The URL can be used to link to this page

Home My WebLink AboutStaff Report 3742 City of Palo Alto (ID # 3742) City Council Staff Report Report Type: Action Items Meeting Date: 5/13/2013 City of Palo Alto Page 1 Summary Title: Long Range Financial Forecast for Fiscal Years 2013 to 2023 Title: Acceptance of Long Range Financial Forecast for Fiscal Years 2013 to 2023 From: City Manager Lead Department: Administrative Services Recommendation Staff recommends that the City Council review, comment on, and accept the attached forecast of revenues and expenses. Motion I move to accept the Fiscal Year 2013 to 2023 Long Range Financial Forecast as staff’s latest projection of the City’s revenue and expenditure picture given current and projected developments. Executive Summary The City’s General Fund Long Range Financial Forecast (LRFF) for the next ten years is based on a variety of assumptions (See pages 6-19 of Attachment A). It is a portrait of the City’s financial condition painted at one point in time. The LRFF was presented to the Finance Committee on December 18, 2012. Staff was directed to return with a forecast based on specific, revised assumptions and comments provided by the Committee. In addition, some revenues and expenditures were changed based on additional data and information that came to light after December 2012. The revised ten year forecast was brought back to the Finance Committee on March 5, 2013, with discussion continuing on March 19, 2013. Again, after the March 19, 2013 Finance Committee meeting, new developments occurred City of Palo Alto Page 2 which altered staff’s calculations of revenues and expenditures for 2014 and beyond. This latest version of the Forecast shows a ten-year cumulative shortfall of $34.8 million. Table 1 is a Summary of the Base Model of the Forecast. Background On December 18, 2012, the Finance Committee directed staff to return with a revised Forecast addressing the issues and information requests cited below. Staff updated the forecast given these requests and incorporated other information that came to light since December. Discussion Finance Committee Point 1: Historical Revenue Trends Staff was asked to review 20 year and 10 year historical growth rates for economically sensitive revenue sources and consider adjusting the forecasted growth rates to more closely match the historical rates. Staff believes that the 20-year historical rates provide a more meaningful reference point since that period incorporated two dramatic economic cycles (dot.com boom and bust and the Great Recession). Staff analyzed 20-year revenue growth rates for combined General Fund tax revenues, combined Total General Fund revenues, and for each of the five major tax categories: property, sales, documentary transfer, transient occupancy, and utility user taxes. Staff controlled the calculations for extrinsic developments such as the State’s intermixing of Vehicle License Fees with property taxes beginning 2004, and the 2 percent TOT rate increase in January 2007. The table below shows historical growth rates over the 10-year and 20-year historical periods; and the rates used in the Forecast versions presented December 2012, March 2013, and today. The term “CAGR” refers to Compound Annual Growth Rate, or an average annual rate of growth over the given period of time. City of Palo Alto Page 3 *Documentary Transfer Tax was available beginning in 1993 so a 19 year CAGR is displayed in the 20 year category. Comparing the 20-year CAGR for the five major tax revenue sources (4.1 percent) with the CAGR of the current version of the forecast (4.13%) shows the forecast is fairly consistent with historical growth rates. However, individual tax growth rates show some variations. Sales tax in the last 20 years grew at an anemic 2.07 percent growth rate, slightly below staff’s projected 2.30% annual growth. On the other hand, the Utility Users Tax grew an average 3.79% over the last 20 years; staff is projecting just 2.85% growth for the next ten. Finance Committee Point 2: Overall Change in 10-Year Cumulative Budget Shortfall The Finance Committee asked for a breakdown of what caused the change from last year’s (May 2012) Forecasted $88 million shortfall over ten years to the current Forecast’s ten-year shortfall, now at $35 million. It will help to look at the same ten-year period: FY 2013 to FY 2022. For that period the current Forecast shows a combined shortfall of $26.5 million. Why the $61 million improvement? The main reason is an improved revenue outlook. Tax revenues were projected last May at $916 million for the ten years; now staff projects $968 million in combined tax revenues from FY 2013-FY 2022 – an increase of $52 million over the ten years. The main sources of the increase were Documentary Transfer Tax ($59 million more), Property Taxes ($28 million more); and TOT ($24 million more); offset somewhat by more conservative outlooks for Sales Tax ($12 million less) and UUT ($48 million less). Category 20-yr CAGR (1992-2012) 10-yr CAGR (2002-2012) Dec 2012 LRFF CAGR (2013- 2023) Feb 2013 LRFF CAGR (2014-2023) May 2013 LRFF CAGR (2014-2023) Property Tax 4.67% 4.88% 4.29% 4.97% 4.97% Sales Tax 2.07% 0.98% 3.96% 3.38% 2.30% Transient Occupancy Tax 4.88% 1.99% 4.50% 4.58% 4.79% Doc. Transfer Tax* 7.30%* 5.31% 4.58% 5.56% 7.42% Utility User Tax 3.79% 5.31% 2.80% 2.85% 2.85% Total of All 5 Major Taxes (adjusted) 4.10% 3.12% 4.04% 4.23% 4.13% Total Revenues (all) 4.56% 2.55% 3.14% 3.32% 3.27% City of Palo Alto Page 4 Non-tax revenues also look better – by $38 million – in this Forecast than in last year’s. This is partly offset by an $18 million hit to Operating Transfers-In, due to a recent change in the Equity Transfer methodology (discussed below). On the expense side, pension rates are higher than they looked last year. After a March 18, 2013 CalPERS Board meeting, two assumption changes will be implemented: changing the smoothing period from 15 to 5 years, and using a closed-end amortization period. These changes are estimated to add 8.5 percent to Miscellaneous group pension rates over five years, and 14 percent over five years for Safety. These rate increases, along with other likely changes in the next 2-3 years, are incorporated into the Forecast. Note that from the March 2013 version of the Forecast to the current version, PERS assumption changes described above as well as others projected in the near future have caused a significant increase in projected pension rates. For Miscellaneous, the increase averages 3.5 percent per year for the ten years of the Forecast, and for Safety, the increase averages 8.7 percent per year. In dollar terms, the combined ten-year projected pension expense in this version of the Forecast is about $23 million more than that projected in the March version. These pension increases are a significant factor in the shortfalls shown in the Forecast beginning in FY 2016. The City has two years in which to restructure and prepare for these changes. Substantive Changes To Revenue and Expense Since December 2012 Forecast Since the December 2012 presentation of the LRFF to the Finance Committee, new data and information have prompted staff to make adjustments to revenue and expenses both in FY 2013 and in future years. These are outlined below:  Recent activity for tax revenues has resulted in an upward revision to FY 2013 revenues of $1.7 million  Because of a decrease in PG&E’s rate of return by the California Public Utilities Commission which affects a key component of the City’s equity transfer formula, the transfer from the City’s Electric and Gas Enterprise Funds is decreasing by $0.7 million in FY 2014 (More information on equity transfer is provided on page 14 of Attachment A)  Salary and benefit projections in FY 2014 were changed based on the City’s Service Employees International Union (SEIU) contract.  Tentative decisions that were made at the March 18, 2013 CalPERS Board meeting impact projected pension rates from FY 2016 onwards. These changes are discussed in City of Palo Alto Page 5 detail in the LRFF report (pages 15-16 of Attachment A). Lastly, the Cost of Services Study is nearing completion, with results expected to Council this summer. Following that, staff is planning a review of City non-fee services as well as of administrative operations to further inform any upcoming structural changes. As with all forecasts, revenues and expenses are moving targets that change with circumstance and time. Nevertheless, the forecast serves as a critical tool in developing the FY 2014 budget and in identifying the City’s most pressing, future challenges. Attachments:  Attachment A: Long Range Financial Forecast Fiscal Years 2013-2023, Council Version dated May 13, 2013 (PDF)  Attachment B: CMR ID# 3618 - Fiscal Years 2013 to 2023 Long Range Financial Forecast (Continued) (PDF)  Attachment C: Excerpt Minutes from Finance Committee Meeting 03-05-13 (PDF)  Attachment D: Excerpt minutes from Finance Committee meeting 03-19-13 (PDF) LONG RANGE FINANCIAL Fiscal Years 2013 to 2023 FORECAST Council Version—May 13, 2013 TABLE OF CONTENTS I. EXECUTIVE SUMMARY 1 II. ECONOMIC OUTLOOK 3 III. UPDATED MODEL 6 CHARTS: - 2013-2023 BASE MODEL 20 - PERCENTAGE CHANGES IN BASE MODEL 22 IV. RESERVES 24 V. ALTERNATE SCENARIO 25 VII. APPENDIX 28 VIII. ENDNOTES 30 VI. CHALLENGES & CONCLUSIONS 26 EXECUTIVE SUMMARY This forecast summarizes the General Fund outlook for Fiscal Years (FY) 2013 through 2023. Rather than a predic on or commitment, a forecast is a ﬁnancial snapshot based on a number of assump ons. This Long Range Financial Forecast (LRFF) is a tool to allow staﬀ and Council members to see the longer‐term results of choices made to date, and iden fy issues that must be addressed in the near term in order to improve the City’s long‐term outlook. The na onal and state economies con nue to show improvement, and for the City, FY 2011 and 2012 end‐ ed with net posi ve results. FY 2011 ended with a $3.2 million General Fund surplus, and FY 2012 ﬁnancial results included a $4.5 million surplus. The LRFF Base Model shows a con nuing posi ve trend. FY 2013 is projected to end with a $3.1 million sur‐ plus. In the LRFF Base Model, the combined shor all for FY 2014 to 2023 (ten years) is $34.8 million. The Base Model can be found on page 20 of this report. Table 1, below, summarizes the Base Model. The