G - Financial Schedules — Cupertino City Council, May 17, 2023

Financial Schedules
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Financial Overview by Fund
The chart above demonstrates how revenues (left to right) and expenditures (right to left) flow out of and into each FY 2023-24 Proposed Budget
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Flow of Funds Chart (Sankey)
The three most important things to learn from this chart:
1 .

The chart above demonstrates how revenues (left to right) and expenditures (right to left) flow out of and into each type of City fund.
2 .

Where revenues meet expenditures at the center of the chart (fund line type), a gap to the left is indicative of expenditures exceeding revenue and a decrease in fund balance/savings for that type of fund. 3 .

A gap to the right is indicative of an increase in fund balance/savings for that type of fund.

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General Fund Contribution Schedule
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No Department budget units reﬂect revenue from interest earnings for Special Revenue, Enterprise, and Internal Service Funds. In previous years, interest earnings were not budgeted for these funds.

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Fund Balance Report
Although the Retiree Medical Fund shows a negative balance, it's important to note that retiree health expensess will be reimbursed by the Section 115 OPEB Trust at the close of each fiscal year.

For descriptions of funds, see Financial Policies: Fund Structure.

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General Fund Summary
The General Fund is the City's main operating fund, responsible for providing essential services such as law enforcement, public works, community development, park maintenance, code enforcement, and administrative support. It is funded by discretionary sources such as property tax, sales tax, transient occupancy tax, and utility tax. The General Fund is typically reserved for operations that lack other dedicated funding sources, while operations such as street maintenance, solid waste collection, and recreation are funded from other sources, detailed in the All Funds Summary section of this document.

For FY 2023-24, General Fund revenue estimates are $80.3 million, reﬂecting a $14.4 million or 15.2% decrease from the previous ﬁscal year's Adopted Budget, mainly due to a sales tax decrease resulting from a CDTFA audit.

General Fund expenditure estimates for the current ﬁscal year are $86.3 million, an $8.9 million or 9.3% decrease from the previous year's Adopted Budget. The General Fund's ending balance is projected to decrease to $107.5 million.

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General Fund Revenues
FY 2023-24 General Fund revenue sources have been carefully evaluated by considering collection history, seasonal paHerns, and economic performance. These estimates are based on projected increases or decreases in activity and receipts in the upcoming year. It is important to note that each revenue source can be aﬀected by external or internal factors beyond the City's control.

As shown in the chart below, FY 2023-24 revenues are estimated at $80.3 million, a 15.2% decrease from the FY 2022-23 Adopted Budget.

The majority of Cupertino's General Fund operating revenues are generated by property taxes (40%), charges for services (15%), sales taxes (14%), and transient occupancy taxes (9%). The chart below illustrates the sources of General Fund revenue by category.

The FY 2023-24 General Fund revenue estimates are discussed by category below.

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Sales Tax
Sales and Use Tax, commonly known as the "sales tax," consists of two components: an excise tax levied on retailers for selling tangible personal property, and an excise tax applied to purchases from out-of-state vendors that are not required to collect tax on their sales. The revenue generated from sales and use taxes collected within Cupertino's boundaries is allocated by the State to various agencies, with the City receiving one percent, as depicted in the chart to the right. The City is exploring a potential new source of revenue by monitoring competing interests for the ¼ cent sales tax imposed on local governments. If a similar ballot measure is presented to the voters in the future, the City could maintain local control over the additional sales tax proceeds.

The City's sales tax revenue comes from ﬁve primary economic categories: business-to-business (including electronic equipment and soOware manufacturers and distributors), state and county pools, restaurants and hotels, general consumer goods, and fuel and service stations and other. The California Department of Tax and Fee Administration (CDTFA) manages the collection and administration of sales and use taxes, which is a signiﬁcant source of revenue for the state and local governments. Businesses are required to register for a sales tax permit and collect taxes from their customers, and the collected taxes are then remiHed to the CDTFA for distribution to the relevant local governments. In addition, the CDTFA conducts audits to ensure tax compliance by businesses. The City receives a portion of the sales tax revenue generated within its boundaries, which funds a wide range of City services and programs.

In December 2021, the CDTFA informed the City of an audit that would be conducted on one of its taxpayers.

The City was verbally informed in March 2023 of the CDTFA's preliminary determination that tax dollars had been misallocated to the City, and potential impacts on City funds were provided. The CDTFA is expected to provide the City with a formal leHer in the next four to six months, including the ﬁnal results of the audit and the actual amount of money lost.

As a result, the City is expected to experience a $30 million, or 73%, decrease in sales tax revenue from the original FY 2023-24 projections provided by its sales tax consultant, HdL. This corresponds to an overall revenue decrease of $30 million, or 28%. In particular, sales tax revenues, which were expected to generate $31.9 million in the FY 2022-23 Adopted Budget, are now anticipated to amount to only $11.4 million in FY 2023-24, marking a decline of 64%.

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Property Tax
Under current law, property is assessed at actual full cash value, with the maximum levy being 1% of the assessed valuation. The assessed value of real property that has not changed ownership can be adjusted by the change in the California Consumer Price Index (CCPI) up to a maximum of 2% per year. Property that changes ownership, property that is substantially altered, newly-constructed property, State-assessed property, and personal property are assessed at the full market value in the first year and subject to the two percent cap thereafter.

In 1978, voters approved the passage of Proposition 13, which froze property tax rates and limited the amount that rates could increase each year. Cupertino had one of the lowest property tax rates in Santa Clara County, receiving only $0.02 for every $1.00 paid. Subsequent legislation required Counties to provide "no/low tax" cities with a Tax Equity Allocation (TEA) equal to 7% of the property tax share. However, the property tax distribution for the no/low tax cities in Santa Clara County was limited to 55% of what other TEA cities in the State received.

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In FY 2006-07, West Valley cities won the passage of State legislation which restored a portion of TEA property tax revenue. This TEA change provided an additional $1.35 million in property tax annually and increased the City's share of property taxes to 5.6%. In conjunction with three other West Valley cities, Cupertino continued legislative eﬀorts to gain parity with other no/low property tax cities in the State. In FY 2015-16, Governor Brown agreed to restore TEA revenues over a ﬁve-year period. In FY 2019-20 TEA was fully restored, and Cupertino kept approximately 7.0% of property tax revenues in FY 2019-20 compared to 6.72% in FY 2018-19. Additionally, the Educational Revenue Augmentation Fund (ERAF), enacted in July of 1992 by the State Legislature to shiO local tax revenues from cities, counties, and special districts to a State control ERAF, absorbs the shift-back of the TEA.

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The City experienced a net taxable value increase of 7.2% for the FY 2022-23 tax roll.

The bulk of the increase was
due to increases in residential properties by $1.3 billion, or 7.2%. This category makes up 61.1% of the net taxable value. Unsecured property tax decreased by $655 million, or 38%. This category makes up 3.5% of the net taxable value. Lastly, commercial property values increased by $1.1 billion, or 13.1%. This category makes up 29.8% of the net taxable value. According to the City's property tax consultant HdL, there were fewer sale transactions of single-family residential homes sales and a ﬂaHening in median sale prices during calendar year 2022. This reduction in sales numbers were mainly driven by interest rate hikes. In most cities the median prices are still higher overall than last year, but the month-over-month median price changes started trailing negatively towards the end of 2022. Staﬀ will continue to monitor the potential impact of long-term and even permanent remote work in the City and region.

Transient Occupancy Taxes
Transient occupancy taxes (TOT) are levied on hotels and short-term room rentals located in the City at 12% of room revenues. In November 2011, 83% of voters approved increasing the rate from 10% to 12%. This rate increase contributed to the upward trend shown in the TOT Historical Trend graph.

TOT is originally budgeted to end FY 2022-23 at $5 million, a 14% increase from FY 2021-22 actuals. However, staﬀ expects to exceed the estimated $5 million in the current ﬁscal year. The anticipated increase is due to the relaxation of prior pandemic-based restrictions, allowing for increased travel and the return of employees to their places of work. A recovery to a $7.5 million level is anticipated in FY 2023-24, up 50% from FY 2022-23 Adopted Budget. Staﬀ will continue to monitor these activities and bring forward adjustments and recommendations as necessary.

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Utility Tax
The utility user tax (UUT), approved by voters in 1990, is assessed on gas, electricity, and telecommunication services provided within the City's jurisdiction at a rate of 2.4% of billed charges. Revenues generated from this tax can be used for general City purposes.

