REPORT TO COUNCIL
SUBJECT
Title
Discussion and Review of Potential General Fund Revenue Opportunities and Budget Amendment
Report
EXECUTIVE SUMMARY
The purpose of this presentation on revenue options is to keep the City Council focused on the fact that the number one priority must be to stabilize our fiscal outlook to preserve service and staffing levels, generate more revenue to meet expenditure growth demands, and develop strategies for unfunded needs/projects. Combined, both revenue and expenditure strategies are needed to balance future deficits.
The following information serves as the master report for revenue opportunities for the City Council Study Session that can be considered for the 2018 November Ballot. During the January 2018 Council Goal Setting Session and the May 22nd Fiscal Year 2018/19 Proposed Budget Study Session, the City Manager presented the City’s 10 Year Fiscal Outlook which forecasts structural deficits over the next ten years. During the January session, the Council authorized staff to return with an analysis of revenue options and, by consensus, expressed support to commit to solve annual deficits with sustainable budget solutions such as on-going expenditure reductions, increases to current revenue sources, and/or identifying new revenue sources to stabilize the City’s future fiscal condition.
Additionally, the City has a number of unfunded capital infrastructure needs and the City Council held Study Sessions in 2017 and 2018 to discuss infrastructure. These unfunded needs include major projects that affect City services such as the Civic Center Campus, City maintenance yard, and fire stations and also quality of life improvements including parks and recreation, and community services facilities. One of the major projects from a need and cost perspective is the International Swim Center (ISC) and Community Recreation Center (CRC).
Over the course of the last few months, staff has worked on revenue options for Council consideration. This report serves as the transmittal memo for the following revenue opportunities:
1. Increase in the Transient Occupancy Tax (TOT) rate,
2. Increase in the Documentary Transfer Tax,
3. Establishment of a Utility User Tax (UUT),
4. Establishment of a Cannabis Tax, and/or
5. Establishment of an Infrastructure Parcel Tax.
The first three items are discussed within the body of this report while the last two items are sub reports within the overall information being provided on revenue opportunities. Recommendations included in this report are required to assess ballot initiatives and the Infrastructure Parcel Tax and Cannabis Tax reports have additional recommendations specific to those revenue items.
To accomplish the work related to understanding the viability of the measures above, staff will be working with consultants to complete the following efforts:
• Statistically Valid and Scientific Community Research and Focus Groups
• Community Engagement & Stakeholder Outreach
• Information and Education Efforts
• Revenue Analysis and Engineering Scoping
At the end of staff’s presentations on all three reports, the Council is asked to provide input regarding all five revenue opportunities and determining which two measures should move forward for further analysis and research for the November 2018 General Election. While all items are viable, it is understood that each require community and stakeholder engagement which, for some, may take more time.
Based on ballot initiative consultants that are experts in the area of ballot initiative strategy, placement of more than one revenue measure on the upcoming November ballot is not advised, due to the anticipated qualification and potential passage of the statewide California Business Roundtable Initiative. This initiative would increase the threshold for passing a new general tax to two-thirds of voters from the current simple majority (50% plus 1). The initiative also creates additional requirements for ballot language when a tax measure is put to the voters. If qualified and enacted by statewide voters in November 2018, this Initiative potentially nullifies any general purpose measure adopted by local voters retroactive to January of this year.
Further, the City’s consultants have informed staff that when there is more than one revenue measure on the ballot simultaneously, voters tend to pick and choose between them or become concerned about a “tax over-reach” on the ballot, often with significant differences in passage rates as large as 10 points or more, even when both measures are passed. Given the uncertainty of the California Business Roundtable Initiative, and the significant impact to initiatives with less than two-thirds voter approval, the City Council must weigh heavily the risk of placing more than one initiative on the ballot and, likewise, determine which initiative is most advantageous to meet the revenue goals of the City.
Last, the results of the community research will be presented to the Council on July 5th with final Council action on a recommended ballot measure on July 17th to place the measure on the November 2018 ballot.