Base Model includes increased pension rates due to impending changes in CalPERS methodologies as well as possible addi onal rate increases in the future. One impending change is a switch from a ﬁ een‐ year smoothing period for recouping PERS por olio gains and losses down to a ﬁve‐year period. A second is due to increased life expectancy among re rees, and the third is the likely lowering of the assumed dis‐ count rate on the PERS por olio from 7.5 percent to 7.25 percent. In addi on, staﬀ has added an addi onal 1 percent per year beginning in FY 2017 for unforeseen pension cost increases. Staﬀ included an alternate scenario that assumes the discount rate declines by 0.5 percent rather than 0.25 percent—adding an addi onal $14.5 million in costs over the eight‐year period from FY 2016‐2023. Staﬀ will be hiring and working with an actuary in the coming months to help validate the cost es mates and assump ons discussed in this report. EXECUTIVE SUMMARY 2 Note: The forecast does not include the savings from the new third pension er implemented as of January 2013 as part of the California Public Employees’ Pension reform Act (see page 26). At the moment, the dollar impact of this legisla on is unknown, and staﬀ will provide Council with updates as new informa on emerges. The Base Model also includes savings from the recent agreements with the Palo Alto Police Oﬃcers’ Associa‐ on (PAPOA), the Service Employees Interna onal Union (SEIU) and the Management/Professional group. The savings from these three agreements add to $2.7 million in FY 2013. Addi onal assump ons incorporated into the Base Model are detailed beginning on page 6. The following pages of this report provide a summary of the na onal, state, and local economic outlook; a detailed look at the ten‐year Forecast; the alternate scenario with higher pension rates; and a discussion of the challenges and conclusions derived from the Forecast. EXECUTIVE SUMMARY 3 ECONOMIC OUTLOOK Economic growth – on na onal, state, and local levels ‐ has begun to look more robust in the past year. The following indicators contribute to the impression that the economy is on a more stable foo ng: Na onal The na onal unemployment rate was 7.6 percent in March, down from 7.9 percent in January 2013 and 8.2 percent in March 2012.1 Beacon Economics is expec ng the U.S. economy to grow by 3% through 2013, and the unemployment rate to drop to 7% by the end of the year.2 According to Beacon Economics: “Op mism for the rest of 2013 is being partly driven by a resurgent housing market. Home prices have been climbing at a signiﬁcant pace and will con nue to rise through this year and 2014, at a minimum. The reason for the jump in prices is simple—ght inventories and incredible aﬀordabil‐ ity. “Overall, the US economy is on the mend. But there are many longer‐term issues the na on must address including working through changes to the na onal healthcare system and tackling funda‐ mental issues related to underfunded Federal en tlements and state and local pesnions.”2 State The state’s unemployment rate fell to 9.6 percent in February—its lowest level in over four years. The median price of exis ng single‐family homes sold in March was $313,000, up 8.3 percent from Febru‐ ary and 24.7 percent from March 2012. The Bay Area median home price was $436,000 in March, up 7.7 percent from February and 21.8 percent from March 2012.3 ECONOMIC OUTLOOK From The Weekly Update, State Treasurer’s Office, April 15, 2013 “One bright spot in the February jobs report from the Employment Development Department was the decline in long‐term unemployment over the past year. Californians out of work for a year or longer dropped both in number and as a share of the unemployed more than any other category of jobless dura on. In February, 617,000 Californians were jobless for 52 weeks or longer, compared to 728,000 in February 2012. That’s a decline of 111,000, or 15.2 percent. Over the same period, as a share of total unemployed, workers jobless for 52 weeks or longer fell from 34.7 percent to 32.8 percent.4 4 Chart Source: State Treasurer’s Oﬃce staﬀ, The Weekly Update, April 15, 2013 Local Caltrain Annual Passenger Counts show a 15.7% increase in ridership to Palo Alto between Feb‐ ruary 2011 and February 2012.5 Palo Alto is seeing a no ceable increase in commercial ac vity, as evidenced by the opening of several new retail stores, and a renewed dearth of parking capacity, with Council and staﬀ now weighing a range of solu ons. The last two years have been a period of steady growth in revenues for local hotels, and ﬁve hotels are in the pipeline, including: Hilton Garden Inn: 175 Rooms. Expected opening: 2014 Hilton Homewood Suites: 138 Rooms, Expected opening, 2014 Casa Olga: 86 rooms. Approved July 23, 2012. Renova ons are currently under con‐ struc on. Expected opening, summer 2013. Mings (1700 Embarcadero): 147 Rooms. Council approval requires that building permits must be obtained and construc on commence must start by April 2014. Wes n annex (711 El Camino Real) (Clement): 23 room expansion. Preliminary architec‐ tural review occurred in May 2012. No formal applica on has been received. ECONOMIC OUTLOOK 5 ECONOMIC OUTLOOK IMPACT OF ECONOMIC OUTLOOK ON ASSUMPTIONS USED IN MODEL As a result of the factors discussed above, the Forecast includes rela vely healthy growth in sales, property, transient occupancy and documentary tax revenues. The following chapter discusses each revenue source in detail. State & Local Unemployment Rates, January 2012‐2013 Source: EDD Labor Market Informa on Division, April 9, 2013 Jan. 2012 Jan. 2013 Palo Alto Civilian Unemploy‐ ment Rate 4.8% 4.2% Santa Clara County Unemploy‐ ment Rate 9.0 8.0% CA Unemployment Rate 11.0% 9.8% 6 ASSUMPTIONS INCLUDED IN THE MODEL The following describes factors assumed in the Base Model. The FY 2013 revenues and expenditures include a number of one‐me expenditures and savings. The Base Model excludes these one‐me items from the succeeding years, beginning in FY 2014: $1.3 million in salary savings due to frozen posi ons (increasing FY 2014 expenditures) $0.2 million in one‐me, non‐salary costs, including $80,000 for a Police Service Study; $50,500 for Com‐ prehensive Plan funding; and $70,000 for an organiza onal study of the Planning and Community Envi‐ ronment department (decreasing FY 2014 expenditures) The payback of a $4.9 million loan to the Technology Fund. The last payment of $1.2 million on this loan was completed in FY 2013 (decreasing FY 2014 expenditures) In addi on to these items, the FY 2014 projected budget assumes a one‐me net decrease in revenues of $1.4 million for the Golf Course Reconﬁgura on project. The en re ten‐year period includes $1 million in ad‐ di onal annual opera onal expenses a ributable to the Library renova ons. Recent agreements with the Palo Alto Police Oﬃcers’ Associa on (PAPOA), the Police Management Associa‐ on (PMA), Service Employees Interna onal Union (SEIU), and the Management/Professional group – re‐ sul ng in a combined savings of $1.9 million in FY 2013 – are included in the Base Model. Total revenues are projected to grow at annual rates ranging from 1.7 to 4.7 percent over the next ten years. Although this is a sign of improved city resources, looming pension and re ree medical obliga ons and infra‐ structure needs exceed available resources. The most recent valua on report from CalPERS increased the FY 2014 City pension rates, resul ng in $1.9 million in addi onal General Fund expense for FY 2014 compared to FY 2013. Furthermore, the General Fund’s re ree medical obliga on is $9.1 million in the coming ﬁscal year and is expected to grow 3.25 percent annually. Staﬀ performed an analysis on revenue growth going back to 1992, reviewing overall General Fund revenues as well as growth rates in the ﬁve major tax categories (Property Tax, Sales Tax, Documentary Transfer Tax, Transient Occupancy Tax, and U lity User Tax). To ensure that the compound annual growth rates (CAGR) for each analysis reﬂected real changes rather than re‐categoriza ons, adjustments to prior year actual col‐ lec ons were made where appropriate. A historical twenty‐year CAGR analysis for all General Fund revenues shows average annual growth of 4.56 percent. Within that ﬁgure, there are signiﬁcant variances between the CAGRs for each of the tax categories. For instance, the 20 year CAGR for Property Tax (the largest tax category) is 4.67 percent, while the CAGR for Sales Tax (the second largest tax category) is 2.07 percent. UPDATED MODEL 7 In the Base Model, the CAGR for projected overall General Fund revenues is 3.27 percent, well below the ad‐ justed 20‐year historical CAGR of 4.56 percent. One of the primary reasons for the decrease is a $0.7million reduc on in the equity transfer. As recommended by the Infrastructure Blue Ribbon Commission (IBRC) report (December, 2011), and ap‐ proved by Council beginning in FY 2013, the Base Model incorporates an addi onal $2.2 million in annual capital opera ng and maintenance funding (“keep‐up”). The IBRC report recommended that an addi onal $4.2 million be contributed annually towards the City’s infrastructure “catch‐up” needs and that funding be found for other project and construc on needs totaling approximately $210 million. These needs, including a new Public Safety Building and rebuilding the Municipal Service Center, and the “catch‐up” funding are not included in the Base Model. REVENUES Tax revenues in Palo Alto have improved markedly since the beginning of the Great Recession and are ex‐ pected to continue their upward trend in the near future. Since the December forecast presented to the Fi‐ nance Committee, several tax revenue categories have been adjusted for FY 2013 and in out years. These changes are based on data available since the December forecast and on the alignment with historical growth rate trends. Sales Tax This economically sensi ve revenue source is bouncing back from its recession low of $18.0 million in FY 2010. Receipts rose to $20.7 million in FY 2011 and to $22.1 million in FY 2012. Staﬀ is currently projec ng sales tax revenues of $23.4 million in FY 2013, nearly $0.8 million above the adopted budget. Receipts in the ﬁrst quarter of FY 2013, which are 6.7 percent above the prior year’s first quarter, support this change. Ro‐ bust economic segments include electronic