The City's tax rate is generally lower than that of other cities within Santa Clara County, as shown in the chart above. In March 2002, voters approved extending the utility tax's sunset date from 2015 to 2030. This extension corresponded with the extended debt maturity date resulting from the reﬁnancing of debt for capital improvement projects. To maintain tax revenues received from telecom services, voters passed a measure in 2009 to update the ordinance to the changing technology in this area.

Budgeted revenues are expected to increase 11.8% to $3.3 million in FY 2023-24. This revenue source will be monitored closely as the fiscal year progresses.

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Franchise Fees
Franchise fees are received from cable, solid waste, water, gas, and electricity franchisees that operate in the City.

The fees range from 1% to 12% of the franchisee's gross revenues, depending on each agreement. As shown in the graph below, these revenues are relatively steady and not sensitive to economic fluctuations.

In FY 2022-23, franchise fee revenues are trending down 7.2% from FY 2021-22 actuals primarily due to a decrease in usage for cable, solid waste, and telecommunication costs, oﬀset by an increase in electricity usage. Budgeted revenues are expected to increase approximately 6.7% in FY 2023-24. This revenue source will be monitored closely as the fiscal year progresses.

Other Taxes
Other taxes are comprised mainly of business license taxes, construction taxes, and property transfer taxes. As shown in the graph, business license and property transfer taxes are relatively steady, while construction taxes are extremely volatile and sensitive to economic fluctuations.

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With the inﬂux of several major construction projects beginning in 2012, revenues began increasing. The largest of the projects included the Apple Park and Main Street developments. These projects, coupled with a strong housing recovery, created a record year for revenues in FY 2013-14. These revenues have since returned to historic levels.

In FY 2023-24, these revenues are expected to decrease by 8.2% from the prior year to $1.6 million.

The projected decrease is based on a 3-year historical trend of actuals for property tax transfers. The recent hikes in interest rates have caused a reduction in home sales numbers, having direct impact on property tax transfers.

For FY 2024-25 and later, a growth rate is applied that is representative of the historical average rate of real property growth due to properties that have transferred ownership.

Charges for Services
Charges for Services account for charges to users of City services funded by the General Fund as well as internal City-wide overhead. The City aHempts to recover the cost of the services, including planning, zoning, and engineering permit processing for new property development, as well as some recreation-related fees. As such, this revenue source is sensitive to economic fluctuations, as shown in the graph below.

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Apple Park and other large developments generated large one-time revenues in FY 2013-14 as well as FY 2015-16 and FY 2016-17. In addition, beginning in FY 2013-14, enterprise funds, internal service funds, and special funds began charging for overhead services previously subsidized by the General Fund. Some internal strategic support services (Human Resources, Finance, City Clerk, etc.) also began charging internal departments to capture the true cost of providing various programs and services within City operations. AOer a comprehensive Cost Allocation Plan was approved by Council in April 2016, internal strategic support services (City Council, Facilities, Maintenance, etc.) were included. In FY 2015-16, the City's administration changed its methodology for tracking developer deposits driven by increased developer activity, and, as a result, both budgets for revenues and expenses were increased by anticipated deposit amounts leading to another large increase in revenue.

In FY 2022-23, the estimated amount is expected to come in roughly $2 million higher compared to budgeted levels due to the Vallco Town Center (renamed the Rise) and its scheduled commencement in FY 2022-23.

However, due to the developer's need to hire a new architect to complete the buildout plans and to value engineer the original design, the $2.3 million for plan review, inspection, and engineering fee revenues will be carried forward and recognized in FY 2023-24.

License and Permits
Licenses and permits include fees for reviewing building plans, building inspections, construction, tenant improvements, and commercial/residential installations for compliance with state and municipal building codes.

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Apple Park and large residential projects (Rosebowl, Biltmore expansion, Main Street) generated signiﬁcant permiHing revenues in FY 2013-14. Since then, activity has slowed until FY 2018-19, when revenues came in 48.8% higher. Although this revenue source is relatively consistent from year to year, ﬂuctuations may occur depending on the timing of projects being completed. The $34 million estimated amount in FY 2022-23 is due to Vallco Town Center (renamed The Rise) and its scheduled commencement in FY 2022-23. However, due to the developer's need to hire a new architect to complete the buildout plans and to value engineer the original design, the $30 million plan check fee revenues will be carried forward and recognized in FY 2023-24.

Use of Money and Property
The use of money and property category is comprised of General Fund interest earnings as well as facility and concession rental income of City-owned property. As of March 31, 2023, the City's portfolio included $21.3 million invested with the Local Agency Investment Fund (LAIF) and $149.7 million invested with Chandler Asset Management. As of March 31, 2023, the City also had $18.3 million in its Section 115 Pension Trust.

Fluctuations in this revenue category are a result of investment earnings, as rental income is fairly steady.

Investment earnings were higher in FY 2019-20 and FY 2020-21 due to investment gains in the City's Section 115 Pension Trust. Investment earnings fell in FY 2021-22 due to mark-to-market adjustments to account for unrealized losses in the City's portfolio.

The portfolio's market value ﬂuctuates depending on interest rates. When interest rates decrease aOer an investment is purchased, the market value of the investment increases. In contrast, when interest rates increase aOer an investment is purchased, the market value of the investment decreases. At the time of purchase, the City FY 2023-24 Proposed Budget
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intends to hold all investments until maturity, meaning that changes in market value will not impact the City's investment principal. If the market value decreases, the City will incur an unrealized loss. However, the loss will only be realized if the City sells its investments before their maturity.

Investment earnings are a function of the amount of cash available for investment, current interest rates, and the composition of investments. The City's investment objectives, in order of priority, are:

Safety to ensure the preservation of capital
Sufficient liquidity for cash needs
A market rate of return consistent with the investment program Economic trends have been decelerating along with tighter ﬁnancial conditions and restrictive monetary policy.

Recent data suggests positive but below-trend growth this year. Although the pace of job growth is moderating, labor markets remain solid, and the U.S. consumer has demonstrated resiliency.

At the end of March, the 2-year Treasury yield was 169 basis points higher, and the 10-Year Treasury yield was about 113 basis points higher, year-over-year. The inversion between the 2-year Treasury yield and 10-year Treasury yield narrowed to -56 basis points at March month-end versus -90 basis points at February month-end.

The average historical spread (since 2003) is about +130 basis points. The inversion between 3- month and 10-year Treasuries widened to -128 in March from -89 basis points in February. The shape of the yield curve indicates that the probability of recession is increasing.

City staﬀ will continue to monitor interest rates as well as economic factors in both the local as well as national economies.

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Fines and Forfeitures
Fines and forfeitures account for revenues generated from vehicle, parking, and miscellaneous code violations issued by the County Sheriﬀ and the City's Code Enforcement oﬃcers. Revenues in this category dropped signiﬁcantly in FY 2020-21 due to pandemic related restrictions and have increased over the next few years as society continued to rebound from the pandemic. In FY 2022-23, this revenue source is expected to reach $427,000. Revenues in FY 2023-24 are expected to remain relatively consistent to FY 2022-23 Adopted Budget.

Intergovernmental
Intergovernmental revenues are made up of federal, state, and regional grants, including miscellaneous intergovernmental revenue.

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FY 2022-23 actuals are estimated to come in signiﬁcantly higher than budgeted levels due to the recognition of COVID-19 relief dollars as part of the American Rescue Plan Act of 2021. The City recorded revenues of $3,594,028 in FY 2021-22 and $6,100,745 in FY 2022-23. FY 2023-24 revenues in this category are anticipated to be 44% lower than the prior year Adopted Budget due to an anticipated decrease in grants or miscellaneous intergovernmental revenue received.

Miscellaneous Revenue
Miscellaneous revenues account for unanticipated revenues such as donations and administrative fees.

In FY 2022-23, miscellaneous revenues are trending down 39% from FY 2021-22 actuals due to a restitution payment related to the 2014 embezzlement and also a payment received for fees in-lieu of public art. The proposed funds will be used for the all-inclusive playground at Jollyman Park. The majority of the General Fund's miscellaneous revenues are due to an annual donation for additional sheriff services at Apple Park.

Other Financing Sources
Other Financing Sources generally account for refundable deposit revenues within the Community Development Department. With signiﬁcant ﬂuctuations, year-over-year, staﬀ conservatively estimate these revenues. In FY 2023-24,

revenues are projected to be higher than the prior year adopted budget due to an increase in cost of
services from 3rd party consultants therefore increasing refundable deposit revenues.

This revenue source is expected to increase to $367,000 in FY 2023-24.

