-time items, projected expenses in this
category will remain fairly consistent at $0.5 million in FY 2018 and beyond. Consistent with
City of Palo Alto Page 19
the 20-year CPI for the San Francisco San Jose Metropolitan Statistical Area, the forecast
assumes a 2.6 percent annual increase starting in FY 2018.
Allocated Charges
Allocated Charges represent expense allocations by the City’s enterprise and internal services
funds for services provided to General Fund departments. For FY 2017, these charges are
estimated at $18.1 million including utilities usage (24.2 percent or $4.4 million), liability
insurance (7.5 percent or $1.4 million), technology costs (33.9 percent, or $6.1 million), vehicle
equipment and replacement costs (27.7 percent or $5.0 million), and other costs (6.7 percent,
or $1.2 million). The FY 2017 charges of the forecast updates the revenue and expense for
these cost plans based on the most current cost data available at the time of Forecast
development. Growth of 2.6 percent is anticipated in the out-years.
Operating Transfers Out
Operating Transfers Out includes transfers from the General Fund to the Debt Service Fund,
Technology Fund, and Airport Fund. Fiscal Year 2016 year-end projected transfers out total
$1.8 million, and are expected to remain at that level for FY 2017. In FY 2018, the transfer level
is anticipated to increase by approximately $0.3 million which is attributable to debt service
payments for the Golf Course Reconfiguration project estimated at $0.5 million annually. This
is offset by elimination of a one-time transfer to the Airport Fund of $0.3 million. Once Golf
Course construction and net operation costs are updated these numbers will change. Based on
the most current information, it is anticipated that as part of the FY17 Budget, a one-time
recommendation to increase the General Fund loan to the Airport Fund will be recommended.
Transfer for Capital and Infrastructure Plan Projects
In FY 2016, the adopted General Fund transfer to the Capital Improvement Fund is $19.0
million. This includes a GF base transfer of $14.0 million and an estimated $7.7 million transfer
resulting from TOT revenues generated by the two percentage point TOT increase (started
January 1, 2015) and revenue from new hotels. This transfer is consistent with City Council
direction to dedicate these TOT revenues to the City’s $126 million Infrastructure Plan.
In the out-years of the forecast, the TOT-associated transfer is anticipated to increase at a CAGR
of 3.6 percent. These additional increases will help to somewhat to offset rising costs of
Infrastructure Plan projects. In addition, the base transfer to the Capital Improvement Fund is
anticipated to increase by 2.6 percent each year. Finally, this category includes the $1.9 million
transfer to the Cubberley Property Infrastructure Fund. This transfer remains flat in all out-
years of this Forecast.
As in past years, the chief contributors to increased expense are salaries and benefits. In
addition, higher costs are a consequence of transfers out related to the Infrastructure Plan
which are, in turn, supported by newer TOT revenues.
City of Palo Alto Page 20
Alternative Fiscal Year 2017-2026 Long Range Financial Forecast Scenarios
At the request of the Finance Committee, staff has generated a Forecast scenario with a poor
CalPERS pension investment return and a scenario with salary growth of 3 percent in the out
years of the forecast. In addition, staff is providing the third scenario with a projected recession
beginning in FY 2019. The likelihood of a recession during the next ten years is strong.
Scenario 1: CalPERS Poor Investment Return
As discussed with the City Council in September 2015 and the Finance Committee in November
2015 and December 2015, the actuarial firm, Bartel Associates, provided the City with a
continuous, poor CalPERS investment performance scenario. Weak portfolio performance,
which Bartel defines as returns between 0.2% and 4.1%, results in significantly higher employer
contribution rates. The table below shows the Bartel projected City pension contribution rates
by plan based on modest returns of 7.0%.
TABLE 7: PENSION RATES BY PLAN (FISCAL YEAR) WITH POOR INVESTMENT RETURNS
Pension Plans 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Miscellaneous 27.7% 28.9% 30.7% 34.8% 37.3% 38.3% 39.5% 40.3% 40.0% 39.7% 36.7%
Safety 41.9% 45.4% 48.4% 55.2% 59.2% 61.3% 63.5% 64.9% 64.4% 63.9% 63.4%
These higher annual pension rates would increase expenditures by a total of $24.5 million over
the Forecast period compared to the base model. General Fund deficits and surpluses would
move in a more negative direction. For example, in FY 2019 a $0.8 million surplus would
transform into a deficit of $0.7 million, a $1.5 million negative swing.
Fiscal Year 2017-2026 Long Range Revenue Forecast – CalPERS Poor Investment Return
Alternate Model
Adopted 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Total Revenue $185,672 $193,953 $202,919 $211,814 $218,393 $225,361 $232,916 $241,044 $249,421 $256,757 $265,564
Total Expenditures $185,672 $194,595 $202,904 $212,482 $220,276 $227,413 $234,512 $241,089 $246,848 $253,119 $257,648
Net One-Time Surplus/(Shortfall)$0 ($642)$15 ($668)($1,883)($2,051)($1,595)($46)$2,573 $3,638 $7,916
Cumulative Net Operating Margin (One-Time)$7,256
Net Operating Margin $0 $15 ($683)($1,215)($168)$456 $1,550 $2,619 $1,065 $4,278
Cumulative Net Operating Margin $7,916
Assumes that the annual shortfalls are solved with ongoing solutions and annual surpluses are spent for ongoing expenditures.
During the Forecast period, the net operating margin fluctuates between positive $4.3 million
and negative $1.2 million. This scenario keeps base model revenues constant since they reflect
staff’s best estimates and Finance Committee direction on growth trends.
City of Palo Alto Page 21
Scenario 2: 3% Salary Growth Alternate Forecast
At the December 2015 Finance Committee, staff was asked to model 3 percent increases in
salary growth beginning in FY 2019 compared to the 2 percent base case. This 1 percent
increase results in additional costs of $8.0 million. Pension rates from the base Forecast were
applied against salaries inflated by 3 percent.
Fiscal Year 2017-2026 Long Range Revenue Forecast – 3 Percent salary growth
Adopted 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Total Revenue $185,672 $193,953 $202,919 $211,814 $218,393 $225,361 $232,916 $241,044 $249,421 $256,757 $265,564
Total Expenditures $185,672 $194,595 $203,117 $211,931 $219,409 $226,094 $232,519 $238,109 $243,882 $250,137 $254,568
Net One-Time Surplus/(Shortfall)$0 ($642)($199)($118)($1,016)($732)$397 $2,935 $5,539 $6,620 $10,996
Cumulative Net Operating Margin (One-Time)$23,780
Net Operating Margin $0 ($199)$81 ($898)$284 $1,130 $2,538 $2,604 $1,080 $4,376
Cumulative Net Operating Margin $10,996
Assumes that the annual shortfalls are solved with ongoing solutions and annual surpluses are spent for ongoing expenditures.
In this scenario, deficits occur through FY2021 with much lower surpluses beginning in FY 2022.
As with Alternative Scenario 1, this model holds base model revenues constant.
Fiscal Year 2019 Recession Alternate Forecast
As described previously, the assumptions included in this Forecast are based on a historical
analysis of increases using the Compounded Annual Growth Rate (CAGR) with adjustments
based on knowledge of one-time and future events. The adjusted CAGR model factors in the
impact of prior recessions, but does not make assumptions about when a recession may occur.
Typically, the average business cycle lasts six years and the period between the last two
recessions was about ten years. Below, an alternative Forecast model is presented which
assumes a recession beginning in FY 2019 and shows its impacts. This model adjusts projected
tax revenues and decreases the rate of growth for certain non-salary expenditures which would
be expected when the next downturn occurs. The model is presented for information purposes
and does not purport to accurately forecast a recession.
Assuming onset of a recession in FY 2019 (see table below), a significant annual deficit of $10.2
million would occur in FY 2019. This scenario only demonstrates the decline in revenues with
no actions to reduce expenditures. Naturally, the Council and City management would take
action, as in the past, to address a recession’s impacts.
City of Palo Alto Page 22
Adopted
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Total Revenue $185,672 $193,113 $200,975 $199,246 $199,565 $202,219 $211,028 $220,604 $230,564 $239,760 $250,867
Total Expenditures $185,672 $195,241 $204,677 $212,420 $220,836 $227,292 $233,636 $239,351 $245,544 $251,718 $257,997
Net One-Time Surplus/(Shortfall)$0 $91 ($3,702)($10,179)($21,271)($25,072)($22,607)($18,747)($10,557)($11,958)($1,766)
Cumulative Net Operating Margin (One-Time)-$125,769
Net Operating Margin $0 ($3,702)($6,477)($11,092)($3,802)$2,465 $3,860 $8,190 ($1,401)$10,192
Cumulative Net Operating Margin -$1,766
Assumes that the annual shortfalls are solved with ongoing solutions and annual surpluses are spent for ongoing expenditures.
The recessionary model assumes a reduction in major tax revenues although they are
anticipated to decline at a lower rate than those in the Dot.Com bubble and Great Recession.
Conclusion
For ease of comparison the Table below shows the bottom line results for the two scenarios
requested by the FC and staff’s base scenario (modified based on FC input).
Comparison of Bottom Lines for Base, Poor PERS Performance and 3 Percent Salary Scenarios
for Fiscal Year 2017-2026 LRFF
Net One-Time Surplus/(Shortfall)
Adopted
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
CalPERS Poor Investment Return 0 (642) 15 (668) (1,883) (2,051) (1,595) (46) 2,573 3,638 7,916
Cumulative Net Operating Margin 7,256
3 Percent Salary Growth 0 (642) (199) (118) (1,016) (732) 397 2,935 5,539 6,620 10,966
Cumulative Net Operating Margin 23,750
Base Forecast - 90 (632) 880 508 1,335 2,836 5,591 8,157 9,739 12,681
Cumulative Net Operating Margin 41,185
The base Long Range Forecast, which includes a 2 percent increase in salaries in out years,
projects a GF deficit of $0.64 million in FY 2017 and a tiny deficit of $0.20 million in FY 2018 and
again in FY 2020 of $0.1 million. Otherwise, there are positive bottom lines through FY 2026,
albeit with rather marginal surpluses in Fiscal Years 2019 and FY 2021. Staff recommends pre-
empting the FY 2017 shortfalls during the FY 2017 budget process with one-time solutions and
while it works on options and recommendations that will mitigate any ongoing deficits.
The Alternative Forecast Models demonstrate the City’s acute vulnerability to poor pension
portfolio performance by CalPERS and to a lesser extent with 3 percent salary increases in out
years. Having healthy reserves, a separate pension trust plan, and exerting fiscal discipline in
the FY 2017 Budget process would help to offset some of the negative impacts revealed in the
table above. Moreover, they would allow the City flexibility and time to plan for further,
potential budget adjustments.
To address the anticipated higher pension costs, staff will bring forth a recommendation as part
of the Fiscal Year 2017 budget to establish a 115 Supplemental Pension Trust Fund with one-
City of Palo Alto Page 23
time sources. The funds in the pension trust fund can be used in the future to alleviate rising
pension costs for one or more fiscal years.
Although revenue receipts have improved considerably since the Great Recession, the City
continues to face numerous funding challenges such as:
Infrastructure rehabilitation costs exceeding original estimates
Rising benefits costs; and unfunded long-term pension and retiree healthcare liabilities
Funding a plethora of initiatives related to potential acquisition of the downtown Palo
Alto Post Office; non-profits such as the History Museum/Roth Building and Avenidas
Senior Center; the Cubberley Community Master Plan; and the Parks Master Plan
retaining and attracting a talented workforce that is responsive to the City Council
priorities and community expectations
Staff will explore options to reduce the unfunded liabilities with ongoing contributions once
funding gaps are addressed in the General Fund. As the City addresses the short and long-term
issues in this report, it needs to continue reviewing its operations and service delivery options.
Over the last few years, the City has outsourced services to the private sector and has entered
into negotiations with the non-profit sector for public-private partnerships. Staff is engaged in
finding a partner to effectively and efficiently operate Animal Services and is exploring different
service delivery options for the City’s aquatic operations. City staff will review cost recovery
levels for services provided to the residents and businesses. During 2016, staff will continue to
bring forward recommendations to increase fees for the Planning and Community Environment
Departments as well as other departments to align the fees with the cost recovery goals set by
the City Council approved User Fee Cost Recovery Level Policy.
Based on a recent analysis of incoming 2 percent and new hotel revenue levels and their
growth trends, staff believes that by FY 2019 the City can expect $8.5 million in receipts. At this
level, and compared to the original Infrastructure Plan analysis, there will be sufficient revenues
to cover up to $30 million in extra COPs for the Public Safety Building and the California Avenue
Garage. Should other Infrastructure Plan projects face higher costs, the picture becomes less
clear and likely will require constraining other expenses or pushing projects further into the
future. Should one or both of the alternative forecast scenarios occur, the City will face weighty
challenges which counsel further disciplined spending and advanced planning. Palo Alto has
demonstrated over the years being fiscally responsible in addressing deficits with permanent
solutions which it is prudent to continue.
During the next two months, staff will continue to monitor revenue sources as well as update
revenues and expenditures based on newly available information. This updated information
will be reflected in the FY 2017 Proposed Budget released to the City Council in late April 2016.
City of Palo Alto (ID # 6428)
Finance Committee Staff Report
Report Type: Action Items Meeting Date: 12/15/2015
City of Palo Alto Page 1
Summary Title: Fiscal Years 2017 to 2026 General Fund Long Range Financial
Forecast
Title: Fiscal Years 2017 to 2026 General Fund Long Range Financial Forecast
From: City Manager
Lead Department: Administrative Services
Recommendation
Staff recommends that the Finance Committee review, comment, and accept the Fiscal Year
2017 to 2026 General Fund Long Range Financial Forecast and forward the Forecast to the City
Council for acceptance.
Executive Summary
The Fiscal Year (FY) 2017 to 2026 General Fund Long Range Financial Forecast (LRFF), which
marks the beginning of the FY 2017 budget planning process, projects a slight General Fund
surplus of $0.1 million in FY 2017, a shortfall of $0.6 million in FY 2018, and surpluses in the
remaining years of the Forecast. Although economic indicators and rebounding tax revenues
reveal that the City of Palo Alto has reached a turning point from the Great Recession, this
Forecast reflects financial obligations and rising benefits costs that diminish the positive outlook
over the next 10 years. Despite improving revenue receipts as projected forward, the City
continues to face challenges related to the funding of infrastructure, the desire to retain and
attract a talented workforce to be responsive to the City Council and the community, rising
benefits costs, and unfunded long-term pension and retiree healthcare liabilities in the amount
of $439 million. Additionally, as an alternative Forecast Model shows, the City needs to prepare
for the next recession. While the base model captures the past 20 years of compounded
revenue annual growth rates, which includes economic booms and recessions, staff included
the alternative model for further discussion. While recessions are difficult to predict, history
shows that one will be experienced during the term of this Forecast.
In June 2014, the City Council approved the Infrastructure Plan in the amount of $125.8 million.
Since approval of the plan, the City was able to dedicate additional funding to close the initial
funding gap of $7.5 million and fund the related public art expenditure of $1.1 million, and a
small Infrastructure Plan Reserve of $0.8 million. However, as discussed during the Council
Infrastructure Plan Study Session on December 9, the projects identified in the Infrastructure
ITEM #12, ATTACHMENT A
City of Palo Alto Page 2
Plan are estimated to cost substantially more due to updated designs, rising construction costs,
and the State imposed requirement to pay prevailing wages. Some of these higher costs will be
funded through higher than previously estimated Transient Occupancy Tax receipts dedicated
to the Infrastructure Plan. Over the ten years of the Forecast, the additional funding for
Infrastructure is estimated at $68 million.
Since the Great Recession, the City Council has approved various strategies to mitigate the
rising cost of salaries and benefits. These strategies include: (1) employees paying their own
CalPERS contribution (between 6 percent to 9 percent of salary) except for the members of the
Fire Chiefs’ Association; (2) sharing future health plan cost increases; (3) creating a second
pension tier (and the state implemented a third tier effective January 1, 2013); (4) reducing
professional development expenses; (5) cost of living freezes for four years; and (6) terminating
the Variable Management Compensation Plan. Continuing with previous actions to curtail the
growth of benefits costs, in 2014, as part of approving the agreement with SEIU and the
compensation plan for Management and Professional employees, the City Council approved the
cost sharing of future health plan costs. Currently, the City is in negotiation with all of its
bargaining groups. It is the City’s desire to retain and attract a talented workforce.
Therefore, this Forecast includes salary and benefits adjustments based upon projected cost of
living increases and market changes. This Forecast provides a long-term view of the City’s
General Fund to provide a strategic focus for addressing future funding needs in the FY 2017
Proposed Budget and beyond. This Forecast assumes FY 2016 service level remain the same. As
in past years, the Forecast has been updated based on current information compiled from
various sources, in addition to utilizing available tools to project revenues and expenditures.
This document facilitates City Council members’ and staff’s understanding of the long-term
impacts of past decisions and identifies issues that must be addressed in the near and long-
term. The Forecast is not a prediction or a commitment of resources; rather, it is a reasonable
snapshot of the City’s future financial condition based on various assumptions and currently
available data.
A continuously improving economic climate is noted by the majority of national, state, regional,
and local economic indicators. This Forecast assumes a continued, gradual growth of the
national economy with positive impacts to the local economy, which is reflective in the
estimates of economically sensitive revenue estimates. It is important to note that consistent
with previous forecasts, the methodology for calculating changes for out-years of the Forecast
(FY 2017 to FY 2026) are based on a historical analysis of increases using the Compounded
Annual Growth Rate (CAGR) with adjustments factored in for known items. By using the
historical average growth rate that incorporates the up and down cycles over the past 10 or 20
years, there is no single year in which a downturn is depicted. Instead, past downturns (e.g. dot
com bust and Great Recession) have been factored into the compound growth rate used to
forecast future revenue streams. Staff performed a reasonableness test of the results and
made appropriate changes to the CAGR analysis.
ITEM #12, ATTACHMENT A
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As shown in the table below, the FY 2017 Forecast Budget anticipates a slight General Fund
surplus of approximately $0.1 million for FY 2017, a shortfall of $0.6 million in FY 2018, and
surpluses in the remaining years of the Forecast. During the forecast period, surpluses range
between $0.1 million and $12.6 million with an approximate cumulative one-time surplus of
$41.0 million. Assuming that the General Fund Budget Stabilization Reserve (BSR) is fully
funded at the City Council approved target level of 18.5 percent of General Fund operating
expenditures, $13.1 million would have to be set aside to maintain the target level. With these
funds set aside, the one-time resources projected in this Forecast would decrease by $13.1
million from $41.0 million to $27.9 million. It is important to note that the majority of these
surpluses are predicted in the last five years of the Forecast. The further we look into the
future, the less reliable these predictions are.
Fiscal Year 2017-2026 Long Range Financial Forecast
The table includes a calculation for the net operating margin which reflects the year over year
change of surpluses and shortfalls. With the net operating margin, it is assumed that each
shortfall is addressed completely with ongoing solutions in the year it appears, and that each
surplus is completely expended with ongoing expenditures. Based on these assumptions, the
cumulative net operating margin, or ongoing surplus, during the forecast period is
approximately $12.0 million, with the majority of these ongoing surpluses generated in the last
five years of the Forecast.
Although this Forecast presents overall a positive fiscal outlook for the City’s General Fund, it is
important to note that it does not include the following potential impacts, which can increase
or decrease the projected annual surpluses to the FY 2017 Projected Budget and the out-years
of the Forecast: (1) ongoing labor negotiations; (2) funding of the Council approved
Infrastructure Plan after completion of full design, increased construction costs, and prevailing
wage requirements; (3) operating budget impact of Infrastructure Plan projects; (4) cost impact
related to the Parks Master Plan; (5) additional costs related to the future Junior Museum and
Zoo facility; (6) potential acquisition of the downtown Palo Alto Post Office; (7) one-time costs
related to City assets managed by non-profits such as Avenidas Senior Center, the Palo Alto
History Museum, the Ventura Child Care Center, the Junior Museum and Zoo, or the Scout
Building; (8) Cubberley Community Center Master Plan; (9) construction loans for the Palo Alto
Airport; (10) potential termination of the Fire Services Contract with Stanford University; (11)
Cadillac Healthcare Federal Excise Tax expected to impact in calendar year 2018; (12) future
changes to pension plan assumptions by CalPERS; (13) Transient Occupancy Tax increases
ITEM #12, ATTACHMENT A
City of Palo Alto Page 4
related to two new hotels on San Antonio Road; (14) Tax revenue alignment with updated
Comprehensive Plan; and (15) changes in the local, regional, and national economy.
At this time, staff projects a $6.5 million General Fund budget surplus for FY 2016. This surplus
assumes City Council authorized budget amendments to date and includes higher tax revenue
estimates as indicated in this Forecast ($5.5 million) and expenditure savings related to the
Retiree Healthcare Implied Subsidy ($1.0 million) as discussed further in the Salary and Benefits
section of this report. The majority of the excess revenue is related to the Transient Occupancy
Tax of which $4.2 million will be recommended for transfer to the Capital Improvement Fund
for the Infrastructure Plan as part of the Fiscal Year 2016 Midyear Budget Review report. This
amount does not assume any other recommendations to adjust revenues and expenditure that
staff intends to bring forward for City Council consideration as part of the FY 2016 Midyear
Budget Review. During the next few months, staff will continue to monitor revenues and
expenditures based on available information and include these updates in the FY 2017
Proposed Budget scheduled for release late April 2016.
Officially, the Great Recession ended in June 2009. According to the National Bureau of
Economic Research, the average duration of a business cycle from 1945 to 2009 lasted about six
years and the period between the last two recessions was about ten years. Therefore, staff has
provided an alternative Forecast model which assumes a recession in the first half of Fiscal Year
2019. As can be seen from this model, the City needs to start preparing for the next recession.
As discussed this fall with the City Council and Finance Committee, during a recessionary
period, the City is expected to receive less revenue and pension cost expenses increase. The
Budget Stabilization Reserve has been used in the past in small parts to buffer revenue
decreases. To address the anticipated higher pension costs, staff will bring forth a
recommendation as part of the Fiscal Year 2017 budget to establish a 115 Supplemental
Pension Trust Fund with one-time sources. The funds in the pension trust fund can be used in
the future to mitigate rising pension costs for one or more fiscal years.
Economic Outlook
In preparing the FY 2017 to 2026 General Fund Long Range Financial Forecast, key economic
indicators and measures available through various publications and reports were reviewed.
Overall, the economic outlook for 2017 calls for continued measured optimism even as global
economic conditions continue to produce uneven economic growth across regions and sectors.
International
As a world renowned hub of technological innovation, and at the heart of the Silicon Valley,
Palo Alto is connected to the global economy in immeasurable ways. According to the October
2015 World Economic Outlook (WEO), “global growth for 2015 is projected at 3.1 percent, 0.3
percentage point lower than in 2014, and 0.2 percentage point below the forecasts in the July
2015 World Economic Outlook Update.”i
ITEM #12, ATTACHMENT A
City of Palo Alto Page 5
Slower global activity is taming inflation in 2015. The continued moderate growth is a
combination of advanced economies anticipating continued grow contrasted with anticipated
declines in emerging markets for the fifth year. With declining commodity prices, depreciating
emerging market currencies, and increasing financial market volatility, downside risks to the
outlook have risen, particularly for emerging markets and developing economies. Modest
increases are anticipated in advanced economies as a result of the strengthening of the euro
and a return of positive growth in Japan assisted by declining oil process and monetary
policies.ii
Looking forward, “Global activity is projected to gather some pace in 2016. In advanced
economies, the modest recovery that started in 2014 is projected to strengthen further. In
emerging market and developing economies, the outlook is projected to improve: in particular,
growth in countries in economic distress in 2015 (including Brazil, Russia, and some countries in
Latin America and in the Middle East), while remaining weak or negative, is projected to be
higher next year, more than offsetting the expected gradual slowdown in China.”iii
United States
In November 2015, the Bureau of Economic Analysis revised their Q3 2015 Gross Domestic
Product (GDP) second estimate to 2.1% compared to the 3.9% increase during Q2. The increase
in Q3 is primarily reflective of “positive contribution from personal consumption expenditures,
nonresidential fixed investment, state and local government spending, residential fixed
investment, and exports that were partially offset by a negative contribution from private
inventory investment.”iv
Overall, Q1 2014 continues to be the worst first quarter showing since Q1 2009, amidst the
Great Recession period, which has been attributed the sharp decline in output and productivity
to unusually cold weather in much of the US in early 2014. According to the UCLA Anderson
Forecast, the federal funds rate is forecasted to be about 1.5 percent by the end of 2016 and
approximately 3.25 percent at the end of 2017. This combined with the continued job growth
and anticipated wage growth will drive consumption levels upward in 2016 leading to the first
year of greater than 3.0% in real GDP since 2005.v The chart below provides a quarterly view of
GDP growth from 2009 to present.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 6
As noted briefly above, the UCLA Anderson Forecast cites several factors attributing to their
favorable outlook for 2016. As of December, UCLA Anderson Senior Economist David Shulman
cites, that “employment remains healthy, with the economy generating jobs at a
200,000-a-month clip that will bring it further declines in the unemployment rate to 4.6
percent.”vi As a result of the continuing decline in unemployment, reaching nearly full
employment levels, and the continued upward pressure on wage increases, it is anticipated
that the likelihood of inflation reaching its 2.0 percent target will be achieved. National
Unemployment levels continue to decline, and are holding steady at October 2015 levels of 5.0
percent in November 2015. This is 13.8 percent below November 2014 levels of 5.8 percent.vii
With the higher wages and a slight rebound in oil prices and housing costs resulting in inflation
reaching 2.0 percent, UCLA Anderson Forecast anticipated that the Fed will begin to normalize
the Federal Funds rate and gradually begin to tighten.viii
California
California’s economy continues to be a bright spot in the nation’s economic outlook with job
growth continuing to outpace national levels. According to the Bureau of Labor Statistics (BLS),
California’s unemployment rate dropped from 7.2 percent in October 2014 to a preliminary
estimate of 5.8 percent in October 2015, a 19.4 percent decline.ix The current UCLA Forecast
echoes this and forecasts continued steady gains in employment through 2017 with an
unemployment rate of 4.9 percent by the end of the forecast period.