equipment, apparel stores, restaurants, and service stations. Weak performers include furniture/appliance stores and business services. Staff’s forecast is in line with that of the City’s sales tax consultant, Muni‐Services, for the next two years. As a consequence of recent data, estimated revenues for FY 2014 were raised $0.5 million above projected FY 2013 revenues. The sales tax growth rate used for the next ten years at 2.3 percent is slightly more optimistic than the 20 year historical growth rate of 2.07 percent. While there are many challenges to sales tax growth, such as growing Internet sales, the proliferation of big box stores outside City limits, and the rise of consumer ser‐ vices (not subject to tax), the City’s efforts in economic development (e.g. Tesla auto sales) and maintaining high profile retailers could boost the future growth rate. Sales tax growth must be monitored carefully since this revenue source represents 14 percent of General Fund resources. UPDATED MODEL 8 Property Tax Unlike many California jurisdictions, Palo Alto’s property taxes did not take a material “hit” as a consequence of the Great Recession. Revenues have remained relatively stable as shown below: For the past several years, staff has primarily relied on County estimates to develop its property tax budget. The County has regular meetings to inform cities and school districts on assessment roll growth and events that can impact revenues (e.g. appeals from commercial and residential properties). Based on recent County data, it is likely that receipts will exceed the FY 2013 adopted budget of $27.3 million by some $0.6 million. As stated in the previous chapter, housing values in Silicon Valley are rising at a faster rate than the rest of California and the country. According to a November “Intero Real Estate Services” update, “While the rest of the country has been recovering…the Bay Area housing market has exploded over the last 18 to 24 months. Most lis ngs are selling with mul ple oﬀers and considerably over list price.” This prognosis for the Palo Alto real estate market will likely translate into higher documentary transfer and property taxes. For FY 2014, property tax revenue is projected at $29.1 million, a $1.2 million or 4.3 percent increase above the current ﬁscal year es mate of $27.9 million. UPDATED MODEL Fiscal Year Property Tax Revenues 2009 $25.4 million 2010 $26.0 million 2011 $25.7 million 2012 $26.5 million $22,194 $22,623 $20,089 $17,991 $20,746 $22,132 $23,364 $15,000 $17,000 $19,000 $21,000 $23,000 $25,000 2007 2008 2009 2010 2011 2012 2013 Sales Tax (Thousands, FY 2013 Projected) Fiscal Year 9 Transient Occupancy Tax (TOT) Since declining to $6.9 million in FY 2010 due to the Great Recession, TOT revenues have steadily risen. In FY 2011 receipts totaled $8.1 million and in FY 2012 they moved to $9.7 million. Staff now estimates they will increase to $10.4 million in FY 2013 and to $11.5 million in FY 2014. Average occupancy and daily rates, re‐ spectively, have surged from 66 percent and $139 per day in FY 2010 to 85 percent and $174 in the first quar‐ ter of FY 2013. With increased business activity and visitors to Palo Alto, staff will adjust the FY 2013 budget upward by approximately $0.8 million. The out years of the Forecast include a CAGR of 4.79 percent. Note that the forecast includes future revenues from the Casa Olga hotel, expected to open this winter. Rev‐ enues from other hotels in the planning stages are not included. Documentary Transfer Tax (DTT) This revenue source is based on the number and value of commercial and residential property sales. In the last decade, revenues have averaged $4.8 million per year. During the recession period, DTT revenues fell to $3.1 million in FY 2009 and to $3.7 million in FY 2010. Results for FY 2011 and 2012 were $5.2 million and $4.8 million, respectively. With revenue stabilizing in the last two fiscal years, the rising value of commercial and residential transactions in the first quarter of FY 2013, and several extraordinary remittances, staff is pro‐ jecting receipts in FY 2013 of $6.8 million, or $1.7 million higher than Adopted Budget. Due to the unusual stream of transactions this fiscal year, a more realistic $5.7 million for FY 2014 is projected. U lity Users Tax (UUT) FY 2013 UUT revenues are expected to be the same as actual FY 2012 revenues, or around $10.8 million. The u lity‐generated UUT projec ons are based on the most recent rate and projected revenue informa on from the U li es department. These numbers could change as the department discusses its proposed rate plan with the U li es Advisory Commission and the Council. Telephone‐generated revenues con nue their down‐ ward decline, due to decreased landline usage. Other Taxes & Fines The large part of this category is comprised of Parking Viola on revenue, which staﬀ is es ma ng to be $1.6 million in FY 2014. Other revenue items such as traﬃc viola ons, administra ve cita ons, and library ﬁnes and fees have con nued to grow over the past ﬁve years. Another component of this revenue category is the Vehicle‐in‐Lieu Fee (VLF). In FY 2012, the state legislature suspended its alloca ons to local agencies in order balance the State budget. Un l the legislature takes ac on to restore it, staﬀ is not projec ng any VLF re‐ ceipts in this forecast. Staﬀ expects that FY 2014 revenue will end at the same level as FY 2013, which is $2.1 million. Charges for Services Total revenues in this category are projected to be $0.5 million higher in FY 2014 than in Adopted FY 2013. This is due to two factors: ﬁrst the Golf Course Reconﬁgura on project will begin later than originally an ci‐ pated, resul ng in less of a hit to Golf Course fee revenue in FY 2014 but more of a hit on FY 2015. Second, plan check revenues are expected to increase by $2.2 million in FY 2014, more than compensa ng for the Golf Course‐related loss. A er the Golf Course project is completed and that revenue normalizes, the Fore‐ cast assumes an annual increase in the Charges for Services category of between 2.6 and 3.7 percent be‐ tween FY 2017 and FY 2023. UPDATED MODEL 10 Stanford Fire and Dispatch Services The City currently is under agreement with Stanford University to provide Fire Response and Dispatch ser‐ vices. Stanford is charged 30.3 percent of the Fire Department’s net cost and 16 percent of the Police Depart‐ ment’s Communica on and Dispatch Division. With the excep on of pension, healthcare, and re ree medical obliga on cost increases, the FY 2014 base does not assume any signiﬁcant changes for the Fire Department and Police Communica on and Dispatch Services budgets. Stanford ﬁre and dispatch revenue is es mated to increase by $0.2 million in FY 2014 due to pension, healthcare, and re ree medical cost increases. The Base Model assumes that revenue from this agreement will increase 3.5 percent annually. Currently, the City is in nego a ons with Stanford for the Fire Services component of the contract. The FY 2013 budget includes a total of $8.2 million of revenue from Stanford for Fire and Dispatch Services. In the best case scenario, the ﬁnal determina on of a new reimbursement agreement could result in $1.4 million in addi onal revenue; in the worst case scenario the agreement could be terminated en rely. The agreement requires the University to give 12 months’ no ce of termina on. Assuming that nego a ons are concluded in FY 2014, a modest increase of 3.5% has been built into the outer years to account for staﬃng and other de‐ partment cost increases. UPDATED MODEL 11 Permits and Licenses Revenue from permits and licenses rose signiﬁcantly in FY 2011 and 2012 due primarily to increased ac vity at the Development Center. Budgeted revenue in FY 2013 decreased because the City implemented a citywide Technology Enhancement Fee and these revenues, which had previously been charged only to some development permits, were moved from the General Fund to the Technology Fund. This revenue category is projected to decrease slightly due to two factors: (a) internal street cut fees, which are based on U li es ac‐ vi es, are reduced by $0.11 million to reﬂect planned project ac vi es; and (b) permit ac vity is assumed to slow by 2 percent per year through FY 2018 based on historic ac vity, followed by 3.5 percent annual growth in subsequent years. Return on Investment General Fund interest earnings have declined 71 percent from FY 2009 to projected FY 2013 levels as higher‐ yielding maturing investments are re‐invested in a historically low interest rate environment. The Federal Open Market Commi ee remains commi ed to keeping interest rates at excep onally low levels through mid‐2015 to s mulate the economy and boost job growth. This ac on will keep downward pressure on the City’s por olio yield in FY 2014. Interest earnings are projected to gradually increase by 1.3 percent in FY 2015 growing to 3.0 percent in FY 2023. It is expected that FY 2013 revenue will be below the adopted budg‐ et by $0.2 million, totaling $0.8 million. In FY 2014, return on investment revenue is es mated to remain level at $0.8 million. Rental Income The largest source of rental income is the City’s Enterprise Funds and the Cubberley Community Center. The rent from the Enterprise Funds declined $2.5 million with the closure of landﬁll, the Middleﬁeld Well site, and the former Los Altos Treatment Plant (LATP) site in FY 2013. FY 2014 rental income also reﬂects the par al closure of restaurant and pro‐shop facili es during the Golf Course Re‐Conﬁgura on Project. For this fore‐ cast period, a 2.5 percent growth rate was assumed for all rental proper es, except for the Refuse Fund rent, which remains ﬁxed un l FY 2021.The City is conduc ng an assessment of all General Fund proper es which might impact the rental income from Enterprise Funds during FY 2014 and beyond. From Other Agencies Revenue from Other Agencies includes income from Community Services Outreach theatre programs, Palo Alto Uniﬁed School District (PAUSD) reimbursements, State of California grants for Police, Libraries and Com‐ munity Services, and dona ons from Friends groups. Many of these are diﬃcult to predict. For example, state grants are reduced when the state experiences budget diﬃcul es. Revenues over the past 4 years have ranged from $0.08 million to $0.3 million. The Forecast assumes a zero growth