Transfers In
Transfers In represent the movement of funds from one City fund to another, the General Fund in this case.

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In FY 2021-22, actual transfers were high due to $4.8 million in transfers related to the American Rescue Plan Act.

In FY 2023-24, the City plans to transfer $15,000 from the City's Tree Fund to the General Fund to support ongoing tree maintenance operations.

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General Fund Expenditures
The estimates for FY 2023-24 General Fund expenditures are based on a thorough analysis of anticipated personnel and non-personnel costs. To create a more ﬁscally responsible budget, department budgets reﬂect a base budget with only justiﬁed ongoing expenses. This accounts for changes in personnel costs as well as any other anticipated or known increased costs in FY 2023-24.

FY 2023-24 expenditures are estimated at $86.3 million, which represents a 9.3% decrease compared to the adopted budget from the previous year. This decrease is primarily aHributed to expenditure-reduction strategies that include:

Eliminating 14 vacant positions.

Decreasing expenditure on materials and contract services.

Reducing spending on special projects and capital outlays.

Reducing the City Manager's Contingency Fund by $25,000 and contingencies by 50%.

Reducing transfers and General Fund subsidies to other funds.

As a result, expenditures were reduced by $20.3 million, or 19.5%, from the original FY 2023-24 Budget. This budget was developed by taking the previous year's base budget and incorporating additional ongoing costs, while also adjusting material and contract expenses based on the Consumer Price Index (CPI), where applicable.

The largest General Fund operating expenditure categories include Employee Compensation and Beneﬁts (42%), Contract Services (29%), Cost Allocation (12%), and Transfers Out (8%) as illustrated in the FY 2023-24 General Fund Expenditures by Category chart.

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Personnel Costs
In FY 2023-24, personnel costs are expected to reach $35.9 million, accounting for 43% of the General Fund expenditures. These costs include salaries and compensation for beneﬁHed and part-time staﬀ (69%), retirement benefits (20%), and other fringe benefits (10%), such as health coverage.

To obtain these ﬁgures, the City extracted data from the payroll system and made necessary updates to account for vacant positions, new hires, salary adjustments, and reallocated positions. Furthermore, the projected costs of beneﬁts for the upcoming year, such as retirement and health plans, were taken into consideration. It's worth noting that the contribution for retiree healthcare, which is an ongoing expense, is not factored into personnel costs as it will be funded separately through the Section 115 OPEB Trust.

The City expects CalPERS retirement rates to rise to $7.1 million, with the normal cost rate increasing to 10.7%, based on the latest actuarial valuation report from CalPERS. These projections are reﬂected in the General Fund forecast section of the budget.

The Proposed Budget includes funding for a total of 212 positions, which is 14 positions less than the FY 2022-23 Amended Budget. This reduction is aHributed to projected decreases in revenue following the CDTFA audit. As a result, 14 vacant positions have been eliminated from the budget. These positions were vacant due to reasons such as resignations, retirements, or not being filled at all.

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To address the City's staﬃng levels in a responsible and sustainable manner, staﬀ has devised a plan to gradually reduce staﬃng levels over the next decade through the elimination of vacant positions. The plan aims to eliminate 3-4 vacant positions annually until the City reaches a staﬃng level of 180 positions, which is consistent with the levels in FY 2015-16. This gradual reduction approach will help ensure that essential services to the community are maintained without significant disruptions.

Non-Personnel
In the General Fund budgeted appropriations for FY 2023-24, non-personnel costs make up 51% of the total at $44.0 million. Contract services are the largest component at 29%, followed by cost allocation charges at 12%, materials at 7%, and capital outlays and special projects at 1%.

One-time projects were separated into a diﬀerent category in FY 2013-14 to ensure expenditure trends reﬂect ongoing needs. In FY 2017-18, special projects and capital outlays were categorized separately from other costs.

Non-Personnel budgets were developed based on previous year's base budget and adjusted for the current year's needs. One-time projects were excluded to reﬂect ongoing expenditure needs. Materials and contract services were adjusted by CPI, where applicable. In response to the anticipated revenue shortfall resulting from the CDTFA audit, departments were asked to ﬁnd ways to reduce the base budget. To balance the budget, various categories including materials, contract services, capital outlays, special projects, transfers to other funds, and contingencies were reduced in the Proposed Budget.

Contingencies
In FY 2013-14, a contingencies expenditure category was added to each program to provide a cushion for any unforeseen expenses. In FY 2020-21, the program contingencies and City Manager Contingency were reduced from 5% to 2.5%. To further reduce expenditures, in FY 2021-22, the City Manager Contingency was reduced to $75,000, and in FY 2022-23, program contingencies are proposed to be reduced to 1.25%, and the City Manager Contingency is proposed to be reduced to $50,000. The City has a track record of underspending in this category.

The program contingency budget may be used by departments to cover unanticipated expenses at their discretion, while the City Manager Contingency requires the approval of the City Manager and is reported to the City Council quarterly for transparency and accountability.

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General Fund Revenue Comparisons with Other
Jurisdictions
The table below shows General Fund Revenue Comparisons with neighboring jurisdictions for FY 2018-19 through FY 2022-23. It shows general fund revenue totals and population. Population data is from the California Department of Finance. Revenue information for other cities in FY 2023-24 is not yet available. Revenue comparisons for FY 2023-24 will be included in the Adopted Budget.

The charts below compares sales tax, property tax, transient occupancy tax, franchise fees, and building permits revenues with other jurisdictions in dollars per capita.

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* Palo Alto - Only cable franchise fees are included. Franchise fees are not part of the General Fund but are included for comparison purposes.
*Santa Clara - Building-related revenues are not reﬂected in the General Fund. Fremont - Building permits are not part of the General Fund but are included for comparison purposes. Mountain View - Building permit revenues are not part of the General Fund, but are included for comparison purposes.

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General Fund Transfers
Transfers out represent transfers of monies out of the General Fund to various other funds. These transfers provide resources to the receiving fund to support operating and capital expenditures. Transfers from the General Fund are as follows:

For descriptions of funds, see Financial Policies: Fund Structure.

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General Fund Fund Balance
As prescribed by GASB Statement No. 54, governmental funds report fund balance in classiﬁcations based primarily on the extent to which the City is bound to honor constraints on the speciﬁc purposes for which amounts in the funds can be spent. Fund balances for governmental funds are made up of the following:

Nonspendable Fund Balance
– includes amounts that are (a) not in spendable form, or (b) legally or contractually required to be maintained intact. The “not in spendable form” criterion includes items that are not expected to be converted to cash, for example, prepaid items, property held for resale, and long-term notes receivable.

Restricted Fund Balance
– includes amounts that can be spent only for the speciﬁc purposes stipulated by external resource providers, constitutionally or through enabling legislation. Restrictions may eﬀectively be changed or lifted only with the consent of resource providers.

CommiLed Fund Balance
– includes amounts that can only be used for the speciﬁc purposes determined by formal action of the City’s highest level of decision-making authority, the City Council. Commitments may be changed or liOed only by the City taking the same formal action (resolution) that imposed the constraint originally.

Assigned Fund Balance
– comprises amounts intended to be used by the City for speciﬁc purposes that are neither restricted nor commiHed. The intent is expressed by the City Council or oﬃcial to which the City Council has delegated the authority to assign amounts to be used for speciﬁc purposes. Through the adopted budget, the City Council establishes assigned fund balance policy levels and also sets the means and priority for the City Manager to fund these levels.

Unassigned Fund Balance
– is the residual classiﬁcation for the General Fund and includes all amounts not contained in the other classiﬁcations. Unassigned amounts are technically available for any purpose. Only the General Fund reports a positive unassigned fund balance. A governmental fund other than the General Fund may report a negative unassigned fund balance if expenditures incurred for a specific purpose exceed the amounts that are restricted, committed, or assigned to those purposes.

In circumstances when an expenditure may be made for which amounts are available in multiple fund balance classiﬁcations, the fund balance in General Fund will generally be used in the order of restricted, unassigned, and then assigned reserves. In other governmental funds, the order will generally be restricted and then assigned.

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General Fund Classification of Fund Balance
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All Funds Summary
This section provides information on the FY 2023-24 Special Revenue, Debt Service, Capital Project, Enterprise, and Internal Service Funds budgets including, expenditure and revenue highlights, transfers to other funds, reserve funds, and the financial forecast. For desciptions of funds, see Financial Policies: Fund Structure.