BACKGROUND
The City’s 2018/19 Annual Operating Budget includes the transition from a Five-Year Financial Plan to the development of a Ten-Year Financial Plan for the City’s General Fund. Moving to a ten-year outlook allows the City Council and staff to work proactively, strategically, and collaboratively on solutions for addressing year-over-year deficits. Further, it allows for a better understanding of today’s fiscal actions over the long-term instead of budgeting year-to-year on a short-term basis.
As noted previously, on May 22nd, the City Manager presented that the City forecasts structural deficits over the next ten years and that committing to solve annual deficits with sustainable budget solutions such as on-going expenditure reductions, increases to current revenue sources, and/or identifying new revenue sources would be required in order to stabilize the City’s future fiscal condition.
As mentioned, the Ten-Year Forecast reflects ongoing annual structural deficits in the City’s General Fund beginning with a $3.5 million deficit in 2019/20 and increasing to an estimated cumulative $28.2 million deficit through 2028/29.
However, by committing to fiscal discipline and addressing the annual deficits with cost reductions, alternative service delivery options, or increasing revenues, the year-over-year deficits range between a projected/estimated low of $1.8 million to a high of $6.7 million over the ten-year period. To the extent that the problems are not solved year-to-year with ongoing solutions, then the value of non-on-going fiscal solutions would carry forward into the next fiscal year requiring steeper budget balancing solutions. If they are not solved with revenue, then expenditure reductions are required.
The biggest cost driver is the rising pension costs, for both retired and active employees, which are relatively beyond the City’s control. For example, on December 21, 2016, the CalPERS Board of Administration approved lowering the CalPERS discount rate assumption, the long-term rate of return, from 7.5% to 7.0% over the next three years. This will increase the City’s contribution costs beginning in 2018/19. Lowering the discount rate means that the City will see increases in both the normal cost (the cost of pension benefits accruing in one year for active members) and the accrued liability.
The City’s fiscal outlook is like many other local municipalities, whereby revenue growth occurs more slowly than expenditures resulting in a structural deficit. Particularly of note is that the General Fund relies partially on volatile revenue sources (e.g., Sales Tax and Transient Occupancy Tax make up 31% of General Fund revenue), which creates a vulnerability for providing continuously excellent services to our community. With these volatile revenue sources, and the predictable increases to pension costs and other post-employment benefits (OPEB) liabilities, what quickly becomes apparent is a need for a strategic work plan to identify new revenue opportunities and manage expenditure increases.
DISCUSSION
As shown in the ten-year financial forecast, the City has less than one year to focus on stabilizing the future years of the fiscal outlook (years 2-10, specifically). This affords the City Council and staff time to work strategically, holistically and collaboratively on budget solutions with minimal impact to service levels: if not, in the next fiscal year, with all things remaining equal relative to revenue, the City must begin to eliminate $3.5 million of expenditures in the General Fund. The goal is to align expenditures with ongoing revenue growth.
As mentioned at the City Council Priority Setting Session held in January 2018, there has been an unprecedented volume of new initiatives and the pace of the organization has increased disproportionately to its increase in capacity and human resources. Doing more with less has impacted quality of service and delays in Council’s desire to achieve other directives, heightened the risk in our administrative processes, and reduced management “grip” on key initiatives-it is also not sustainable in the long-term. In order to address some of these capacity issues, the Proposed 2018/19 Operating Budget included the City Manager guideline of “streamlining administrative processes with a focus on lowering costs”. For example, the proposed budget includes funding for a dedicated risk management function, contract management, and a public records request system which represent areas of costly delivery of service, cost exposure, and/or significant drain on resources for lack of appropriate systems and dedicated resources. Streamlining these efforts will increase citywide efficiencies and will free up staff to pursue other process improvements and other tasks.