rate from FY 2014 onwards. Charges to Other Funds Eighty‐six percent of this category is General Fund administra ve cost plan alloca on charges to the Enter‐ prise Funds. For FY 2013, the projected amount is $10.9 million. In FY 2014 onward, forecasted increases are around 2 percent. UPDATED MODEL 12 UPDATED MODEL 13 UPDATED MODEL Other Revenues Major revenue sources in this category are Animal Services charges to Los Altos and Los Altos Hills, dona‐ ons from non‐proﬁts for City libraries, and revenues which do not belong to other categories. In FY 2013, Other Revenues are projected at $1.2 million – the same level as in the Adopted Budget. Projected FY 2014 revenues of $2.0 million include a $0.7 million dona on from various non‐proﬁts to libraries; a 2 percent an‐ nual increase is assumed throughout the Forecast period. Opera ng Transfers In Opera ng Transfers include the equity transfer from the Electric and Gas Funds, as well as transfers from the University Ave Parking Permit Fund and the California Ave Parking Permit Fund. In accordance with a meth‐ odology 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 U li es Commission (CPUC). On December 26, 2012, the CPUC issued its decision to lower PG&E's rate of return on equity. As a result, the equity transfer from the Electric and Gas Funds is projected to decrease from $17.7 million in FY 2013 to $17.0 million in FY 2014. The City A orney's Oﬃce will be providing Council with addi onal informa on regarding the equity transfer in light of the provisions of Proposi on 218, which prohibits ci es from raising fees without voter approval, and Proposi on 26, which prohibits ci es from raising taxes without voter approval. EXPENSES Salary A 2 percent annual salary increase for SEIU and Management/Professional is assumed beginning in FY 2014. For all other labor groups, 2 percent annual increases are assumed beginning FY 2015. These as‐ sump ons are for forecas ng purposes only and do not represent a commitment or recommenda on from staﬀ. Unfreezing posi ons frozen in FY 2013 added $1.3 million in salary costs to the FY 2014 base. In addi on, the net FTE change from FY 2013 Adopted Budget to FY 2014 Proposed Budget is a 1.26 FTE decrease. 14 UPDATED MODEL The chart below shows how staﬃng has decreased in the GF since FY 2004, but Salary & Beneﬁt cost has not. The chart below indicates the degree to which General Fund FTE reductions are tempered by real‐ locations to other funds. While overall GF staff has decreased by 180.1 over the last ten years, 72 of those FTE have been transferred to other funds, leaving a net decrease of 108.2 FTE in the GF. 15 UPDATED MODEL Beneﬁts Pension The Forecast uses CalPERS’ es mated pension rates for FYs 2014, 2015, and 2016. The most recent rates were received in November 2012. However, FY 2014 rates will increase slightly since the City opted not to phase‐in an assump on change, in order to reduce its costs over the long term.6 The CalPERS Board met on March 18, 2013 and tenta vely approved a set of assump on changes pro‐ posed by their Chief Actuary. Speciﬁcally, the changes include transi oning from a 15‐year smoothing method to a 5‐year smoothing method, and moving from an open to a closed amor za on period. This would add approximately 1.7% per year from FY 2016‐2020 for the Miscellaneous group, and 2.8% per year for the Safety group. In spring of 2012, Council directed that the forecast assume 3 percent annual increases in pension rates beyond the 3 years projected in the annual CalPERS Actuarial report. In the December 2012 and March 2013 versions of the Forecast, staﬀ had included those 3 percent increases. However, in this version of the Forecast, staﬀ has incorporated into the forecast a number of speciﬁc poten al rate increases and subs tuted 1 percent addi onal annual increases rather than 3 percent. Staﬀ believes that the inten on of the 3 percent increases was to reserve against future changes in CalPERS assump ons and rate‐se ng. Given the certainty of smoothing and amor za on changes, and the likelihood of the mortality increase and a discount rate change, staﬀ has instead incorporated these speciﬁc changes to CalPERS rates. These changes oﬀset most of the need for the 3 percent annual placeholder. (See page 16 for details.) Staﬀ has modiﬁed the alternate scenario to reﬂect a discount rate change of 0.5% rather than the 0.25% change reﬂected in the Base Model. The CalPERS Board is expected to consider the discount rate change in February 2014, so this change would not impact rates un l FY 2016. Star ng in January 2013, pension reform requires new members of CalPERS be enrolled into a new pen‐ sion plan that oﬀers lower pension beneﬁts. CalPERS is calcula ng the actual cost for Palo Alto, so an es‐ mate is not available at this me. The Base Model does not include the poten al savings from a 3rd pension er for new employees. As a point of reference, the June 30, 2011 CalPERS Ac‐ tuarial Valua on indicated that the City’s Miscellane‐ ous group’s Pension Funded ra o (using Market Value of Assets) was 69.5% ‐ up from 62.2% in the prior year. The City’s Safety group’s Funded ra o was 71.8% (again using Market Value of Assets). The prior year’s ra o had been 64.8%. Pension seems to be one of the largest variable among the expense categories , with evolving rate changes over which the City has li le control. Staﬀ is staying in close contact with PERS actuarial staﬀ to stay up to date on all pending changes. 16 The chart below details the components of the CalPERS rate projec ons used in the Base Model Forecast. CALCULATION OF PENSION RATES USED IN BASE MODEL Health Care Re ree Annual Required Contribu ons (ARC) are based on the January 1, 2011 actuarial study for FY 2012, 2013, and 2014, as amended by the Council Direc on of April 16, 2012. In se ng the ARC, the actu‐ ary assumes it will increase each year by 3.25 percent, the presumed annual increase in payroll. The forecast assumes a 10 percent annual increase in medical costs and a 4 percent annual increase in dental and vision costs. This assump on results in a $0.76 million increase between projected FY 2013 and 2014 costs. Over the next ten ﬁscal years (2014 through 2023), these healthcare cost will increase from $9.5 million to $20.8 million, or 218 percent. The Aﬀordable Care Act (“Obamacare”) has provisions which must be implemented in calendar year 2013 in prepara on for eﬀec ve dates in 2014. Staﬀ is in the process of examining these requirements and planning for their implementa on. The costs of this implementa on are not included in the forecast. Contract Services FY 2013 Projected Contract Services includes $80 thousand of one‐me contracts, such as the Police Organi‐ za on study, and a placeholder of $0.5 million for assumed savings from the re‐organiza on of Palo Alto Ani‐ mal Services. The FY 2014 base removes these one‐me FY 2013 expenses and projected savings. The Ani‐ mal Services savings are allocated across various categories in the FY 2014 Budget. Total expense for this category totals $10.7 million, a $0.4 million increase over the FY 2013 adopted budget. In FY 2015 and beyond, contract expenses are projected to remain rela vely stable, with a 3.0 percent annual growth rate throughout the forecast period. UPDATED MODEL 17 UPDATED MODEL Supplies & Materials The base model assumes an increase in this category from $3.2 million in FY 2013 and $3.9 million in FY 2014, mainly due to the purchase of books and other materials for the Mitchell Park Library. In FY 2015, Communi‐ ty Services will see a small increase of approximately $31,000 for Supplies & Materials at the Palo Alto Golf Course. This is based on the Na onal Golf Founda on es mates to maintain the newly redesigned golf course. Costs will remain rela vely constant looking forward to outer years, with a consistent yearly increase of 3.0 percent. General Expense The majority of General Expense includes categories like travel and mee ngs, telephone and non‐city u li‐ es, con ngency accounts, and debt service payments for the newly signed Golf Course Lease Agreement. Projected FY 2013 expenses of $4.6 million reﬂect annual debt service which was originally budgeted as a transfer to Debt Service Fund. In FY 2014, General Expense remains mostly ﬂat, and from FY 2014 onwards, annual increases of 2.5 to 3.0 percent are assumed. 18 Cubberley Lease This category represents lease payments to PAUSD for the Cubberley facility. The Forecast assumes the lease contract with PAUSD will con nue beyond 2014. Payments from FY 2014 onward are based on projected 3 percent annual CPI increases. The Cubberley lease expense in FY 2014 is es mated at $7.3 million. Rents and Leases Expansion of the Development Center increased this expense category by $0.2 million in FY 2013. Rent and Lease expense for FY 2014 is es mated to remain at $1.2 million. From FY 2015 onwards, this expense is ex‐ pected to increase by 3 percent per year. Facili es and Equipment An addi onal $0.2 million was added to Facili es and Equipment during FY 2013 due to one‐me increases for the Development Center upgrade. Facili es and Equipment expense for FY 2014 is $0.5 million, increasing by 5 percent in 2015, then 4 percent in 2016, and 3 percent per year for the remaining years of the Forecast. Allocated Charges Allocated charges represent expense alloca ons by the City’s enterprise and internal services funds for ser‐ vices and products they provide to General Fund departments such as u li es usage, liability insurance, tech‐ nology costs, and vehicle replacement costs. The last year of the General Fund loan repayment to the Tech‐ nology Fund was in FY 2013; the FY 2014 base model is reduced by this amount to total $15.1 million. Beyond FY 2014, the Base Model assumes a modest annual growth rate of 2 percent in Allocated Charges. Opera ng Transfers Out Opera ng Transfers Out includes transfers for Debt Service, Tech Fund, and the Airport Fund. Transfers out is reduced by $0.5 million due to the reﬁnancing of the Golf Course debt. The Golf Course debt will be paid down by FY 2018. Funding for the Airport Fund from the General Fund con nues through FY 2014 and the FY 2013 projected base model assumes an addi onal $0.2 million will be transferred to the Airport Fund. The Base Model assumes that the Airport Fund will be self‐sustaining in FY 2015. Transfer to