After enduring a year of layoffs, slumping revenues and benefit reductions for city employees, Palo Alto officials are bracing for more financial pain in the coming years as pension costs continue to rise -- due to bad state-level investments that could possibly double city costs.
The troubling assessment emerged at last week's meeting of the City Council's Finance Committee, where the committee closed the 2010 budget and approved the annual Comprehensive Annual Financial Report -- a detailed listing of the city's funds. This year's General Fund budget totaled $143.44 million.
The committee learned that the city's belt-tightening will likely extend into future years to account for looming pension obligations and uncertainties over revenue sources.
"We do have a problem, and we do have to make some changes," Administrative Services Director Lalo Perez told the committee Dec. 21.
"We're going to need to come up with additional money, and that's going to either come from a reduction in expenses for the city operations, an increase in revenues or an increase in contributions from employees."
The biggest question looms over pension costs, which are expected to rise steeply in the next two years -- in some cases possibly more than doubling -- because of the recent investment losses suffered by the California Public Employees' Retirement System (CalPERS). The pension fund's investment portfolio lost about 24 percent of its value in fiscal year 2010 -- a loss committee Chair Greg Schmid called "astounding."
Perez said the city's contributions could drastically shoot up if CalPERS decides to revise the projected rate of return for its investments from 7.75 percent to 7.5 percent, as the pension fund's staff has recommended. The board is expected to consider the change in February.
Palo Alto currently contributes 24 percent of public-safety employees' salaries for pensions, while the employees contribute 9 percent. The city now pays between 19 and 22.75 percent for non-public-safety employees, with contributions varying by labor groups, according to the Comprehensive Annual Financial Report.
The CalPERS change could force the city to pay as much as 33 cents for every dollar of salary for "miscellaneous employees" (those not in public safety) starting in 2013. For public-safety workers, the city's contribution could soar to between 49 percent and 52 percent of salaries.
"We're talking about major increases in pension costs," Perez warned.
The committee had discussed the pension problem in the past. At its Oct. 5 meeting City Manager James Keene characterized the pension situation as an issue that needs to be taken seriously.
"I'm in the camp that thinks there is a day of reckoning that's going to come some time in the future, and it's going to be pretty significant," Keene said at the October meeting.
He acknowledged that the problem is statewide but said Palo Alto could benefit from proper planning and building the rising costs into the city's long-term financial forecasts.
The pension problems hit at a time when Palo Alto is recovering from a particularly grueling budget year. With tax revenues slipping, the city had to close a $6.3 million hole in the middle of the last fiscal year (which ended June 30). Officials then wrestled with a $7.3 million "structural deficit" (a deficit that extends to future years) later in the year. The council closed the structural cap by laying off workers, freezing salaries, reducing expenditures across City Hall and reducing employee benefits.
The city also recently instituted a two-tiered pension system in which newly hired workers get a less lucrative pension formula than existing workers -- a change that is expected to partially mitigate against the rising pension costs.
Pension costs aren't the only fiscal challenge on the horizon in Palo Alto. Perez said last week that staff continues to keep an eye on overtime costs for public-safety workers -- costs that routinely exceed budget projections. Staff also remains concerned about tax revenues from commercial properties, Perez said.
On a more positive note, Perez said there have been "positive trends" in sales-tax revenues, which dropped by more than $2 million in each of the last two fiscal years. Perez said staff has lately been receiving good feedback from local businesses, particularly high-end retailers. Sales-tax revenues are projected to rise from $17.3 million in fiscal year 2010 to $18.2 million in the current fiscal year, which ends June 30.