As part of the City’s budget stabilizing strategies and addressing the City’s infrastructure needs, staff has identified five possible new revenue opportunities, which are:
1. Increase in the Transient Occupancy Tax (TOT) rate,
2. Increase in the Documentary Transfer Tax,
3. Establishment of a Utility User Tax (UUT),
4. Establishment of a Cannabis Tax, and/or
5. Establishment of an Infrastructure Parcel Tax.
Both the Cannabis Tax and Infrastructure Parcel Tax will be discussed in separate reports to Council. Certain taxes would require the City to draft regulatory ordinances and licensing procedures which would then be submitted as a measure to the voters for approval. The three revenue sources discussed in this report are considered a general tax and would have to be approved at a General election by a simple majority (50% plus 1) of voters.
Revenue from the taxes discussed in this report (if approved by the voters) would be used to offset future General Fund deficits and address other service needs such as deferred projects, staffing shortages, etc. It is important to note that these options are revenue opportunities that can be presented to the voters at the appropriate time, with some requiring community/stakeholder engagement to test feasibility and others more readily available.
The purpose of this presentation on revenue options is to keep the City Council focused on the fact that the number one priority must be to stabilize our fiscal outlook to preserve service and staffing levels, generate more revenue to meet expenditure growth demands, and develop strategies for unfunded needs/projects. Combined, both revenue and expenditure strategies are needed to balance future deficits.
Below is a discussion of three revenue opportunities:
I. Transient Occupancy Tax (TOT)
A Transient Occupancy Tax (TOT) commonly known as a “hotel tax”, is charged by the City to guests of hotels and short-term rentals within the City. Currently, TOT revenue accounts for 8% or approximately $21 million of the City’s General Fund revenue. This revenue is used for general local governmental purposes such as Police, Fire, Public Works, Parks and Recreation, and Libraries. The City of Santa Clara’s current TOT rate is 9.5% which is one of the lowest in the County (see Table 3).
Note: Sunnyvale is considering a 2% rate increase.
In addition to the current TOT rate, in May 2010 the City Council approved the formation of a Community Facilities District (CFD) as part of the Levi’s Stadium project. The CFD includes hotel properties in the vicinity of Levi’s Stadium. These hotel property owners voted unanimously to place a special tax on hotel room nights equivalent to a 2% TOT rate. This special tax is pledged to finance portions of the publicly owned infrastructure for the stadium project. The Forty Niners SC Stadium Company, LLC (StadCo) agreed to loan the Santa Clara Stadium Authority (SCSA) a not to exceed amount of $35 million to fund CFD infrastructure with a maximum principal amount of $38 million including capitalized interest. This loan bears interest at a fixed rate of 5.73% and the loan is payable solely from amounts actually received by the SCSA from the CFD. This debt is secured by and payable solely from the special taxes levied on the hotel properties within the CFD and does not represent an obligation or debt of the City or the City’s General Fund. Section 10.3 - TOT Credit in the Disposition and Development Agreement (DDA) states in part that the City may increase the TOT rate from time to time. However, if the City increases the TOT by 1%, the funding amount that would go to the Stadium Authority, once the debt has been fully paid, would be reduced proportionately. With the addition of the CFD, hotel guests currently pay 11.5% at the nine hotels located around the Stadium and Convention Center.
The City currently has 37 businesses that pay TOT, including online rentals. The majority of these businesses charge hotel guests the 9.5% TOT rate. However, the nine hotels located in the CFD area provide 75% of the City’s overall TOT revenue.
If the City’s TOT rate was increased by 1% to 10.5% it could generate an estimated $2 million annually in additional revenue for the City’s General Fund. However, it is important to note that TOT is a volatile revenue source because it is strongly correlated with the state of the economy. For example, in the last recession this revenue source decreased by 28% or $3.2 million in 2009/10 when compared to the peak of $11.3 million in 2007/08. In 2016/17 (the most current fiscal year) this revenue rose to $20.1 million. While increasing the TOT rate is a viable option, a recession in the future years could substantially reduce this anticipated revenue.
Given that this is a user tax, it is likely to have 50% +1 voter approval since it impacts those using services that generate TOT, which is more likely to be a tourist or visitor not a resident.
