Forecast shows tax revenues on the rise in Palo Alto

Despite mounting infrastructure costs and colossal pension obligations, Palo Alto is banking on good times ahead when it comes to the city budget, according to a new economic forecast released by the city.

The Long Range Financial Forecast, which covers the years 2021 to 2030, sets the stage for what portends to be a relatively calm and drama-free budget-setting season, with revenues rising in most categories. On the other hand, it puts a damper on the City Council’s infrastructure ambitions and suggests that the city’s hotel tax revenues, which have been on an upward trajectory in recent years, may be in for a rocky period.

Overall, however, the news is largely positive. The forecast, which the council’s Finance Committee discussed Tuesday night, shows the city’s revenues rising by 7%, or $9.8 million, between the current fiscal year and the next one. This is driven largely by strong growth in sales and property taxes. The forecast shows sales taxes going up from $34.35 million in fiscal year 2020 (which began on July 1) to $37.6 million in 2021.

The forecast also predicts that the trend will continue, and even accelerate, over the next decade. Sales tax receipts are expected to climb by about 4% every year and reach $51.8 million in 2030.

“The sales tax revenue forecast is driven by strong personal income and spending growth and a larger share of consumer spending online,” the forecast states. “New and innovative retail formats have helped revive physical retail presence. Stores that were once strictly online are now finding physical presence within communities.”

Property taxes, which make up general fund’s largest revenue source, are expected to show even greater growth. The forecast projects that the city’s property tax revenues will go from the current level of $48.6 million to $52.9 million in 2021. Revenues in this category are then projected to grow by about 5.8% annually and reach $85.7 million by the end of the decade.

The one area where the committee has some cause for concern is hotel taxes. In the last two quarters, the occupancy rate at local hotels has dipped. While transient-occupancy tax revenues this year are expected to reach $27.2 million, about 6% higher than in fiscal year 2019, it is about $2.1 million, or 7.2%, below the estimate in the city budget for fiscal year 2020.

The trend isn’t limited to Palo Alto. According to a survey by the consulting firm CBRE Hotels, hotels in northern California had experienced an average 1.4% decline in occupancy rate in September. In Palo Alto, the decrease was 4.7%.

Even so, city officials expect this revenue source to recover and increase in the coming years. With two Marriott hotels slated to open in the next year or two, the forecast projects that revenues from hotel taxes will go up by $4.3 million, or 15%, between the current fiscal year and the next.

Councilwoman Alison Cormack said the trend with hotel-tax revenues is something that the council needs to pay attention to, particularly as the city considers changing its relationship with the San Mateo County/Silicon Valley Convention and Visitors Bureau, a regional organization that markets hotels and other destination. On Monday night, the council considered a request from nearly 20 local hotels to leave the organization, but agreed to delay its decision until next fall.

Citing the numbers in other cities, Cormack noted that the dip in hotel occupancy can be attributed to “macroeconomic trends, as opposed to something happening in our own city.” Hotel executives have pointed to government policies such as recent travel bans and the trade dispute with China as reasons for a slow-down in hotel bookings.

Committee Chairman Tom DuBois also suggested that the data on hotel bookings may be somewhat skewed by the presence of Airbnb.

“The hotel scene is changed and it’s more complicated,” DuBois said. “Maybe this doesn’t capture what’s happening.”

Another area where the forecast warns of troubling signs is infrastructure. When the council adopted its infrastructure plan in 2014, it estimated that the projects in the plan would cost about $125.8 million. Since then, costs have jumped to $280.6 million.

The figures, Cormack said, suggest that the council may not be able to complete all the projects on its wish list.

“This is just math,” Cormack said. “And as I look at this scenario and think about the fact that we’re a service-driven organization, it’s not clear to me that we’ll be able to sustain the increase in construction costs and all the projects that are in the pipeline.”

The forecast also doesn’t account for several large infrastructure projects that the city is planning to pursue in the coming years, including the redevelopment of Cubberley Community Center and “grade separation,” the re-alignment of rail crossings so that trains and cars would no longer intersect. Even as the city is counting on healthy revenue growth from sales and property taxes, it is also preparing to ask voters next year to approve a business tax that would pay for transportation improvements such as grade separation.

Staff and committee members also noted that the numbers could change significantly, whether because of a recession or labor agreements that result in higher than projected expenditures.

The forecast argues that the city “must continue to exercise diligence to remain fiscally sustainable and balance the ecosystem of resources, the cost of doing business, and service delivery level.”

“A continued scrutiny of the expansion and enhancement of existing services, the addition of new services, and the priorities of the community will be necessary, especially as a slowing of the economy is anticipated in the coming years,” the forecast states.