In addition, UCLA Anderson Forecast senior economist Jerry Nickelsburg reviewed economic
indicators that differentiate the state of California from the U.S. average forecast such as trade
through California’s ports, travel through international airports, state government finances, and
residential construction and employment. Overall, continued steady growth through 2017 is
anticipated in these sectors with some notable historical highs in port activity in September
ITEM #12, ATTACHMENT A
City of Palo Alto Page 7
2015 as well as record levels of travel, continued residential construction, and steady growth in
employment of 2.6 percent for 2016 and 1.4 percent for 2017. California’s payroll will grow
more, at about the same rate and personal income growth is estimated to be 4.3 percent in
2015 and forecast to be 3.4 percent in 2016 and 3.2 percent in 2017.x
According to the Zillow Home Value Index, the median home value in California for October
2015 is $449,500. California home values have gone up 5.8 percent over the past year (October
2014 to October 2015) and Zillow predicts they will rise 2.8 percent within the next year. The
median price of homes sold is $418.250. xi
Palo Alto and the Bay Area
Palo Alto’s traditional economic indicators of growth and prosperity, which are highlighted
below, continue to be strong. The unemployment rate in the San Jose, Sunnyvale, Santa Clara
Metropolitan Statistical Area (MSA), ticked up slightly in the preliminary October 2015 estimate
to 4.0 percent, up from 3.7 percent in September 2015, but down from the October 2014 rate
of 5.0 percent.xii
The employment picture, though returning to normalcy nationally, is showing different
influential factors. Of particular focus in the UCLA Anderson Forecast and significant to the
Silicon Valley in particular is the office-using employment which includes the three leadings
sectors – information, financial services, and professional and businesses services.
These positions are significant as they have the highest average annual salaries for their
employees ranging from $70,070 to $105,000 annually. This is compared to other employment
sectors such as manufacturing, education and health, trades, and leisure and hospitality which
range from $34,490 to $61,000 annually. Therefore, growth in these lucrative sectors is critical
to the prosperity of cities as they bring significant purchasing power.
Finally, home values in Palo Alto continue to reach new highs. According to the Zillow Palo Alto
Real Estate Market Summary, the average price per square foot for Palo Alto was $1,468, an
increase of 12.6 percent compared to the same period last year. The median sales price for
homes for August 2015 to November 2015 was $2.5 million, a 22.5 percent increase from the
same period a year ago. Over the last five years, sales have appreciated a staggering 154.2
percent in Palo Alto. The number of sales has increased 1.2 percent and the average list price
for homes was $3.1 million, according to Trulia.xiii
Fiscal Year 2017-2026 General Fund Long Range Financial Forecast
The FY 2017-2026 General Fund LRFF projects a slight General Fund surplus of $0.1 million for
FY 2017, a shortfall of $0.6 million in FY 2018, and surpluses in the remaining years of the
Forecast. During the forecast period, surpluses range between $0.1 million and $12.6 million
with an approximate cumulative one-time surplus of $41.0 million. Assuming that the General
Fund Budget Stabilization Reserve (BSR) is fully funded at the City Council approved target level
of 18.5 percent of General Fund operating expenditures, $13.1 million would have to be set
aside to maintain the target level. With these funds set aside, the one-time resources projected
ITEM #12, ATTACHMENT A
City of Palo Alto Page 8
in this Forecast would decrease by $13.1 million from $41.0 million to $27.9 million. It is
important to note that the majority of these surpluses are predicted in the last five years of the
Forecast. The further we look into the future, the less reliable these predictions are.
The operating margin reflects the variance between the projected General Fund revenues and
expenditures for each year of the forecast or the annual surplus or deficit. With the operating
margin, the year over year change in surpluses and deficits, it is assumed that each shortfall is
addressed completely with ongoing solutions in the year it appears and that each surplus is
completely expended with ongoing expenditures. During the Forecast period, the net
operating margin fluctuates between negative $0.6 million and positive $2.9 million. Although
this Forecast projects healthy revenue growth, the revenue growth is barely keeping pace with
the projected expenditure growth during the first five years of the Forecast. In the second half
of the Forecast, revenues substantially outpace expenditures resulting in significant surpluses
ranging from $2 to $12 million annually. This is primarily due to tapering off of City pension
rate increases as discussed further in the salary and benefits section of this report.
Fiscal Year 2017-2026 Base Long Range Financial Forecast
The graph below provides a representation of the operating and net operating margin of the
base model as described above.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 9
It should be noted that this Forecast, as outlined in the following sections of this report, does
not include the following potential impacts to the FY 2017 Projected Budget and the out-years
of the Forecast:
(1) Labor negotiations: The City is currently in negotiations with the Palo Alto Police Officers
Association (PAPOA), the International Fire Fighters Association (IAFF), the Service
Employees International Union, the Police Management Association, and the Fire Chiefs
Association. Any agreements reached between the City’s bargaining units and approved
for the Management and Professional Personnel Compensation Plan and the City will be
incorporated into future budgets and forecasts, as applicable.
(2) Infrastructure Plan capital budget impacts: In June 2014, the Infrastructure Plan was
approved by the City Council and contains $125.8 million in projects recommended by the
Infrastructure Committee; however, the Plan’s construction and design costs were based
on data from 2012. As construction costs have increased and the City is required to pay
prevailing wages, the Plan is not sufficiently funded. However, the higher than
anticipated revenues for Transient Occupancy Taxes related to new hotels and the 2%
voter approved tax increase will partially offset the higher construction costs.
(3) Infrastructure Plan operating budget impacts: In June 2014, the City Council approved the
Infrastructure Plan which includes $125.8 million in projects recommended by the
Infrastructure Committee. This Forecast does not assume ongoing operating impacts as a
result of the Infrastructure Plan, but future forecasts will include operating cost impacts as
the specific projects are designed.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 10
(4) Parks Master Plan: the Parks Master Plan will be finalized in 2016 and future forecasts will
include associated cost impacts as necessary.
(5) Junior Museum and Zoo: In November 2014, the City Council directed staff to negotiate a
capital lease with the Friends of the Junior Museum and Zoo for the reconstruction of the
Junior Museum and Zoo. This Forecast does not assume any additional operating costs
related to the renovated building.
(6) Acquisition of the downtown Palo Alto Post Office: The City may acquire the downtown
Palo Alto Post Office with the plan to relocate staff from leased facilities. The acquisition
would be financed through issuance of debt with the annual debt service paid through
lease cost savings. If the Palo Alto Post Office is acquired, it would require substantial
improvements while the City pays the annual debt service, and during that time the City
will also have to continue paying for leasing existing facilities. Staff is reviewing potential
strategies, which would reduce the impact to the General Fund in the short-term.
(7) City owned assets operated by non-profit organizations: This Forecast does not include
any additional capital investments for the Avenidas Senior Center, the Palo Alto History
Museum, the Ventura Child Care Center, the Junior Museum and Zoo, or the Scout
Building.
(8) Cubberley Community Center Master Plan: The FY 2016 Adopted Capital Budget included
funding for the Cubberley Community Center Master Plan. Costs in excess of the
dedicated Cubberley infrastructure funding as agreed to between the Palo Alto Unified
School District and the City are not assumed in this Forecast.
(9) Loans to the Airport Fund for capital improvement projects: Staff intends to apply for
Federal Aviation Administration (FAA) reimbursable grants during the Forecast period. If
approved, the FAA reimburses 90% of capital improvement costs. Since some of these
capital improvements may bridge fiscal years, the General Fund may have to provide
loans crossing fiscal years until the Airport Fund receives the FAA reimbursements.
(10) Fire Services Contract with Stanford University: On October 8, 2013, the City received a
Notice of Termination letter from Stanford with the intent to terminate the contract with
the City no sooner than one year and no later than two years from the date of the notice.
During the termination period as well as the last two months, the City continued to
negotiate with Stanford to settle on a service level and cost. This Forecast assumes the
continuation of the contract for $6.5 million.
ITEM #12, ATTACHMENT A
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(11) Cadillac Healthcare Federal Excise Tax: Beginning 2018, a 40 percent excise tax will be
imposed on the value of health insurance benefits that exceed a certain threshold.
CalPERS may be able to design healthcare premiums to stay below the threshold and
discussions are in the preliminary stage. Congress is also discussing possibly delaying or
modifying this tax. If the tax is applicable, the City may have to pay the tax.
(12) CalPERS City contribution increases: Currently, CalPERS assumes an annual investment
return of 7.5%. This Forecast assumes that CalPERS will meet the annual investment
return. However, staff provided an alternative Forecast which assumes a poor investment
return for the next ten years. Further, the CalPERS Board approved a gradual de-risking
strategy, which is intended to reduce the assumed investment return to 6.5% over the
next 20 years in the years when CalPERS earns an investment on its portfolio in excess of
11.5%. In the event that the de-risking strategy does not result in a reduction of the
expected rate of return, the CalPERS board will revisit this assumption as part of their
process starting in November 2017 with formal action to take place in February 2018.
(13) Transient Occupancy Tax increases related to two hotels on San Antonio Road: The City is
in the process of reviewing plans for two Mariott hotels with a potential location at San
Antonio Road. This Forecast does not assume any potential Transient Occupancy Tax
increases from these two hotels.
(14) Tax revenue alignment with updated Comprehensive Plan: The City is currently in the
process of updating its Comprehensive Plan including the potential fiscal impact of various
land use scenarios. The fiscal impact of various land use scenarios will be brought forward
for City Council discussion in 2016.
(15) Changes in the local, regional, and national economy: This Forecast assumes a steadily
growing local economy. Any changes may have positive or negative impacts on
economically sensitive revenues such as Sales Tax and the Transient Occupancy Tax.
At this time, staff projects a $6.5 million General Fund budget surplus for FY 2016. This surplus
assumes City Council authorized budget amendments to date and includes higher tax revenue
estimates as indicated in this Forecast ($5.5 million) and expenditure savings related to the
Retiree Healthcare Implied Subsidy ($1.0) as discussed further in the Salary and Benefits section
of this report. The majority of the excess revenue is related to the Transient Occupancy Tax of
which $4.2 million will be recommended for transfer to the Capital Improvement Fund for the
Infrastructure Plan as part of the Fiscal Year 2016 Midyear Budget Review report. This amount
does not assume any other recommendations to adjust revenues and expenditure that staff
intends to bring forward for City Council consideration as part of the FY 2016 Midyear Budget
Review.
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Since the Great Recession, the City Council has approved various strategies to reduce the costs
of salaries and benefits. These strategies include: (1) employees paying their own CalPERS
contribution (between 6 percent to 9 percent of salary) except for the members of the Fire
Chiefs’ Association; (2) sharing the cost of health plan costs at 90/10; (3) creating a second
pension tier (and the state implemented a third tier effective January 1, 2013); (4) reducing
professional development expenses; (5) cost of living freezes for four years; and (6) terminating
the Variable Management Compensation Plan. Continuing with previous actions to curtail the
growth of benefits costs, in 2014, as part of approving the agreement with SEIU and the
compensation plan for Management and Professional employees, the City Council approved the
cost sharing of future health plan costs. However, in comparison to market studies to
comparable agencies, the salaries of our employees, primarily safety employees, have fallen
behind. Currently, the City is in negotiation with all of its bargaining groups. It is the City’s
desire to retain and attract a talented workforce. Therefore, this Forecast includes salary and
benefits increases to adjust employees’ salaries to the average of the market over the next few
years. Due to these adjustments, for Fiscal Year 2018 only, revenue growth is outpaced by a
salary and benefits growth resulting in a shortfall of about $0.6 million. Looking forward to the
next fiscal year, in Fiscal Year 2019, this Forecast predicts a surplus of $0.9 million. Therefore,
the projected Fiscal Year 2018 shortfall can be bridged with one-time funding.
The next section of the report discusses the analysis and assumptions of major revenue and
expenditure categories. Consistent with the 2016-2025 LRFF, the methodology for calculating
changes for out-years of the Forecast (FY 2018 to FY 2026) are based on a historical analysis of
increases using the Compounded Annual Growth Rate (CAGR) with adjustments factored in for
known items. Staff performed a reasonableness test of the results. Typically, the average
business cycle lasts six years and the period between the last two recessions was about ten
years. Therefore, this report includes an alternative Forecast model with a recession assumed
in Fiscal Year 2019.
Revenues
City of Palo Alto tax revenues continue to parallel the strong local economy. Robust residential
and commercial property values, business driven transient occupancy and daily rates, and the
emergence of new hotels have propelled key revenue sources upward since Fiscal Year 2013.
The fundamental economic drivers of low unemployment, strong incomes in Silicon Valley,
vibrant business activity, and the demand for Palo Alto property will continue to buttress
revenue in the near future.
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Fiscal Year 2017-2026 Long Range Revenue Forecast
The tables above (also available in Attachment A) highlight the annual revenue estimates and
year over year increases for this Forecast. Compared to FY 2016 projected, FY 2017 revenues
are estimated to increase by $5.0 million, or approximately 2.6 percent. Based on the
economic analysis presented in the previous section of this report, revenue estimates, which
are primarily linked to the performance of the regional and local economy, are reflective of
increased consumer spending, continued rise in home prices, and the opening of hotels. The
upward trend of the City’s tax revenues is expected to continue over the next 10 years.
These tax revenues have significantly improved since the beginning of the Great Recession. The
table above illustrates the steady growth projected for the General Fund’s revenue streams, by
percentage, from FY 2017 through FY 2026.
During the 2013 Finance Committee discussions, it was recommended that staff consider use of
a historical annual growth rate derived for each tax revenue source to project future revenue
streams. This methodology was used in the final forecast presented for FY 2015 to 2025 and
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has been used in this forecast as well. The Compound Annual Growth Rates (CAGR) utilized in
this Forecast is cited in each revenue section and reflected in the revenue section table.
The graph above depicts a historical and the base model projected view of the five major
General Fund tax revenues. It includes 10 years of actual revenue history; the projections for FY
2016 based on actual data available for the first five months of the fiscal year; as well as the
projections for FY 2017 and the subsequent years of the Forecast. Revenue forecasts are based
on current data and application of the Compound Annual Growth Rate (CAGR) methodology.
The following section is a detailed discussion of General Fund Tax revenue and other major
revenue sources by category.
Sales Tax
Sales taxes have risen from a low of $17.9 million in FY 2010 to a projected level of $27.9
million in FY 2016. They are expected to grow by a compound annual growth rate of around 2.6
percent through FY 2026. Staff has factored into the forecast weakening receipts over the past
several years from a few key generators. In addition, the ongoing movement of tangible good
purchases from brick and mortar stores to online vendors continues and poses a long-term
threat. Evidence of this was reported in a December 1, CNBC article, “According to the Adobe's
Digital Index, total online sales on Cyber Monday rose 16 percent compared to last year, to
$3.07 billion.” The article goes on to say that in-store data “showed sales were down an
estimated 10.4 percent over Black Friday weekend” compared to the prior year.
As reported to Council, there was a one-time tax windfall from one vendor in FY 2014 and a
Government Accounting Standards Board tax accrual adjustment in FY 2015. In each year, sales
tax was reported at $29 million. As shown below, the FY 2016 and FY 2017 projections return
to a more realistic level in 2017.
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TABLE 1: SALES TAX REVENUE BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $22.1 $25.6 $29.4 $29.7 $27.9 $28.5
Restaurant and auto sales are trending higher, while department store and electronic firm sales
are trending lower. The State will terminate its “triple flip” program this January so the City
will receive more timely payments and slightly higher interest earnings due to better cash flow.
The CAGR applied to the period FY 2016 through FY 2025 is 2.6 percent which is in line with
historical growth rates.
Property Tax
As the table below indicates, since FY 2012 property taxes have risen substantially. Staff
projects this source to grow at 5.9 percent over the next ten years which is in line with
historical trends. The recent purchases of the Tibco Site in the Stanford Research Park ($330
million) and the Epiphany Hotel ($71.6 million) evidence a compelling commercial real estate
market. Other contributing factors include: single family home sales that have exceeded asking
prices and the unleashing of latent property values from the sale of long held homes that were
“shielded” from assessed value appreciation by Proposition 13.
TABLE 2: PROPERTY TAX REVENUE BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $26.5 $28.7 $30.6 $34.1 $35.1 $37.5
The City’s property tax estimate for FY 2016 is based on information received from quarterly
meetings with the Santa Clara County Assessor’s Office. The estimate includes appeals on
record with the Assessor’s Office, additions to the roll, and movements in assessed values.
Projections beyond FY 2016 are based on historical growth rates. The CAGR used in this 10 year
forecast equals 5.9 percent, slightly higher than the 5.4 percent in last year’s forecast. This
higher growth rate is justified by the factors cited above.
As requested by the City Council, staff contacts the Palo Alto Unified School District (PAUSD)
regarding their assumptions in property tax growth. Typically, the initial growth assumptions
used by PAUSD in developing their budget are lower than the City’s.
As the budget year progresses, however, PAUSD will align their property tax revenue with
actual increases that tend to be closer to the City’s projections. PAUSD’s growth rate
assumption for FY 2016 was 5.34 percent.
In FY 2015, the Administrative Services Department contracted with a firm to produce detailed
reports on property taxes. The consultant’s reports have provided key insights into Palo Alto’s
real estate market that supports property taxes growing at around 6 percent per year,
including:
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There are 8,010 residential properties in Palo Alto under $600,000 in Assessed Value
(AV). These properties, over a seven year period ending in FY 2015, turned over at an
average rate of 582 annually.
On average, 3.1 percent of the above residential parcels annually changed ownership
and the average AV increased by 171 percent. For example, a property with an AV of
$1,000,000 is expected to sell in today’s market at $1,710,000 which is somewhat
conservative given current sale prices.
Per the 2015-2016 Assessor’s Roll, average Assessed Value of residential properties in
Palo Alto equal $1,080,000.
Transient Occupancy Tax (TOT)
As the table below shows, Transient Occupancy Taxes continue to perform exceptionally well.
As summarized in the table below, average daily room rates and occupancy levels continue to
demonstrate considerable strength since FY 2011. Generally, occupancy levels between 80 and
85 percent indicate full occupancy. Demand for Palo Alto rooms is strong, leading to
construction and planned construction of five new hotels. A vibrant business and tourist
environment has led to a surge in hotel bookings from San Francisco down through the
Peninsula to San Jose.
TABLE 3: TRANSIENT OCCUPANCY TAX BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016* 2017
General Purpose Revenue
(millions)
$9.7 $10.8 $12.3 $13.4 $15.3 $16.1
Infrastructure Revenue (millions) N/A N/A N/A $3.3* $9.2 $9.7
TOTAL $9.7 $10.8 $12.3 $16.7 $24.5 $25.8
Average Daily Room Rate $165 $182 $208 $208 $253 N/A
Average Occupancy (percent) 79% 80% 79% 79% 80% N/A
* This $3.3 million is currently retained in the Budget Stabilization Reserve to support Infrastructure
Plan projects, as recommended for approval by the Finance Committee as part of closing the Fiscal
Year 2015 budget.
** Projected revenue based on trend and Fiscal Year 2016 year to date data. Average Daily Room Rate
and Occupancy are year-to-date through October 2015.
This forecast includes estimated revenues for all of the new hotels that have come on-line, the
Epiphany and the two new Hilton hotels as well as the Westin Annex which is expected to open
this year. Plans for a hotel on the Ming’s restaurant site have been terminated. The new hotels
planned for San Antonio Road are not included in the LRFF. Revenues from the 2.0 percent TOT
increase effective January 1, 2015 and from the new hotels that are dedicated to infrastructure
are isolated in the LRFF. The CAGR applied to the period FY 2016 through FY 2026 is 4.8
percent which is in line with historical growth rates.
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Documentary Transfer Tax (DTT)
After two solid years of unusually strong performance, the Documentary Transfer Tax will likely
approach more normal levels in FY 2016. Through November 2015, transactions and receipts
are down 24 percent and 35 percent, respectively, compared to the same prior year period. As
mentioned above, there were sizable, one-time transactions (Hudson Pacific purchases of office
space) along the Page Mill corridor last FY that are unlikely to be duplicated in FY 2016. Based
on current activity, staff expects $7.1 million in FY 2016 with a mild uptick in FY 2017 to $7.4
million.
TABLE 4: DOCUMENTARY TRANSFER TAX BY FISCAL YEAR (MILLIONS)
Fiscal Year 2012 2013 2014 2015 2016 2017
Revenue $4.8 $6.8 $8.1 $10.1 $7.1 $7.4
The CAGR applied to the period FY 2016 through FY 2026 is 5.8 percent, again, in line with prior
year CAGR trends.
Utility Users Tax (UUT)
The Utility Users Tax forecast includes a 5 percent tax on water, gas and electric usage and a
4.75 percent tax on telephone activity. In FY 2015, the step down tax for large users of utilities
was eliminated.
Receipts anticipated from the UUT are based on the Utilities Department’s five-year revenue
and rate projections. These estimates could change as the department discusses its proposed
rate plan with the Utilities Advisory Commission and the City Council during the annual budget
process. With the drought and heightened water conservation efforts as well as lower gas
prices and consumption, the utilities UUT is expected to decline from FY 2015 to FY 2016.
Revenues in FY 2015 registered at $7.6 million and these are expected to drop to $7.1 million in
FY 2016. Upward movement in revenues is anticipated in FY 2017 with increasing rates.
Telephone receipts have been increasing marginally since FY 2014 and are expected to do so
despite the drop of 0.25 percent in the UUT rate for this category.
Other Taxes & Fines
Based upon a review of historical collection patterns, it is anticipated that the budgeted
revenue estimate for this category will need to be reduced as part of the FY 2017 Proposed
Operating Budget. As such, this forecast assumes a reduction of 7.2 percent, primarily
attributable to lower parking violations and library fines. In the remaining years of the forecast,
revenues are anticipated to increase between 2.7 and 4.9 percent.
Charges for Services
For FY 2017, total revenues in this category will increase 1.7 percent or $296,000 from the FY
2016 Adopted Budget. Revenues collected primarily reflect the costs to provide services to the
community and therefore, are significantly impacted by personal service costs. The slight
increase reflects an increase in estimated receipts to maintain cost recovery levels in FY 2017
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partially offset by any one-time revenue adjustments approved as part of the FY 2016 Adopted
Budget and adjustments reflective of the Golf Course closure in Fiscal Year 2017. The golf
course revenues are decreased by $542,000 from the FY 2016 Adopted budget due to the
anticipated closure. This decline in revenues is partially offset by a reduction in contract
services associated with operating the Golf Course. As discussed in City Manager Report (CMR)
#6335, to be heard by the City Council on December 14th, 2015, the Golf Course is now
anticipated to remain open through the end of FY 2016 and construction is now anticipated to
begin in the summer of 2016 and continue through FY 2018.
Ongoing, this Forecast assumes an increase in charges for services revenue by approximately
3.1 percent to account for general salary and benefit increase included in the Forecast. These
figures do not include Charges for Services revenue for Stanford Fire & Dispatch which is
explained in further detail below.