II. Documentary Transfer Tax
A Documentary Transfer Tax (Transfer Tax) is a tax imposed by states, counties, and cities on the transfer of the title of real property from one person (or entity) to another within the jurisdiction. It is based on the property’s sale price and is usually paid by the party transferring or conveying title to the property. As with TOT, this is also a very volatile revenue source that is impacted by the state of the economy. For example, in the last recession this revenue source decreased by over 50% or $0.7 million in 2009/10 when compared to the peak of $1.2 million in 2007/08. In 2016/17 (the most current fiscal year) this revenue rose to $1.7 million.
The Santa Clara County Transfer Tax is $1.10 for each $1,000 sale amount (for example a property that is sold for $500,000 would require payment of a $550 transfer tax). Of the $1.10, the City of Santa Clara receives $0.55 and the County receives the remaining $0.55. Charter cities may adopt, with voter approval, an additional transfer tax (which would stay with the City) plus the Documentary Transfer Tax of $1.10 per thousand (which would stay with the County).
The City is projected to receive approximately $2.0 million in the proposed 2018/19 Operating Budget in Transfer Tax revenue. An increase of an additional $1.10 for a total Transfer Tax of $2.20 for each $1,000 sale amount would result in an estimated increase in revenue of $1.9 million. For the average residential home sold currently with a median sale price of $1,450,000 the tax increase to the buyer would increase by $1,595 from $1,595 to $3,190.
While this too is a user tax, it does require community and stakeholder engagement to better understand areas that may have unintended consequences of the goal of generating more revenue for the General Fund. This user tax would impact individuals involved in real estate transactions and, therefore, would require input from real estate stakeholders. This is likely a strategy that is best postponed once a comprehensive engagement process is completed with input received and a proposal reflected of that input that accomplishes the goal of revenue generation for the City.
III. Utility User Tax
The City currently does not collect a Utility User Tax (UUT), which is imposed by a city on the consumption of utility services, including (but not limited to) electric, gas, water, sewer, cable television, telephone (including cell phone and other telecommunication services), and sanitation. The rate of the tax and the use of the revenues are determined by the City. The tax would be levied by the City on the customer of the utility services, collected by the utility as part of its regular billing procedure, and then remitted to the City.
City UUT rates in the region range from 1% to 11%. The particular utilities to which the tax applies can vary and different rates can be applied to residential versus commercial users. The average UUT rate for Cities located in Santa Clara County is 3.7%. Most large cities have UUTs and roughly half of California residents and businesses pay a UUT.
The City of Santa Clara does not currently have a UUT. The Water and Sewer Department discontinued charging its excise tax in 2009. Based on an analysis of the Fiscal Year 2016/2017 charges for electricity, water, and sewer as well as estimates for telecommunication services and natural gas charges, staff believes that the City could generate close to $7 million in tax revenue for each 1% of UUT tax. The estimated UUT on telecommunication and gas charges is based on estimates from nearby cities.
For a $200 million infrastructure improvement measure, the accompanying infrastructure improvement needs report states that a parcel tax of $20-$25 for every $100,000 of assessed value would be needed. Such a tax requires 2/3 voter approval. The property assessment would be sufficient to pay off a 32.5 years General Obligation Bond with an annual debt service between $12.5 million and $14.1 million (depending on the interest rate environment at the time of debt issuance). Alternatively to issuing bonds, the Council could also dedicate some of the UUT revenue stream to issue Certificates of Participation, a debt service instrument, in order to fund the $200 million infrastructure needs.
In order to address the City service and infrastructure improvement needs, voter approval of a broad utility user tax of 3% with a 50% +1 vote would be required. A 3% tax increase is estimated to generate approximately $20.6 million. This would generate between $6.5 million to $8.1 million additional revenue available to the General Fund to preserve City services once the annual debt service payment for the infrastructure improvements is made.
Since the UUT impacts residential and commercial customers, this revenue option would require robust community engagement to determine an approach that is responsive to input and the goal of generating more revenue to the General Fund.
IV. Cannabis Tax
See attached report.
