UPDATE: The school board will discuss the tax shortfall in a special budget study session on Wednesday, July 27, 4-6 p.m. at the district office, 25 Churchill Ave.
The Palo Alto school district is suddenly facing a $3.7 million budget gap due to a new property-tax revenue estimate from the Santa Clara County Assessor's Office that is about 3 percent lower than the district had planned for.
The district learned last week that projected property-tax revenue has dropped to 5.34 percent, significantly lower than the 8.67 percent the district relied on in creating its 2016-17 budget, adopted on June 21. The decrease is due to a rise in assessed properties that are exempt from property taxes, primarily $1.2 billion in exemptions from the major expansion of Stanford University hospitals.
Monthly reports that the district receives from the assessor's office only include gross real property values, not exemptions, though these reports have "provided a reasonable basis for estimates in past years," Chief Business Officer Cathy Mak wrote Thursday in a memo about the budget changes. On June 1, the assessment growth was estimated at 8.62 percent.
The drop, which Mak and Superintendent Max McGee both said was a complete "surprise," will have an automatic impact on the district's new three-year teacher's contract, and likely on the district's reserves.
Though the estimated total tax shortfall is $5.2 million of the $231 million budget, the new projection will trigger a safety-net condition in the teacher's contract that eliminates a 1 percent bonus for teachers when property-tax revenue is less than the district budgeted by 1.5 percent or more. This reduces the actual gap to $3.7 million.
Mak and McGee have preliminarily suggested that the district make up for the lost revenue by pulling $1.2 million from unrestricted, undesignated funds; $1.2 million from bond funds designated for computer updates; $375,000 unused dollars in the budget that had been allocated for the hiring of teachers to accommodate enrollment growth; and not transferring $919,000 to the district's Basic Aid Reserve Fund, McGee said Thursday.
The lower projection also means negotiations with the teachers and classified employee unions can be reopened on the 3 percent raise promised in the third year (2017-18) of their contracts, which in total provides a 12 percent base salary increase over three years, plus the off-schedule bonuses. (An off-schedule bonus is not added to the employee's base salary.)
"As you can imagine, I was surprised and disappointed to receive this news as I consider the three-year contract one of our great collaborative achievements from last year," McGee wrote in an email to the school board and his cabinet on Wednesday.
The size of the salary increases required unprecedentedly high assumptions about the rate of increase in secured-property-tax revenues, which provide about 70 percent of the district's revenue, for the next three years in order to achieve balanced budget projections.
The sole Board of Education member to vote against the teachers' contract, Ken Dauber, raised alarm bells about the contract's budget implications given these high assumptions, while his colleagues relied on an assurance that the local housing market would provide early indicators, at least 18 months in advance, of any major changes in property-tax revenue.
Dauber told the Weekly Wednesday night that he believes the board acted imprudently in viewing the budget projections as conservative. A primary consequence, in his eyes, will be that the district can't afford as many teachers as it budgeted for, and classes could be larger as a result.
"I think the important thing is that our students not suffer the consequences, but it's likely that they will because the board didn't act prudently and leave us any wiggle room," he said. "We don't have a cushion."
"It's just deeply disappointing and upsetting that after one of the biggest property-tax increases in history that produced one of the largest surpluses that the district is likely to ever see, the board and senior staff mismanaged it to the extent that we now face this problem," he added.
Santa Clara County Assessor Larry Stone, reached in Prague Thursday morning, told the Weekly that his office meets with school-district representatives on a quarterly basis and also provides them monthly gross assessment updates.
"We meet with them for just this reason, so they can clearly understand that these are just monthly gross numbers, not net numbers," he said.
And while the exemption estimates don't come in until the end of the fiscal year (the Assessor's Office didn't know the amount until May, Stone said), Stanford University represents the second largest exemption in the state.
"If you're a finance director or superintendent of Palo Alto Unified, you know there's a lot of exempt property," he said. "These aren't rookies here."
The "point of surprise" for the school district might have been that as construction progresses and a project nears completion, so do the property's exemptions, resulting in this year's particularly large amount, Stone said.
Total exemption values came in at $9.1 billion this year, compared to $8 billion last year, according to Mak.
Looking to any compounding effect on the 2017-18 budget, Mak wrote in an email that the district will "revise both the property tax growth assumption and the expenditure budget accordingly."
Dauber cautioned that this is not a "one-year budget issue" that one-time fixes will solve.
"The impact is ongoing," he said. "The only way to solve this on a permanent basis is to reduce our expenses. One-time fixes aren't going to do it because we'll just have the same problem next year."
School board President Heidi Emberling said she was "shocked" to see the new projection and didn't think the district could have anticipated an exemption as large as $1.2 billion.
"This was not predictable. If it was predictable, then we have to figure out where our systems went wrong. We rely on certain indicators throughout the year to do our planning, and we don't have a crystal ball. We do the best planning we can with the information we have at the moment," she said.
When asked about various areas where the district could look to recapture the lost revenue -- drawing from reserves, rolling back management staff's compensation increases, asking the teachers' union to re-open the contract for the coming school year -- she said, "Right now, everything is on the table."
The board will discuss the budget changes at its first meeting of the school year in August.