Stanford Fire & Dispatch Services
The City has two separate agreements with Stanford University to provide fire response
services and emergency dispatch services. As part of these agreements, Stanford is charged
30.3 percent of the Fire Department’s net cost and 16 percent of the Police Department’s
Communication and Dispatch Division to reimburse the City for Stanford’s proportional share of
these services. The term of the fire response service contract between the City and Stanford is
through September 30, 2026; however, at Stanford’s request, the two parties have been in
negotiations over the past two years to restructure the contract. On October 8, 2013, the City
received a Notice of Termination letter from Stanford with the intention to terminate the
contract with the City no sooner than one year and no later than two years from the date of the
notice. During the termination period as well as the last two months, the City continued to
negotiate with Stanford to settle on a service level and cost. Based on outcome of these
negotiations, this Forecast assumes the continuation of the Fire Services contract for $6.5
million and dispatch contract for $741,000 with Stanford University escalated by the increased
salary and benefits costs.
Permits and Licenses
Revenue from permits and licenses has experienced consistent growth over the past several
years, primarily due to increased development activity around Palo Alto. Based on year-to-date
estimates, FY 2016 revenues are projected to reach the Adopted Budget revenue estimate of
$8.2 million. Revenues collected primarily reflect the costs to provide services to the
community and therefore, are significantly impacted by personal service costs. In FY 2017,
revenues in this category are expected to increase 5.6 percent, consistent with the projected
increased personal service costs. From the FY 2016 projected level with ongoing annual
increases of 2.6 percent through the forecast. As discussed in the FY 2016 Adopted Budget, the
Planning and Community Environment and Development Services departments are reviewing
the cost recovery model for these departments. Upon completion of this analysis, the staff will
evaluate changes in planning and development fees and bring forward recommended
adjustments as appropriate as part of the annual budget process.
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Return on Investment
Interest earnings continue to be depressed as a consequence of the Federal Reserve’s loose
monetary and interest policies. Expectations for earnings from investments are around $0.9
million which is a 1.9 percent increase from FY 2015 yearend projections.
Rental Income
The largest source of rental income comes from the City’s Enterprise Funds and the Cubberley
Community Center. Compared to the FY 2016 Adopted Budget, rental income will decrease
from $15.3 million to 15.0 million. The decrease includes a projected loss of $500,000 in rental
income at Cubberley due to Foothill College moving out. As part of the development of the
Fiscal Year 2017 budget, staff will pursue replacement tenants to offset the rental loss figure
related to Foothill College. The forecast does assume that by Fiscal Year 2018, Cubberley will
have new tenants on board resulting in a rental income revenue increase of $200,000. The
forecast out years also assume a 2.6 percent growth for all rental properties, except for the
Refuse Fund rent which is assumed until FY 2021 as approved by the City Council to account for
the closing costs related to the Middlefield Well landfill site.
Revenue from Other Agencies
Included in this category is funding from Community Services Outreach theatre programs,
reimbursements from the Palo Alto Unified School District (PAUSD) for School Resource
Officers, and state and federal grants, if received. Many of these revenue streams are difficult
to predict and are dedicated often to specific purposes. In this category revenues over the past
five fiscal years have remained well below $0.5 million. This forecast assumes $0.4 million for
FY 2017 with a growth rate of approximately 1.3 percent in subsequent years due to the
unpredictability of this funding source.
Charges to Other Funds
Approximately 86 percent of this category is General Fund administrative cost plan charges to
the Enterprise and Internal Service Funds. Internal support departments such as ASD, HR, and
Council Appointees provide services to enterprise and internal service funds. The costs for
these services are recuperated through the administrative cost plan charges. The charges for
Fiscal Year 2017 are determined based on actual services provided in Fiscal Year 2015. The FY
2017 projected amount is $11.5 million, a decrease of 3.2 percent, from the FY 2016 Adopted
Budget. The decrease in cost plan charges to the Enterprise and Internal Service funds is
attributable to internal support departments providing more support to General Fund
departments in Fiscal Year 2015. The forecast includes increases ranging between 2.6 to 4.9
percent each year based primarily on assumed increases in salary and benefit costs. In addition
to the General Fund administrative cost plan, this revenue category includes several other
allocations, most notably Public Works administration charged to Public Works Enterprise
Funds and public safety communication services provided to the Utility Department.
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Other Revenues
Major revenue sources in this category are reimbursements for the Shuttle program (e.g. City of
East Palo Alto), Animal Services charges to Los Altos and Los Altos Hills, reimbursements from
PAUSD for its share of Cubberley and athletic field maintenance, donations from non-profits to
City libraries, and miscellaneous revenues. Revenues for this category are estimated to decline
by 16.4 percent in FY 2017, mostly due to the elimination of $0.3 million in one-time revenue in
approved in the FY 2016 Adopted Budget. The FY 2017 projected revenue for this category is
$1.3 million, with a 2.6 percent to 2.8 percent annual increase forecasted for through FY 2026.
Operating Transfers In
Operating Transfers include the equity transfer from the Electric and Gas funds as well as
transfers from the University Ave Parking Permit Fund. In accordance with a methodology
approved by Council in June 2009, the equity transfer is calculated by applying a rate of return
to the capital asset base of the Electric and Gas funds. This rate of return is based on PG&E's
rate of return on equity as approved by the California Public Utilities Commission (CPUC). Using
the Utility Department’s projections from the Electric and Gas Five Year Financial Forecasts, as
approved by the City Council in spring 2015, the equity transfer from the Electric and Gas funds
are projected to increase from $17.3 million in FY 2016 to $18.8 million in FY 2017 (8.4
percent), and then increase annually by 2.3 percent over the rest of the forecast period. The
higher increase in FY 2017 reflects updated Gas Fund capital asset data while the subsequent
years reflect the average annual adjustment in the equity transfer since 2009. Overall
Operating Transfers are estimated to increase to $20.1 million in FY 2017, an increase of $1.5
million from the 2016 Adopted Budget level of $18.6 million.
Expenditures
As part of developing the FY 2017 Forecast expenditure budget, the General Fund expenditure
categories have been adjusted by removing FY 2016 Adopted Budget one-time expenditures
and updating major cost elements such as salary and benefits costs. The tables below display
the General Fund expense forecast. Compared to FY 2016 Adopted Budget, FY 2017
expenditures are estimated to increase by $9.7 million, or 5.2 percent primarily due to
increased salary and benefits, an increased transfer to infrastructure, and allocated charges
costs from Enterprise Funds and Internal Service Funds.
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Fiscal Year 2017-2026 Long Range Expenditure Forecast
Salary and Benefits
The table above (also available as an attachment) depicts the salaries and benefits costs for the
next ten years. Over the Forecast period, the salaries and benefits cost gradually increase in
comparison to the total expenditure budget. In FY 2017, salaries and benefits costs represent
60.6 percent of the expenditure budget; in FY 2026, the salaries and benefits cost represent
61.8 percent of the budget. In the same period, though, the benefits cost as a percentage of
total salaries and benefits costs increase from 50.6 percent in FY 2017 to 53.7 percent in FY
2026. Over the Forecast period, salaries compounded growth is 28.0 percent versus a
compounded growth in benefits costs of 42.4 percent. This compounded growth is less than
estimated in the previous Forecast primarily due to lower estimated City pension contributions
in the out-years of the Forecast as described in more detail below. The following sections
describe the assumed increases in salary and benefits costs and depict the reasons for the
faster increasing benefits versus salaries costs.
Salary
Consistent with the City’s change in salary budget methodology that was implemented as of
recent budgets, positions are budgeted at actual rate of pay including benefits as of fall 2015.
Then, by position, salary costs are updated in accordance with applicable Memoranda of
Understanding (MOU) between the City and its labor groups and the Management and
Professional Personnel and Council Appointees Compensation Plan. It is important to note that
the City is currently in negotiations with the Palo Alto Police Officers Association (PAPOA), the
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International Fire Fighters Association (IAFF), the Service Employees International Union, the
Police Management Association, and the Fire Chiefs Association. This Forecast includes salary
and benefits increases based on projected increases in the cost of living and market based
adjustments. The Forecast also assumes step increases consistent with applicable MOUs and
merit increases for Management and Professional employees.
Benefits
Pension
The forecast includes the pension rates from CalPERS as of the June 30, 2013 valuation for the
City’s Miscellaneous and Safety plans, as updated by Bartel Associates (Bartel), the City’s
actuary. Staff asked Bartel to update the pension rates based on the latest available
information from CalPERS since CalPERS advised cities that the actuarial valuations as of June
30, 2014 will become available in December and project the rate for the ten-year period of the
Forecast. In the last Forecast, staff relied on the CalPERS projections and extended those for
the out years of the Forecast. Once CalPERS releases the latest valuation, staff will update the
pension costs for the Fiscal Year 2017 budget as necessary.
As shown in the table below, the FY 2017 pension contribution rates for the Miscellaneous and
Safety plans, as calculated by Bartel increased from the current year. For the Miscellaneous
Plan, the projected pension contribution rate increase is 1.8 percentage points from the FY
2016 rate of 27.7 percent to a FY 2017 rate of 29.5 percent. For the Safety Plan, the projected
pension contribution rate increase is 2.7 percentage points, from the FY 2016 rate of 41.9
percent to a FY 2017 rate of 44.6 percent. The table below shows the pension contribution
rates from FY 2018 through FY 2026.
TABLE 5: PENSION RATES BY PLAN (FISCAL YEAR)
Pension Plans 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Miscellaneous 27.7% 29.5% 31.3% 33.1% 34.9% 35.3% 35.6% 35.4% 35.2% 35.0% 31.9%
Safety 41.9% 44.6% 47.9% 50.8% 53.6% 54.1% 54.6% 54.1% 53.7% 53.2% 52.8%
The City pension contribution rates assumed in this Forecast are substantially lower for the last
few years of the Forecast period than assumed in the last Forecast due to a change in
methodology for projecting the rates. Last year, staff used a linear extrapolation of rate
increases provided by CalPERS during the first four years (CalPERS only provides rates for five
fiscal years). This year, staff asked Bartel and Associates to provide projection of the City
Contribution rates as presented to the Finance Committee in November. To exemplify the
impact of this change in methodology, the last Forecast assumed for FY 2025 a 42.6% City
contribution rate for Miscellaneous employees and a 64.3 % City contribution rate for Safety
employees. The lower City contribution rates for this Forecast resulted in lower overall benefits
costs.
It is important to note, however, that the CalPERS Board approved a de-risking policy of its
investment portfolio in order to reduce the assumed investment return of 7.5% to 6.5% over a
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20 year period. With this policy CalPERS will only reduce the investment return assumption in
years with investment returns higher than 11.5%. However, the Board is scheduled to revisit
this policy in February 2018. If the Board decides to reduce the assumed investment return
regardless of the actual earnings at this time, the City’s contribution rate would most likely
increase for FY 2021.
Retiree Healthcare
This Forecast includes the Annual Required Contribution (ARC) per the May 2014 actuarial
valuation based on information as of June 30, 2013, (accepted by the City Council on June 9,
2014) for the City’s retiree healthcare plan as updated by Bartel. Bartel’s update to the last
actuarial valuation assumes the latest CalPERS mortality rate assumptions, incorporates the
investment gain for the Retiree Healthcare Trust Fund as of June 30, 2015, and assumes a
lowering of the assumed investment return assumption from 7.61% to 7.25%. Currently, Bartel
is preparing the Retiree Healthcare valuation as of June 30, 2015. Staff will incorporate the
findings of the valuation as part of the FY 2017 budget. As this Forecast predicts surpluses in
the out-years, staff intends to revisit the investment earning assumptions for further reductions
in coming years.
The table below details Bartel’s estimate for the City’s annual Retiree Healthcare contribution
by the General Fund, non-general funds, and all funds for the next ten years.
TABLE 6: RETIREE HEALTHCARE ANNUAL REQUIRED CONTRIBUTION (IN MILLIONS BY FISCAL YEAR)
Fund 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
General Fund $10.0 $10.9 $11.2 $11.6 $12.0 $12.4 $12.8 $13.2 $13.6 $14.0 $14.5
Non-General
Funds
$4.8 $5.2 $5.4 $5.6 $5.8 $5.9 $6.1 $6.3 $6.6 $6.8 $7.0
TOTAL $14.8 $16.1 $16.6 $17.2 $17.8 $18.3 $18.9 $19.5 $20.2 $20.8 $21.5
On June 9, 2014, City Council accepted the Retiree Healthcare Plan GASB 45 Actuarial Valuation
as of June 30, 2013 and approved full funding of the Annual Required Contribution (ARC) for
Retiree Healthcare for FY 2015 and FY 2016. As documented in the report (CMR #4891) which
recommended approval of full payment of the ARC, the primary reason for the increased ARC
for Retiree Healthcare was the inclusion of a new actuarial standard regarding the implied
subsidy of healthcare premiums of active employees in relationship to healthcare premiums for
retirees. CalPERS blends active employees with pre-Medicare retirees and charges them the
same medical premium; however, younger employees on average consume less healthcare
services and therefore are subsidizing older employees and retirees. The implied subsidy is the
difference between average retiree claims and retiree premiums charged by CalPERS.
Consistent with City Council direction, as recommended by staff, the City budgeted for full
payment of the ARC for FY 2015 and FY 2016, including the implied subsidy. The implied
subsidy for FY 2015 was $1.9 million for all funds. As part of preparing for the FY 2015 CAFR,
staff worked closely with the City’s actuary, the managers of the City’s trust fund for Retiree
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Healthcare, and the City’s external auditor about the implied subsidy in the Retiree Healthcare
Fund. After many discussions, staff realized that the implied subsidy budgeted in the Retiree
Healthcare Fund should have been budgeted as a contribution from the City’s healthcare
premiums for active employees. However, the FY 2015 budget had fully funded the City’s
healthcare premiums of approximately $17.4 million for active employees. Therefore, the cost
of healthcare premiums related to the implied subsidy in the amount of $1.9 million was
budgeted twice. For FY 2015, the savings of healthcare premiums related to the implicit
subsidy remained in the General Benefits Fund for future use. For FY 2016, staff will bring
forward recommendations as part of the FY 2016 Midyear Budget Review report to correct
departmental budgets regarding the implied subsidy. Starting with this Forecast and the FY
2017 Budget, staff correctly budgeted for the implied subsidy for active employees healthcare
premiums. This means that for all funds approximately $2.2 million of the active employees
healthcare premiums are included in the Retiree Healthcare ARC.
Healthcare
Consistent with the previous Forecast and as a result of the most recent labor agreement
between the City and the Service Employees International Union (SEIU), the City’s contribution
amount towards medical costs for SEIU employees is based on a flat contribution from the City
with the employee contributing towards the remaining medical plan premium. This flat
contribution towards medical costs is also used for the Management and Professional
employees. All other labor groups eligible for medical benefits will remain on the 90/10
contribution structure until new labor agreements are reached with the City and the affected
bargaining groups. This Forecast assumes an annual health care cost inflator of 8 percent for
the labor groups on the 90/10 medical benefit structure, and a 4 percent annual health care
cost inflator for the labor groups on the flat rate contribution structure. Consistent with the
previous Forecast and with historical trends, the 2017-2026 LRFF assumes a 4 percent increase
for dental and vision costs for the out-years.
Contract Services
The FY 2016 Adopted Budget included $17.4 million to fund contract services of which
approximately $2.4 million was for one-time items that include $0.3 million for trash
receptacles on University Avenue, $0.3 million for the Fry’s Master Plan, and $0.3 million for
the continuation of services at the Palo Alto Animal Shelter and transition operations to a non-
profit. This $2.4 million has been removed from the forecast for FY 2017 and beyond. In
addition, the FY 2016 Adopted Budget assumed that the Golf Course would be closed during
the second half of the fiscal year; however, due to continued delays in securing the required
permits to begin the Golf Course Reconfiguration Project, as detailed in CMR #6335 to be heard
by City Council on December 14, 2015, this Forecast assumes that the project will begin in early
FY 2017. As a result, contractual expenses related to the Golf Course are anticipated to be
reduced by approximately $0.6 million from the FY 2016 Adopted Budget level. This reduction
in Golf Course expenses is partially offset by a reduction in revenue collections in Charges for
Services. In FY 2018, upon the assumed completion of the Golf Course Project, contractual
expenses will increase by approximately $0.9 million.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 25
As discussed with the Finance Committee in October, staff continues to look for implementing
alternative service delivery models such as partnering with a non-profit agency to provide
animal services or identifying a partner for the City’s swim program. For the FY 2017 Forecast
Budget year, $0.1 million has been added for the maintenance of the Magical Bridge
playground and parkland maintenance. In the out-years of the Forecast, a 2.6 percent growth
factor for contract services is assumed. This is aligned to the 20 year historical average of the
San Francisco Metropolitan Statistical Area Consumer Price Index – All Urban Consumers of 2.6
percent.
Supplies & Materials
The category for Supplies and Materials decreases from $3.7 million in FY 2016 to $3.6 million
in FY 2017 due to the elimination of one-time items funded in the FY 2016 Adopted Budget. For
the out-years of the Forecast, it is assumed that costs will increase based on the 2.6 percent
annual CPI increase.
General Expense
This category includes costs for travel and meetings, telephone and non-city utilities,
contingency accounts, subsidies and grants provided through the Human Services Resource
Allocation Process (HSRAP), and bank card service charges. The FY 2017 Forecast for this
category remains flat as compared to FY 2016 at $4.7 million. For the remaining years of the
forecast, this category assumes annual increases between 2.5 and 2.6 percent. These figures
do not include General Expenses for the Cubberley Lease which is explained in further detail
below.
Cubberley Lease
In Fiscal Year 2015, the City and Palo Alto Unified School District (PAUSD) agreed to an
extension of the Cubberley Lease by five years starting January 1, 2015. As part of the lease
agreement, the City Council approved creation of a fund for Cubberley infrastructure
improvements. Based on the new lease, $1.9 million will be transferred to the Cubberley
Property Infrastructure Fund for future infrastructure improvements. Therefore, the $1.9
million is classified as an Operating Transfer Out which is discussed in further detail below. With
the Cubberley infrastructure funds set aside, the FY 2017 Forecast Budget includes $5.8 million
for Cubberley Lease payments. In accordance with the lease agreement, the Forecast assumes
a 3.0 percent annual CPI increase for the lease payments to the Palo Alto Unified School District
(PAUSD) for the Cubberley facility. Also, the lease agreement period is five years; however, for
planning purposes in this Forecast, it is assumed that the agreement will continue during the
entire Forecast period.
Rents & Leases
Rent and Lease expenses for FY 2017 are estimated to increase by $38,000 from the FY 2016
adopted level of $1.5 million. The largest expense in this category is $1.1 million for the
ITEM #12, ATTACHMENT A
City of Palo Alto Page 26
Development Services Center. From FY 2018 forwards, this expense is expected to increase by
2.6 percent per year.
Facilities & Equipment
Facilities and Equipment expenses for FY 2017 are projected to decrease by 20.1 percent, or
$0.1 million, as compared to the FY 2016 Adopted Budget, due to the elimination of one-time
funding included in FY 2016. One-time items funded during FY 2016 include the purchase of 30
AEDs ($50,000), community center furniture replacement ($25,000), and the build out of office
space at the Development Center ($20,000). After the elimination of one-time funding,
projected expenses in this category of $0.5 million will remain fairly consistent in FY 2018 and
beyond. Consistent with the 20-year CPI for the San Francisco San Jose Metropolitan Statistical
Area, the forecast assumes a 2.6 percent annual increase starting in FY 2018.
Allocated Charges
Allocated Charges represent expense allocations by the City’s enterprise and internal services
funds for services and products they provide to General Fund departments. In FY 2017, these
charges are estimated at $18.1 million including utilities usage (24.2 percent or $4.4 million),
liability insurance (7.5 percent or $1.4 million), technology costs (33.9 percent, or $6.1 million),
vehicle equipment and replacement costs (27.7 percent or $5.0 million), and other costs (6.7
percent, or $1.2 million). The FY 2017 charges of the forecast updates the revenue and expense
for these cost plans based on the most current information available at the time of Forecast
development. Growth of 2.6 percent is anticipated in the out-years, which is based on the
average annual expense growth over the forecast period.
Operating Transfers Out
Operating Transfers Out includes transfers from the General Fund to the Debt Service Fund,
Technology Fund, and Airport Fund. Fiscal Year 2016 year-end projected transfers out total
$1.8 million, and are expected to remain at that level for FY 2017. In FY 2018, the transfer level
is anticipated to increase by approximately $0.3 million, primarily attributable to debt service
payments for the Golf Course Reconfiguration project ($0.5 million), partially offset by the
elimination of a transfer to the Airport Fund ($0.3 million)
Transfer to Infrastructure
In FY 2016, the adopted General Fund transfer to the Capital Improvement Fund is $19.0
million, which includes the base transfer of $14.0 million and $5.0 million from additional
Transient Occupancy Tax (TOT) proceeds generated through a two percentage point TOT
increase as well as through the addition of new hotels. Incremental TOT increases from the
rate increase and new hotels are dedicated to the Capital Improvement Fund to support the
Infrastructure Plan, consistent with City Council direction. The transfers to the Capital
Improvement Fund are anticipated to increase significantly as compared to the FY 2016
Adopted Budget, as the revenue generated from these new sources has outpaced initial
ITEM #12, ATTACHMENT A
City of Palo Alto Page 27
projections. In FY 2016, an additional $4.2 million is anticipated to be transferred to the Capital
Improvement Fund. In the out-years of the forecast, the TOT-associated transfer is anticipated
to increase between 4.1 and 5.2 percent annually. These additional increases will help in
offsetting the rising costs of Infrastructure Plan projects and ensuring the projects in the plan
will remain fully funded. Additionally, the base transfer to the Capital Improvement Fund is
anticipated to increase by 2.6 percent each year. Finally, this category includes the $1.9 million
transfer to the Cubberley Property Infrastructure Fund, described earlier in this document. This
transfer remains flat in all out-years of this Forecast.
Alternative Fiscal Year 2017-2026 Long Range Financial Forecast
In order to provide potential alternative perspectives, staff analyzed two other long range
alternatives including one with a low pension investment return and another with a projected
recession beginning in FY 2019.
CalPERS Poor Investment Return
As discussed with the City Council in September 2015 and the Finance Committee in November
2015, Bartel Associates provided the City with a continuous poor CalPERS investment
performance scenario. A continuous poor CalPERS investment scenario which Bartel defines as
investment returns between 0.2% and 4.1% will result in exceedingly high pension rates. The
table below shows the Bartel projected City pension contribution rates by plan based on
continuous poor investment results.
TABLE 7: PENSION RATES BY PLAN (FISCAL YEAR) WITH FOR POOR INVESTMENT RETURNS
Pension Plans 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Miscellaneous 27.7% 29.5% 31.3% 33.8% 36.9% 39.1% 41.6% 43.8% 45.6% 47.0% 45.4%
Safety 41.9% 44.6% 47.9% 52.0% 57.0% 60.3% 64.1% 67.6% 70.2% 72.2% 73.9%
Based on these higher annual pension rates, pension costs would increase by a total of $34.0
million over the Forecast period, compared to the base model. The General Fund annual
surplus in FY 2018, the first year impacted by the higher rates, would be reduced from $1.1
million in the base model to $0.7 million, a 36 percent reduction. This trend would continue
through FY 2026 as the projected General Fund surplus of $3.4 million in FY 2026 would
become a General Fund deficit of $5.4 million. During the Forecast period, the net operating
margin fluctuates between positive $0.6 million and negative $5.4 million. This model does not
project any additional revenue growth compared to the base model, which is the main reason
expenditures begin to outpace revenue in FY 2021 and this gap continues to grow through FY
2026.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 28
Fiscal Year 2017-2026 Long Range Revenue Forecast – CalPERS Poor Investment Return
Alternate Model
Fiscal Year 2019 Recession Alternate Forecast
As described previously, the assumptions included in this Forecast, consistent with previous
forecasts, are based on a historical analysis of increases using the Compounded Annual Growth
Rate (CAGR) with adjustments factored in for reasonableness. The adjusted CAGR model
factors in the impact of prior recessions but does not make assumptions about when a
recession may occur. Typically, the average business cycle lasts six years and the period
between the last two recessions was about ten years. Below, an alternative Forecast model is
presented for informational purposes showing the projected impact of a recession beginning in
FY 2019. This recessionary model adjusts the projected tax revenues and decreases the rate of
growth for certain non-salary expenditures, which would be expected when the next downturn
occurs.
Assuming an onset of a recession at the beginning of FY 2019, as can be seen in the table
below, a significant annual deficit of $9.7 million would exist in FY 2019. Assuming the FY 2019
deficit is not solved with ongoing expenditure reductions the annual deficit would grow to
between $10.6 and $21.7 between FYs 2020 and 2024. However, as shortfalls are addressed
primarily due to expenditure reductions, the subsequent ongoing deficits are reduced as shown
in the net operating margin analysis. By addressing the net operating margin shortfalls over
three years, the City will return to surpluses starting with FY 2022.