V. Infrastructure Parcel Tax
See attached report. Given that this revenue option is the most studied of all presented, absent approval of other revenue opportunities, the Council will need to weigh heavily the viability of staff’s ability to implement a significant capital program of this magnitude while concurrently reducing expenditures and staffing to balance the budget. Meaning that, the voters may approve a Parcel Tax for investment in projects important to the City; however, given the 10 Year Fiscal Outlook, during the same time, the ability to deliver in the context of reduced staffing levels throughout the City will impact the ability to successfully deliver the projects.
Other Actions
If Council would like to continue with the Ballot Measure process, staff requests that the Council focus on the top two ballot initiatives and grant staff the authority to enter into contracts to conduct the required community research, outreach, and testing to determine which option would be most successful when tested against other potential revenue generating ballot initiatives that the City Council will consider concurrent with this report.
As time is of the essence, and a standard procurement process would cause for delay with obtaining necessary information to initiate ballot language by the July 17th City Council meeting, staff requires Council approval to authorize the City Manager to waive the procurement process and proceed to execute contracts for these services to expeditiously complete this work and return on July 5th with an update to the City Council and planned action on July 17th:
• For study of any potential revenue ballot initiatives, a contract for up to $250,000 with a consultant/consultants to complete statistically valid community opinion research, additional analysis, and development of draft ballot language. This work includes the Infrastructure Ballot Measure, but also other revenue opportunities (Transient Occupancy, Documentary Transfer Tax, and Utility User Tax).
• If the City Council selects the Infrastructure Parcel Tax as a viable option to study further, in addition to the above contract, a contract amendment up to $300,000 with a consultant to complete additional financial analysis to inform the decision process as outlined in the accompanying infrastructure improvement needs report. The additional work will help determine the financing capacity of the new tax measures to support Council priority projects, review the capital cost estimates and analyze project financing, review construction costs for the ISC/CRC, additional outreach and review tax revenue collection
Next Steps
Next steps, depending on which revenue opportunities the Council would like to pursue, include positioning ourselves for the upcoming election by beginning:
• Public outreach/engagement, community research, drafting regulatory ordinances if required, and preparing any licensing procedures which would then be submitted as a measure to the voters for approval. The goal would be to test with the community the combination, or balance, of initiatives that could be supported by voters toward successful passage and implementation
• Present to Council on July 5, 2018 regarding results from the community research
• Present to Council on July 17, 2018 regarding ballot language and moving forward with the process.
FISCAL IMPACT
Staff is requesting a budget amendment in the amount of $250,000 from General Fund Budget Stabilization Reserve (BSR) for community outreach/engagement.
BUDGET AMENDMENT
COORDINATION
This report has been coordinated with the City Attorney’s Office and City Manager’s Office.
ENVIRONMENTAL REVIEW
The action being considered does not constitute a “project” within the meaning of the California Environmental Quality Act (“CEQA”) pursuant to CEQA Guidelines section 15378(b)(4) in that it is a fiscal activity that does not involve any commitment to any specific project which may result in a potential significant impact on the environment
PUBLIC CONTACT
Public contact was made by posting the Council agenda on the City’s official-notice bulletin board outside City Hall Council Chambers. A complete agenda packet is available on the City’s website and in the City Clerk’s Office at least 72 hours prior to a Regular Meeting and 24 hours prior to a Special Meeting. A hard copy of any agenda report may be requested by contacting the City Clerk’s Office at (408) 615-2220, email clerk@santaclaraca.gov <mailto:clerk@santaclaraca.gov> or at the public information desk at any City of Santa Clara public library.
RECOMMENDATION
Recommendation
1. Review and Provide direction on the Potential General Fund Revenue Opportunities
2. Authorize the City Manager to enter into contracts to conduct the required community research and outreach.
3. Approve the appropriation of $250,000 from the General Fund Budget Stabilization Reserve to the City’s Clerk’s operating budget
Staff
Reviewed by: Angela Kraetsch, Director of Finance
Approved by: Deanna J. Santana, City Manager