Revenue Estimates
Estimates for FY 2023-24 fund balance and individual revenue accounts are based upon a careful examination of the collection history and paHerns as they relate to such factors as seasonality and performance in the economic environment that the City is most likely to encounter in the coming year. Each source of revenue can be influenced by external and/or internal factors outside of the City's control.

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Special Revenue Funds
Special Revenue Funds account for the proceeds of speciﬁc revenue sources that are legally restricted to expenditures for speciﬁc purposes. Special Revenue Funds include the Park Dedication, Transportation, Storm Drain, and Environmental Management/Clean Creeks funds.

Revenue
Revenue sources are projected to decrease by $3.6 million. Other Taxes is decreasing due to a decrease in BMR housing mitigation revenue. Use of Money & Property is increasing due to budgeting for interest earnings in each fund. Fines and Forfeitures decreased due to decreased admin citations for Non-Point Source. As a result of anticipated revenue shortfalls due to the CDTFA audit, transfers from the General Fund to the Special Revenue Funds have been reduced as part of an expenditure reduction strategy aimed at decreasing General Fund subsidies of Special Revenue Funds.

Expenditures
Expenditure uses are projected to decrease by $23.1 million primarily due to a decrease in Capital Outlays and Contract Services. Capital Outlays are lower as Capital Improvement Program (CIP) projects are not budgeted.

The City is currently working on an updated Capital Improvement Program, which will be presented to City Council on May 17 and added for Council consideration at the ﬁnal budget hearing and adoption. As part of an expenditure reduction strategy, departments decreased their materials and contract services.

Fund Balance
Fund balance represents fund savings and is calculated by taking the beginning balance and then adding the diﬀerence between revenue and expenditures to arrive at the ending fund balance. It is projected to increase by $2.3 million due to BMR housing mitigation revenue for Aloft and 19191 Vallco Parkway.

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Debt Service Fund
The Debt Service Fund provides for the payment of principal, interest, and associated administrative costs incurred with the issuance of debt instruments for the City’s Public Facilities Corporation. The budget funds the Corporation’s annual payment of principal and interest on the City Hall/Community Hall/Library Certiﬁcates of Participation (COP) that will be paid off by July 1, 2030.

On September 29, 2020, the City’s 2020A Certiﬁcates of Participation (2020 COPs) were successfully sold in order to refund the City’s 2012 Certificates of Participation for debt service savings. The refunding generated net present value savings of approximately $3.14 million, 11.61% of refunded par, and a True Interest Cost of 0.72%. Savings to the City’s General Fund amounts to approximately $494,000 per year for the next ten years or almost $5 million in total savings.

Revenue
Revenue sources are relatively unchanged from the last ﬁscal year. The $2.7 million transfer from the General Fund funds the annual payment of principal and interest for the City’s debt.

Expenditures
Expenditure uses are relatively unchanged from the last ﬁscal year. The $2.7 million in expenditures represents the annual payment of principal and interest for the City’s debt.

Fund Balance
Fund balance represents fund savings and is calculated by taking the beginning balance and then adding the diﬀerence between revenue and expenditures to arrive at the ending fund balance. Fund balance is relatively unchanged from the last fiscal year.

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Capital Project Funds
This fund pays for the acquisition of major capital facilities and/or construction of major capital projects.

Revenue
Revenue sources are projected to decrease by $9.0 million because Capital Improvement Program (CIP) projects are not budgeted. The City is currently working on an updated Capital Improvement Program, which will be presented to City Council on May 17 and added for Council consideration at the ﬁnal budget hearing and adoption. As a result of the revenue shortfalls stemming from the CDTFA audit, the annual transfers from the General Fund to the Capital Reserve have been eliminated.

Expenditures
Expenditure uses are projected to decrease by $30.3 million because Capital Improvement Program (CIP) projects are not budgeted. The City is currently working on an updated Capital Improvement Program, which will be presented to City Council on May 17 and added for Council consideration at the ﬁnal budget hearing and adoption.

Fund Balance
Fund balance represents fund savings and is calculated by taking the beginning balance and then adding the difference between revenue and expenditures to arrive at the ending fund balance.

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Enterprise Funds
Enterprise Funds are set up for the provision of speciﬁc services that are funded directly by fees charged for those goods or services. Enterprise Funds include the Resource Recovery, Sports Center, Blackberry Farm Golf Course, and Recreation funds.

Revenue
Projected revenue sources are expected to rise by $0.6 million, driven by an increase in fees and Use of Money & Property. However, as a result of anticipated revenue shortfalls due to the CDTFA audit, transfers from the General Fund to the Enterprise Funds have been reduced as part of an expenditure reduction strategy aimed at decreasing General Fund subsidies of Enterprise Funds.

Expenditures
Expenditure uses are projected to decrease by $0.9 million due to a decrease in contract services, contingencies, and special projects resulting from expenditure-reduction strategies.

Net Position
Enterprise funds carry net position instead of fund balance. Net position is calculated by taking the beginning balance and then adding the diﬀerence between revenue and expenditures to arrive at the ending net position.

However, some of these resources are not liquid and represent capital assets. These monies are generally accumulated to support capital replacement and/or expansion needs. It is projected to decrease due to revenues being lower than expenditures.

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Internal Service Funds
Internal Service Funds are used for areas where goods or services are provided to other departments or governments on a cost-reimbursement basis. Internal Service Funds include Information & Technology, Vehicle & Equipment Replacement, Workers' Compensation, Compensated Absences & Long-Term Disability, and Retiree Medical funds.

Revenue
Revenue sources are projected to decrease by $2.5 million as a result of reduced transfers from the General Fund for IT, Workers' Compensation, and Compensated Absences. Furthermore, starting in FY 2022-23, the City will be funding Other Post-Employment Benefits (OPEB) costs with the City’s Section 115 OPEB Trust, as the City’s OPEB plan is over 100% funded. This has led to the elimination of transfers from the General Fund to the Retiree Medical Fund.

Expenditures
Expenditure uses are projected to decrease by $2.1 million mainly due to a decrease in Special Projects.

Net Position
Internal Service Funds carry net position instead of fund balance. Net position is calculated in the same manner as fund balance, taking the beginning balance and then adding the diﬀerence between revenue and expenditures to arrive at the ending net position. However, some of the resources are not liquid and represent capital assets.

These monies are generally accumulated to support capital replacement and/or expansion needs. It is projected to decrease by $3.3 million due to revenues being lower than expenditures. Although the Internal Service Funds show a negative balance, it's important to note that retiree health expenses will be reimbursed by the Section 115 OPEB Trust at the close of each fiscal year.

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General Fund Forecast
Overview
City staﬀ prepares medium-term (5-year) and long-term (10-year and 20-year) forecasts as part of the budget process. While long-term projections may be less precise than short-term projections, they can help identify potential structural budget issues in advance. However, given the unpredictability of the CDTFA audit, this budget only includes a 10-year forecast.

The California Department of Tax and Fee Administration (CDTFA) is currently conducting an audit on one of the City's taxpayers. This is expected to have a substantial impact on the City's ﬁnances, with a projected decline of $30 million, or 73%, in its sales tax revenues from the initial FY 2023-24 forecast provided by HdL, the City's sales tax consultant. As a result, the City's total revenues are also anticipated to decrease by $30 million, or 28%, from the original FY 2023-24 forecast.

The City recognizes the importance of ﬁscal prudence and responsible ﬁnancial management in light of this signiﬁcant revenue loss. To address the potential shortfall resulting from the CDTFA audit, City staﬀ has updated the ﬁnancial forecast and is actively exploring various strategies to balance the budget. Unfortunately, these strategies will result in service level reductions for the community, and the impacts will be shared across all areas.

The City is also evaluating diﬀerent revenue-generating options to mitigate the budget shortfalls caused by the audit.

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To address the structural deﬁcit caused by recurring expenditures consistently surpassing recurring revenues, the City has been implementing cost-cuHing measures while ensuring that essential services continue to be provided to the community.

The City is taking a proactive approach to minimize the impact on its staﬀ and residents, and City staﬀ will continue to keep the Council informed of any new developments related to the audit and its impact on the City's ﬁnances. It is crucial to note that the CDTFA audit has resulted in a structural deﬁcit, and the City will need to continue implementing long-term solutions to address this ongoing challenge.

Despite the challenging times, the City's ﬁnancial position remains strong, and it has a number of advantages that will help it weather the storm without having to resort to more painful cuts. These advantages include an unassigned General Fund balance of over $50 million, a fully funded retiree healthcare program, and a Section 115 Pension Trust of over $17 million that can be used to oﬀset the impact of revenue losses. These reserves can be utilized to oﬀset deﬁcits until the City can align its ongoing expenditures with its revenues. It's important to note that these reserves are one-time funding, which cannot be relied upon to sustain the City's ﬁnances in the long run.