Infrastructure In FY 2013, adopted and projected transfers to the capital project fund remain at $13.2 million. In FY 2014, they are projected to remain at $13.2 million. Beginning in FY 2013, an addi onal $2.2 million per year is added to fund the annual maintenance of exis ng infrastructure or “keep‐up” needs as deﬁned by the (IBRC) Infrastructure Blue Ribbon Commission Report. An addi onal $4.2 million per year will be required to fund deferred maintenance or “catch‐up” needs as deﬁned by the IBRC Report. This addi onal contribu on is not included in the Base Model. UPDATED MODEL 19 FACTORS NOT INCLUDED IN THE BASE MODEL The allocated cost of various IT Department’s new ini a ves such as migra on to cloud based technolo‐ gies, purchase of new equipment and related maintenance/support costs The IBRC’s recommended $4.2 million per year increase in infrastructure expenditure Any new revenue stream earmarked for infrastructure. Council may consider such a revenue source in the future. Possible TOT revenues from four of the ﬁve expected to open in the next two years (See details on page 4. Casa Olga revenues are included in the Forecast; the others are not.) Savings from the PEPRA‐mandated 3rd pension er (2% at 62) for new employees Costs of implemen ng the Aﬀordable Care Act, beyond the costs of extending coverage to dependents up to age 26 UPDATED MODEL 20 BASE MODEL GENERAL FUND LONG RANGE BASE MO FY 2013‐2 21 BASE MODEL E FINANCIAL FORECAST DEL 2023 22 BASE MODEL GENERAL FUND LONG RANGE BASE MODEL PERECENT 23 BASE MODEL FINANCIAL FORECAST TAGE CHANGES 24 RESERVES RESERVES FY 2012 ended with a Budget Stabiliza on Reserve (BSR) totaling $28.1 million. Although the Base Model pro‐ jects surpluses in FYs 2013, 2014, and 2015, the next seven years of the Forecast include shor alls, with the reserve balance dropping below the 18.5 percent minimum reserve level—to as low as 5.8 percent of pro‐ jected Budget in FY 2023. The graph below illustrates the projected BSR levels as compared to the minimum reserve levels. $12.0 $17.0 $22.0 $27.0 $32.0 $37.0 $42.0 Projected Base Model: Projected BSR Compared Against 18.5% BSR Level Budget Stabilization Reserve Actuals & Projection Minimum Reserve ‐ 18.5% 25 ALTERNATE SCENARIO ALTERNATE SCENARIO In this Alternate Scenario, it is assumed that in addi on to the smoothing, mortality, and the 1% assumed addi onal increases beginning in FY 2017, PERS will reduce the discount rate by 0.5 percent rather than 0.2 percent, resul ng in a 7 percent discount rate. The addi onal 0.25% cut would cost the General Fund an extra $14.4 million over the period of the Forecast. Alternate Scenario 1 26 CHALLENGES: PENSION REFORM The California Public Employees’ Pension Reform Act of 2013 (PEPRA) was enacted fall 2012 and has generat‐ ed increased a en on and ques ons from CalPERS re rement system members and employers. The new law includes a suite of changes to current re rement formulas, new members, employer/member contribu ons, and working a er re rement. PEPRA also establishes a cap on the amount of compensa on that can be used to calculate the re rement beneﬁt for all new CalPERS members. At this me, the dollar impact to the City of this new legisla on is unknown. Staﬀ will provide Council with updates as more informa on and data emerge. CONCLUSIONS The LRFF shows be er “bo om line” results than in last year’s presenta on. This is due to employee beneﬁt concessions, budget reduc ons, and higher revenues in evidence since last year’s (May 2012) forecast. Since FY 2010, the City has realized $16.7 million in savings from structural changes, the fruit of Council’s and staﬀ’s “thinking diﬀerent.” With beneﬁt costs con nuing to increase at a faster pace than revenues, the City must con nue to ﬁnd addi onal structural savings. In addi on to employee beneﬁt obliga ons, the City’s infrastructure needs – capital opera on and mainte‐ nance, project “catch‐up”, and other projects iden ﬁed in the IBRC report – should be addressed and planned for via this forecast. The Cost of Service study is nearly complete and will allow the Council to thoroughly review the price of do‐ ing business and make decisions on what services can be provided and/or how they can be provided. The re‐ view will also iden fy services and back‐room opera ons provided with no fees. Although successful eﬀorts have been made, the City must con nue to explore its beneﬁt structure, alterna‐ ve forms of service delivery, and more eﬃcient opera ons to realize a sustainable, long‐term, ﬁnancial fu‐ ture. CHALLENGES & CONCLUSIONS 27 28 APPENDIX CONCESSIONS TO DATE Since 2009, Council and staﬀ completed the nego a on of agreements with labor groups to eliminate more than $8.5 million in salary and beneﬁt expense. The City is working with the Police Management Associa on (PMA) to nego ate cost savings. The following is a list of current labor contracts and agreements: SEIU (current contract) Es mated Savings: $0.55 million per year, or 0.76 percent of total compensa on Created a second er to our re rement structure (2 percent at 60) for new employees hired or a er July 17, 2010. Shi ed full cost of employee PERS contribu on to employee. Implemented the 90/10 medical cost sharing plan. Decrease alterna ve medical cash‐out beneﬁt to a ﬂat $284 per month, eﬀec ve October 1, 2012. 1.65 percent cost of living increase eﬀec ve ﬁrst day of pay period including July 1, 2012 Reduced ﬂoa ng holidays by three days. An addi onal ﬂoa ng holiday will be eliminated a er June 30, 2013. Management and Professional (current agreement) Es mated Savings: $0.51 million per year, or 1.5 percent of total compensa on Eliminated the Variable Management Compensa on plan as of FY 2009. Shi ed full cost of employee PERS contribu on to employee. Implemented the 90/10 medical cost sharing plan. Decrease alterna ve medical cash‐out beneﬁt to a ﬂat $284 per month, eﬀec ve October 1, 2012. Three percent salary increase to par ally oﬀset pension contribu on costs Changes to the group’s professional development plan, including elimina ng use of professional develop‐ ment funds to purchase electronic technology and gym memberships and reducing the annual amount per employee from $1,500 to $500. Gym members can be reimbursed through management excess bene‐ ﬁt. Eliminated car allowances for newly hired Department Directors. Interna onal Associa on of Fire Fighters (current contract) Es mated Savings: $1.6 million per year, or 6.8 percent of total compensa on Created a second er to our re rement structure (3 percent at 55) for new employees. Shi ed full cost of employee PERS contribu on to employee. Eliminated minimum staﬃng requirements. 29 APPENDIX Implemented the 90/10 medical cost sharing plan. Cost‐of‐living freeze for FYs 2012‐2014. Eliminated tui on reimbursement program. Fire Chiefs’ Associa on (current agreement) Es mated Savings: $91 thousand per year, or 9.8 percent of total compensa on Created a second er to our re rement structure (3 percent at 55) for new employees. Shi ed full cost of employee PERS contribu on to employee. In March 2013, the city paid employee re rement contribu on “resets” to 5.1 percent. Eliminated the Variable Management Compensa on plan. 1.33 percent salary reduc on. Eliminated three holidays. Implemented the 90/10 medical cost sharing plan. Palo Alto Police Oﬃcers’ Associa on (current contract): Es mated Savings: $1.4 million per year, or 7.7 percent of total compensa on Created a second er to our re rement structure (3 percent at 55) for new employees. Shi ed full cost of employee PERS contribu on to employee. Eliminated tui on and training beneﬁt. 1.33 percent salary reduc on. Eliminated three holidays. Implemented the 90/10 medical cost sharing plan. Prior to 2009, between 2004 and 2006, the City implemented for all bargaining units: 20‐year ves ng period to qualify for lifelong City‐paid health coverage Highest cost health care plan op on eliminated, saving almost $10,000 per year for each employee moved away from this op on. The aforemen oned concessions and staﬃng reduc ons have been tough decisions that were not taken lightly. Like the City, our employees face rising household costs and diminished asset values. Further‐ more, the impact of the posi on elimina ons is that our employees are stretched thin, and our ability to take on new projects is reduced. 30 ENDNOTES 1. Bureau of Labor Sta s cs, Economic News Release, April 5, 2013 2. Beaconomics, Spring 2013 3. “The Weekly Brieﬁng, State Treasurer’s Oﬃce, April 22, 2013 4. “The Weekly Brieﬁng, State Treasurer’s Oﬃce, April 15, 2013 5. MuniServices Economic Overview 3Q2012 News, page 14 6. In its November 2012 actuarial reports, CalPERS presented the op on to phase in an as‐ sump on change over two years—resul ng in the 2014 rates seen here on page 16—or to adopt the changes right away. Turning down the phase‐in op on would result in about $0.6 million in addi onal General Fund pension costs in FY 2014, but about $1.2 million in savings over the subsequent 19 years. The City opted to turn down the phase‐in. Since this decision was made in recent weeks, the addi onal cost was incorporated into the FY 2014 Proposed Budget, but the savings were not incorporated into the subsequent years of this Forecast. ENDNOTES 31 Visit our website at: www.CityofPaloAlto.org A D A S‐ Contributors Chris ne Paras Amber Cameron Sco Jensen Tarun Narayan Sherry Nikzat Lalo Perez Joe Saccio Dale Wong In compliance with Americans with Disabili es Act (ADA) of 1990, this document may be provided in other accessible formats. For informa on contact: ADA Coordinator City of Palo Alto 285 Hamilton Avenue (650) 329‐2550 Prin ng City of Palo Alto Nancy Nagel Tony Sandhu 32 The City of Palo Alto is located in northern Santa Clara County, approximately 35 miles south of the City of San Francisco and 12 miles north of the City of San Jose. Spanish explorers named the area for the tall, twin‐trunked redwood tree they camped beneath in 1769. Palo Alto incorporated in 1894 and the State of California granted its ﬁrst charter in 1909. 