The recessionary model assumes a reduction in major tax revenues, though they are
anticipated to decline at a lower rate than those in the Dot.Com bubble and Great Recession.
The economically sensitive revenue sources follow somewhat different patterns in reacting to a
recession. Acting like a harbinger, historical data indicates that Documentary Transfer Taxes
decline just prior to the onset of a downturn.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 29
Sales Tax and TOT decline dramatically, as was the case during the Dot.Com bubble and Great
Recession, in the year a recession is declared. A recession’s impact on Property Taxes,
however, lags behind the other categories by approximately 2 years as it takes considerable
time for the County Assessor to reflect residential and commercially assessed valuations
downward. Staff’s assumptions for economically sensitive revenues in this alternative scenario
are as follows:
Documentary Transfer Tax: declines by 8.5% or $0.6 million in FY 2018 followed by another
decline of 22.4% or $1.5 million in FY 2019.
Sales Tax: declines 11.8% or $3.5 million in FY 2019 and by another 5.0% or $1.3 million in FY
2020.
Transient Occupancy Tax: declines by 11.5% or $3.1 million in FY 2019 and dips further in FY
2020 by 4.6% or $1.1 million
Property Tax: Palo Alto has been fortunate in past recessions with property taxes plateauing
rather than declining. Beginning in FY 2019, staff expects revenues to level off at $43.0 million
and stay at this level through FY 2021.
Conclusion
The Long Range Forecast projects a slight General Fund surplus of $0.1 million for FY 2017 and,
except for a budget shortfall in FY 2018, reflects a generally positive outlook over the next 10
years. Economic indicators demonstrate that the local business environment is rebounding;
however, substantial financial obligations and added uncertainties may diminish the General
Fund surplus over the next 10 years.
Despite improving revenue receipts as projected forward, the City continues to face challenges
related to the funding of infrastructure, the desire to retain and attract a talented workforce,
being responsive to the City Council priorities and the community expectations, rising benefits
costs, and unfunded long-term pension and retiree healthcare liabilities in the amount of $439
million. Additionally, as an Alternative Forecast Model shows, the City needs to be prepared for
the next recession. Having healthy reserves and a potential separate pension trust plan to
offset a recession impact will be critical in order to have a future budget that allows staff and
the City Council at least a year to plan for permanent budget adjustments.
While the City is addressing these short and long-term issues, the City needs to continue
reviewing its operations and service delivery options. Over the last few years, the City has
outsourced services to the private sector and entered into negotiations with the non-profit
sector for public-private partnerships. Staff is engaged in finding a partner to effectively and
efficiently operate Animal Services and is exploring different service delivery options for the
City’s aquatic operations While the City further explores alternative service delivery models
with the goal to reduce staff levels and related benefit costs, the City will also review cost
recovery levels of services currently provided to the community. In early 2016, staff will bring
forward recommendations to increase fees for the Planning and Community Environment
Departments as well as other departments to align the fees with the cost recovery goals set by
the City Council approved User Fee Cost Recovery Level Policy.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 30
This 10-year Forecast assumes an additional $68 million to be dedicated towards the
completion of infrastructure needs. Although these additional funds are substantial, they may
not be sufficient to build the projects due to escalating construction costs or within existing
timelines. Therefore, as prior infrastructure plans have not completely materialized to
completion, it will be important to focus on maintaining the current plan as a top priority and
not be tempted to increase ongoing operational expenses that surface unless they are deemed
absolutely necessary in order to complete the plan.
The City is currently updating its Comprehensive Plan. Staff is in the final stages of assessing
the fiscal impacts of the various planning scenarios that will be used to analyze policy choices
that will have to be made as part of the Comprehensive Plan Update. Once the City Council
approves the Comprehensive Plan update with its inherent policy choices, revenue assumptions
for future Forecasts will be aligned with the new Comprehensive Plan.
During the next two months, staff will continue to monitor revenue sources as well as update
revenues and expenditures, as applicable, based on newly available information. This updated
information will be reflected in the FY 2017 Proposed Budget, which is scheduled to be released
to the City Council late April 2016. While facing some significant unfunded financial challenges,
the City is in a good position to plan accordingly and based on the diversified revenue sources it
can continue to address the necessary infrastructure needs, but decisions must be prioritized
and focused.
Attachments:
Attachment A: Revenues (PDF)
Attachment B Expenditures (PDF)
Endotes
i International Monetary Fund (IMF), World Economic Outlook: Executive Summary, October 2015,
Page XV
ii International Monetary Fund (IMF), World Economic Outlook: Executive Summary, October 2015
iii International Monetary Fund (IMF), World Economic Outlook: Chapter 1 Recent Developments and
Prospects, October 2015, Page 1
iv U.S. Department of Commerce Bureau of Economic Analysis (BEA), “National Income and Product
Accounts Gross Domestic Product: Third Quarter 2015 (Second Estimate),” November 24, 2015.
v UCLA Anderson Forecast, December 2015
vi UCLA Anderson Forecast, December 2015
vii Bureau of Economic Analysis (BEA), Labor Force Statistics from the Current Population Survey,
December 2015
viii UCLA Anderson Forecast, December 2015
ix Bureau of Economic Analysis (BEA), Local Area Unemployment Statistics, December 2015
x UCLA Anderson Forecast, Job growth, wage increases to push real GDP growth past 3% for first
time since ’05, December 2, 2015.
ITEM #12, ATTACHMENT A
City of Palo Alto Page 31
xi Zillow, California Home Prices & Values, Zillow Home Value Index, Accessed December 2015
xii United States Bureau of Labor Statistics (BLS), Local Area Unemployment Statistics: San Jose-
Sunnyvale-Santa Clara, CA MSA, Accessed December 2015
xiii Zillow, Palo Alto Real-Estate Market Overview, Zillow Real Estate Data for Palo Alto, Accessed
December 2015
ITEM #12, ATTACHMENT A
Attachment A Fiscal Year 2017-2026 Base Long Range Financial Forecast - Revenues
ITEM #12, ATTACHMENT A
Attachment B
Fiscal Year 2017-2026 Base Long Range Financial Forecast – Expenditures
ITEM #12, ATTACHMENT A
FINANCE COMMITTEE
DRAFT TRANSCRIPT
Page 1 of 76
Special Meeting
December 15, 2015
Chairperson Schmid called the meeting to order at 6:10 P.M. in the
Community Meeting Room, 250 Hamilton Avenue, Palo Alto, California.
Present: Filseth, Kniss arrived at 6:17 P.M., Scharff, Schmid (Chair)
Absent:
3.Fiscal Years 2017 to 2026 General Fund Long Range Financial
Forecast.
Chair Schmid: Look at numbers, why don't we turn to Item Number 3,
General Fund Long Range Financial Forecast.
Lalo Perez, Administrative Services Department Director and Chief financial
Officer: Thank you Vice Mayor Schmid. We have staff from our (Inaudible)
office and (Inaudible) office that's going to make a presentation and after
we conclude our presentation from staff, we want to have Mr. Bartel do a
presentation on a potential methodology of funding on (Inaudible) liability
through the establishment of the 115 Trust we've been discussing. So with
that, let me turn it over to Kiely Nose to start the presentation.
Kiely Nose, Budget Manager: Hi, I'm Kiely Nose, I'm the Project Manager.
So the Long Range Forecast is really the kickoff of the 2017 fiscal year
budget process and today, we're going to discuss what the short term and
long term financial outlooks for the next 10 years primarily focusing on the
major revenue and its expenditure reduction. So How are we doing? So
before I start, you know, we talked about historically the picture perfect and
that's with a--what the city can afford all of our service levels. We have the
same amount of library hours, police services, you know, (Inaudible)
staffing, able to be funded and generally a slight ongoing surplus, would be
ideal. So that's How are we doing. The graph before you, is showing then
surpluses and deficit as projected during the next 10 years. So for fiscal
year '17, at this time, we're projecting very slight surplus of approximately
100k and then the fiscal year '18, we're primarily due to expend
ITEM #12 ATTACHMENT B
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expenditures growing at a more rapid pace than our revenues. The models
projecting a slight short of all profits of at least 600k. Thereafter, we
projecting annual surpluses somewhere between 500k and 12.7 million over
the course of the remaining years. So as I said, the blue depicts the annual
surpluses and shortfalls, however, typically as part of the annual budget
process, the city spends the surpluses in respond to new service needs and
solves those deficits hopefully on a long going basis. These new service
needs have an ongoing budget impact, however. So for example, the blue
line dipping in this fiscal year 2020 and starts to rise again in fiscal year 2021. Therefore, if we just focus on the blue line, it's not representing the
entire picture, so we need to look and analyze year over year change of the
annual surpluses as they're spend in deficit as they're resolved and that's
what the red line is showing you. So the red line shows the year over year
change of the annual surpluses and deficits. So for example, if we again
take the fiscal year 2020 as the annual surplus after the fiscal year '19 starts
to decrease, the red line is going to dip in 2020. This chart is just the
Forecast Model in numerical format and it includes the percentage increases
year over year. Most notably you'll see in fiscal year '18, that the expenses
are growing faster at 5.4 percent and revenue is at 5.1 and this primarily
due to salary and benefit adjustments based on projected cost of living
increases and market changes. As the community is quite aware, with every model, there's a significant number of unknowns. So this slide is identifying
all the unknowns noted in the report before you. The major ones you guys
have probably seen before are things like the Fire Services contract to
Stanford, obviously our pension, retiree, healthcare, trust, the unfunded
liability. At this time, I'll turn it over to Tarun who's going to discuss the
revenue sections in further detail.
Mr. Narayan: Good evening, my name is Tarun Narayan. I'm the manager
of Treasury, Debt and Investment and I will spend about five minutes
approximately in the next two slides going over in dept. into the five major
revenue sources. To begin with, overall the city's revenue continues to see
strong revenue recovery since the "Great Recession." In addition, sales,
property and documentary taxes had in the last two years significant one
time receipts that resulted in above normal revenues while transient
occupancy tax had a rate increase, the 2 percent and new hotels. Utility
User tax was the exception. Its performance was mediocre. Now, I'll be
discussing the details of these in a moment. So the bullet point two in this
particular slide, as in the past two years, per the council direction, the
compound growth rate, known as the CAGR, is used to forecast the 2017
through 2026 projections. Imbedded in the CAGR are things like past
recessions, however, reasonable and informed adjustments are made such
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Finance Committee Special Meeting
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as the Tier 1 rate change, the new hotels, changes in major tax generation
and one-time events. So if you go to slide number 8, the following graph
shows 22 years of major tax revenues. The five major tax revenues; 11
years of actuals—
Chair Schmid: Could I just ask a question.
Tarun Narayan, Manager of Treasury and Debt Investment: Yes.
Chair Schmid: The compound annual growth rate comes from the past, is it
2005 to 2015 or is it the 20 year? How far is that—
Mr. Narayan We look at both the 20 year, 10 years, and 5 years typically.
We used 10 years as the guideline, but we do also look at the shorter
duration to just kind of get a reasonable [test].
Mr. Perez: Vice Mayor Schmid, just to remind the committee cause some of
you were not part of the committee. That was based on directions from a
prior finance committee that staff to use those compounded annual growth
rates, focusing on the 20 years.
Mr. Narayan So as I was saying, this chart has 11 years of actuals and 11
years of projection. Property tax, the redline in the graph is the biggest
receipt of the major five revenues. As indicated in the report, property tax
has risen substantially in the last few years and are projected to have CAGR
of 5.9 percent over time over the next 10 years. A slightly higher than last
year's CAGR, which was around 5.4. City property tax estimate for fiscal
year 2016 is based on information received from the quarterly meetings with
the Santa Clara County Assessing office. Projections beyond 2016 are based
on historical growth rate as well as the information provided by a consultant.
Property tax receipt for fiscal year 2017 estimated at $37.5 million. At this point, I'd like to share a few statistical highlights about our property tax in
the past, the council has shown interest in. We have approximately 8,000 or
43 percent of our residential properties have 600,000 in assessed
evaluation. Of these, on average, a little over 3 percent—
Council Member Kniss: Would you repeat it once more?
Mr. Narayan About 8,000 or 43 percent of all residential properties in Palo
Alto have a value of under 600,000, assessed value.
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Council Member Kniss: You mean houses; you're not talking about
apartments at all?
Mr. Narayan No.
Council Member Kniss: Just—
Mr. Narayan Well, residential does include not only single homes,
apartments, multi condo units.
Council Member Kniss: Okay. So it's all of our residential are included in
this—
Mr. Narayan Exactly, all residential, correct. Of these, a little over 3 percent annually change ownership resulting in today's sale price of nearly
about 2.7 times above the assessed value. At this time, I like to bring your
attention to an error on the top of page 16 of the (Long Range) Financial
Report. It states the property tax within the assessed value of 1.0 million
would sale for 1.7 million today. It actually would sale for 2.7 million. The
1.7 million really only represents a growth in assessment.
Council Member Scharff: Those on page 17 of the staff report.
Mr. Narayan: Actually on the top of 16 I believe, unless (Inaudible) have
changed.
Council Member Scharff: Okay, got it.
Mr. Narayan: The top section, second bullet. So on average, 1 percent of
all resident properties could change hands and the 7.1 percent includes all properties including the 600,000 that I just cited. However, this can vary
greatly in a given year. So just give you a example. In 2010, only 1.7
percent of residential properties changed hands, while in 2012, 10.3 percent
did. While in last year 2015, 6.4 percent did. So the 7.1 percent average,
can be misleading when you get to any given year. On the other hand, on
average, 1.2 percent commercial properties annually change hands.
Similarly, they do fluctuate, but it's a small fluctuation. For example, in
2010, only 0.4 percent of property change hands.
Council Member Scharff: Do you know what it was this year, change hands?
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Mr. Narayan This last one was--hold on one second, I do. In 2015, it was
like 1.9 percent.
Chair Schmid: What is that a share of 1.9 of what?
Mr. Narayan 1.9 percent represents just the commercial properties, so
overall we have about 1800 commercial properties and we have 18,000
residential properties.
Chair Schmid: And what's the ratio on average of turnover?
Mr. Narayan So the average is 1.2 percent, but similar to residential
properties it can fluctuate like in 2010, it was 0.4 percent and in 2015, it was 1.9 percent. So it can fluctuate in any given year. 1.2 percent is
average for about 7-year period.
Mr. Perez: What this doesn't tell us is how is it turning over and what shape
does it re-assess or not, depending on the way the ownership is transferring.
Chair Schmid: Right. It reassesses no matter how the ownership is
transferred.
Mr. Perez: Not in commercial.
Chair Schmid: No, in commercial, it does.
Chair Schmid: Tell me how you would structure it so it doesn't. I mean, it
does.
Mr. Perez: My understanding is depending on the percentage. In LLC, if you
stay under 50 percent, it does not and this example—
Council Member Scharff: Right, if you stay under 50 percent.
Mr. Perez: Yes.
Council Member Scharff: But then you're not having an ownership change.
If you sell less than 50 percent.
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Council Member Kniss: It somehow do it Craig all the time. Same as Macy's
case in 1986 when they challenge prop--13.
Mr. Perez: This property in Beverly Hills, so there's several examples. It's a
process, it's not a single transaction.
Council Member Scharff: But you can come in under the assessment and
look at as a step transaction and collapse if it's over a certain number of
years.
Mr. Perez: It gets more complicated, but yes. I mean, I'm not an expert—
Council Member Scharff: Basically, if it's over 50 percent ownership change in an LLC, then you get reassessed.
Mr. Perez: That's my understanding. So I'm not insinuating all of these are
not change in assessed evaluation, but my understanding is there are cases-
-and I've been in situations—
Council Member Scharff: I think they're really rare. I think they're really
rare you're actually selling the property. I mean, there are ownership
changes where someone comes in and says; I want, you know, I'm going to
buy a portion or I'm going to buy a partner out. That's it. It's not really an
ownership change in terms of what we think, you know, you still have the
majority of ownership in when we actually sell these properties, but we have
notice, right, I mean, the reason this comes in is because we always ask
ourselves why is the share of property taxes continually pay more by residential and by commercial and that's--over time, that gap is widen.
Before Prop 13, I forgot, I think it was actually more by commercial and less
by residential and over time, it shifted into where residential was paying the
bulk of it. And I think you hit on the reason for that, which seemed really
clear, which is that the velocity of turnover in commercial is much, much
lower.
Mr. Perez: Correct.
Council Member Scharff: And also we have many more residential
properties and our residential properties are really expensive. I mean,
they're, you know--and so, I think that's what's driving it and I think when
we talk about the minor cases, which I believe to be minor cases--you know,
when a partner buys another partner out, it doesn't get the 50 percent,
that's not really the main case. I don't think you really have the situation
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where every time someone does a commercial transaction, it's structured in
a way that can't be turned over. I think that's really rare. It's really hard to
do. You know, if you have a corporation for instance, if 50 percent of the
stocks sells right? And those transactions are really hard to sale cause
there's really negative tax consequences for selling real estate in a corporate
form. So I think it's really rare frankly.
Mr. Perez: I think you're right on the residential and obviously we're seeing
that there's a high number of properties held with assessed evaluation of
600,000 or less. It shows that a lot of our residence held their properties or a lot of the owners held the property for a long time and don't see the shift
in changes.
Council Member Kniss: But one of the things--I met with the realtors last
week about something else and they say that Palo Alto's turnover half as
fast as most of the other cities on the Peninsula, which means that your
property tax--that we need to look at that in light of the property tax. So
it's one of the things that you might check on because the faster your
houses turnover, the more your property tax goes up obviously.
Mr. Narayan One of the distinction of more so trend that I see, I've been
looking at this for the last 15 years in Palo Alto, and a lot more of the
residential properties are being put in trust, so you know, when the next
generation typically would turn over by then on most of us be retired and probably not here anymore, that definitely will probably impact down the
road in terms of future growth rates. But we're probably looking at maybe
20, 30 years down the road.
Council Member Kniss: Meaning that when they're put into trust, that the
tax basically stays the same.
Mr. Narayan: Right. I mean, typically--I'm not an expert in trust, but
typically if they put it in a family trust and gave it to the children for
example, they wouldn't really be a change of ownership as far as the county
is concern and they wouldn't shake our reassessment to the market values.
Chair Schmid: Now in maturing of the city, property tax would be a decline
in the share of homes that would have been owned for 40 years and are still
near--at, or near 1979 limit. They're fewer those involved and there's more
of those who are moving into trust, so you're undermining the most dynamic
part of the property taxes and the question is, as you do a long term
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forecast, wouldn't that employ the property tax would begin to level off, if
there isn't a new dynamic entry.
Mr. Narayan: Yeah, that would be the implication that several decades
down the road when typically, would have changed hands because a new
generation would be coming in. That would definitely the growth would
plateau.
Chair Schmid: Yeah. So your forecast does not contain that. You think as
you say still 20 years to go?
Mr. Narayan: Yeah. I think it's along in the horizon because what I see is, you know, families in the last 10, 5 years etcetera, if you--and this is just
my guestimate, if you take maybe probably a 30-year-old comes in, stays
here and maybe, you know, 20, 30 years on average before they passed it
one. Do it’s still beyond, I think, our 10 year forecast, so eventually, it would
have impact but not in the horizon we are looking at.
Council Member Scharff: So I don't actually understand the family trust
thing either. So you know how it works? I mean, what you're suggesting is
that I can take my property, put it in irrevocable family trust, which would
not trigger reassessment at that point?
Mr. Narayan: I believe you have to change the ownership to do it, so if you
had an existing property—
Council Member Scharff: But at the time you change the ownership, you're then get reassessed at that point.
Mr. Narayan: Yeah, yeah.
Council Member Scharff: Right? So I mean, for instance--so yes, so I think
you might be able to do that, but are we saying people are actually--you
know, if you have a 1970's assessment—
Mr. Narayan: Yeah.
Council Member Scharff: Take Greg Schmid, you know, pay no property
taxes, right, have a 1970's -- you buy the house in the '70. the '80s?
Chair Schmid: '70's.
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Council Member Scharff: In the '70s, right? If he put his property into a
family trust for your kids, you would now have today's assessment. That's
what would happen.
Mr. Narayan: That's correct.
Council Member Scharff: So if you did that—
Chair Schmid: Mr. Narayan, what were you say?
Mr. Narayan: I'm not an expert, but my general understanding, how my
understanding was, is you had to change ownership, the trust would affect
the change of ownership, but I'm not an expert on the legal, whether you could do it without triggering a reassessment market evaluation. Cause on
of the thing that county does is, regardless of what the sales price of a
property is, the county will review what the market evaluation is relative to
the sales price—
Council Member Scharff: They never say it’s less.
Mr. Narayan: Yeah, so it it's—
Ms. Nose: Sometimes they do.
Mr. Narayan: If it's significantly of, they will use the market value.
Chair Schmid: If it's within a family, is it treated as a reassessment
ownership?
Council Member Kniss: No, no. The kids can (Inauidble0 it, which is the
best deal going.
Suzanne Mason, Assistant City Manager: But in a trust, when a person dies,
who owns the trust, I’m going through this now, then the value gets set and
then when you go to sell that property, the growth that you're going to pay
the capital gains on--
Council Member Scharff: That's capital gain.
Ms. Mason: Right. But then that growth, that assessed value at that point,
became a tax base and so...
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Council Member Scharff: See, I don't think we understand this. I think we
make these statements without actually understanding.
Council Member Kniss: Why don't you invite the assessor to come to these
(meeting.)
Council Member Scharff: Actually that might be a good idea because—
Council Member Kniss: Yeah or David, you know, David (Gainsburg) who
works for him, very, very informative.
Council Member Scharff: Cause I mean, we have to—
Chair Schmid: Do you have an idea--you said you've been tracking this for a number of years. How many family trust?
Mr. Narayan: I haven't quantified because there's no easy way to kind of
quantify without just looking at the name and see which ones has trust
associated with it, but just of the top of my head, I see at least--initially I
see these are a quarter, they're now by half, a little over half of that was--
Council Member Scharff: But you understand that a revocable trust has no
impact on property taxes? No impact on anything? It's just in a state
planning (Inaudible). So you'll see stuff in so and so family trust and so and
so revocable trust, that is not what we're talking about here. That is no
impact on it.
Mr. Narayan: Unfortunately the documents i see does not really tell me
what type of trust they are.
Mr. Perez: So why don't we put a pen on that and invite the county
assessor?
Council Member Scharff: I agree, but I just think that they're, I just think
that they're this, there's this--the sense that we say this in the community
and we make these statements, I don't think they're true. And I think we
see on the thing that it says "Trust," but we don't understand that a
revocable trust is not that kind of a trust which allows you to keep your
1970s assessment.
Chair Schmid: You were just finishing up property tax.
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Mr. Narayan: Right. So moving on to sales tax, which is the blue line on
the graph, as indicated, this is the second highest of the revenue sources.
The city does employ consultant to help us analyze the forecast data for this
revenue. Sales tax in the last two years had one-time event that resulted in
higher revenues than normal. In fiscal year 2014, there was a lot of
exceptional receipt from a single vendor and then in fiscal year 2015, there
was an accounting one-time accrual adjustment was made that resulted in
14 months of sales tax being recognized in a month most of the typical 12
months, so those two events kind of elevated the sales tax beyond what the normal levels are. So the fiscal year 2016 and '17 projection, then returned
the receipt levels to a more representative level of about 27.9 million for the
'16 and 28.5 million. The sales tax has a CAGR of about 2.6 percent over the
next 10 years, so very modest. Factor into the forecast, our weekly receipts
over the past several years is from a few key generators. Areas of concerns,
we have in this area is mostly of the online sales tax, which has been a
concern for numerous years. So for example, the total online sales as was
reported in the report for Cyber Monday rose about 16 percent compared to
last year. Our consultant (Inaudible) Services tells us that annually it
estimated that one percent of Palo Alto's retail sales moved to online sales.
The (Inaudible) is in 2017, we estimating a Mercedes Benz dealership
opening up in the last quarter of fiscal year 2017—
Council Member Scharff: Can I just ask a question? Are we going to make
more money on the Mercedes dealership or the hotel? Which would have
done it better for the city? I'm just curious.
Mr. Narayan: It's probably about comparable, I think between the two.
Mr. Perez: Those are some assumptions obviously on the room rate and the
average occupancy. We were making a different assumption given the
location.
Mr. Narayan: It's all on average--our consultant tells us a dealership like
that can generate anywhere from 800,000 to maybe 1.1 million. A
combination of car sales versus the operations side of it. The hotel is
probably a little bit higher than probably that, but then the Mercedes could
be a concern in this area. Who knows, could have a higher sale beyond the
average, so. The negative of sales taxes is in the potential loss of the prior
(Inaudible). The receipts have been declining for the last several years. The
other concern we have, the HB Split, we do get some potential revenues
from them and we just don't know what the potential impact may have on
us. That concludes the sales tax item so if you—
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Chair Schmid: Let's see, let me ask a couple of questions on the sales tax.