These resources give the City a buﬀer and more options to manage its ﬁnances eﬀectively. With a solid ﬁnancial footing and prudent planning, the City is well-positioned to navigate these uncertain times and maintain its commitment to its staff and community.

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Forecast Methodology
A ﬁnancial forecast is a crucial tool for planning and budgeting, allowing staﬀ to analyze trends and anticipate the long-term impacts of budget decisions. It plays a vital role in modeling the eﬀects of various factors, such as retirement costs, employee compensation, and revenues, on the City's budget.

It is important to note that the forecast is not a plan but rather a model that relies on revenue and cost assumptions, which are updated regularly as new information becomes available. While cost projections, which are based on known costs, are relatively reliable, revenue forecasts are subject to uncertainties related to future economic conditions. Economic forecasts can change frequently, making it diﬃcult to commit to a particular prediction of the future. As such, staﬀ must update the forecast regularly to ensure it reﬂects the latest information and trends.

While economic conditions are the primary drivers for economically sensitive revenues such as sales tax and property tax, other factors drive non-economically sensitive categories such as utility user taxes and franchise fees. These revenue categories are more heavily impacted by utility rate changes, energy prices, and consumption levels. Revenues from local, state, and federal agencies are primarily driven by grant and reimbursement funding.

As a result, these revenues experience no signiﬁcant net gain or loss during economic expansions or slowdowns.

All revenue projections are based upon a careful examination of the collection history and paHerns related to seasonality and the economic environment the City is most likely to encounter in the future. Staﬀ also considered the potential impacts of the CDTFA audit in determining the most reasonable estimated figures.

A discussion of the national and local economic outlooks used to develop the revenue estimates for the FY 2023- 24 forecast is included below. To create the revenue forecasts, the City reviewed national, state, and regional economic forecasts from multiple sources, including the Congressional Budget Oﬃce, California’s Legislative Analyst’s Oﬃce (LAO), and the Center for Continuing Study of the California Economy (CCSCE). To develop the sales tax, property tax, and transient occupancy tax (TOT) revenue projections, the City worked with HdL Companies, a tax consultant.

The City's Consumer Price Index (CPI) forecasts are an average of State and County CPI from:

UCLA Anderson Forecast for the Nation and California
California Department of Transportation’s California County-Level Economic Forecast In 2019, the City worked with UFI (Urban Futures, Inc.), a financial advisory and consulting firm, to:

Review, update, and enhance the City’s baseline financial forecast.

Evaluate fiscal strategies, including potential local revenue measures.

Develop capital financing options, structures, and estimates for identified projects.

Prepare an analysis of city charter costs/benefits related to fiscal activities.

This forecast includes the updates and enhancements that UFI has made to the City’s baseline financial forecast.

National Economic Outlook
Real gross domestic product (GDP) increased at an annual rate of 2.6% in the fourth quarter of 2022, aOer increasing by 3.2% in the third quarter. The increase in the fourth quarter primarily reﬂected increases in inventory investment and consumer spending that were partly oﬀset by a decrease in housing investment. The deceleration in the fourth quarter, compared to the third quarter, primarily reﬂected a downturn in exports and decelerations in consumer spending, business investment, and state and local government spending. These movements were partly oﬀset by an upturn in inventory investment, a smaller decrease in housing investment, and an acceleration in federal government spending. Imports decreased less in the fourth quarter than in the third quarter.

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Economic trends have been decelerating along with tighter ﬁnancial conditions and restrictive monetary policy.

Recent data suggests positive but below-trend growth this year. Although the pace of job growth is moderating, labor markets remain solid, and the U.S. consumer has demonstrated resiliency.

Cupertino Economic Outlook
The City does not anticipate signiﬁcant impacts on property tax revenues in FY 2023-24. The City is optimistic about the future of transient occupancy tax (TOT) revenues, as the relaxation of pandemic-related restrictions has boosted business travel. Although strong in previous years, construction activity will continue to ﬂaHen out as recent large development projects, notably Apple Park, are now complete.

As more information becomes available, staﬀ will bring forward updates and adjustments to City Council regularly as necessary.

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Revenues
The City relies heavily on three revenue sources: property tax, sales tax, and transient occupancy tax (TOT), which together make up the majority of its General Fund revenues. However, the City is facing a signiﬁcant drop in revenue due to the impact of the CDTFA audit, which is expected to reduce revenues by $30 million, or 28%, from original projections.

The City's General Fund revenues are projected to be $80.3 million in FY 2023-24, and are expected to increase over the forecast period. Property tax and transient occupancy tax are expected to continue to be strong revenue sources, with projected increases. However, sales tax is projected to decrease signiﬁcantly due to the CDTFA audit.

The National Bureau of Economic Research (NBER), an American private nonproﬁt research organization, deﬁnes the beginning and ending dates of recessions. The NBER deﬁnes a recession as "a signiﬁcant decline in economic activity spread across the economy, lasting more than two quarters which is six months, normally visible in real gross domestic product (GDP), real income, employment, industrial production, and wholesale-retail sales. Since World War II, recessions have lasted an average of 11.1 months and have occurred, on average, about every 58.4 months (4.8 years). As a result, the forecast assumes a recession every four years where revenues remain flat while expenditures continue to increase.

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Sales Tax
Prior to FY 2023-24, sales tax has been the City’s largest revenue source. Sales taxes are collected at the point of sale and remiHed to the California Department of Tax and Fee Administration (CDTFA), formerly the Board of Equalization. The CDTFA allocates tax revenue owed to the City in monthly payments. Each quarterly payment is divided into three monthly payments: two advance payments and a ﬁnal reconciliatory payment that reconciles the actual revenue collected with the CDTFA's projected revenue for that quarter.

Sales tax revenues experienced a signiﬁcant increase in FY 2020-21 and FY 2021-22. The City's business-to- business (B2B) industry and online sales were the primary drivers of this growth. The pandemic contributed to the surge in B2B revenues as businesses transitioned to remote work. Meanwhile, brick-and-mortar retail sales decreased due to Shelter-in-Place orders, resulting in an increase in online sales. However, the City believes this increase was a one-time event due to the pandemic.

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In FY 2023-24, sales tax revenues are projected to be $11.4 million, a decrease of $30 million, or 73%, from the original forecast due to the CDTFA audit. Sales tax revenues are projected to increase by an average annual growth rate of 1.6% in the forecast. Staﬀ used conservative estimates for business and industry, general consumer goods, restaurants and hotels, and state and county pools.

The City faces a concentration risk due to the dependence on a single industry, particularly the B2B sector, which is sensitive to economic forces. Two technology companies account for a signiﬁcant portion of the City's total sales tax revenue.

To mitigate the volatility of B2B revenue, the City's long-term ﬁscal, strategic plan aims to diversify its sales tax sources. Recently completed development projects, such as Nineteen800 and Main Street, have boosted retail sales and can help reduce the City's reliance on B2B revenue.

Property Tax
Property taxes are projected to remain stable in the near term. However, the impact of potential remote work on property taxes in the long term is uncertain. The trend towards remote work has caused people to reconsider where they choose to live, which could lead to a decrease in demand for residential real estate. Additionally, companies may need less oﬃce space if fewer employees are working at the oﬃce, which could decrease demand for commercial office space. This could result in a reduction of property tax revenue for the City.

In FY 2023-24, property tax revenues are expected to reach $31.7 million and increase at an average annual growth rate of 3.1% in the forecast. The moderate forecast is based on a range of factors, including historical trends for the City and projections for the region. While property tax has grown at an average annual rate of 11% historically, this projection assumes a lower growth rate due to the absence of significant development projects.

It is essential to note that major development projects, such as Main Street and Apple Park, have been signiﬁcant contributors to the historical growth in property tax revenues. However, the current projection does not assume any such developments in the near future, resulting in a more modest growth rate forecast.

The City will continue to monitor economic and market trends to ensure that property tax revenue projections remain accurate.

Transient Occupancy Tax
The COVID-19 pandemic had a signiﬁcant impact on Transient Occupancy Tax (TOT) revenues, with a dramatic decline in revenues due to the reduction in travel. The City experienced a decrease in TOT revenues from $8.9 FY 2023-24 Proposed Budget
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million in FY 2018-19 to $2.1 million in FY 2020-21, with a partial recovery to $4.4 million in FY 2021-22. TOT revenues are heavily reliant on business travel, which may be aﬀected by remote work or economic conditions.