30% post‐consumer recycled City of Palo Alto (ID # 3618) Finance Committee Staff Report Report Type: Action Items Meeting Date: 3/19/2013 City of Palo Alto Page 1 Summary Title: (Continued) Long Range Financial Forecast Title: Fiscal Years 2013 to 2023 Long Range Financial Forecast (Continued From March 5, 2013) From: City Manager Lead Department: Administrative Services Recommendation Staff recommends that the Finance Committee review and comment on the attached forecast of revenues and expenses and provide direction on assumptions used in the forecast. Motion I move to accept the Fiscal Year 2013 to 2023 Long Range Financial Forecast and forward it to the full Council for review and input. Executive Summary The City’s General Fund Long Range Financial Forecast (LRFF) for the next ten years is based on a variety of assumptions. It is a portrait of the City’s financial condition painted at one point in time. Background The LRFF was presented to the Finance Committee on December 18, 2012 (staff report ID #3248). The Committee directed staff to revise the forecast to address the Committee’s concerns and provide additional information. An updated draft of the LRFF was presented to the Finance Committee on March 5, 2013 (staff report ID #3531). Due to the length of the Committee’s agenda on March 5th, staff was directed to continue discussion of the forecast at the next Finance Committee meeting. No motion was made to provide staff with additional direction or to accept the LRFF and forward the forecast to Council. City of Palo Alto Page 2 Although the discussion of the forecast was tabled for future discussion and no motion was made to formally provide staff with direction to update the forecast, the Finance Committee raised a number of concerns and issues for staff to consider:  Related tax revenue associated with hotels currently under construction and earmark revenue streams for infrastructure expense  Calculate the pension savings for 3rd Tier employees  Clarification of CalPERS pension rate estimates included in the base model and alternative scenario  Reconsider having Utility Users’ Tax (UUT) revenue increase, specifically for the Electric UUT revenue component  Reconsider sales and documentary transfer tax estimates Staff is requesting a formal motion with direction on changes/additional clarification requested by the Finance Committee so that the forecast can proceed to the Council for further discussion. Staff would point out that the Long Range Forecast serves as a guide and is expected to be dynamic and subject to change. Additionally, with the mid-year review each year, the City is able to adjust revenue estimates and expenditures based on actual experience and the mid- year allows the Council the ability to make adjustments and spending decisions based on more current facts. In other words, some conservatism in our forecasts provides valuable flexibility in the course of any given year. Finally, Staff would suggest that trends concerns and assumptions can be expressed as “Trends to Watch” in the report, for example, without necessarily changing the Forecast itself going forward. FINANCE COMMITTEE DRAFT EXCERPT MINUTES Page 1 of 8 Regular Meeting Tuesday, March 5, 2013 Review of Fiscal Years 2013 to 2023 Long Range Financial Forecast. Christine Paras, Principal Financial Analyst provided corrections to pages 476, 498, and 504. Economic improvements and the decreasing employment rate were reflected in the December and current Long Range Financial Forecasts (LRFF). Positive results for Fiscal Year (FY) 2011 and FY 2012 allowed the City to transfer $7.6 million General Fund surplus funds to the Infrastructure Reserve. The December LRFF included projected surpluses over the next three fiscal years. The previous LRFF showed a combined $4.2 million surplus in the base model over FY 2014-2023. That was a turnaround from May 2012 when there was an $88 million budget gap over ten years. When Staff presented the draft LRFF in December, the Finance Committee (Committee) indicated a number of concerns and follow- up items for Staff. The first one was addressing outer year projections and how they seemed overly optimistic. The Committee asked Staff to rely on a longer period of historical data to build projections for outer years. The second item was the major factor that led to a ten-year budget surplus in the last report, compared to the $88 million shortfall. In May 2012, Staff began with a ten-year budget shortfall of $88 million. In December 2012, Staff forecasted a $4.2 million surplus over the next ten years. Today the LRFF showed a ten-year surplus of $500,000. The main drivers behind the change were improved tax revenues and budget savings from miscellaneous groups. The third item was an updated Utility User Tax (UUT) revenue. The fourth item was the California Public Employees Retirement System (CalPERS) smoothing methodology and mortality experience. The Committee wanted a cumulative deficit-surplus total added to the forecast. Finally, the Committee wanted Staff to show detail of true General Fund Full Time Equivalent (FTE) reductions, rather than transfers between General Fund and other funds. Staff updated the model and proposed changing a number of items in the model. Changes resulted in a $500,000 hit to the General Fund in FY 2014. Staff projected a $4.2 million increase in overall revenue for FY 2013. $2.5 million of that increase was included in the LRFF presented in December 2012. In FY 2014 Staff projected a minimal revenue increase. Staff included in the FY 2013 numbers within the updated base model an additional $1.7 million in tax revenue, resulting from a one-time Documentary Transfer Tax receipt. The second item Staff changed in the DRAFT EXCERPT MINUTES Page 2 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 base model was a $1.3 million General Fund hit due to the change in equity transfer calculation. Staff received rate updates in January 2013 regarding the rate of return from Pacific Gas and Electric (PG&E). The Utility Funds were based on capital assets in those funds and tied to PG&E's rate of return. The calculation of the equity transfer was updated for those lower rates. The base model presented in December 2012 reflected a total $18.3 million equity transfer from Utilities. The base model now reflected a $17.4 million transfer from electric and gas. The third item included in the update was the deferral of the Golf Course reconfiguration. The project was deferred from July 2013 to April 2014, resulting in a savings of $700,000. Joe Saccio, Assistant Director of Administrative Services recalled one of the main concerns in the December 2012 Committee discussion was whether Staff was overly optimistic in the LRFF. In addition, the Committee suggested using historical and trends to forecast the future. Staff provided the average ten-year and twenty-year compound annual growth rates comparing the December 2012 LRFF and the current LRFF. The compound annual growth rate over 20 years for the total five major taxes was 4.1 percent. The December 2012 LRFF was 4.04 percent, and the current LRFF was approximately 4.23 percent. Property Tax was 4.97 percent; sales tax was 2.07 percent over 20 years; Transient Occupancy Tax (TOT) was 4.9 percent over 20 years; Documentary Transfer Tax over 20 years was 7.3 percent; and UUT was 3.8 percent. All revenues were 4.6 percent over 20 years. Overall Staff used 3.32 percent for all revenue. Revenue levels for Property Tax were stable overall. Unlike some communities, Palo Alto property taxes remained relatively stable. Approximately 300 homes under $500,000 turned over during the last six years. Sales tax was a concern in that it was growing at slightly more than two percent per year, less than the rate of inflation. Staff projected 3.38 percent, because Palo Alto was attracting and maintaining businesses. TOT projected revenues were roughly in line. The volatility in the Documentary Transfer Tax caused Staff to project a conservative figure. Staff did not include Casa Olga (new hotel) in the LRFF, nor did they include other hotels in the next two or three years of the LRFF. He conservatively estimated Casa Olga revenue at $450,000- $500,000. Lalo Perez, Director of Administrative Services explained TOT for new hotels was not included in the LRFF because Staff recommended using the TOT for Infrastructure. Vice Mayor Shepherd inquired whether Staff included Hewlett-Packard's return to Palo Alto in sales tax projections. Mr. Saccio reported Staff and the Utilities Department were waiting for that DRAFT EXCERPT MINUTES Page 3 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 to happen. Utilities did not see the expected increase in electric demand. Mr. Perez indicated Staff was monitoring the situation. Vice Mayor Shepherd asked if Staff had an explanation. Mr. Perez noted Staff attempted to discuss it with Hewlett-Packard; however, they were protecting their privacy. Mr. Saccio reported Staff used information from the Utilities Department as of February 11, 2013 to calculate the five percent growth in UUT. Ordinarily revenues were 5 percent; however, some large users had a step-down in terms of UUT depending on usage. Mr. Perez reported the CalPERS chief actuary will be recommending that the CalPERS Board lower the expected rate of return; the expected amount was either 1/4 or 1/2 percent. Council Member Schmid asked if CalPERS was currently using 7.5 percent. Mr. Perez stated 7.5 percent was the current rate of return. The recommendation will be presented to the CalPERS Board around February 2014, and the impact will occurr in FY 2016. The expected impact was an approximate 2.5 percent increase for the Miscellaneous, and approximately four percent for Safety. The three percent embedded in the base model covered a 1/4 percent increase. If the rate of return increased 1/2 percent, then the base model was not sufficient. The proposal in February 2014 was to move from a 15 year smoothing period to a five year period. That accounted for approximately $34 million of the impact in the alternative scenario of $50.6 million in additional expenses. The mortality factor accounted for approximately $17 million of the $50.6 million. If the CalPERS Board acted on these three issues, the alternative scenario became part of the base model. Staff proposed hiring an actuary to assist with the next step. Pension reform went into effect in January 2013, and neither the base model nor the alternative model showed the potential savings of the new third tier of pension reform; the City was to have a $586,000 cumulative surplus in that period for the base model. If the CalPERS