I know in our comprehensive annual financial report, it has 10 years of data
and very striking increase in the last three years in the non-retail, All Other
it's called. Now, you mentioned the Tesla Special K's—
Mr. Narayan: In 14 years.
Chair Schmid: And then the 14-month year, we had—
Mr. Narayan: In the 15th.
Chair Schmid: But my understanding is also part of the Stanford
Development agreement is that they would make all purchases on site. That's recording for Palo Alto and I'm wondering if there's a significant
source of sales tax is coming out of that construction related purchases. Do
you know anything about that?
Mr. Narayan: Unfortunately, I can look into it, but I don't have a break
down on that. So no.
Chair Schmid: I'm concerned that it wasn't just two things that are
happening, but it's this Stanford. You know, if you see the chart that you
have there, the increase is not just the about, but it's actually a four or five-
year increase, which coincides with the Stanford Development project. So
I'm concerned that the sales tax might end up taking a bit of a hit once
that's completed, what 2018.
Mr. Perez: Yeah, we can definitely get those numbers and look at it and the other concern is the shifting to more online sales as well.
Chair Schmid: Yeah, that's another question. I thought that online sales
were being taxed and they were going to be redistributed through the
county back to the city. Is that right?
Mr. Perez: With the exception of specific agreement such as Amazon. There
were cut out agreements that wherever the warehouse distribution was,
that's where the sales tax would go to, that particular agency. That was a
deal with the state agree upon to keep Amazon and warehouses—
Chair Schmid: So we're not likely replace the retail sales, not likely all of
them. Maybe some of them, but not all of them.
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Mr. Perez: For these carved out agreements, correct.
Chair Schmid: I've noticed that our retail sector, put it together is about
where were in 2006. There's no increase taking place.
Mr. Perez: Retail has been flat.
Chair Schmid: Yeah. I guess it's hard when you keep trying to put in
grocery stores, they don't work. There might be a reason.
Mr. Perez: Probably.
Mr. Narayan: That'd be the questions?
Chair Schmid: Yeah.
Mr. Narayan: So will move on to transit occupancy tab. This is now
represented by two line in the graph. The blue is the general fund portion
while the brown color is the infrastructure receipts. So we broke it down to
two so you can see what the general fund and the infrastructure portion are.
So the hotel occupancy in daily room rates have risen substantially even
with additional three hotels, we with the fourth expected to open up soon. I
talked to the folks at Clemente they originally expected to open up in
November, but they had problems with the contractors, so they're hoping to
now either mid-January or February. As I said, they have all this staffs
trained and waiting so they really, really want to open up as quickly as
possible, but they have to get the construction out of the way.
Council Member Kniss: How big is--how many rooms are there? It looks small from the street.
Mr. Perez: It is. It's going to be mostly high end suits. You have 1.—
Mr. Narayan: There are 23 rooms.
Mr. Perez: Clemente was talking about—
Council Member Kniss: So you'll have the Sheridan at 112, and then you'll
have the Western that's next—
Mr. Perez: Yes.
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Council Member Kniss: And now you have the Clemente, which is your high-
end—
Mr. Perez: Yes.
Council Member Kniss: Suites?
Council Member Scharff: And a boutique.
Mr. Perez: Yeah.
Council Member Kniss: Yeah, yeah.
Mr. Perez: He was--I don't know where's he's going to end up, but he was
trying to do an all-inclusive suites concept in the range of $800 a night.
Council Member Scharff: That's cheaper than the (Inaudible).
Council Member Kniss: They should give us tours—
Mr. Perez: That's what he said. With the inclusive, it's even a better deal
(Inaudible).
Council Member Scharff: Can we annex that?
Council Member Kniss: So just 23 rooms. That's ridiculous.
Mr. Narayan: To continue on, in 2010, the occupancy rate was about 66
percent while in 2015, it's 80 percent so that's represent about 21 percent
increase while room rates while 140 back in 2010 is by 242 in fiscal year
2015. So that's a 71 percent increase. I looked at the last few months of
2016, it has a similar occupancy, slightly below in a given month like 77, 78
percent, but the average room rates are higher at $253. In some months, it's high as 266, so a day.
Council Member Scharff: It averages all the cheaper hotels in (Inaudible)—
Mr. Narayan: Yes, yes.
Council Member Scharff: Right? Like the glass slipper and—
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Mr. Narayan: Yes. It's an average of all of them.
Council Member Kniss: It think those are less than 260 a day.
Chair Schmid: The increases are hard on taxes.
Council Member Scharff: I don't know. They might not be.
Mr. Narayan: So to kind of give you an idea on rooms on average can be
like 275--oh, there's one at 434 in a particular given month, while the lower
ends can be in the 70, 80, 90 dollars’ range. So there's quite a range, you
know, from 450 to under a 100 dollars. So on the (Inaudible), let's focus on
the TOT for the infrastructure. This includes estimated revenues for all of the new hotels build and about to open, so that's about four, Clemente is the
fourth one, that's not opened yet, but does not include those in planning
stages. In fiscal year 2016 and '17, we had a 9.2 million and a 9.7 million
that are forecasted for infrastructure TOT. The shock increase TOT from
2015 of 3.3 million to 2016 of 9.2 million as a tri-burial to the following; the
two Hilton hotels, they were opened four months in 2015. That means we
have an additional eight months of new revenue in the 2016, so that's a
substantial increase. As I mentioned, the Clemente is expected to open in
the next month or two, so those will be new additional revenues as well as
the 2 percent TOT increase. You know, we applied half the year in 2015, so
when you analyze the rate, it adds another six months of new revenue. So
that's where you see the 2015 spiking up tremendously to 2016. As for the--so what did happen, not included in the TOT forecast? As you know the
(Inaudible) hotel has been cancelled this time and now is being planned for
the Mercedes Benz dealership. The two Marriott hotels in the planning
stages, those hasn't been included in this particular forecast.
Chair Schmid: Included or decided where to include it?
Mr. Narayan: No, no, it hasn’t been included in the long range forecast.
The two Marriott’s that are planning.
Chair Schmid: I guess the question is they are opened as to how that
revenue is treated. That correct?
Mr. Narayan: Yeah, that's--.
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Mr. Perez: In terms of where they go for infrastructure or the general? You
know, we believe, but you know, obviously, this is a policy area for you as a
committee for you to consider. We discussed what we knew at the time and
again, I don't recall us talking about any future hotels should be included, I
think you kind of left it open for yourselves to make those calls as you went.
Chair Schmid: Okay. Thank you.
Mr. Narayan: Okay. ON the general fund TOTs representing by the green
line in the graph, the CAGR growth rate for the next 10 years is by 4.3
percent. That does include a new source of revenue, which is that Air B and B revenue source is included in the general fund portion.
Council Member Scharff: How much are we getting from that?
Council Member Kniss: Yeah, that's like a (Crosstalk.)
Mr. Perez: We have to give you a range because we can't speaks to a
specifics.
Council Member Filseth: Do you have a range you could give us?
Mr. Narayan: Yeah. It's around, you know, 500,000 to about 800,000.
Chair Schmid: That's a big number.
Mr. Narayan: Yeah, it's a big amount.
Council Member Kniss: And we're getting?
Mr. Perez: Yes.
Council Member Kniss: It's gone up a lot.
Mr. Narayan: In 2015, we got six months’ worth and so the annualized
number is you know, in the 5 to 800,000 range.
Council Member Filseth: This is an old number, but in August, there were
over 7,000 listings for the Peninsula South Bay for Super Bowl week and
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there's an expectation that there's going to be huge numbers, so if you want
to list your homes—
Council Member Scharff: I know; I was just talking my wife into it—
Council Member Kniss: The same. I tried to talk my husband into it—So,
would you explain though on Air B and B, is the tax collecting from the
parent company?
Mr. Narayan: Yeah. The one thing about Air—
Council Member Kniss: It's not individually, I presumed?
Mr. Narayan: Yes. We do receive it from the parent company, not individuals. In the prior years, we used to receive a handful from
individuals, but now with the new agreement, it comes from the parent. The
things they don't provide us is some statistics like the number of rooms are
being rented, what the average is. Unlike our normal hotels where they do
provide statistics about averages or things we can deduced based on what
they do know what the averages are. Air B and B is kind of an exception.
They send us a monthly total. That's pretty much it.
Council Member Kniss: Can we demand more than that or is that the
agreement that cities have with the parent company?
Mr. Perez: They've taken an interesting approach that they gone into
negotiations with almost agency by agency, which is kind of different.
Council Member Kniss: Kind of.
Mr. Perez: But we can tell you is that we were one of the early
implementers beyond--in the area and others are following suit. We were
up there with some of the major cities like San Francisco, New York in terms
of early on, so you know, should acknowledge Joe and Karen, Molly and her
staff for working on this and getting us ahead of the curb.
Council Member Scharff: It's a good question on this topic too (Inaudible),
now it's delay I guess. So we're projecting that transit and occupancy taxes
are going to grow at five percent compound over the next 10 years.
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Mr. Narayan: Yeah, about four or five percent, the CAGR by 4.3 in terms of
the general fund or are you talking about the infrastructure?
Council Member Scharff: You know; I was looking at both.
Mr. Narayan: Okay. They have about a similar growth pattern beyond the
first one or two years.
Council Member Filseth: So that's about twice code. So why is that? Is it
going to be a question of we think that hotel rates are going to continue to
grow on sustain basis faster than the rate of growth of other costing barrier
or we're expecting demand is going to increase faster than--cause we're adding--we're going to have supplies, but if there's no more people, it just
going to (Inaudible). So why is that? What's the assumption?
Mr. Narayan: The data would suggest to do that. I mean, we do see the
occupancy slightly declining, which is typical, but typically when that
happens, the room rate would decline correspondingly, but it's actually going
the other direction. The room rates, so the hotels are able to basically
demand a higher price for what they got.
Council Member Filseth: Because there's no--because they get bigger,
because there's more desire.
Mr. Narayan: Yeah.
Council Member Filseth: So we just put a growth limit on our offices through
the city. Is that going to impact that at all?
Mr. Narayan: That's a tough one.
Mr. Perez: It's not something we're studying, it probably more appropriate
for the fiscal study on the (complex) instead of--the planning and permit has
hired an expert, an outside financial--It looks like that's --We are looking at
long term study, 10 years’ horizon.
Council Member Filseth: But we do know its not just Palo Alto that is a
destination. I was thinking we're a big destinations point, don’t get me
wrong, especially this is Stanford--
Mr. Perez: You Google expansion.
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Council Member Filseth: Exactly and you know, they love to have more
hotels. Santa Fe is expending; Santa Clara is expending in terms of hotel
growth. There's a huge demand, that growth is there. The concern we
have, if we have another experience like we did with the dot.com bust, in
two years, we lost about 50 percent.
Council Member Scharff: So I'd like to jump in on that since you mentioned
(my name). I actually think it you'll have no impact whatsoever and the
reason I know you'll have no impact is you're going to have continued
Facebook expansion on one side and you’re going to have the (Inaudible), and you're having--I think the bigger risk frankly is that they build a lot
more hotels in Redwood City, right, which is also a huge expansion. Huge
office space growth and that starts to capture--
Mr. Perez: Of course.
Council Member Filseth: If anybody looks out there and say wait a second,
this thing is going to grow at five percent a year compounded, right? You
know, from now until next century. They're going to do the same as we're
doing.
Chair Schmid: Well, there're two plans in Menlo Park. There are two plans
in Redwood City and there's the big one in Santa Clara.
Council Member Filseth: But we're talking about in 10 years. There'll be
more. Right?
Chair Schmid: Yeah.
Council Member Scharff: So I actually don't think we're going to get the five
percent growth because every city wants a hotel also. If anything, we're
probably the most anti-hotel of all the cities.
Council Member Kniss: We are, absolutely.
Council Member Scharff: Everybody else bends over backwards to get a
hotel and so my sense is they will build to the market. Right. At which
point, occupancy will start to fall and they'll start to take ours, and so I don't
see the five percent compounded growth rate.
Chair Schmid: I think I agree with you. I think that's right.
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Mr. Narayan: The (Inaudible0 has been our concern based on the
information we have. You're probably right. As the surroundings areas,
including maybe two Marriott’s. At some point, they will be at an impact.
But based on what we have today, that's we have forecasted on.
Council Member Scharff: So the other thing I like to say on that is I think,
since I went through it on the Finance Committee, I think if we think back to
the way we were thinking in 2009, 2010, you know, very different attitude,
very different occupancy rates, hotels were --you could see that, where it
was dipping. Right? And if you look back at the financial forecast from 2011, 2012, they're so much more conservative. The revenues are $30
million less in the (outfields), 40 million dollars in the outfields, makes a
huge difference. So I actually think, you know, in business cycle, we like at
the peak right now. Right? We're on peak. That means, we're going to go
down, one way to go.
Council Member Filseth: I know. This time it's different.
Mr. Perez: You know, that's a good observation cause you're actually right
at that point, but my recollection and that's where Joe and I were very
concerned was that we heard the economy just about, you know, we can't
generalize what you hear, what's having doubts of us recovering really
quick. We were very concerned about that and that's--we looked at our
numbers then and obviously it didn’t' turn out to be that way. We came out much, much faster than the rest of the nation in our period.
Council Member Scharff: Joe has never been a consensus of year out
economist we're going to have a recession, evert.
Mr. Perez: There is--you know, most of them agree that if you look at it in a
10 year forecast, you're going to have--I think a statistical number around
the area a year, so.
Council Member Kniss: You put that in every report, so.
Chair Schmid: We're going to thank you for doing that by the way.
Council Member Filseth: So yeah, I'm with you. I think actually the
conditions sustain five percent a year. I don't see it.
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Council Member Scharff: I think we should build a new office and build
another 30 new hotels.
Council Member Filseth: But no parking.
Chair Schmid: Can we move ahead?
Mr. Narayan: The next big item is the document transfer tax, which is the
purple line, the graph. This revenue source is somewhat unpredictable given
the volume of the mix of promotional and residential transactions can vary
significantly from year to year. The prior two years, document transfer tax
receipts, the '14 and '15 fiscal years, have record setting years; $8 million in '14 and $10 million in '15. The fiscal year '14 has numerous commercial and
high volume residential home sales while fiscal year 2015 had a $1 Billion in
commercial sales by a single entity involving seven major properties that
netted the city $3.3 million. So that $10 million dollars we received, 3.3 of
them was from this transaction. This kind of transaction is like a once a
decade event.
Council Member Filseth: That's the Hudson properties.
Mr. Narayan: Yeah, yeah. The sales price went by $1 billion of that, which
was substantial.
Council Member Filseth: Another one-time event.
Mr. Narayan: You're not likely to see that for a while.
Chair Schmid: It's not a one-time event because that's a change of ownership of property.
Mr. Narayan: That's true.
Chair Schmid: Why doesn't it show up in the property tax? If you look at
the property tax during that year, the share pays by non-residents.
Mr. Narayan: Yeah. We would actually see the full impact of that in 2017.
We were just talk with the county, so there's transactions occurred around
the April timeframe. So the way the county has it is, in the first fiscal year,
it went to the supplemental property tax and the supplemental property tax
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is shared by everybody in the county. We get a piece of San Jose’s; they
get a piece of ours.
Because it occurred after January 1st, the second year, which is the 2016
will also went up in supplement, will summarily share. Actually, I calculated
around 450 to 500,000 in terms of secure property taxes. We won’t really
see that back until the '17 fiscal year, so it's going to be a little bit delayed
as what you would think of where it would hit immediately.
Chair Schmid: But we can anticipate then in '17 that there will be some
recognition of what's happening in document transfer tax?
Mr. Narayan: Yes.
Council Member Scharff: So you think it's about 500,000 more?
Mr. Narayan: Yeah. So if you had about, you know--we looked at what the
old AV was, compared it to what the new AV would be based on the sale--
assuming the sale price, it does assume that they didn't exorbitantly
overpaid because as the county said, they looked at all the transactions,
look at the market valuation relative to the sale prices and if there's a big
differential, they'll re-evaluate.
Council Member Scharff: So which transactions was this?
Mr. Narayan: These were, like I said 7 major series. You had a lot of --
Mr. Perez: Camino (Peach) property.
Council Member Scharff: So it's Palo Alto Square
Mr. Perez: There were four other properties; four or five total.
Mr. Narayan: Yes, so these cover like the hotel research center, the Palo
Alto Square, there was the 3400 of the Hillview area, the Page Mill Center,
the Clock Tower Square, the 3176 Quarter Drive and the Marketeer Place.
Each of them have--some of them have multiple address location, multiple
buildings.
Chair Schmid: A lot of those are on the Sanford property, so it did not
include property?
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Mr. Narayan: These were--the ones we counted for were all within the city's
jurisdiction, therefore subject to--
Chair Schmid: But when you get to Porter and other places, the land is
owned by Stanford, inside the city.
Mr. Narayan: Yeah. If it's inside the city, it would be subject to our property
taxes.
Council Member Scharff: The fact that its own by Standard, it's long term
grounding, so long term grounding changes--
Mr. Narayan: As long as its-yeah
Council Member Scharff: Assessment based on ownership of the long term
grounding.
Mr. Perez: 50 years for long--
Mr. Narayan: As long as it is not within the Stanford boundary, it would be
subject, yeah. So to continue on, the fiscal year 2016 is early projection of
7.1 million and 7.4 returns the receipts to levels more representative. As I
indicated, the last two years, we think was exceptionally high and we have
are not anticipating that levels will continue on. So that's for the
documentary. I'll take a moment if there's any additional questions for that.
Chair Schmid: Are you going to add them up?
Mr. Narayan: Yes, they are.
Chair Schmid: I guess the bottom line, you have total source of funds run between 3.5 and 4 percent per year. Is that correct?
Mr. Narayan: I did not add--I mean, I do not have to add those specifics--
but hold on one second.
Chair Schmid: Yeah, so bottom line.
Mr. Perez: You're asking about the growth rate?
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Chair Schmid: Yeah.
Mr. Perez: It’s 3.8 percent.
Chair Schmid: Okay. But that includes the two years of--
Mr. Perez: 3.58 percent.
Chair Schmid: Okay. Yeah.
Council Member Filseth: Actually go back to the projected. They used the
inserting point as planned, adopted? If you go back to projected, that's the
number you get, 3.58 percent.
Chair Schmid: So that's your best interpretation over the next decade.
Mr. Narayan: Yes.
Chair Schmid: What we might anticipate our revenue probably be.
Mr. Narayan: Correct.
Chair Schmid: 3.5, 3.6.
Mr. Narayan: Yes.
Mr. Perez: It derived from finance committee directions to use a 20 year
CAGR.
Chair Schmid: Right, but when we talk about sustainable budget, I guess
want to be thinking in those terms. It's a very important number for us.
Mr. Narayan: I mean, we do analysis also with the recession model, which
is represented to kind of reflect.
Council Member Scharff: We'd like you to do that and we'll get that corrected.
Mr. Narayan: Yeah, okay.
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Council Member Kniss: I think this is all intriguing, it's fascinating. But once
I go out 10 years, what's that really doing for me?
Mr. Perez: That's a good question. you know, sometimes there's discussion
among our group of finance officers that maybe 10 is too long, other
agencies use 5. Steven Levy, who we have reviewed this for us as a
courtesy, tells us, the best couple of years, that's the best that I can help
you. Beyond that, you know, it’s a guess.
Council Member Kniss: I agree with him. I don't know how you can make
predictions. We can make guesses--
Chair Schmid: When we approve infrastructure investment, we're doing it
for the long term.
Council Member Kniss: Of course we're doing it for the long term, but--
Chair Schmid: When we sign an employment contract, that's for the long
term.
Council Member Kniss: I don't disagree at all. What I'm saying is 10 years
out is pretty far and most economist that I've talked to said that's too far to
project their income.
Chair Schmid: But we have to project revenue stream just as we are
projecting expenditures.
Mr. Perez: When we talk about the city's long term, that's a 30 process.
I'm not trying--
Council Member Kniss: That's true, if we're talking liabilities, but I think the
projection for revenue is a tough one.
Mr. Perez: One of the reason that we want to do it as an organization
beyond our planning is to demonstrate to the rating agencies that we're
looking and we're planning and we're trying to adjust for the unforeseen.
And that helps us when we go to the rating agency presentation. For
example, when we bid the general obligation funds for the library, a lot the
records that we have on place where--we had a deficit, we covered. We
maintained our reserve levels and we projected what our long term
expenses were and we showed them those documentations and that's what
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led us to getting a triple A rating. So that's another reason why we want to
do it beyond our typical plan.
Chair Schmid: I think when we look at number (Inaudible), is a critical
number in what is available to have.
Mr. Perez: I think actually -- to answer your question, I think the list is
fairly short, but it's very important. Right? One is anything relating to
infrastructure, okay, is a long term kind of thing. Anything in this town
that's going to inquire land, okay, is a very long term kind of thing because
it's very, very expensive, okay. Anything related to our long term liability, that's a long term kind of thing. So I mean, if the alternative is, you know,
we plan on a one-year basis. Right? Or a two-year basis, that just basically
mean anything we get, we spend it. Right, you know. We have stuff that
we have to deal with. So I agree with you, right, I think our ability to
predict exactly what our revenues are going to be, you know, one year, two
years from now. I think we did pretty good actually. As you point out, it's
throw darts, but you have to understand the directions because small
changes of this stuff, although long periods of time, make an enormous
difference, so you have to project—
Council Member Scharff: That's the (inaudible) is what you just said; that it
allows us to prove the point that if we change the pensions just a little bit,
we change, you know, the healthcare just a little bit, we get the extra hotel, it's just a little bit. I mean, it's those small changes make huge difference
and that's what this shows.
Council Member Filseth: We also go another one, it's not really our business,
but it is our business, okay. We're just, you know--
Chair Schmid: Well, it’s the small change that (crosstalk) not a--
Council Member Filseth: To build another high school, it cost $500 million
dollars.
Chair Schmid: Not a leap thing, but something that flows.
Council Member Filseth: So there's an element of this that's a great concern
to all of us, the PAST's business cause its (Inaudible) school capacity. That's
a long term thing.
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Chair Schmid: So Mr. Narayan?
Mr. Narayan: Um-umm.
Chair Schmid: The bottom line is very important for us.
Mr. Narayan: Right. So the last item is, just to finish it off is our utility user
tax, which is in the turquoise color. This resource has a 10 year CAGR of 3.2
percent. The utility user tax for 2016 beyond forecast equal points the two
changes by the voters in 2014, that was the telephone UTT was reduced by
(Inaudible) of 75 percent and the logic to use discounts was eliminated. The
receipts anticipated from the UTT for electric, gas and water is basically (inaudible) plus 5-year revenue. A rate projection, and this is important
because these estimates could change as the department discusses the
proposed rate plan with the Utility Advisory Commission, the Finance
Committee, as well as the City Counsel and based on decisions that are
made will correspondingly change the forecast accordingly. The forecast
assumed for '16 and '17 about 10.5, 11.2 million in UTT receipts. So
overall, for the last couple of years, as you can see based on the forecast,
we our projecting very healthy revenue increases with exception of UTT,
which is more in the line of, you know, a slight increase, but mostly being on
the flat side.
Chair Schmid: Great.
Ms. Nose: So turning to expenses, salaries and benefits comprised about 61 percent of our annual expenditures. Positions are budgeted at actual rate of
pay including benefits as of fall 2015. The city's currently in negotiations
with various bargaining groups, so our forecast includes salary assumptions,
benefits increases based on projection increases and the cost of leaving and
market (base services).
Council Member Scharff: So you're saying two and a half percent? What
are you saying?
Ms. Mason: We're using CPI based figures and market based assumptions
going forward and I'm not sure that they're absolutely flat.
Ms. Nose: No. Especially giving the current negotiations.
Mr. Perez: These are based on the data that's been compiled.
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Council Member Scharff: So we must be using the number in our
assumptions.
Chair Schmid: Walter, you must know about this.
Mr. Rossmann: What we do is--we obviously--as we're progressing from
labor negotiations, we get updates from the authority we get from the
council. That's included in that forecast. Once we go beyond the terms of
the contracts, we range down to two percent salary increase, so it’s (hourly)
years of the forecast, and thereafter, with the corresponding benefits
increases.
Council Member Scharff: So the hourly years, we're looking at two percent
increase?
Mr. Rossmann: That's correct. That's tradition what we've done in the last
few years.
Council Member Scharff: I know, do we capture, you know, there's the
salary increase and then there's the, you know, general staff increases, and
merit increases that occur.