Although leisure travel has recovered faster than expected, business travel has been slower to recover. The City is cautiously optimistic that business travel will continue to increase in FY 2023-24.

The City's current forecast assumes that TOT revenues will recover to $7.5 million in FY 2023-24, and gradually increase from the new normal. The forecast projects an average annual growth rate of 1.9% for TOT revenues. This moderate forecast is based on historical tax collections and assumes slower growth than historical trends.

The TOT revenues are aﬀected by the tax rate charged on hotels, occupancy rates, and average daily room rates (ADR). Given that TOT revenues in Cupertino are mainly driven by business travel, any shiO in travel habits or economic conditions could significantly impact this revenue source.

Licenses and Permits
Licenses and permits revenue is expected to decrease in FY 2023-24 due to the slowdown in development activity, but is expected to increase slightly in the out-years. The City's forecast projects an average annual growth rate of

0.3% for licenses and permits revenue, based on forecasts of California residential building permits, non- residential building permits, and construction payrolls from the UCLA Anderson Forecast for the Nation and California.

It is important to note that this forecast does not take into account any signiﬁcant development projects that are awaiting approval. In the event that new development projects are approved, staﬀ will update this forecast accordingly.

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Charges for Services
Revenues from charges for services have decreased from their FY 2016-17 levels, primarily due to a decrease in development activity.

Charges for services revenues are projected to increase at an average annual growth rate of 2.0%. Other Service Fees, Cost Allocation Plan Charges for Services, and General Service Fees are expected to increase by 2.75%, reﬂecting full-time salary growth. Planning Fees and Engineering Fees are forecasted based on construction and development factors, such as California residential and non-residential building permits, and construction payrolls from the UCLA Anderson Forecast for the Nation and California.

This forecast does not consider any signiﬁcant development projects awaiting approval. The City will update the forecast if new projects are approved.

Other Revenue
Utility taxes
are forecasted to increase by an annual average growth rate of 0.5% based on historical trends. In recent years, increases in rates have been offset by decreases in consumption.

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Franchise fees
are projected to increase by an average annual growth rate of 1.2% based on a trend of historical data.

Other taxes
are made up of construction, property transfer, and business license tax revenue. Revenue is projected to increase by an average of State and County CPI.

Use of money and property

is expected to grow at a rate of 0.4% each year based on the City’s current conservative investment strategy and low-interest rates. The Section 115 Pension Trust is expected to grow at the discount rate of 6.25%.

Intergovernmental revenues
are projected to grow at a rate of 0.4% each year.

Fines and Forfeitures
are forecasted to remain constant in the forecast.

Miscellaneous revenues
are forecasted to increase by CPI each year.

Non-operational revenues (Transfers and Other Financing Sources) are not assumed in the forecast.

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Expenditures
In FY 2019-20, the City developed a zero-based budget, which involved analyzing every function of the City for its needs and costs. As a result, all costs were justified, and base budget savings were achieved.

However, for FY 2023-24, the City is facing an expected revenue shortfall due to the CDTFA audit. To address this, departments have been asked to reduce their base budget expenditures by reducing materials and contract services by 40% and 20%, respectively. These efforts will help balance the City's budget.

In addition to these cost-saving measures, the City is proposing several budget-balancing strategies, including:

Eliminating 14 vacant positions
Decreasing expenditure on materials and contract services Reducing spending on special projects and capital outlays Reducing the City Manager's Discretionary Fund by $25,000 and contingencies by 50% Decreasing the amount of transfers to other funds
Utilizing the City's Section 115 Trusts to fund pension and OPEB (Other Post-Employment Benefits) costs To inform these decisions, the City developed a forecast based on actual expenditures in prior years and FY 2023- 24 projections. The forecast also considered factors such as CPI, construction and development activity, and CalPERS Normal Cost and Unfunded Liability projections. The forecast will be adjusted throughout the year to account for one-time changes and budget adjustments.

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The chart above illustrates the projected General Fund expenditures, which are estimated to be $86.3 million in FY 2023-24, with an expected increase over the forecast period. The forecasted expenditure growth is primarily driven by increasing Law Enforcement costs. To provide an in-depth understanding of the estimated expenditure categories in the General Fund Forecast, the following discussion focuses on the assumptions made for each category.

Personnel Expenditures
Salaries
FY 2023-24 salaries and beneﬁts reﬂect the cost-of-living adjustments approved by the City Council in August 2022. The City is currently negotiating with its bargaining groups because the agreements, which expire on June 30, 2025, include a salary and beneﬁts reopener. In the forecast, full-time salaries are expected to increase by the CalPERS payroll growth rate. On the other hand, part-time salaries are forecasted to grow at a rate of 1.5%, because historically, part-time salaries have tended to grow at a slower rate than full-time salaries.

Employees who have yet to reach the top step in their classiﬁcation’s salary range are eligible to receive a step increase on their anniversary date. Typically, classiﬁcations have ﬁve steps, with each increase equivalent to a 5% increase in salary. Currently, approximately 38% of employees are below Step 5.

Health Benefits
In FY 2023-24, health beneﬁts account for about 7% of all personnel costs in the General Fund, primarily due to health insurance costs. The City pays employees a ﬁxed amount for health and dental insurance costs instead of covering a percentage of premiums. In October 2016, City Council approved labor contracts that signiﬁcantly increased the City’s health insurance contributions to align the City with the median oﬀerings of our comparator cities. For the duration of the contract, cost increases in health and dental premiums above the negotiated amounts were fully absorbed by employees. The City is in negotiations with its bargaining groups, CEA and OE3.

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Retirement Benefits
Rising retirement costs are driving the increase in employee beneﬁts. Cupertino oﬀers retirement beneﬁts to its employees through the California Public Employee’s Retirement System (CalPERS), which experienced a signiﬁcant decline in its assets due to poor investment returns during the Great Recession. Moreover, changes in actuarial assumptions and enhanced beneﬁts due to higher life expectancies have further increased the plan's liabilities. Consequently, the City's pension costs have escalated considerably and currently constitute one of the City's largest financial obligations.

The table below illustrates the City's CalPERS costs over the next few years.

In December 2016, the CalPERS Board of Administration implemented a three-year phase-in beginning in FY 2018-19 to lower the discount rate from 7.5% to 7.0%. This was done to enhance the ﬁnancial stability of the pension system, resulting in signiﬁcant increases in retirement costs. Additionally, in FY 2021-22, the discount rate was further lowered from 7.0% to 6.8% due to the FY 2020-21 investment gain of 21.3%, which triggered the Funding Risk Mitigation Policy.

The City’s retirement rates are based on a blend of all three tiers (2.7% @ 55, 2% @ 60, and 2% @ 62). Although employees pay a diﬀerent rate depending on their tier, the City’s costs are the same for all three tiers. The table below shows the current breakdown of City employees amongst the three retirement tiers. The majority of employees in the City are currently covered under Tier 3.

A retiree's highest monthly pension benefits are calculated by multiplying:

Service credit: the number of years of CalPERS service.

Benefit Factor: percentage of pay based on age.

Compensation Basis: the highest monthly average salary for a defined period.

Other Benefits
The forecast assumes health insurance, dental insurance, and vision insurance increase by CPI. No increases were forecasted for the following beneﬁts: internet allowance, standby pay, Employee Assistance Program, and Deferred Compensation. Rec Bucks are assumed to increase at a 0.5% growth rate.

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Non-Personnel Expenditures
Non-Personnel budgets were developed based on previous year's base budget and adjusted for the current year's needs. One-time projects were excluded to reﬂect ongoing expenditure needs. Materials and contract services were adjusted by CPI, where applicable. In response to the anticipated revenue shortfall resulting from the CDTFA audit, departments were asked to ﬁnd ways to reduce the base budget. To balance the budget, various categories including materials, contract services, capital outlays, special projects, transfers to other funds, and contingencies were reduced in the Proposed Budget.

Materials

costs are forecasted to increase by CPI.

Contract Services
costs are projected to grow by CPI except for the Law Enforcement contract with the Santa Clara County Sheriﬀ’s Oﬃce. Law Enforcement costs are projected to grow by CPI plus 2%. Per the terms of the contract, the annual increase is limited to the lesser of:

Percentage increase in total compensation and annual CalPERS cost increase Annual CPI plus 2% and annual CalPERS cost increase
The City's current agreement with the Santa Clara County Sheriﬀ's Oﬃce is set to expire in June 2024, and negotiations are ongoing for a new agreement. In anticipation of potential increases in Law Enforcement costs, a placeholder increase has been included in the forecast. These costs have been a signiﬁcant driver of the City's expenditure growth in recent years, and it is expected that they will continue to increase in the coming years.