Board acted on the recommendations and impacts passed through to the City in FY 2016, the City was to have a $50 million deficit. Chair Burt inquired whether the $50 million deficit excluded consideration of the third pension tier. Mr. Keene asked where in the alternative scenario was the additional 1/4 DRAFT EXCERPT MINUTES Page 4 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 percent. Mr. Perez stated it was in the base model starting in FY 2017. Chair Burt asked if the second 1/4 percent was included in the alternative model. Mr. Perez indicated it was not in the alternative model. Mr. Keene reported that was an additional increment on top of the $50 million if that occurred. Council Member Berman reiterated that the 1/4 percent was included in the base and alternative models, but note the 1/2 percent. Mr. Perez agreed. The base model contained the 1/4 percent. The potential second 1/4 was not contained in either model. Chair Burt asked how the alternative model was different from the base model. Mr. Perez explained the alternative model included the smoothing change from 15 years to 5 years, in addition to the mortality experience. Council Member Berman inquired whether Staff felt the CalPERS Board wanted to take the recommended action. Mr. Perez believed there was enough pressure from experts for the CalPERS board to act. The third tier for pension generated some savings to offset some of these impacts. The City had 2,000 employees either retired or working for other agencies, which was a large number compared to the number of active employees. Those 2,000 employees were not going to move into the new tier. The question was how many of the 900 active employees moved to the third tier once they were replaced. An expert was necessary to determine the potential savings. Mr. Keene felt many employees preferred to retire later in order to receive a higher pension amount. Mr. Perez reported another reason for the CalPERS Board to take action was the cap in the Tier 3 was tied to the Social Security number. Council Member Berman inquired whether the increase in retirement age was mandated by State legislature. DRAFT EXCERPT MINUTES Page 5 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 Mr. Keene stated it was part of Governor Brown's plan. He inquired if there was a sense of whether or not the CalPERS Board adopted either the 1/4 or 1/2 percent. Mr. Perez stated the CalPERS Board was concerned about the impact on local governments. A few agencies were in bankruptcy and had issues with payments. He believes the CalPERS Board will adopt 1/4 percent, given the impact to local governments. Mr. Saccio reported Moody's and Standard &Poor’s had utilized a 5.75 percent return rate to evaluate the liabilities to cities, and that exerted pressure on the CalPERS Board. Vice Mayor Shepherd asked Staff to explain why they used these numbers when Staff knew they were wrong. Mr. Perez suggested having the discussion with an expert. The Committee needed to discuss options and plan for the potential impact. Using the numbers provided an indication of the need to plan for the following two years. Chair Burt believed the 1/4 percent reduction was likely, and suggested people assume another 1/4 percent reduction would occur in a few years. Mr. Perez was comfortable including an additional 1/4 percent reduction in the alternative scenario. Vice Mayor Shepherd inquired whether Staff included an incremental note in the LRFF stating the monetary impact for each 1/4 percent incremental change. Mr. Perez agreed to add that if it worked mathematically. Mr. Keene said he could provide a general number, because the specific amount was to change, as the percentage changed. Council Member Schmid believed CalPERS was in a position to take higher risks to achieve higher rates of return, because any consequence fell to cities. With benefits growing on the order of 6 1/2 to 7 percent per year, and salaries growing at two percent, the City was in a long-term situation where it was not be able to pay employees to keep up with the rate of inflation. DRAFT EXCERPT MINUTES Page 6 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 Chair Burt asked if the Committee should continue the Agenda Item due to the time. Mr. Keene asked if the Committee had additional questions. Mr. Perez noted the Agenda Items for the next meeting on March 19, 2013. Chair Burt suggested continuing discussion of the LRFF. Mr. Perez inquired whether Staff should prepare additional information for the next discussion. Chair Burt wanted the alternative scenario to become the base model. Mr. Perez felt that would be assuming the CalPERS Board would approve the change. Chair Burt considered approval of the 1/4 percent change as the base model, and not approving it is an alternative model. Council Member Berman stated there was no analysis of the pension third tier. Chair Burt agreed that would need to be analyzed in order to have a realistic LRFF. Mr. Keene noted the information was evolving. Chair Burt believed a placeholder was more accurate than pretending nothing would occur; projection required the best thinking. Mr. Perez said he could include a simple calculation; however, the calculation would most likely be very complex. Chair Burt suggested including a rough number in order to have a more accurate forecast. Vice Mayor Shepherd inquired whether Staff needed to return once information was more certain. Chair Burt wanted Staff to return with updates based on the Committee's feedback. Hotels under construction needed to be included in the long term projection. He suggested the Committee earmark certain new revenue streams for infrastructure; he said that could be done within the LRFF. He DRAFT EXCERPT MINUTES Page 7 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 encouraged Staff to reconsider the UUT increase and the anticipated gas and water increases in coming years. He was skeptical of the anticipated high sales tax; however, the Documentary Transfer Tax was probably underestimated. He wanted to make the numbers as realistic as possible, with the understanding that certain numbers were the best estimates given. Mr. Keene reported Staff could prepare a LRFF over the next month, with the qualification that it utilized best estimates. Until June, Staff needed to be working on the Budget. Council Member Berman suggested including Cubberley needs, and inquired whether the $7.5 million lease payment was included. Mr. Perez indicated the full amount was included, and Staff anticipated it continue for the modeling. Chair Burt requested Staff to explain the radical impact of changing smoothing from a 15-year period to a 5-year period. Mr. Perez was going to provide information he received at the finance officer conference. Chair Burt wanted to understand if CalPERS was restating an adjustment in long term projections and burying it within a discussion of the shorter-term smoothing. Vice Mayor Shepherd inquired whether Staff had enough direction to return with updated information. Mr. Keene answered yes. Vice Mayor Shepherd noted the LRFF was utilized in Budget discussions, and expressed concerns about changes in revenue forecasts. Mr. Saccio suggested Staff utilize 20-year amounts into the future. Chair Burt requested an explanation of the rationale to utilize data other than the 20-year data. Council Member Schmid felt the importance of the LRFF was context for the Budget debate. Mr. Keene stated the LRFF was used to inform Budget decisions. The Committee did not think about this in terms of tradeoff implications. DRAFT EXCERPT MINUTES Page 8 of 8 Finance Committee Regular Meeting Draft ExcerptMinutes 03‐05‐13 Chair Burt said a reasonably accurate LRFF was an informed Budget decision. FINANCE COMMITTEE EXCERPT MINUTES Page 1 of 7 Regular Meeting Tuesday, March 19, 2013 Fiscal Years 2013 to 2023 Long Range Financial Forecast (Continued From March 5, 2013) Lalo Perez, Administrative Services Director wanted to provide Staff with feedback to the Finance Committee's (Committee) comments at the end of the prior discussion, and to receive input for discussion with the Council. The Mayor indicated he wanted the Long Range Financial Forecast (LRFF) to be an Action Item on the Council Agenda. The first comment concerned tax revenue associated with hotels currently under construction, and earmarking those funds as revenue streams for infrastructure expense; He said Staff could include that in the LRFF. The second comment concerned calculating the pension savings from the third tier pension benefits. Staff suggested hiring an actuary firm to assist in calculating those savings because the alternative scenario contained an approximate $50 million impact between the years of 2017 and 2023. He remarked that the $50 million impact should be offset by savings. The third comment requested further clarification on the CalPERS pension rate estimates included in the base model. Staff suggested utilizing the actuary firm to validate their application of the CalPERS estimates. With regard to the fourth comment from the previous meeting, Staff requested clarification. With regard to the fifth comment, Staff was comfortable with their estimates for sales and Documentary Transfer Taxes. If the Committee had concerns, Staff would note them in documentation to the Council and in the model. Chair Burt indicated the Committee needed to decide whether to make the first comment a recommendation to the Council. MOTION: Vice Mayor Shepherd moved, seconded by Council Member Schmid to have Staff put the related tax revenue associated with hotels currently under construction in the Long Range Financial Forecast. Chair Burt noted the comment also contained a provision to earmark revenue streams for infrastructure expense. EXCERPT MINUTES Page 2 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 Vice Mayor Shepherd did not want to earmark revenue for infrastructure expense. Council Member Schmid did not recommend earmarking funds at this time. Chair Burt wanted to earmark funds for infrastructure. He asked if Staff needed a Motion. James Keene, City Manager suggested the Committee move the separate items. MOTION RECAPPED: Vice Mayor Shepherd moved, seconded by Council Member Schmid to include Transient Occupancy Tax for hotels currently under construction in the Long Range Financial Forecast. SUBSTITUTE