Mr. Rossmann: That's correct.
Council Member Scharff: And the two different basic organizations, and so I
understand why the two percent’s' in there, but--do we ever go back and
look historically what the number is and use that number? Wouldn’t' that
make more sense? I mean, we're not saying we're giving that--but historically, it's gone up three percent on average over the last 10 years or
four percent or five, I don't know what it is.
Mr. Perez: So, there's been discussion about that and there's been different
viewpoints from the council. Some feel that if you imbed something like that
into this document, then it becomes the promise for future increases. We've
gone back and forth over time, so what we basically said is well, instead of
going one way or another, why don't we pick up a number that we take is a
base for assumption purposes and use that knowing that the numbers could
be different in some cases--
Council Member Scharff: Higher.
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Mr. Perez: You know, we had several years where we didn't have any
(inaudible). And so--
Chair Schmid: The way we kept back salary and benefit down though is
recession only laid off 40, 50 people.
Council Member Scharff: Right. Almost 70 positions.
Chair Schmid: So it doesn't reflect what people are actually earning.
Council Member Scharff: Even in the recession, there's no cost of living
increase? Like I know there were staff increases and I know there were
merit increases.
Mr. Perez: Yes, there were.
Council Member Scharff: So you average that over the employees, I bet it's
at least one and a half percent increase or something, I don't know, maybe
one percent.
Mr. Rossmann: You see council member, if you look at the hourlies of the
forecast, the last page of your CMR, that's on the board, if you take the
tables of expenditure, we're showing you dollars as well as increases. So
you see that (Inaudible) in there, it's the only staff increases which apply.
What we do is we take a payroll snapshot. If somebody's in staff one, this
would be in 2015, the second one in '16--actually, starting in '16, '17 staff
two, etcetera, etcetera, until we reach the max. You see in the salaries,
starting with 2019, 20, it drives down to about 2.2 average 2.2 average increase in salaries. Benefits goes down between 3.5 and the (Inaudible)
below 2.5 percent. The reason--Cali will talk about it in a second, but I am
going to preview it for you, the reason why benefits are actually decreasing,
is health benefits are the same, but if we look to the Bartel presentation, we
saw--in the finance committee in November, the Bartel--John is actually
projecting pension rate increasing forward, he sees a flapping of the pension
rate increase at the very last of the part of the 10 year forecast and we use
those numbers. It’s a (Inaudible) benefits actually decreasing per year. The
rate of increase is decreasing.
Ms. Nose: So as Walter mentioned, he does assume things as staff
increases consistent with (inaudible) raise as well as merit increases as well.
The remaining expense options are outlined on this slide. Things like 80
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percent of annual growth for 2010. Health benefits and other expenses are
growing by the CPI.
Chair Schmid: A couple of questions before you leave salary and benefits.
Are you assuming the same number of workers in the city now and 10 years
from now?
Ms. Nose: Correct.
Chair Schmid: Yeah, that's a big assumption.
Ms. Nose: Yeah, big assumptions.
Chair Schmid: Because we're making changes or growth.
Council Member Filseth: You're assuming a head count in growth in 10
years?
Ms. Nose: Correct. It assumed the current level service, which is the
current headcount of the organization. So if we wanted to increase services,
you know, we would add positions and build expenses at that point.
Chair Schmid: So that's a big assumption. Second, big assumption on
benefits. Now, I thought we had quite a dynamic meeting in November
about the pensions and there were two big issues coming up in the future.
One, under Estimate of (CalPERS) on mortality, length of life--healthy life
and so on, I thought they had said they were going to start to adjust from
that two years from now. That they are currently understanding that they
might have done that and there will be a rate adjustment in two or three years. But I think there were some issue around that. The second issue with
(Inaudible), which they just passed, instead of using 2013 as the baseline,
we now had two years of very slow and investment returns and there will be
some adjustment. What they would like to do would be to lower their risk
profile by raising the rate and they have a way of doing that, they're just not
going to (Inaudible) rate increase, but they have all sorts of slip it in. Those
are two fundamental forces I thought we talked about and so I was
surprised to see, but you actually have the benefit about percentage point
lower than it was last year.
Mr. Perez: Why don't we talk to the pension and the assumption on those
rates and then I'll cover the others.
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Mr. Rossmann: So you're correct Vice Mayor. The comparison to last year's
forecast, the pension benefits is lower than we actually see in this year's
forecast. And with primarily (Inaudible) a lack of understanding the factual
science, but we did last years, we look at the four to five years CalPERS has
provided us and we literally extrapolated that. Talking to John Bartel, we
actually realized that's not how Capers would have done it, that's not they
actually do it therefore we adjusted that downwards. We see those changes
in the tables under the pension section of the forecast. The second thing is
you talk about there's—
Chair Schmid: The pension forecast tables though were based upon a rate
of return which CalPERS has since acknowledged is too high.
Mr. Rossmann: That is correct. What CalPERS adopt is the risking strategy
would say if indeed the rate of return is excess of 11 and a half percent, the
assumed point of seven and a half percent points, then at that time, they
will bring down the cost--they'll bring down a reduced investment term
assumption with no cost to the city. That's what they're trying to do.
Chair Schmid: Which means an increase to the rate of the city.
Mr. Rossmann: Not necessarily an increase. They only like to do this once
an investment is at 11.5 percent or higher in that years.
Chair Schmid: In that year.
Mr. Rossmann: In that year. That's when they're going to reduce it down. That's what they're saying today, it may change in the future.
Mr. Perez: What they said also is if through this process, it doesn't
materialize, they will revisit those assumptions so you listed a little earlier in
your comment, in February 2018, with discussion in the fall of 2017. In
other words, if nothing changes, the rate still where it is, they would update
that discussion and then the demographics, the image.
Chair Schmid: Yeah, I guess I'm concerned that the city is buying into their
key assumptions that everything is okay and are taken care of and they
show in the past they have not been very good at--
Mr. Perez: So that's a good point. Within our report, we're also talking
about having a discussion with you about going forward with the Section 115
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Trust because if that doesn't materialize, as you're stating, then we want to
have the ability to cover all that and Section 115 Trust we believe it’s
appropriate to help us with that--
Chair Schmid: But you’re sort of undermine that case by accepting the
CAGR's assumption that everything is okay.
Mr. Perez: Well, you know, I think you have to have a base. Right? And
the base is it got to be in the report. Now, from there, I think we can do our
own scenario. We kind of gave you our own scenario. Maybe that's too
drastic--
Council Member Filseth: I actually think we should have a conversation
about that tonight, which is what's the base scenario.
Mr. Perez: Sure.
Chair Schmid: Yeah.
Mr. Perez: And, you know--
Council Member Filseth: (Inaudible) cause right now or later, but--
Mr. Perez: What we've given you is from the direction we've been given
from prior finance committees.
Council Member Filseth: Yeah. This is the base now. I think we should have
discussion about this.
Ms. Nose: And then a little short later, we do have the alternative as well
that has the lower risk investment.
Council Member Filseth: Yes.
Ms. Nose: So kind of looking at salary and benefits a little bit more at a
(Inaudible) level, benefits cost is a percentage of our total salaries and
benefits, increased from 15.6 percent in fiscal year 2017 to 53.7 in 2026.
So over forecast period, salaries have compounded growth at 28 percent
versus a compounded growth of benefit cost of 42.4 percent. So this
compound growth is estimated as you guys noted, then the previous
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forecast, primarily due to that lower city pension contributions in those app
years.
Council Member Scharff: Can you go back to the previous slide for just one
second?
Ms. Nose: Yeah, of course.
Council Member Scharff: Just want to observe that 3.9 percent annual
growth salaries and benefits. I don't know that salaries and benefits, but
historically, the general fund expenses are within 4.9 percent a year. Right?
Council Member Filseth: So it's much actually, a little higher than that. Okay. We just sort of concluded that with a projected increase in revenues
is going to be 3.58 percent, so that's actually below the growth and salary
benefit expenses.
Ms. Nose: Correct.
Council Member Filseth: Okay. Go ahead.
Mr. Rossmann: Recognizes that the budgets, salary budgets are only 61
percent of the total budget.
Council Member Filseth: Sure.
Mr. Rossmann: Right.
Council Member Filseth: Total budget historically have increased 4.9 percent
a year. So that means that other 39 percent has a decreased.
Mr. Rossmann: That's correct. Not increases--
Council Member Filseth: Not increase (Inaudible).
Mr. Perez: Council Member Filseth, just so we understand when your crunch
your numbers. Are you including transfers into now in your calculations?
Council Member Filseth: You know; I'm trying really hard to use the same
numbers that you guys did.
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Mr. Perez: My only concern is, for example, we've been more aggressive on
infrastructure. We've increased our funding for infrastructure, which is in
the transfers out, so--
Council Member Filseth: It’s actually the same thing cause at some point, I
like, you know, I don't know this, I'm not saying I did the same analysis with
the citywide revenues and expenses and those gross were actually higher.
Mr. Perez: That's even a bigger variable because the commodities being
involved. Right? So that's why it's important for us to figure out how we set
up a view and comparison from other years because of these significant variables that we can have in different policy settings in one year to another.
Ms. Nose: So I think we've gotten to everyone's looking forward to, which is
our alternative forecast model.
Chair Schmid: Oh, wait a minute.
Ms. Nose: Sure.
Chair Schmid: I guess in the other expenses--big item is Contract Services
get a huge hit in Contract Services in 2017, 2018. What's taking place
there? I thought there was a movement to try and find opportunism to
bring in sufficient services. Is that possible?
Mr. Rossmann: Sure. So what you see is what happens every year as part of
the budget. You might recall when you went through review of the 2016
budget, we asked for allotted one time additions, one time contractual services. These are taking out, so that's the change you'll see from '17. $4
million dollars in '16 down to 14.5 million dollars in '17. Then if we
escalated the fact, which is an average CPI of the last 20 years in San
Francisco Bay area of 2.6 percent. That's what the city has factored in the
forecast. That does not minimize the point that we continuously try to seek
opportunities to outsource--to change our alternative source LTTR models.
You saw this in Fire Finance Committee in October with aquatic services as
the next step. So staff still explore this, maybe not as systematically as we
would like ourselves, but we still continue across departments to figure out
how we can do things differently.
Chair Schmid: Just as an example, I mean we have substantially increased
our spending on infrastructure and 80 percent of that is going to be based
on contracting.
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Mr. Rossmann: That is correct.
Chair Schmid: So shouldn't that show up as an increase in contracting?
Mr. Rossmann: No, it would not show up. It was going to happen in the
Capital Improvement fund. We transferred the dollars from the Channel
Fund to Capital Improvement fund and that's where you see the expense for
contracting services. This is only channel funds pictures, not city wide all
fund pictures.
Chair Schmid: Okay.
Council Member Scharff: So I have a question. You know, it's really hard for council member. We transfer money all over the place, we do different
things. So I always look for simple measures if we're on track and I think
one of the simple measures I like to see is what percentage over time is
salaries and benefits versus other expenditures. You told us like 60, 61,
right? So is there a chart that shows us, you know, over the last years, it
stayed--if it stayed constant, then I think everything sort of going up
together.
Mr. Perez: That is right. I've looked--
Council Member Scharff: And it has stayed constant.
Mr. Perez: I looked at 2000, it was 60 point something percent.
Council Member Filseth: You got to figure out what to do. Maybe you got to
put half right? You got to figure out how to deal with capital expenditures in that mix to cause you're really looking at sort of--
Council Member Kniss: Apples and oranges.
Mr. Perez: It is apples and oranges, and that's what I was saying, It’s kind
of hard--because depends on how we were structure them, you know, we
may change in that year on how we created (inauidble0 services for IT for
example, when we positioned that, we put them in a service fund. So
there's all sorts at play that makes it really complicated to have a constant
comparison over a long period of time.
Chair Schmid: Okay, you were going to move on.
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Ms. Nose: Okay. So as we discussed, in order to provide some potential
alternatives, we analyzed to other long range options. One is the low
pension budget return and the other is the projected recession beginning in
the fiscal year 2018. The first one is the CalPERS Poor Investment Return
Model. So this scenario reflects continuous poor CalPERS investment
performance resulting in exceeding high pension rates. Our rates of return
are between 0.2 and 4.1 percent and you can notice what happens to our
bottom line. You'll see our operating budget surpluses reduced in fiscal year
19 and then in fiscal year 2020, we actually flip to a deficit in comparison to that base model.
Council Member Scharff: So in 10 years, it's about 50 million dollars in
differences is what it looks like. Correct?
Mr. Perez: it goes from a surplus of 40 to a loss of 11.
Ms. Nose: Oh, I see what you're saying. Yeah. So then, the second model
that we have presented is the 2000- an estimated 2019 Recession and this
recession model assumes a reduction in our major tax revenues and they
are anticipated to cline, but they are declining at a lower rate than those we
saw in both the dot com bubble and the great recession.
Council Member Scharff: So, if I see that one right, you basically dig about
a $100 million hold. Right?
Ms. Nose: Yeah.
Council Member Scharff: So it's about to a 140 short of the normal plan.
Now I noticed on there, you used the normal expenditure train, not the low
CalPERS expenditure train. Because of the big recession, you know, how
realistic is it you'll have the normal CalPERS expenditures. It seemed like
you'd have to add on cause if you added that on as well, you'd have another
100, another fixed rate, another 15 grand. Right? So you're $200 million
dollar short over the 10 years. Now, that's probably not real, I mean I think
0.2 to 0.4 percent is probably pretty conservative right?
Mr. Perez: Very conservative.
Council Member Scharff: Pretty conservative, yeah. And in a recession,
we'd only be a few years right, but I think it's going to be south of there
right. Probably not a good assumption at seven and a half percent return
compounded through the 10 years of big recession.
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Ms. Nose: Definitely.
Council Member Scharff: Wonder if we did like, you know, six percent? You
said before 6.5 percent or something like that. Right? That's what they got.
Mr. Narayan: We--I could--probably not off the top of my head right now,
but that's a (calculated) ball number. I just don't think I have it right now.
Council Member Filseth: That actually was going to going to be--if we're
going to sort of talking about this, it seems to me that the base planning
case that the (Inaudible) use, you know, as good conservative folks
shouldn't, you know, the CalPERS, I think we ought to look at--you think 6.5 percent is--?
Mr. Narayan: As long as you're asking me--
Council Member Filseth: Yeah.
Mr. Narayan: I think--what you would hear me say is the--ignoring for a
moment the CalPERS risk mitigation strategy. So do me a favor set that
aside.
Council Member Filseth: We set that aside a long time ago.
Mr. Narayan: I think that green line is what I would refer to as 50 percent
confidence level number and what you may want to look at, is something
that would be a little higher, maybe a 60 percent confidence level number.
That probably comes closer to the seven rather than 6.5.
Council Member Filseth: I sort of think 6.5 might be a good number. I think if you took--
Council Member Scharff: So what kind of confidence you think 6.5?
Mr. Narayan: These are all of the top of my head, but I think that probably
get closer to a 70 percent confidence level. When we're talking about the
volatility, that's a very high confidence level with the volatility we have.
Council Member Filseth: We're a municipal kind of thing, you know. We're
not like--we're not--it's not a Vegas road trip here.
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Mr. Narayan: Yeah, think that's--
Council Member Scharff: Think it's too conservative. What about 6.75?
Mr. Narayan: Well, so you asked me before.
Council Member Scharff: You said seven.
Mr. Narayan: I did. So it doesn't mean that you couldn’t' use something
other than that, but that's a--
Chair Schmid: Let me put the issue in a slightly different way, we're talking
about long term (Inaudible). And you can have an average of seven percent
return and if the last two years dipped down a little bit, your sum at the end, ends up being what your--close to what your projections are. But if those
two years of dipping, where maybe the market is only four percent happen
early on, it creates a whole in the deficit.
Mr. Narayan: It does.
Chair Schmid: Which is not recovered. Now the question is, you know, are
we in such a situation now because if people ask you to get together with
the first half of this year to raise the return fairly low, or if the market is
overvalued and is going to go through a readjustment at point, we could see
a substantial hole even if over 10 or 15 years, you've reached the seven
percent.
Mr. Narayan: So how do I say this? It's almost as if you knew what my
slides were. We kind of have a couple of sample investment return projection and our projecting annual rates based on those investment return
and so I think we can get to and answer that help you with that question.
Council Member Filseth: So I was going to suggest that I think we should do
that. Right? And the other factor I think we should put into this mix is if you
go back to the slide about--go back about three slides, 3.9 percent of annual
growth rate of salaries cause the annual growth rate of salaries, okay, also
impacts this curve. So I think we ought to pick a number that' not two
percent or whatever it is somewhere. I realize they're sort of like a bunch of
things associated, but I think we ought to pick, you know, a number we feel
more appropriate, put that next and that ought to be our base case. Cause,
you know, everybody knows this, but I'll throw it around anyway, this chart,
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you know, assumes that this is going to happen. Right? This doesn't
happen, this doesn't happen, so I think we need to be a little more careful
with the (Inaudible) here. I think we should be a little more conservative.
Mr. Perez: Why don't we switch on over to the presentation Mr. Bartel.
John Bartel is here from Bartel and Associates. I won't have the
presentation for you on paper, Mr. Bartel arrived this evening. I can provide
that to you later electronically and make it available in the documentation.
Council Member Scharff: Is this Walter's last meeting with us.
Mr. Perez: It is unless you make him come back tomorrow.
John Bartel, Bartel and Associates: Mr. Bartel: Let me go through some of
this information relatively quickly. You all have seen it before and I'm going
to --if you want me to slow down, please tell me to, but my goal is to get
towards the end where we look at supplemental pension trust. So I am only
going to spend time on the very last score bullet there, the CalPERS Risk
Mitigation Strategy. I do want to take a couple of seconds and talk about
that. Everybody should understand that is not cost neutral. Everybody
should also understand we have not yet factored it into our contribution
projections. Here is really what CalPERS is doing. I'm going to start this out
with, you know, there's a lot of great actuarial jokes. I'm going to limit it to
this one. You all may have heard this before. Two actuarial are at the
actuary range. One shoot misses the target 10 feet to the left. The other one takes the bull and arrow and go I can do better than that, misses the
target 10 feet to the right. They turn to each other, shake each other's
hands and go great. And then the guy watching goes, what the heck, are
you doing? You didn't even hit the target. And they go, no, but on average,
we got a bullseye. That really is sort of the natural of actuarial projection.
What's going on here with CalPERS is they are moving one of those arrows a
little bit. So what that means is, the two actuaries, if you move the arrows,
don't get a bullseye. So what CalPERS is doing is taking off a portion of the
expected investment return, the positive return and what that really means
is that the average return will be less than the expected return. So the risk
Mitigation Strategy will not--will almost certainly not be cost neutral, will
increase rates over time. There's not really much doubt about that. You
should expect that to be the case. That increase by the way, will be the last
then if the increase happened all at once today.
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Council Member Kniss: And that's an important point.
Mr. Bartel: No, it's very important. That's right. Slide two, Historical
CalPERS Investment Return. What you're really seeing is that volatility. So
if you think about this a little bit, we haven't done this graph, we almost
certainly will, but if historically CalPERS has had their risk engagement, what
would have happened is the lower returns would remain, but the upper
returns would really drop because you're really pulling a large portion of
those gains off the table.
Council Member Kniss: Would you go back to that other slide? Because what you've got written way at the bottom there, can't really see from here,
it's pretty significant.
Mr. Bartel: No. They--well--$1.
Council Member Kniss: Cause that's taking you last, basically, 20 years.
Mr. Bartel- Yeah, that's right.
Chair Schmid: If I could just point out on that chart, in 20 years, the first
has--first business cycle has six years of pro-rate of return.
Mr. Bartel: That's right.
Chair Schmid: The second one has four, third one has two, the fourth one
has (Inaudible).
Mr. Bartel: That's right. I don't pretend to know what a good investment
cycle is, but I will tell you is, the end of the '90s was particularly good. No questions about that.
Council Member Kniss: And the beginning of 2000’s, was particularly bad.
Mr. Bartel: That's absolutely right. There's really two periods there.
There's the early 2000s that were particularly bad, and then of course the
recession. That's absolutely right. You all have seen these graphs before.
This is the contribution projection for miscellaneous. So this is the short
term and this is the longer term. I'll just say this one thing. There's a
change by CalPERS in terms of paying unfunded liability off before we've
done these projections, before that change, you would not see the city's rate
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dropping to the normal cost rate. You would see the rate getting to a
slightly lower amount, but remaining quite high for a long period of time. So
change--see the safety graph look somewhat similar. What I really want to
spend a little bit of time on is the irrevocable supplemental pension trust. I
am--the more we look at these trust, the more I'm convinced they a
modestly good job of helping bring the unfunded liability down, but where
their value really is, is really as a rate stabilization fund. You kind of see this
in the next couple of slides, but there really are three variables here.
Variable Number 1 is how much additional receipt money would you want to put into the trust could be a single sum amount right up front. Could be a
constant amount over a period of time, so that's Variable Number 1.
Variable Number 2 is what do you want to your contribution rate to be.
What do you want your table contribution are to be and then option number
three, or questions number three is, how long do you want the trust be
viable? How long do you want the trust to exist and essentially not run out
of money? The idea really is that you put your supplemental contributions
to the trust and then you compare your CalPERS actual rate to whatever
your budgeted or to our target rate is and then if CalPERS rate is below that,
you keep your budgeted rate and you put that difference into the trust and
that's the CalPERS rate is higher than your budgeted rate, you pull money
out of the trust to pay for it. So again, you keep your budgeted rate. So what we're going to do is look at two investment return scenarios.
Investment return scenario A--both of these have some sort of investment
return cycle to them, if you will. Investment Return A starts out with a 1516
and 1617 returns, quite bad and then you end up with three good years, two
bad years, two good years and scenario B is two good, very good investment
return; three bad, two good, two bad. And what you really see--we're going
to show you the--we'll look at the miscellaneous plan is investment return
scenario A, which starts out with those two very bad investment returns,
gets to much higher contribution rate. If we were to extend this projection
out a little bit, those two lines would actually cross. Green line, the scenario
A line might come down a little bit. Purple or blue line for scenario B, might
go up a little bit, but we're projecting out through 2024 and so what we're
doing is for the purposes of our miscellaneous trust, we are assuming the
city takes a -- we can certainly use different numbers, but we're assuming
the city sets up a trust, puts an additional $1 million a year into the trust as
additional contribution and sets the CalPERS contribution at 35 percent. So
the buzzard in the mount is 35 percent, so if your CalPERS is below that, you
put that additional amount into the trust, if it's higher than that, you pull it
out of the trust. So what we did is we put those two scenarios, set the
budgeted rate at 35 percent, so you can see early on for scenario A, what
you're doing is, you're pulling, you're taking that delta and putting the
additional amount into the trust and later on under scenario A, you pull that
out--what is fascinating to me about this is, this particular scenario, we do
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have an interactive model we could bring that up and kind of play it a little
bit, but what you see here with this scenario is at June 30, '25, you have not
exhausted your trust. And by the way, one thing--on assumption I did not
put here, is the assumption is--the money in the supplemental trust is
invested more conservatively. It's assumed to be a five percent rate of
return rather--an expected five percent rate of return rather than a 7.5
return. In this scenario, at June 30, 2025, even though you're pulling a lot
of money out late in the period, that additional million dollars here plus the
additional contributions means that June 30, '25, you still have a positive balance in the trust. In the interest of full disclosure, you don't have a
large--in this scenario, you do not have a large deposited balance, but you
have not run out of money in the trust. And then you go to scenario B and
scenario B, your contribution is consistently below your 35 percent budgeted
amount. That is absolutely tied to that early--those early good returns,
which drive the rate down and if we do the same projection with safety, but
instead of 35 percent for safety, we use 51 percent contribution rate. If you
go to compare the 51 to what we projected again under scenario A, you still
end up with a positive balance; same scenario, a million dollars. So if you
were to do one for both miscellaneous and safety, that would be a combined
two million, so a million dollars into the safety account, again early on under
scenario A, you would be feeding the trust and later on under scenario A you start withdrawing from the trust. You could come up with different
contribution patterns, you could say, well, maybe we don't want to start out
with a 51 percent budget for '16, '17, you could gradually build up to a
number. My guest would be then if you gradually build up from the 51
percent, you probably have to--you probably have to end up at a slightly
higher than a 51 percent in order to keep the trust solvent. This idea, the
use of the trust for something like that is--I think allows you a lot more
certainty in terms of budget. It has the added advantage, although I don't
think this is a significant advantage, but it has the added advantage that
anything you put into the trust, reduces your (Inaudible) 68 net pension
liability. My expectation would be that it would be probably very positively
received by the rate agencies. One thing that relatively quickly, happy to go
back and answer any questions.