Cost Allocation
is projected to grow by 2.8%.

Capital Outlays
and
Special Projects
are projected to increase by CPI. In the last ﬁve years, the City has spent about $5 million per year on capital outlays and special projects, excluding development projects that include pass-through revenue. Capital Outlays and Special Projects are proposed to be reduced as an expenditure- reduction strategy.

Contingencies
are projected to increase by CPI. Program contingencies are proposed to be reduced to 1.25%, while the City Manager's Contingency Fund is proposed to be reduced to $50,000 in FY 2023-24. Program contingencies were cut in half to 2.5% in FY 2020-21, and the City Manager’s Contingency Fund was reduced to $75,000 in FY 2021-22. In prior years, program contingencies were 5% of Materials and Contract Services, and the City Manager’s Contingency was 5% of General Fund Materials and Contract Services, excluding the law enforcement contract. It's worth noting that the City has historically underutilized contingencies, and the use of these funds would require pre-approval by the City Manager or their designee.

Transfers
represent the General Fund’s contributions to other City funds to support debt payments, pay retiree health costs, ﬁnance capital projects, replenish capital project reserves, acquire new equipment, and subsidize enterprises and operations. AOer the implementation of a comprehensive Cost Allocation Plan in FY 2015-16, General Fund expenses have been shiOed to other City funds, causing some of those funds’ revenues to fall short of expenses and necessitating the use of fund balances to cover expenses. The General Fund beneﬁts in the near term from the cost shiO; however, aOer fund balances in those other funds are drawn down to minimum levels and absent aggressive revenue or cost actions in those other funds, General Fund subsidies are necessary to maintain fund balance minimums.

Projected General Fund subsidies to each fund are based on the following assumptions:

Special Revenue Funds: $2.5 million annually.

Debt Service Funds: $2.7 million based on the 2012 COPS debt service schedule.

Capital Reserve: $0 million.

Retiree Medical Fund: $0 million.

Compensated Absences Fund: $0.8 million and increases at a rate of 2.8% per year.

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Innovation and Technology Fund: $1 million and increases at CPI annually.

Enterprise Funds: $0.5 million and increases at CPI per year.

Transfers from the General Fund to other funds have been reduced as part of an expenditure reduction strategy aimed at decreasing General Fund subsidies of other funds.

The City is expected to complete its debt payments for city facilities by FY 2029-30. Until then, the City will pay approximately $2.7 million annually in principal and interest on its Certiﬁcates of Participation for City Hall, Community Hall, and Library. These funds will be transferred from the General Fund to the Debt Service Funds.

Starting in FY 2022-23, the City funds Other Post-Employment Beneﬁts (OPEB) costs with the City’s Section 115 OPEB Trust because the City’s OPEB plan is over 100% funded. The OPEB Trust had a balance of $36.1 million as of March 31, 2022. Funding OPEB costs with the OPEB Trust will eliminate the transfers from the General Fund to the Retiree Medical Fund.

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Pension
CalPERS
The City provides a deﬁned beneﬁt pension to its employees through the California Public Employees' Retirement System (CalPERS). Retirement beneﬁts are calculated using a formula based on an employee’s age, earnings, and years of service. The retirement benefits are funded by:

Investment earnings (60%)
Employer contributions (29%)
Employee contributions (11%)
Each year, CalPERS determines an employer's contributions based on actual investment returns and actuarial assumptions, including:

Expected investment returns (discount rates)
Inflation rates
Salaries
Retirement ages
Life expectancies
Contributions to fund the pension plan are comprised of two components:

Normal cost (the cost of the benefits earned in a respective year) Amortization of the unfunded accrued liability (UAL)
CalPERS Discount Rate
Defined benefit plans are highly sensitive to the discount rate assumption. The discount rate is the expected rate of return of the plan's assets over the long term. The discount rate will depend on the plan's size, asset allocation, time horizon, and other considerations.

From the City's perspective, the discount rate is important as it is used to determine the City's annual contributions to the plan, the plan's unfunded liability, and the plan's funded status. In other words, the discount rate is used to determine whether a plan has enough assets to meet its future obligations. The discount rate must be realistic to allow the City to foresee funding issues that may impact future operating budgets and future generations of retirees and plan members. If the discount rate assumption is too high and investments earn less than expected, a funding shortfall may result, requiring the City or CalPERS members to make greater contributions than expected.

CalPERS Investment Earnings
The City's pension plan heavily relies on investment earnings, which fund nearly 60% of retirement beneﬁts.

Thus, the plan is sensitive to the investment returns of CalPERS. When investment returns fall below the discount rate, contributions must increase to cover the shortfall.

Currently, CalPERS assumes an annual investment return of 6.8%. However, the investment returns earned by CalPERS have fallen short of the discount rate assumption approximately half the time over the past 20 years, as shown in the chart below. Investment returns for individual ﬁscal years have ranged between -24.0% and +21.7%.

For instance, CalPERS suffered negative investment returns in 2001 and 2002 due to the dot-com crash and in 2008 and 2009 due to the Great Recession.

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Note: Beginning in 2002, investment returns are reported as gross of fees.

For FY 2021-22, CalPERS reported an investment return of -6.1%. The average investment return is 6.7% for a 5- year period, 7.7% for a 10-year period, 6.9% for a 20-year period, and 7.7% for a 30-year period. As returns in a given year are volatile, it can be more instructive to look at returns over longer time horizons.

CalPERS Update
Asset Liability Management Process
In November 2021, CalPERS completed its quadrennial Asset Liability Management (ALM) process, which reviewed investment strategies and actuarial assumptions. At the November 15-17, 2021, meetings, the CalPERS Board approved a 6.8% discount rate, selected a new asset allocation for the fund's investment portfolio, and adopted new actuarial assumptions.

During the ALM process, the board examined different potential portfolios and their impact on the CalPERS fund.

Ultimately, the board selected the portfolio with an assumed investment return of 6.8%.

The new portfolio includes a 5% allocation to leverage.

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CalPERS Plan Status
As of the most recent actuarial valuation on June 30, 2021, the City’s pension plan had assets of $127.1 million and liabilities of $168.4 million, resulting in an unfunded liability of $41.3 million and a funded ratio of 75.5%. The unfunded liability is the diﬀerence between assets and liabilities, while the funded ratio is the ratio of assets to liabilities.

A deﬁned-beneﬁt plan is considered adequately funded if its assets equal or exceed the value of its future liabilities. When the funded ratio is lower than 100%, the plan has insuﬃcient assets to pay all future liabilities.

The funded status of the system decreased because:

Poor investment returns during the Great Recession significantly decreased the plan’s assets.

Enhanced beneﬁts and actuarial assumption changes due to increased life expectancies increased the plan's liabilities.

Over the past few years, CalPERS has taken steps to improve the long-term ﬁnancial sustainability of the system.

In December 2016, the CalPERS board voted to reduce the discount rate, also known as the assumed rate of return for investments, from 7.5% to 7.0% over three years from FY 2018-19 to FY 2020-21. In February 2018, the CalPERS board also voted to decrease the amortization period for new pension liabilities from 30 years to 20 years, eﬀective July 1, 2019. While these changes will provide long-term beneﬁts to the pension plan, they will also increase the City’s pension contributions.

Impact of CalPERS Investment Returns
CalPERS assumes it will earn investment returns of 6.8% each year. If investment returns are higher than 6.8%, the City's contributions decrease. On the other hand, if investment returns are lower than 6.8%, the City's contributions increase.

Challenging and volatile ﬁnancial markets impacted CalPERS investment returns for FY 2021-22. During this period, CalPERS earned an investment return of -6.1%, which is lower than the assumed rate. The investment performance is expected to aﬀect the City's pension contributions starting in FY 2024-25. In 2022, ﬁnancial market volatility increased due to heightened geopolitical risk, supply chain boHlenecks and persistent inﬂation, and the Federal Reserve’s pivot to a less accommodative monetary policy.

Impact of CalPERS Discount Rate Changes
Due to lower-than-historical interest rates and economic growth, market experts project lower returns for the next several decades. The Pew Research Center forecasts a long-term investment return of 6.5% for typical pension fund portfolios.