MOTION: Council Member Burt moved to have Council consider earmarking revenue streams for infrastructure expense. SUBSTITUTE MOTION FAILED DUE TO LACK OF A SECOND. Vice Mayor Shepherd did not object to the Committee asking the Council to hold a policy discussion regarding earmarking funds. Chair Burt inquired whether the City had other definable new revenue sources. Mr. Perez could not recall any new revenue sources. There were some implied such as the Utility Users Tax (UUT). Chair Burt stated a change in the Cubberley lease could be a new revenue source. Vice Mayor Shepherd reported discussion from the Infrastructure Committee meeting indicated a bond may not be needed. Chair Burt suggested the Finance Committee recommend that full Council consider whether discrete new revenue streams needed to be earmarked for specific purposes such as infrastructure. Vice Mayor Shepherd requested Chair Burt make a suggestion that was separate from the Motion to prevent confusion. Chair Burt agreed. MOTION PASSED: 3-0, Berman Absent EXCERPT MINUTES Page 3 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 MOTION: Council Member Burt moved, seconded by Vice Mayor Shepherd that the Finance Committee recommend the Council hold a discussion on whether discrete new revenue streams be identified for specific purposes, such as infrastructure use. Council Member Schmid felt the Motion was a policy change when the Committee was considering amendments to the LRFF. Chair Burt explained potential new revenues would have a multi-year impact on the LRFF. Council Member Schmid believed defining new revenue sources for infrastructure was separate from review and approval of the LRFF. Chair Burt stated budgeting one or two new revenue streams was a part of the LRFF. Vice Mayor Shepherd indicated a Committee could hold a broader discussion. She wanted the Infrastructure Committee to develop new revenue streams; however, she thought this would be a good conversation for the Council. MOTION PASSED: 2-1, Schmid no, Berman absent Chair Burt recalled the next topic was calculation of the pension savings for third tier employees. Staff wished to hire an actuary. He inquired whether Staff needed a Motion for Staff to hire an actuary. Mr. Perez answered no and said hiring an actuary was within the City Manager's authority. Vice Mayor Shepherd inquired whether this work was within the scope of work for Bartel Associates. Mr. Perez replied no. The previous work was regarding retiree medical. Vice Mayor Shepherd asked if this work could be added to Bartel Associates' scope of work for the next cycle. Mr. Perez reported the City had not engaged Bartel Associates for pension services. Given the significant impact of Staff estimates, it was beneficial for an actuarial firm to validate Staff's calculations. Vice Mayor Shepherd wanted to understand the importance of the information at the current time. EXCERPT MINUTES Page 4 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 Mr. Perez felt it was important because Staff wanted to ensure they were making sound decisions based on sound information and said data was based on actual demographics; however, some assumptions were based on California Public Employees' Retirement System (CalPERS) experience. He said a pattern could develop in the next five to ten years that would shift because the City will have savings from new employees moving into the third tier. Vice Mayor Shepherd wanted to ensure Staff worked efficiently. Chair Burt clarified that the actuary would project the number of employees in the third tier and the point in time that would impact City liabilities. Mr. Perez reported the actuary would make assumptions regarding employees' retirement dates and the likelihood of employees being in tier two, versus being in tier three. Chair Burt inquired if the impact was many millions of dollars. Mr. Perez answered yes. The unknown factor was when the impact would occur. Chair Burt acknowledged that the actuary could only provide a best estimate. At the current time Staff did not include any estimate, and it was a significant change. Mr. Perez indicated Bartel Associates performed the same analysis for other agencies. Council Member Schmid stated the difference between tier two and tier three was savings; however, CalPERS reform opened the possibility of losses for the City. Mr. Perez explained the two percent at age 60 could move to 2.418 percent at age 63. In tier three, a cap on the maximum pension allowance an employee could earn was tied to the Social Security limit. The question was how many employees would go to in tier two. Chair Burt stated the Committee did not need to take action on the request to hire an actuary, and continued to the third topic. Mr. Perez reported Staff was comfortable with their estimates. He said an actuary could validate those estimates to ensure Staff's calculations were sound. EXCERPT MINUTES Page 5 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 Vice Mayor Shepherd said she had no confidence in CalPERS' rate of return. She hoped the LRFF would include the effect of each 1/4 percent rate change. Chair Burt did not believe this was a point of contention. Mr. Keene indicated Staff could include a note and some calculations in the LRFF. Vice Mayor Shepherd wanted to ensure that was included. Chair Burt indicated the third topic required no action by the Committee. With regard to the fourth topic, he was concerned about projecting the prior anticipated utility increases for the future. While capital expenditures continued to increase for various utilities, the commodity costs on gas and electric might not rise at historic rates. Experts in the industry were reexamining those historic trends and escalations, and suggesting the escalations may not occur at the same rate. Renewables and non- renewables were experiencing market changes, which could be new trends. He requested Staff discuss with Utilities Staff any anticipated trends that should be factored in. Mr. Perez indicated Staff would do so. Council Member Schmid agreed that Staff should review that. Vice Mayor Shepherd noted Utilities did not provide the majority of revenues. Chair Burt inquired whether the Report included a breakdown of revenues from different streams. Joe Saccio, Assistant Director of Administrative Services reported the last LRFF included a compound annual growth of approximately 2.9 percent for UUT. The historical 20-year compound annual growth was 3.8 percent, and the prior ten years was 5.3 percent. Chair Burt suggested the adjustment was included. Mr. Saccio noted Staff had lowered the projected annual growth. It was incumbent on Utilities to explain their forecasts in terms of prices of commodities and capital. Chair Burt inquired about the percentage of the Budget. Vice Mayor Shepherd stated the sales tax had been erratic. EXCERPT MINUTES Page 6 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 Chair Burt recalled the final topic was long-term projections for sales and Documentary Transfer Taxes. The concern was that the 20-year compounded growth was 2.07 percent, the 10-year compounded growth was one percent, and the forward projection was 3.38 percent for sales tax. Mr. Saccio explained Staff reviewed the forecast and assumptions. Those were reasonable growth rates for the next few years. Comparing the four quarters of calendar year 2012 to the four quarters of calendar year 2011 resulted in a 12.4 percent increase. Chair Burt felt that information was not relevant in projecting a 10-year forecast. He requested Staff's rationale for projecting 3.4 percent growth when the prior growth was only one or two percent. Mr. Saccio said Staff considered the first couple of years when preparing the LRFF. Chair Burt indicated the LRFF did not appear to include a recession. Mr. Saccio recalled the Committee's prior instructions were to review the prior 20 years and include all the recessions in those 20 years in order to determine a rate of growth. Chair Burt asked how Staff moved from 2.0 percent growth to a projected 3.38 percent growth. Mr. Perez reported Staff was comfortable with the projected growth for the next five years. Staff reviewed the final five years, and either made adjustments or stated the Committee was uncomfortable with Staff's long- term projections for sales tax. Council Member Schmid felt the general economic outlook as stated on pages three and four was optimistic. He thought it would be good to have a section about persisting economic problems. Vice Mayor Shepherd inquired whether Staff relied on any new source of sales tax. Mr. Saccio responded no and said the Amazon tax would go to the jurisdictions where warehouses were located. Vice Mayor Shepherd indicated the Amazon tax would be ZIP code specific, and was projected to provide $2.5 billion to the State of California. EXCERPT MINUTES Page 7 of 7 Finance Committee Regular Meeting Excerpt Minutes 3/19/2013 Mr. Saccio stated the State of California would receive its share of the sales tax, but the one percent of sales tax for local jurisdictions went to the local jurisdictions where the Amazon warehouse is located. Vice Mayor Shepherd asked if the City would receive funds from the Amazon sales tax. Mr. Saccio replied no. Staff relied on sales tax from Hewlett Packard; however, that had not occurred. Vice Mayor Shepherd inquired whether Staff could resolve the higher projection for sales tax. Mr. Perez stated Staff would review the second of the five years of the LRFF and would provide more detail. If Staff did not change their opinion, they needed to provide an explanation. Vice Mayor Shepherd asked if Staff preferred to present the LRFF to the Council or if they preferred returning to the Committee. Mr. Perez suggested that was preferable in light of Budget hearings beginning in May. Mr. Saccio noted that the major taxes over the past five years had a cumulative growth rate of 4.1 percent. The forecast contained 4.2 percent growth. Every year some taxes did not meet projections and others exceeded projections. In totality, projections were close to the trend in historical growth. Chair Burt stated the LRFF should be as close to correct as possible. The Amazon issue raised the question of how much Staff considered trends of internet sales and their impact on 10 and 20-year trend. He noted that changes in tax law could change that.