Council Member Kniss: And you'll make this available for us?
Mr. Bartel: Yes, yes.
Council Member Kniss: Great.
Chair Schmid: You mentioned concrete numbers, million dollars for each.
Was that taken from our numbers or is it just a (crosstalk).
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Mr. Bartel: No, it's a--it is a number that was discussed with staff as a--as
something that might be achievable. But just to be clear, it's not--this is not
a recommended approach by any stretch of the imagination. This is--
Chair Schmid: Just trying to carry that through, you know, at five percent
interest over three, four years. You don't have a huge amount, so your
ability to subsidize rate is limited.
Mr. Bartel: That's right. We wanted though to use a--so the five is going to
vary a little bit because it does have some equity exposure, if you will. So
we build it to be a--not as volatile as the CalPERS return, but if the idea is that its rate mitigation, I think of rate of mitigation as being more valuable
when rates go up then when rates go down. And so the idea is that it
accesses a little bit of an edge against the rates going down. So that's really
why I would--I don't find--it's not really a recommendation, it’s just kind of
an example.
Chair Schmid: I guess my recollection of investment return is you earn 65
percent in the last three years of a 20-year investment and this seems like
it'd be very active in and out over the business cycle.
Mr. Bartel: That's right.
Chair Schmid: It never gets big rates of return.
Mr. Bartel: I think that's right. The other comment I will make on this is,
this process is not design to have a lot of money in it. It is designed so that if you--if you start to see it having a lot of money in it, you want to consider
revisiting in, you know, if the trust ends up a lot of money, you ought to
revisit every couple of years, your 51 percent or whatever your target rate
is. So if you have a lot of money in the trust, maybe you bring the 51 down
to 49 to be some advantage.
Chair Schmid: So it's more to help you over this cycle--
Mr. Bartel: It's exactly right.
Chair Schmid: That have been via the retirement fund.
Mr. Bartel: That's exactly what it--that's what I absolutely think the value
when this (Inaudible), used to do exactly that.
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Council Member Filseth: As opposed to paying down the UL early for
example.
Mr. Bartel: That's right, that's right. I would not--
Council Member Filseth: If you wanted to pay on the UL early, what would
you do?
Mr. Bartel: For me--let me give you my caveats cause the caveats is if I
were--if I were on the city council, I would want very badly to pay that
Unfunded Liability down as soon as possible. I will tell you, in normal
environments, I think paying any Unfunded Liability sooner rather than later is absolutely the way to go. The challenge though is under the CalPERS
model. If you pay the Unfunded Liability down very quickly, you end up with
a high degree of likelihood that--much of that money you put in the trust is
not--would not be useable. Meaning that your CalPERS contribution rate
can't drop below the normal cost, so if you end up being more than a 100
percent funded, it would be the (Inaudible) equivalent of having a reserve in
your city investment funds that you could not use for anything. If I were--
for me, that's bad. And so I want to pay the Unfunded Liability down, but i
want to do it cautiously so that I have access to that money. So that is an
advantage to these trust. We think--
Council Member Filseth: Its part of the rational to keep the amount in the
low so you don't have that much risk.
Mr. Bartel: That's right.
Council Member Filseth: Could you use this in combination with some other
mechanism to pay down the Unfunded Liability quicker?
Mr. Bartel: The--just to be overly simplistic. If you wanted to pay Unfunded
Liability down so bad, you couldn't resist that urge, I actually think you could
move it into the Supplemental Trust. That reduces your Unfunded Liability,
but it does not give that money to CalPERS quite as quickly, which I think
mitigate your volatility and so it gets your Unfunded Liability. The downside
to that is, the information coming from CalPERS still shows the higher
Unfunded Liability, but it allows you to use that money to pay--to set a
budget number that might actually be lower than the normal cost.
Council Member Filseth: I think we kind of rely CalPERS for our--I mean; I
think you said it beautifully earlier this evening. You said "we got a liability
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and we got an asset," and right now, we ask CalPERS to tell you what the
value of our asset is. That's just too creepy. I think we need to know.
Council Member Kniss: I just want to ask, what (Inaudible) Mr. Bartel--
Mr. Bartel: Call me John, please. I know people call me Mr. Bartel, that was
my father's name.
Council Member Kniss: I can remember John far better.
Mr. Bartel: I respond to John better, just so you know.
Council Member Kniss: Jim and I was just talking on the side. He did say
you are the California expert on this.
Mr. Bartel: That's way too nice. In the interest of full disclosure, I like low
expectations.
Council Member Kniss: Then so you cannot be disappointed.
Mr. Bartel: There you go, there you go.
Council Member Kniss: So as we look at something like this, tell us what
other municipalities have done that is similar or dissimilar and who has come
out ahead and who hasn't and you know, looking--one of the things about
PERS that always bothers me is that their widely volatile in their returns.
And we'll get all excited and they'll say no, that was 13 percent return year
and next year, they go down two. So it's--I know what their portfolio looks
like, but it just always seems--it always just seems kind of screwy to me.
Mr. Bartel: let me give you kind of a couple of--
Council Member Kniss: That's a technical term.
Mr. Bartel: A couple--yeah, no, I think you're absolutely right that volatility
in the investment return--you should get used to it. It's going to be there
and you should recognize that particularly in today's communication
environment where newspapers are incredibly good at short articular, 30
second sound bites on TV, it's--you can't--it is veritably impossible to
communicate other than short term volatility in the numbers. But you
should absolutely understand that volatility is going to be there for a long
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time. That's number one. Number two, that volatility will translate into
contribution rate and budget volatility. There's no question about that.
What I'm suggesting about a supplemental trust is a relatively new concept.
A little over a year ago, Irvine Range Water District establish the first--it
certainly was the first in the State, may very well be the first in the Nation.
I'm told not, but I can't attach an agency mean to whoever else did it. It
was a relatively new concept at the time and if you want examples of how
these trusts have worked, we're brand new. Meaning, this is--sometimes for
public agencies closer to the bleeding edge--they don't want to be on the bleeding edge, they're nervous about the leading edge, this is leading edge
and that makes agencies nervous. We think--I've not talk with folks who
really are setting these trusts up, but we think they're probably year to date,
less than 20 agencies have actually set these up so far.
Council Member Kniss: So there's not much precedence here for
predictability.
Mr. Bartel: There is not, there is not.
Council Member Kniss: Let me ask something else. Do you remember the
(inaudible) scheme that went on here quite a while? We waited at the
county three years to do it and then we absolutely, you know, (Inaudible). I
remember thinking at the time, it was hard to believe this was real, but they
sold it, sold it, and sold it, finally, the fourth year we brought it; went right down. And this sounds so appealing, but again it's that same, where will
the--it's hard to remember what happened in '08, so with this, I think uh, it
looks terrific. What happens when hit 2019 and the predicted recession
happens?
Mr. Bartel: We can--just so you know, we can certainly model that. What I
will tell you is--
Council Member Kniss: I would love to see that model.
Mr. Bartel: What I will tell you is what makes this work is not magic. You're
not getting something for nothing. What you're getting, the reason you can
have in this particular example 51 percent contribution rate is that there's
nothing magic about that. The reason you get there is because of the
discipline of two things and that discipline is the additional million dollars a
year going in, okay.
Council Member Kniss: It's substantial.
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Mr. Bartel: It is substantial. And the discipline for in this '16, 17 years,
right here, having CalPERS sends you a report that says 44.6 and you pay
that difference into the trust. So let's be clear here, there is no magic about
this. It is all about having the discipline to put those additional monies in.
So when we talk with our clients about this, we think this works better at an
agency that number one is fiscally conservative; number one, and number
two is has that discipline to put that additional money aside. If you don't
have that discipline, there's--let's be clear, the money that's going into the
supplemental trust is not, you know, we're not talking about leverage real estate here, we're not talking about slots, we're not talking about alternative
investments, I'm suggesting it should be more conservative, not less.
Council Member Filseth: The thing you're talking about, the swap
(Inaudible), is actually a swap for financial instrument. Is that what you're
talking about?
Mr. Bartel: Yeah.
Council Member Kniss: Yeah, a very tempting financial instrument. This is
putting aside a 13th mortgage payment on your house.
Mr. Bartel: Yeah!
Council Member Filseth: It's not, it's not--
Council Member Kniss: It's a good way of putting it, but it--
Council Member Filseth: It's not a full swap or something like that.
Mr. Bartel: That's a much better analogy--
Council Member Kniss: But what I'm hearing John say though is that the
discipline factor is very interesting. We already said, if we hit a recession
and your budget is really tight and you're going to say, sorry employees
you're don't get that raise this year because we're putting a million in this--
Council Member Filseth: We're considering--
Mr. Bartel: Well let's be clear--
Council Member Filseth: We're considering two things.
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Mr. Bartel: --That's exactly why it's there.
Council Member Filseth: We're considering two things. Right? CalPERS
going to get hit by the same recession, okay.
Mr. Bartel: Right.
Council Member Filseth: They're going to get hit worst cause they're
leverage.
Mr. Bartel: That's right.
Council Member Filseth: The second is, consider the alternative. The
alternative is you spend it now. You foot the bill for future generations and they pay for it.
Council Member Kniss: Eric, I totally agree with you, but I've been in those
situations where all of a sudden the income is just going down like this and
you're saying, I just don't want to put that million in, and that means that--
Council Member Filseth: Well the alternative is you run it up on the credit
card and you foot the bill to future generations.
Council Member Kniss: I guess you could do that, but--
Council Member Filseth: That is what you'll have to do.
Council Member Kniss: But what happens also is that we're not all sitting
here in five years or 10 years or whatever that may--you got to practically
swear in blood that whomever else comes along sticks that million aside and
I think that's where the rub may come on this is can you get that long term commitment of a million every year for essentially forever.
Mr. Bartel: Let me go back and re-emphasize something that is said.
Council Member Kniss: I'm from New England, you know, we--
Mr. Bartel: I know. It--I don't think this is right for all of our clients. Let's
be clear. Because you have to have some confidence that this discipline is
going to be there, but let's be clear, if it's not, the money is still in the
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irrevocable trust. You've access to it; not to fix sidewalks, not to fix
infrastructure, but to supplement your contribution to CalPERS'
Council Member Kniss: It's a very tempting kind of thing to do. Pretty
sophisticated and can be somewhat hard to explain especially when you
have 1000 employees.
Chair Schmid: Jim?
Mr. Keene: Thank you. This may be a completely off the wall question, but
sometimes I think when we're really talking long term, we're concerned
about not only the volatility, but the stability of CalPERS. I know we talked about our behavior working relationship to not only how CalPERS invest
money, but how other participants in the CalPERS system managed their
responsibilities and reliabilities. To me it's not only just like a comparison of
running up a credit card, it’s also like you have your money invested in a
bank that a bunch of other people have their money invested in the same
bank. I mean, it ultimately, at some point in time, I think we have to be
thinking about how much of our money we got in a bank that if the whole
thing starts to have problems, we're not necessarily protected from the
weakness in other sectors within the collective. And I don't know how we
get to that when you start thinking out the long term and maybe I'm sort of
over estimating. I mean, that's the very dark sort of look at this, but you
know--
Chair Schmid: Let me give a contrary point of view. You know CalPERS got
us in the late '90s, during a period of boon stocks and--will take care. But
they got us permanently, we're in. The long term financial forecast is kind
of in four ways to help us deal with some fundamental problems like we're in
a situation now where our long term forecast said we can get two percent
salary increases, and much more in the benefit package, but people need
money in their pockets to live. This doesn't help us deal with the issue of
how can we put more in the pockets? Can we hire workers; can we do
infrastructure? It just helps us through the business cycle to say, okay, we'll
keep doing it in a (steady way). So you know, it doesn't build up a fund that
could substitute for CalPERS, it only says we can keep our rates up.
Mr. Bartel: I think I absolutely agree with everything you said, but maybe
with one minor modification. Do me a favor and look at slide 19. So slide
19 is really crummy investment return early on, which drives up those rates
later on. So for me, and I know this is not always the easiest conversation
to have, but when you're talking with employees about pay raises, look at
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this area right here. To the extent that you don't have the discipline to put
the million dollars in, to the extent that you don't have the discipline in this
scenario to put the 51 rather than the 44.6 in, you're going to be hit with
those higher rates which will make it harder for you to give those pay raises.
Chair Schmid: Yeah, if this was true, but what you have here is you put in
$3 million over three years. Now you have 10 years where you're putting in
$40 million dollars and it doesn't add up.
Mr. Bartel: Well, what you're doing in this--so this is safety, right? And so
what you're doing is you're taking your--the million dollars is really going in over that 10-year period. So you're really putting in 10 million bucks.
Chair Schmid: Oh, I see. That's a three-year period.
Mr. Bartel: Pardon me?
Chair Schmid: Isn't it a three-year period?
Mr. Bartel: No, the million, the presumption is they're two pieces to the
additional contribution in this scenario and the two pieces are a million
dollars every year annually. In addition to the million, you're putting in--
your budget is 51 percent, so in the first three years, you're putting in 51
minus the CalPERS, but in off hand, you're putting in a million. And so what
we're saying is, in this scenario, that buys you the ability to have a lower
budgeted rate over that period of time, but kind of two things are really
going on here--
Chair Schmid: But only if you've had 10 years of years of where you could
build that up. Here you only have two years to build it up--
Mr. Bartel: No, just to be clear. This analysis is based on that scenario. So
in other words--
Chair Schmid: Doesn't it say in 2019, you start paying--?
Mr. Bartel: In 2019, in the '18, '19 fiscal year, that's the first year you start
drawing money from the trust. You're drawing from the trust, but you still
putting money in because the presumption is, you can continue to put your
million dollars in.
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Chair Schmid: But just the space you have when you accumulate and when
you de-accumulate is way out of line.
Mr. Bartel: What we didn't show here, we could show you the trust balances
so that could see it. Now, everybody should be clear here. In this scenario,
at June 30, '25, there is not very much money left in the trust, but it's still
positive. It's a small positive--I'm sorry, I don't remember, but I bet it's less
than a million and a half or something--it's a small number. But this does
get you to that positive, that positive--
Council Member Kniss: So is this your--what Eric was saying here, you're making the 13th mortgage payment, and at the end of 10 years, you come
out ahead because you put the money aside.
Mr. Bartel: Yeah, that's right.
Council Member Kniss: Yeah, no, I--
Mr. Bartel: That's really what's going--
Council Member Kniss: As I said, it's very tempting.
Council Member Scharff: So I think what the issue is you get to is the
discipline. I think Liz raised the right issue. So actually, I don't think it's an
employee issue. I'm thinking about in 2009, 2010, you know, we basically
decided that we weren't going to cut services and instead we didn't give
raises. A lot of cities gave raises and cut services, that's your two choices.
We in Palo Alto, didn't cut services.
Council Member Kniss: You do one or the other.
Council Member Scharff: Right. Do one or the other. And you know, and
what is it? One percent, one percent increase at CIU is a million dollars,
right? Roughly, right? and then it's an ongoing --than ratchet it up, so
you're at that extra million. So that's where all the money is. I mean, if
we're talking a million dollars a year, that actually I think we can keep the
discipline to do that. If it gets more than that, I think it could be a problem
because what you're going to be tempted to do, is you're going to say, you
know, we don't have no money to pay crossing guards and are we going to
cut the crossing guards or we're going to cut this, we're going to cut this. I
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mean, that's my sense of where that goes when you have 300 angry people
show up, so--
Council Member Kniss: Or as we one-time try to raise the price according to
the children's theatre. That's one of my favorites; don't do it.
Mr. Bartel: I understand the bigger context.
Mr. Perez: I'm going to clarify something. Please go ahead.
James Keene, City Manager: Maybe you've said this before. Supposed
John, if we were to take what the cost is under that model, under the green
line including the $10 million contribution or whatever and you're sort of explaining where we're going to be. If we didn't make that contribution or
we adjust again the total up what our cost would be each year on the green
line, what would be the delta between the expense over that period of time?
Mr. Bartel: I can't answer that question of the top of my head, but that's a
very reasonable question.
Council Member Kniss: Probably the same.
Mr. Keene: Okay. I mean, if it's pretty close to the same--
Council Member Kniss: We're just stretching it out.
Mr. Bartel: It's the same. The question, under this scenario, is the saving.
Mr. Keene: Okay.
Mr. Bartel: But the reason it's a savings, is because you're putting more in
sooner. That's the reason it's a saving.
Council Member Kniss: You're earning sooner.
Chair Schmid: A little bit, yeah.
Council Member Scharff: I do want to say it’s a benefit to the employees to
do this. I think we should because they know that we're actually going to
pay the pensions. I mean, that's really what it is.
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Council Member Filseth: That's the bigger picture.
Mr. Keene: Can I put another thing in here I think it's a really, really
important point, it's been--it's very difficult to get this across the labor and
our employees is that--in one sense tries to stabilize our situation so we
don't get in a situation where we're sort of over committing on in agreement
and giving a bigger pay raise because in the short term, it looks like we're
doing better that we really are and there's this pressure to do this, and then
suddenly we get in a few years down the road in the future, we got another
contract and suddenly it's way worst and we're down and yet it's way more erratic behavior.
Council Member Filseth: I mean, doing this is what enables us to make it
secure for (SCU) in the future, right? By getting control of this stuff. Now
there's a temptation, tricky road we want to go down, you know, well gee,
that's somebody's else’s problem, I don't think we should do that. Right?
This is--doing this, getting our house in order, you know, is good for
everybody. Right? Cause it enables us to protect people, not just this year,
but well into the future.
Mr. Perez: Yeah, to that point, I do believe--
Council Member Filseth: I don't think we're going to be (Inaudible) anytime
soon, but the principle is the same.
Mr. Perez: Yes, and you know, I think, you know, there's a couple of things that from a staff's perspective that--we want some kind of stability and
when we can figure out where the comfort level is on the contribution. We
learned from the last recession, the pain you talked about earlier, reduced
about 70 positions, we were fortunate to be able to freeze positions and not
lay off but a handful. But that cost a lot of issues to the organization and to
the staff and to the community because different services were impacted
temporarily because of the vacancies. So if you have a mechanism where
you can draw money from this trust, it allows you to have time to make
those informed decisions as a whole and that's a huge benefit to the
community and to the organization because then you're not freezing critical
positions because you have to because of the (Inaudible) commitments that
you have. So that's one thing that's attractive about this for us from an
operational standpoint. The other piece to make sure that we're all clear,
John, let me repeat it and please correct me. So what we're talking about
here, this safety, so in miscellaneous, keep in mind that it includes the
Enterprise Funds so it's not a million dollars, it's you know, 550,000—
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Council Member Kniss: You mean to the General Fund.
Mr. Perez: To the General Fund contribution. So it's a little less, obviously
it's still a number, but the other number is the difference to the delta
between the 39.5 and the 51 percent. How much is that?
Council Member Scharff: I was going to ask that question.
Mr. Perez: I don't know if you have the chart that shows the dollar figure of
that.
Mr. Bartel: I did not bring those. Sorry.
Mr. Perez: So what my point is trying to be is, you have a lot--we have a lot
of obligations and commitments that we have. So we've been focusing
tremendously on infrastructure. Right? And so we're going to have that as
a priority. If we were to make some commitment to this, this would part of
that equation and that we need to tie in to our thinking of how we go
forward. We may not feel that we can be as aggressive, I'll say--I don't
know what word to use right now, I'm trying to illustrate the point. We may
not be as comfortable with that number. Let's just say for the sake of
discussion that it's another $4 million plus the $1 million--half a million, so
it's $4.5 that you would have to put in. That competes with everything else
we have.
Council Member Scharff: That I'm concern about. I was going to say that.
Mr. Perez: Right. It's something that we can work towards. There's various
ways to do it and we've had this discussion and obviously the lesser amount
you put in, the harder it is. The illustration I can give you of how it works
and you've had really good physical policies from my perspective that you
adopted, is over a five-year period of time, we've contributed over $30
million to the infrastructure we (Inaudible). Setting that aside ahead of time
and it was based on the research policy and the budget that was issued and
sort of said anything above an 18.5 will go to infrastructure. So there's
ways that you can think about it. You can say if there is a such a experience
in the future year, and I'm just throwing out number--illustrations just so
you can grasps some policy concept, we can say 2/3s of it go to
infrastructure and 1/3 goes to Unfunded Liability or whatever.
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Council Member Scharff: So I want to jump in. This is actually my whole
concern in doing this. Is we have an infrastructure plan, construction cost
rep from say again, 30--40 percent. What I'm really interested right now is
finishing our infrastructure plan. And after we finished our infrastructure
plan, then I think we can focus on this. And actually a little concern that
we're going to need every penny that we can scrunch up to get our
infrastructure plan done. I mean, I'd be fine if we took a look at the
infrastructure plan and said, okay, where's all the money coming from? How
are we going to do it? What are we going to fund it and then we look at doing this? But I don't really think that we can take out 3 or $4.0 million a
year. i actually thought we could probably squeeze a $1.0 million a year for
this, but it's the delta between the rest, I don't know, 51 percent and you
know, I mean, I might not even be opposed to just saying let's just put a
million aside starting now and then with the promise that after we finish
infrastructure, we then do the 51 percent, but we start out having a fund
already in there because we put a million aside every year. Something
along like that. When we start the precedent, we start thinking--we do it,
but we know we aren't there yet.
Mr. Perez: My sense is that, that's where you're going to be? So, you know,
there's some one time dollars that we can identify in the tune of $3 million
from various sources so we can go into--that we can seed funds. I think it's important to seed funds, not trust funds. We may not, you know, you may
not be comfortable already for the whole amount, but what I would want us
to consider as an organization and you know, discuss it with Jim, we're
concerned about that recession that's blooming. Right? So we want to have
that--
Council Member Scharff: Probably about six months long.
Council Member Filseth: Probably got one day, one day.
Mr. Keene: All those projections actually identify the recession occurring the
year after he retire. Pointed that out to him.
Mr. Perez: And so it'd be great to have that trust fund so that because we
want to have that flexibility of having that time to make informed decisions.
Good job (cross talk).
Mr. Bartel: You mind if--yeah--so everybody should understand though that
you delay putting in the additional amount in, what that means is your 51
target is not going to be a 51 target. It's going to be a 52--
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Council Member Filseth: Or more.
Mr. Bartel: Fifty-two so don't kid yourself about that. I'm not trying to tell
you; you should do this instead of--
Mr. Keene: I think Greg's point is really good and going back to that, the
benefits of this lies in the discipline. The problem we have and this is budget
Terry challenge always is that there's tradeoffs, we have a number of long
term goals that require discipline; the funding of the infrastructure plan
requires discipline over any number of years. Actually trying to keep our
pay rates competitive enough in the marketplace requires discipline over the years, the same thing with this. I would say on the other hand though, Greg
brought up a really good point is, I think we need to--I don't think we can
just rest on our morals about growing revenues, on the other hand when we
have some of these demands, we need to be opened to thinking about the
fact that new revenues streams or increases in revenues allow us to
maintain this discipline on the cost side of stuff too. I'm not advocating one
way from the other, but it's like, you know, there's a hydraulics here
between these different choices we have. Think of an equalizer on your
stereo or something, I mean how you're going to adjust of these different
beavers.
Mr. Perez: There's another factor to Joe just reminded me off, that's where-
-and John pointed out earlier, that's where disclose more of our numbers and moving them into our financials. The rating agencies are also going to
look to see what we're doing. Right? And so it's good that we put $70
million aside in our retirement/medical and if we have something, even a
modest start, they will look at it in a positive way because we're going to
issue more debt and we want to be--
Council Member Filseth: That's the only place (Inaudible), painless interest.
Chair Schmid: You know, I guess I'm concerned to make a once and for all
contribution to get it started. But to get an annual payment, a guaranteed
annual payment without a revenue base building on, you know, what the
numbers tell us here, is that we have salaries growing at two percent per
year and benefits are four percent per year and you want to exacerbate that
deferential. Is that a benefit to the workers? That's my question.
Council Member Kniss: I think that's rhetorical, isn't it?
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Council Member Scharff: So are we going to talk about approving a long
range financial cause I actually have issues with approving a long range
financial forecast.
Council Member Filseth: I got a whole list here too.
Council Member Scharff: Well, I'm just thinking that it's 9:40 and--were you
planning us to vote to recommend one of these trusts? Where are we in
terms of action and--
Chair Schmid: Yeah, what do we need to do?
Mr. Perez: You know from a setting up the trust, that we have time. It's not--if you're not ready tonight--
Council Member Scharff: No, I'm ready, I'm ready to make a motion on it.
Mr. Perez: Okay.
Council Member Scharff: I like to actually make a motion on it.
Chair Schmid: Why don't we first go back to the long range financial
forecast before we decide on it.