During its Asset Management Liability Process, CalPERS considered discount rates between 6.25% and 7%.

Ultimately, CalPERS approved a discount rate of 6.8%, a decrease from the previous discount rate of 7%.

The discount rate has a signiﬁcant eﬀect on the City's CalPERS contributions. If the discount rate is less than the discount rate assumption, the City's CalPERS contributions will increase. If CalPERS lowers the discount rate by one percentage point, the City's contributions will increase by up to $2.9 million per year. This analysis would show the potential contribution impact if CalPERS were to lower the discount rate.

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Section 115 Trust
A Section 115 Trust is a tax-exempt investment tool that allows local governments to pre-fund pension and retiree health costs. Once contributions are placed into the trust, the City can only use assets from the trust for retirement plan purposes. The City may make withdrawals to either reimburse the City for retirement system contributions or to pay CalPERS directly. The benefits of a Section 115 Trust include the following:

Local control over assets: The City controls the contributions, withdrawals, investment strategy, and risk level of assets in the Trust.

Pension rate stabilization: Assets can be transferred to CalPERS at the City’s discretion to pay for Normal Cost or UAL contributions and can be used to reduce or eliminate large ﬂuctuations in the City’s pension costs.

Potential for higher investment returns than General Fund: Investment requirements applicable to the City’s General Fund assets under Government Code 53601 do not apply to Trust assets.

Diversification: Trust assets will be diversified from CalPERS investments.

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City Strategies
Given that pension obligations are one of the City’s largest ﬁnancial obligations, the City has taken proactive steps to reduce the impact of pension cost volatility. In March 2018, the City provided options to Council to address rising pension costs. In April 2018, the City presented a long-term pension funding strategy to the Fiscal Strategic Plan CommiHee. In May 2018, the City established a Section 115 Pension Trust to reduce the eﬀect of pension rate volatility on the City’s budget. The Section 115 Pension Trust helps the City to:

Grow assets for future pension contributions.

Invest assets over appropriate time horizons.

Earn higher investment returns than the General Fund.

Reduce pension contribution volatility.

Diversify funds from CalPERS investments.

As a ﬁscal sustainability measure, the City funds the Section 115 Pension Trust using a more conservative discount rate of 6.25%. The City's pension funding goal is to accumulate suﬃcient funds in the Pension Trust to fund the diﬀerence between a 6.25% and a 7% discount rate and achieve a funded ratio of 80% over 20 years. The City's projections indicated that the City would need to accumulate over $42 million in the Pension Trust within 20 years to achieve its pension funding goal.

As a result, the funding strategy proposed $8.0 million in initial funding, along with additional funding of $10.0 million over the first five years. The City has contributed $16.0 million, including:
$8 million in FY 2018-19
$4 million in FY 2019-20
$2 million in FY 2020-21
$2 million in FY 2021-22
As of June 30, 2022, the Section 115 Pension Trust had a balance of $17.2 million and had earned an annualized investment return of 3.94% gross of fees since inception.

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Fund Balance
The foresight of the City Council and staﬀ in previous years to focus on ensuring healthy reserves is paying oﬀ in full. Increases in sales tax revenues and budget reductions in FY 2020-21 have contributed to this planning strategy and will provide additional resources for the City in the future.

The General Fund’s Unassigned fund balance remains healthy and will be able to assist in addressing funding gaps. In addition, the General Fund's Committed and Restricted fund balance includes:

Economic Uncertainty Reserve: may be used to mitigate potential shortfalls.

Capital Projects Reserve: may be used to fund capital projects.

Section 115 Pension Trust: may be used to fund pension costs. Funds in the Section 115 Pension Trust are restricted and can only be used to pay CalPERS or reimburse the City for pension contributions.

In FY 2023-24, the General Fund’s total fund balance is projected to be $107.5 million, and the General Fund's Unassigned fund balance is projected to be $47.1 million. Fund balance is decreasing due to a persistent structural deﬁcit, resulting from ongoing expenses exceeding ongoing revenues. To address this, the City intends to utilize the fund balance to cover the shortfall until revenue and expenditure can be brought into alignment.

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Potential Budget-Balancing Strategies
Historically, the City has maintained a structurally sound budget, with revenues surpassing expenditures in most ﬁscal years. During periods of excess revenue, the City has transferred the surplus fund balance to the Capital Reserve Fund in accordance with the City's Fund Balance and Use of One-Time Funds Policy.

However, the forecast shows a potential structural deﬁcit resulting from the anticipated decrease in sales tax revenue due to the CDTFA audit. A structural deﬁcit occurs when recurring expenditures consistently surpass recurring revenues, leading to an ongoing imbalance that cannot be remedied through short-term solutions.

Potential
Strategy
Description
Potential Impact
Currently
Recommended
Section 115 Pension
Trust
In FY 2017-18, the City established a
Section 115 Pension Trust to mitigate
pension rate volatility when CalPERS
investment returns are below the
discount rate or when CalPERS
changes assumptions. The City can
also use it to offset pension costs in
any given year.

The City established a Section 115
Trust to reduce pension rate volatility
when CalPERS investment returns
are below the discount rate or when
CalPERS changes assumptions. The
City can also use it to offset pension
costs.

The fund has a balance of $17.2
million.

Yes
Section 115 OPEB
Trust
In FY 2009-10, the City established a
Section 115 OPEB Trust to help fund
its retiree health obligations, also
known as other post-employment
benefits (OPEB).

The OPEB plan is fully funded.

Starting in FY 2022-23, retiree health
costs will be funded by the OPEB
Trust rather than the General Fund.

The fund has a balance of $33.3
million.

Yes
Capital Projects
Reserve
The General Fund Capital Projects
Reserve may be used to fund capital
projects.

The reserve has a balance of $10
million.

Yes
Economic
Uncertainty Reserve
The General Fund Economic
Uncertainty Reserve may be used to
mitigate potential shortfalls.

The reserve has a balance of $24
million.

No
As of June 30, 2022
1 1
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Expenditure Reduction Strategies
Potential
Strategy
Description
Potential Impact
Currently
Recommended

No new positions
Cost containment strategy
$0
Yes
Vacancy control
Keep non-essential positions unfilled as they
become vacant.

Approximately
$186,000 per
position on
average
Yes
Employee cost-sharing of
increases to CalPERS
Negotiate to share costs of increases to
CalPERS employer rates with employees.

Would be subject to bargaining unit
agreement.
$250,000
approximate based
on a 5% rate
increase
No
Defer or eliminate
negotiated increases
Would be subject to bargaining unit
agreement.

Approximately
$0.3 million
savings based on a
1% decrease
No
Furloughs
Employees would take up to a 10% decrease
in pay in exchange for 1 unpaid furlough day
per pay period. Would be subject to
bargaining unit agreement.

Approximately $3
million savings
based on a 10%
decrease
No
Reduction in force
Identify positions to be reduced (laid off)
based on MOU provisions and service level
needs.

Approximately
$186,000 per
position on
average
No
Reduction in capital
outlays and special
projects
Cost containment strategy
Up to $4 million
Yes
Reduction in
contingencies
Cost containment strategy
Up to $400,000
Yes
Defer or cancel capital
projects
Cost reduction strategy
Varies
Yes
Reduction of Community
Funding and Historical
Society Funding
Cost reduction strategy
Up to $110,000
Yes
Reduction of festival fee
waivers
Cost reduction strategy
Varies
Yes
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Revenue Generation Strategies
Potential Strategy
Description
Potential Impact
Currently
Recommended

¼ Cent Transaction and
Use Tax (TUT)
Voter approval is required
Could increase sales tax from 9.125% to 9.375%
$5.2 million
No
Transient Occupancy Tax
(2% increase)
Voter approval is required
Could increase transient occupancy tax from
12% to 14%
$1.7M @ $10M
base
$1.25M at $7.5M
base
$833k at $5M base
No
Parcel Tax
Voter approval is required
$3.5M flat rate per
parcel
$3.6M variable
rate per SF
No
Other Revenue Tax
Measures
Urban Futures, Inc. (UFI) has been contracted
to analyze potential revenue tax measures.

Varies
No
Increase fees and cost-
recovery
Matrix Consulting Group has been contracted
to conduct a fee study, which is scheduled to
take place from April to July 2023. The study
aims to assess the potential for fee increases
and cost recovery.

Varies
Yes
Sale of City-owned
Properties or Assets
The sale of city-owned assets would generate
one-time revenue.

Varies
No
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Cupertino City CouncilMay 17, 2023

Cupertino City Council
May 17, 2023