Council Member Scharff: Why don't we finish this?
Mr. Perez: Yeah, let's finish this.
Council Member Scharff: Let's finish this because this is a different issue.
Chair Schmid: Do you want to make a motion?
Council Member Scharff: Yeah. Before I make a motion though, I think I
just want to--so what we would need to--what would the motion look like? It would look like go direct staff to recommend to the council that we set up
a trust. Right? Cause that's what we would be doing.
Council Member Kniss: Don't you want to evaluate before you recommend
it?
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Council Member Scharff: Well, we have evaluated it. That's what we've
been doing here tonight?
Council Member Kniss: Well, in for what? For 45 minutes?
Mr. Bartel: The one--what I think you should--there are more than one
provider for these trusts.
Council Member Scharff: Okay.
Mr. Bartel: So I think if you direct staff to look at the providers and come
back with a recommendation--
Council Member Scharff: And Liz is right. So it'd be to evaluate--there you go, use the words.
Mr. Perez: Yes, so that--we want to go through a competitive process, so
request for proposal so maybe the staff (Inaudible) a request for proposal
for the establishment of a trust and come back with additional information
and options I would say because you would want to have options on how to
fund such trust.
Council Member Scharff: Absolutely.
Council Member Kniss: And you may have to spend some time with the five
council members who are here and--no, I think they probably would want a
good deal of input on this.
Mr. Perez: Excellent point. Something to consider.
Council Member Filseth: You could refer to the next finance committee to vetted it out and then go to council. It's fine too.
Council Member Scharff: So but when would you get the request for
proposal? You need council authorization to do that. You could do that
with--So I mean, I think the best, the best of all possible worlds would be,
do we ask you to evaluate, go get request for proposals, come up with
options, come back to finance committee and finance committee then makes
a recommendation based on having all that information and we had some
full item and, you know, we talk about exactly how much money we want to
put in with the different options, and then we go to council with a specific
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recommendation that's been vetted by, you know, four people who either
agree or disagree or come out cause this is a complicated stuff and I think
this is exactly what a committee can do to make it easier on council.
Chair Schmid: One key thing that John brought up is to not just make a
single payment to establish it, but rather to try and get it as (Crosstalk).
Mr. Perez: So whatever John is showing you, the different options, the
model that John shows with the numbers--
Chair Schmid: Right.
Mr. Perez: I think that's key.
Council Member Scharff: Absolutely.
Mr. Perez: An alternative model would show me that a million or some
number and then one-time funding as we went--off the top of my head,
those three could be likely scenarios we could present you.
Council Member Scharff: Okay. So I'll make a motion that we--that staff go
forth to request for proposals, evaluate it, come up with information and
come back to Finance Committee with options.
Council Member Kniss: Whomever they may. Remember, it will be a new
finance committee, but I think that's a good idea actually.
Council Member Scharff: Right, then there'll be more council members
getting vetted on it.
Chair Schmid: Do you want to be more specific on what proposed, what the proposal is?
Council Member Scharff: Well, do I need to be? I mean a request for
proposal to--of setting up one of these--what do we call them?
Council Member Kniss: 115 Trust.
Council Member Scharff: 115 Trust. An irrevocable 115 Trust.
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Mr. Perez: Right now we know of two financial institutions that provide such
services and so we'll see what else is out there.
Chair Schmid: Okay--
Council Member Kniss: Second.
Chair Schmid: There's a second, good. Do you want to speak? You want to
speak?
MOTION: Council Member Scharff moved, seconded by Council Member
Kniss to direct Staff to conduct a Request for Qualifications (RFQ), evaluate
it and return with information to the Finance Committee with the options.
Council Member Scharff: I think this is definitely worth exploring. As I said,
I think that I probably have issues putting the Delta in, but I think if we set
this up and start the process--I understand that, you know, that we might
be at 52 percent, but I do think, looking at these competing dollars, I do
think we need to (Inaudible) our infrastructure and we may be fine. No one
is actually vetted where we are on the infrastructure in terms of how much
money we need and that's the big competing dollar amount. And there are
other things that are interesting like we haven't looked at the issue that
when the police move--the public safety group move out of their public
safety building, there's all that space here. We might actually be able to
move the people out of the development center into that space or rent the
space out and cover a substantial amount of money that we can then use for the rest of the infrastructure projects. So I mean, I think there's lots of
different--I do hope staff thinking of a financing plan, you know, based on
new construction cost numbers cause that's going to come up fairly quickly.
As we go to council on every item and you say--
Chair Schmid: It's not in your proposal at all.
Council Member Scharff: No, no, no, it's not, but I mean, I do think these
are related in terms of different cost issues and what we're going to spend
money on.
Chair Schmid: Liz, do you want to speak to your second?
Council Member Kniss: Only that I think this is still needs to be an
exploration and that's what I hear us getting into. And then to remember
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that this should not be taking lightly. This is a really major step and I
support it, now I'd be interested in hearing what else you find out as you call
around and go with an RFP and so forth and see what other entities have
already tried it.
Chair Schmid: No other comments, then what I have here is where asking
staff to evaluate proposals for irrevocable 115 Trust and come back to the
Finance Committee with information and options.
Council Member Scharff: Well, to get our--who option?
Mr. Perez: We would.
Chair Schmid: Okay. All in favor:
Chair Schmid: That passes anonymously.
Council Member Kniss: And thank you John for coming.
Council Member Kniss: Aye
Council Member Scharff: Aye
Chair Schmid: Aye
Council Member Scharff: Aye
INCORPORATED INTO THE MOTION WITH THE CONSENT OF THE
MAKER AND THE SECONDER to add to the Motion, “to return with an
Irrevocable 115 Trust proposal.”
MOTION RESTATED: Council Member Scharff moved, seconded by Council
Member Kniss to direct Staff to:
A. Prepare and issue a Request for Qualifications (RFQ) to the creation of
an Irrevocable 115 Trust; and
B. Return to the Finance Committee with options and analysis based on responses to the RFQ.
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MOTION AS AMENDED PASSED: 4-0
Chair Schmid: Okay. What are the steps we need to do with the long term
financial forecast?
Mr. Perez: So to get to the point, we want to hear from your feedback on--it
sounds like you had some ideas on what you think our base model should
be, so we're open for that discussion.
Chair Schmid: Okay. First, suggestions, comments?
Council Member Kniss: So may I ask the outstanding question. How about
how long you all want to stay late on this? I mean, are we talking about 11 again tonight?
Chair Schmid: We're trying to drive to a resolution of lung range financial
forecast, so if you want to make a motion, suggestions--?
Council Member Scharff: I have some suggestions.
Chair Schmid: Yeah.
Council Member Scharff: I think the first thing is that--I think that we
should go with Mr. Bartel's seven percent in here. I think the seven and a
half is too long.
Council Member Filseth: Think six and half is too conservative?
Council Member Scharff: I think six and half is too conservative. I think we
went with seven. I still think these--I still think we're way too optimistic
about how much revenues--I think we're going to have a recession. So I think if we re-did this with the seven, I think we're getting a lot closer and
you know, I'm open to the thought of wage growth at a higher level at the
moment. You know, where you talked about three percent or whatever?
Council Member Kniss: You mean factoring it in at higher level.
Council Member Scharff: Factoring in at a higher--
Council Member Kniss: Instead of two and a half?
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Council Member Scharff: Instead of two percent. And I tell you, I don't
think that's a--I think it's sort of a promise. I mean, I would actually--but
on that issue, I would defer to Susan and (Laurel) really and then if you
guys told us that you thought that would cause problems in bargaining, then
we'll just leave it alone, and if you do, I mean, I could go either way on that.
I do think, I do think that we could easily go--I easily think we're going to go
negative on this stuff fairly quickly, which is fine. I think going negative on
this stuff is just fine cause that's where I actually think we are. If we don’t'
get new revenue sources, and the only reason we didn't go negative on this time is if you took out the TOT increase, right, we're going negative.
Council Member Filseth: The Hudson property is TOT.
Council Member Scharff: Right. I mean, so you took out (tasler) sales tax,
one little bump for that, then the Hudson deal, then the, right? So I don't
think all that stuff is sustainable except of in the top of the boom, which is
where we are.
Ms. Mason: So all I want to say is I do think that going forward in the long
term, we do need to look at a 115 Trust. We need to look at prudent
measures that addressed the long term liability. We need to look towards
our employees to be partners in this, that this is not just about the city's
contribution, this is about us partnering and that's what I've heard council
share, that they're looking for increased partnership on sharing the benefits. We're doing that with our health benefits, so I guess one of my concerns
about going forward is I think it's important to start investing in the trust
and maybe building a line item for that and then having a fair balance salary
line. I just think that we need to think in both on a balance measure that
employees are our partner in this and so maybe there is a higher salary
amount down the road, but employees are also contributing to the cost of
their pension and the cost of their health insurance. So I guess in the long
term, I hope we have a balanced approach.
Council Member Scharff: Well that was one of the things I was saying is
that we could actually start--you know, we start seeing this trust to get
some in it, and then we actually have as part of the negotiations. Maybe
there's an employee contribution to trust overtime.
Council Member Filseth: That's an interesting idea.
Council Member Kniss: I'd say that's a thought.
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Council Member Scharff: You know, I don't think it's that far off. They
contribute to other things and--
Ms. Mason: And if employees start contributing to the employer share and
that possess the ability to create a more stable environment and jobs are
protected.
Chair Schmid: Let's try and focus--
Ms. Mason: It's a partnership.
Chair Schmid: Let's try and focus on the recommendation we're making for
this financial quarter.
Council Member Filseth: We're all in the same bucket. The fact is city has
spent $500 million dollars we didn't have. Okay. We're all in the same
boat, so how do we get out of it? If we could do it together, that's great.
Chair Schmid: Any other concrete changes recommended?
Mr. Perez: In terms of the concern about the use of the higher number, we
do state in our tax over and over and in our staff report that these are for
projections and not to be taking as a promise. So if you’re comfortable with
that language--
Council Member Scharff: Well, I'm comfortable. The only thing I want to run
by is whoever does these, what do they call that, they're not mediations,
they're fact finding, whether or not the fact finder will use it against us. If
the fact finders will use it against us, then I don't want to do it.
Ms. Mason: So--
Council Member Scharff: I don't know, I'm just--cause one of the factors in
fact finders is whether or not you have the money and whether or not you
think about--
Ms. Mason: We do not, you know, we have many needs. Our infrastructure
is a critical need and so, we negotiate based on fair place in the market and
the cost of living. We do not negotiate based on our ability to pay because
there are many needs in this community that need to be addressed. So the
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fact finders could look at the long range forecast and say yes, you set aside
that expense. And I'm not saying--
Council Member Scharff: So it's not a set aside right? What it is, is simply--
I think we go negative. Do we go negative; you think if we do the seven
percent on the forecast?
Mr. Perez: Yeah, most likely it will.
Council Member Scharff: I think we go negative.
Mr. Perez: In the out years, may not.
Council Member Scharff: But in the short term, we go negative?
Mr. Rossmann: If you bring in the best return on assumption to seven
percent, that may not hit us in '17, it's probably will start hitting us in '18 or
'19. If CalPERS faces some changes.
Mr. Perez: One option is for you to consider is leave the base model with
the two percent, direct us to do an alternative model with higher salary, so
it's an alternative, it's an option.
Council Member Kniss: So what don't you leave it at the two for now--
Council Member Scharff: Why don't we leave at the two and we'll do an
alternative.
Council Member Kniss: The two and the four--
Council Member Scharff: And then we'll do an alternative. I do think we
should change it to the seven.
Mr. Perez: We're fine with that. It's--your budget decisions aren't going to
be driven by the year that's in front of you. Right?
Chair Schmid: We've got three discussions on valuating the pension fund
and I think each time we come--I would make another suggestion that the
sales tax revenue be a little lower. You can take a look at the Stanford
impact on it, but I think that's a big plus.
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Mr. Perez: Sales tax or hotel tax?
Council Member Scharff: Sales tax. I also think maybe the hotel goes up or
it doesn't. I don't know. Maybe I think we're overly optimistic. I guess
that's my--remember I showed you that in 2010, we thought we'd have a
167 million and 182,000 in 2016 and we'd have expenditures of 182,767,
that was probably--and we went to revenue of 170,498 and expenditures of
only 172, so we started and now we're at what? 190, 189 expenditures. So
it's really tough to tell in the recession, we were really conservative on our
revenues. Now we're in the peak boom, I think we're overly thinking our revenues (Inaudible) and they're much higher than I think they were then.
Council Member Filseth: Further on this path, I have another one, which is
property tax growth is at 5.9 percent, but city rental growth is at 2.6
percent. Why? Why should rental income track property values?
Mr. Perez: So what we do there is we have an appraiser come every two
years and help us do a general appraisal update of our properties and then
we increase it by CPI. We've had that, that's an internal practice or policy
for some time. We do not update on a yearly basis.
Council Member Filseth: So it's driven (Inaudible) not market?
Mr. Perez: In between prices.
Council Member Filseth: Correct.
Chair Schmid: Should we change that?
Mr. Perez: You have the ability to direct us to do that.
Council Member Scharff: I like to direct you to look at changing it. Evaluate
changing it.
Mr. Perez: Okay. So we'll take that as a separate discussion from the long
range if that's okay.
Chair Schmid: That's fine.
Mr. Perez: Then we can move forward with this and have that discussion.
So I'll make a note to future finance meeting discussion.
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Council Member Filseth: I have a second concrete question. The retiree
healthcare fund. We're talking about 7.6 percent. We assumed 7.6 percent
RY now, maybe going to 7 in the quarter. Why wouldn't that go to the same
percent we were talking about here for the CalPERS, for the--
Mr. Perez: There's three rate assumption options and Walter did one of the
scenarios and if my memory is correct, it's about a $2 million difference.
Mr. Rossmann: So what we planned in the forecast is 7.25 investment
return. That is still pending for final evaluation for hotel, which we'll get in
February. We'll come back to the finance committee, usually during the budget season and the city council would have to approve the evaluation.
We believe it’s prudent to go to 7.25 at this time, 7.61 percent.
Council Member Filseth: Is there--why would we not go to 7 percent if we're
talking about seven percent in (Inaudible). Why are they different?
Mr. Perez: Let me pull up the percentage real quick. 7 percent itself is not
an option. Let me tell you what they are. So they're going to revise the
numbers, they're telling us to 7.28 for strategy one. 6.73 for option two and
6.12 for option three.
Council Member Filseth: So CalPERS is at 7.5 and they're at 6.12?
Mr. Perez: Keep in mind that--
Ms. Mason: They give you the option.
Mr. Perez: In this trust, you have options and the risk tolerance and they don't invest in the same manner as the pension trust.
Mr. Rossmann: So we did ask Mr. Bartel to let us know how much the
difference in cost would be. So at 7.25, it will cost us, all funds, not just
general funds, $16.1 million. If we go to 6.75, it jumps up from $1.6 million
to $70.7, so we felt that it was too much of a jump in one year, so we
brought it down to 7.25, but our goal is definitely long term to come down to
6.5 percent investment turn option, which is what best practice has tell us.
We bring it down every several years.
Council Member Scharff: And this is in the long range forecast?
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Mr. Rossmann: The long range forecast, we assume 7.25 this time.
Council Member Scharff: So why not just assume the 6.5 in the long range
forecast because it doesn't affect budget, it would just--
Mr. Perez: Well, we should probably use one of the numbers in their
buckets right.
Council Member Scharff: yeah, we use their bucket, right, but I mean, why
use the 6.73 or--in the long range forecast, why not use the number--in the
budget, you might want to use separate number because you might want to
break it down less, but--
Mr. Rossmann: Sure. I think the hesitancy often times to model this is
every time we do this, we meet with Mr. John Mr. Bartel and we ask him to
provide this for a fee, so if the Finance Committee is interested in seeing
that, we'll be happy to go him. I'm sure he'll be happy to provide the
information for a check. But we don't have to explain--
Council Member Filseth: How big of an account are we with John Mr. Bartel.
I mean, I like the guy, right, so. How big of an account are we in?
Mr. Perez: How big--I'm sorry
Council Member Scharff: What are we talking about in cost?
Mr. Rossmann: His fees probably 200, $300 in hour.
Council Member Kniss: Say that again?
Mr. Rossmann: I think it's (Inaudible).
Council Member Scharff: Cheap for a law firm.
Council Member Kniss: That sounds way too low.
Mr. Rossmann: He said about 400, staff is (crosstalk).
Council Member Kniss: If you could find someone at 200, that is amazing.
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Council Member Filseth: So a year we're paying him 10, 20, $30,000 or
something like that?
Chair Schmid: Okay. Why don't we focus on what we want staff to do?
Council Member Filseth: That's my list. I'm done.
Mr. Perez: You've seen the 7 percent rate of return assumption for CalPERS.
Salary increase have a separate assumption with the historical growth. Is
that what you'd like to see on the salary?
Council Member Filseth: Yeah.
Mr. Perez: Sales tax lowered, one potential bench marking is taking out the Stanford dollars so we can identify?
Council Member Filseth: Yeah.
Mr. Perez: Would be one likely scenario.
Council Member Filseth: Hotel, gas, you think five percent is aggressive?
Council Member Scharff: Is that what we're doing right now, five percent
increase?
Council Member Filseth: Five percent on the forecast.
Council Member Scharff: I actually probably think it's more like thee.
Council Member Filseth: You think.
Council Member Scharff: I mean, you know, I hate to just like pull
something out of the air.
Mr. Perez: Yeah. Let us work on something there. Keep in mind we only use 70 percent of the projected income or the infrastructure.
Chair Schmid: Yeah, that's conservative.
Pere: We feel that we did an adjustment.
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Chair Schmid: Yeah.
Mr. Perez: And then--I got side tracked and I didn't quite finish capturing
the property tax request. I'm sorry.
Council Member Filseth: Oh, I think you guys were going to look at the
possibility on the tax.
Council Member Kniss: Talked about lowering it.
Ms. Mason: Lowering the property tax.
Council Member Kniss: I think evaluate it maybe--
Chair Schmid: Yeah, evaluate might be good.
Council Member Scharff: So the property tax is the one I feel the most
comfortable with actually.
Council Member Filseth: I think we were talking about increasing the rental.
Look at Kendal Rentals (Crosstalk).
Mr. Perez: I think; I feel the same way for quite some time. Especially with
the high number of under 600,000.
Council Member Filseth. Right.
Mr. Perez: Okay, so nothing on property tax. That's all I had.
Chair Schmid: Okay, so we have a motion with a list of recommendations.
Is that what you need to go ahead?
Mr. Perez: Yeah. Our second recommendation or part of that
recommendation is our question to you. Assuming we made these changes, we feel comfortable in sending our report to council if you do.
Chair Schmid: Yeah. I think it's important that council get involved. So it's
time to get it to council.
Council Member Filseth: Shouldn't it combine back here first?
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Council Member Scharff: It's a different finance committee, I'd say yes.
Council Member Kniss: It will be, yes.
Council Member Scharff: Except for that if different finance committee, will
have the whole thing over again. If they have to do the whole thing over
again, I'd probably take pity on them and just send it to council.
Mr. Perez: Thank you.
Council Member Kniss: Let's do that.
Chair Schmid: It's important to start the budget process. This document is
helpful to get that underway.
Council Member Kniss: The budget process starts in January anyway.
Council Member Filseth: By the way, you're going where again, Sunnyvale?
I'd send it to Sunnyvale.
Mr. Perez: They actually do a 20 year forecast.
Council Member Kniss: What?
Council Member Filseth: They do a 20 year forecast.
Chair Schmid: Are we ready for a vote to move to finance financial report?
No other suggestions?
Council Member Filseth: What exactly are we voting on?
Chair Schmid: We're recommending--
Mr. Perez: To make those changes and then we would--
Council Member Scharff: Why don't you run through all of them again so we're (Inaudible).
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Mr. Perez: Change the rate of return assumption on CalPERS to seven
percent. Look at the salary increases historical and create a separate
scenario maintaining the base model that the current staff recommendation.
Council Member Kniss: We're keeping the two and fourth?
Mr. Perez: Correct. And then revisit the sales tax and lowering with
potentially the Stanford expansion dollars and then revisit the hotel tax
scenario and separately, we're committed to review the rent increases
separately.
Council Member Filseth: I know what I want to say. I want to make sure I understood this. I think you said it earlier is that the forecast that exist
today, assumes no change in headcount for the next 10 years. Is that right?
Mr. Perez: Correct.
Council Member Filseth: There ought to be a big asterisk on that so
everybody understands that.
Mr. Perez: We'll highlight it. It's been consistent with--
Council Member Kniss: That's been pretty stable.
Council Member Scharff: Well, the headcount hasn't been stable. It moved
along (Crosstalk.)
Mr. Perez: No, the modeling sorry.
Council Member Scharff: Yeah, the modeling been stable, but the headcount
changed dramatically.
Council Member Kniss: Well since when?
Council Member Scharff: Oh, in 2009, we cut back 30 or 40 positions.
Council Member Kniss: Since seven, eight years ago. I think the last three
years been pretty stable.
Council Member Scharff: No, no, now it's going up.
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Mr. Perez: Going up.
Council Member Scharff: Now it's going up at--
Mr. Perez: For some of the (crosstalk.)
Council Member Kniss: Well how much? Didn't we do 13 last year?
Council Member Scharff: 15 or something like that.
Ms. Mason: But there's a net reduction too. It wasn't a total (crosstalk.)
Council Member Kniss: Yeah, and we lost some others, and--
Mr. Perez: The net is about that.
Council Member Filseth: Net 15 over 10 years is a 150.
Mr. Perez: Because we had some reductions contracting out with some
additions.
Council Member Kniss: I thought--didn't Greg insist on two extra positions
going out? I think you did.
Council Member Filseth: Um, umm.
Chair Schmid: Okay. If there's no recommendation on staffing, we have a
motion. All in favor.
Council Member Kniss: Aye.
Council Member Filseth: Aye.
Chair Schmid: Aye.
Council Member Scharff: Aye.
Chair Schmid: That passes unanimously.
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Council Member Scharff: If it's unanimous, this doesn't go in council, right.
Council Member Filseth: It does.
Council Member Kniss: It shouldn't.
Mr. Perez: Unless you want something different.
Council Member Filseth: It should go for discuss.
Council Member Scharff: You'll make the changes first, then you'll go to
council and then we should have a discussion with council on long range.
Mr. Perez: Okay.
Council Member Filseth: I think we're going to want to look at it again.
Chair Schmid: It is important--
Council Member Filseth: In some way, shape or form, we're going to look at
it again before we just say--
Chair Schmid: It is important thought that I’d be available at the council
retreat. So if it’s hard to find in an agenda spot, maybe we could have
unconsent available for the retreat and can be used.
Council Member Filseth: Well, consent means the council approves it. I
don't think--I mean, I don't know what I'm approving.
Mr. Rossmann: Vice Mayor Schmid, I think it'll be difficult for staff to get
this done by the council retreat. The first engagement is to meet with Mr.
Bartel, get his numbers. We have all of this in between, where the majority
of our staff is not in the office. So this may not be a possibility.
Chair Schmid: Well I can see the motion on the benefit funds might not be
available, but could there be a paper copy of the financial forecast revenues
and expenditures?
Mr. Rossmann: I think (Inaudible) Carl and Marly (Inaudible) in front of you
or an update one.
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Chair Schmid: An updated one.
Mr. Perez: So the concern is can we get--cause Mr. Bartel has a lot of
customers and usually that's why we--
Chair Schmid: Do you need him for the--?
Mr. Perez: For the seven percent assumption because we didn't have him
do that.
Chair Schmid: Okay. Yeah, I mean it is beneficial to have this as the
council begins to think long term.
Mr. Perez: So let us work, let us work with the timeline starting with Mr. Mr. Bartel and then we'll slide it into an action item.
Council Member Kniss: Yeah. I rather come out right and be available for
budget, you know, that--
Chair Schmid: Yeah. I guess the CAC is also getting into discussions of the
DEIR and the scenarios and again, that would be an important element both
for the council and the CAC to have available, so when it's available.
Mr. Perez: Okay.
MOTION: Council Member Scharff moved, seconded by Council Member
Kniss to recommend the City Council accept the Fiscal Year 2017 to 2026
General Fund Long Range Financial Forecast and forward the Forecast to the
City Council for acceptance with the following changes:
A. Use a seven percent rate of return assumption for CalPERS pension; and
B. Revisit Sales Tax revenues and lower by some factor, such as Stanford
Expansion Sales Tax Revenue; and
C. Revisit Transient Occupancy Tax projections; and
D. Produce an Alternative Scenario reflecting a three percent salary
expense for projection purposes.
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MOTION PASSED: 4-0
ADJOURNMENT: The meeting was adjourned at 10:34 P.M.