City Council
Staff Report
From: City Manager
Report Type: ACTION ITEMS
Lead Department: Administrative Services
Meeting Date: January 20, 2026
Report #:2512-5601
TITLE
Review the FY 2027-FY 2036 Long Range Financial Forecast (LRFF) and FY 2027 Budget Development Guidelines using the LRFF as the Baseline for Developing the FY 2027 Budget as Recommended by the Finance Committee, CEQA Status – Not a Project
RECOMMENDATION
The Finance Committee and staff recommend the City Council accept the Long Range Financial Forecast (LRFF) for Fiscal Year 2027-2036 (Attachment A) and the FY 2027 annual Budget Development Guidelines (Attachment B) and direct staff to use this forecast as the baseline for developing the FY 2027 budget.
EXECUTIVE SUMMARY
On December 2, 2025 the Finance Committee reviewed the FY 2027-2036 Long Range Financial Forecast (LRFF) (Attachment A) along with the annual Budget Development Guidelines (Attachment B) and unanimously recommended that it be forwarded to the City Council for acceptance1. The Committee also reviewed major tax revenues and Section 115 Pension Trust on November 18, 2025 which were incorporated into this LRFF2.
This preliminary forecast is based on the most current information available, actual revenues and expenses for FY 2025, and projected results through FY 2026 at the report was released.
General Fund expenditures are based on current City Council approved service levels, including the recent expense reductions approved by the City Council on September 8, 2025. 3The current outlook anticipates continued economic stagnation and uncertainty, which is reflected in this forecast.
1 Finance Committee, December 2, 2025; Agenda Item #3; SR #2511-5473, https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=16338 2 Finance Committee, November 18, 2025; Agenda Item #2; SR # 2511-5392, https://portal.laserfiche.com/Portal/DocView.aspx?id=236317&repo=r-704298fc&searchid=a6cdeee1-f142-41c5- be56-9a6a512108b3
3 City Council, September 8, 2025; Agenda Item #3; SR #2506-4818, https://portal.laserfiche.com/Portal/DocView.aspx?id=221264&repo=r-704298fc&searchid=95735611-6c94-45fd- 9e08-5713bd4b0286
The base case LRFF projects a shortfall of $14.9 million in FY 2027, followed by shortfalls ranging from $15.1 million in FY 2029 down to $6.2 million in FY 2032. FY 2033 has a projected surplus of $1.0 million which continues to grow through FY 2036. This forecast maintains current service levels approved in FY 2026 and should be used for planning purposes to assist in gauging effects of major policy interventions against a likely 'status quo' version of the future.
These amounts represent a larger than previously projected deficit. The projected $14.9 million shortfall for FY 2027 is $6.8 million greater than the $8.1 million deficit forecasted for FY 2027 just seven months ago (May 2025) and $7.0 million greater than the $7.9 million projected in the December 2024 LRFF. This change is driven by a combination of lower projected revenue (most notably Property Tax and Sales Tax) and higher-than-anticipated expenditure growth (detailed in Attachments C and D). City staff will continue to review and refine these projections to establish the FY 2027 budget. Individual fiscal years will vary from this forecast as changes in revenue estimates or operating transfers occur.
Instead of modeling alternative budget scenarios, staff developed a menu of budget balancing strategies for the Council’s consideration. This framework provides budget-balancing options, including revenue enhancements, expenditure reductions, and adjustments to pension and capital funding. The strategies are designed to facilitate a discussion on the trade-offs required to close the budget deficit in FY 2027 as well as the structural deficit in the out-years.
While the projections in the FY 2026 Adopted Budget included deficits in the LRFF, this revised LRFF reflects larger deficits in the near term primarily due to reduced property and sales tax revenue. The FY 2026 budget process addressed the projected shortfall with some ongoing budget cuts and dedicated one-time reserves. The City now faces the challenge of developing the FY 2027 budget and planning for the subsequent years, which will require strategic work over the next several months to balance the community's desired service levels with the financial resources projected.
BACKGROUND
Annually, the Office of Management and Budget produces a ten-year General Fund Long Range Financial Forecast (LRFF). The LRFF reflects staff's best estimates on the projected revenues and expenditures over the next ten years based on the information that is currently available. It is important to note that the LRFF is a planning document and is separate and distinct from the development of the City's annual Operating and Capital Budgets. There are assumptions and parameters modeled in the LRFF, and these assumptions are revised and refined as more information becomes available through the budget development process.
The LRFF contains a high-level comprehensive review of revenues and expenditures, especially costs to provide current City Council-approved service levels, including current contracts, updates to salaries and benefits based on the current employee population, and current labor contracts. This Forecast provides short-term and long-term financial status of current service levels to inform policy decisions and evaluate long-term goals. The City Council last accepted the FY 2027-2036 Long Range Financial Forecast on January 13, 2025.7 Per City Council policy, items that are unanimously approved by the Finance Committee are placed as a consent agenda item for the City Council. Though this report was approved unanimously, staff and the Committee have placed this item on the City Council’s action agenda for deliberation of the full Council to acknowledge the importance for financial planning.
ANALYSIS
Finance Committee Review
The Finance Committee reviewed the FY 2027-2036 Long Range Financial Forecast (LRFF) on December 2, 2025. Following this review, staff updated the attached LRFF (Attachment A) to ensure the data aligns with the final presentation materials delivered to the Committee.
These revisions specifically make minor adjustments in Table 1 Base Case and Table 5 Revenues. For the City Council's immediate reference, the updated Table 1: FY 2027-2036 Long Range Financial Forecast (Base Case) is provided below.
Revised Table 1: FY 2027-2036 Long Range Financial Forecast (Base Case) (All figures in millions)
FY 26
Adopted
FY 26
Projected FY 27 FY 28 FY 29 FY 30 FY 31 FY 32 FY 33 FY 34 FY 35 FY 36 TOTAL
REVENUE
Revenues
Uncert Reserve
$307.2
$301.2
$5.8
$298.0
$292.2
$5.8
$305.1 $316.9 $327.2 $340.4 $353.0 $365.2 $378.4 $390.3 $404.6 $418.8 TOTAL
EXPENDITURES $307.0 $307.0 $320.0 $329.7 $342.5 $354.6 $363.7 $371.6 $377.4 $386.0 $393.3 $405.6
SURPLUS/
(DEFICIT) $0 ($9.0) ($14.9) ($12.8) ($15.3) ($14.2) ($10.7) ($6.4) $1.0 $4.3 $11.3 $13.2 Revised Table 2: FY 2027-2032 Budget Balancing Strategies (All figures in millions)
FY 2027 FY 2028 FY 2029 FY 2030 FY 2031 FY 2032
Revenues:
Explore new/updated fees and other revenues $0.8 $0.8 $0.8 $0.9 $0.9 $0.9 Budget Stabilization Reserve (BSR) $2.0 $0.0 $0.0 $0.0 $0.0 $0.0 Budget Reductions:
FY 26 Approved Reductions thru FY 32
($6 m w/$3.4 m on-going ~ $2.4m GF + $1 m CIP)
$3.4
in base
$3.4
in base
$3.4 $3.4 $3.4 $3.4
FY 27 Additional Reductions thru FY 32
(to be determined during FY 2027 budget development)
$7.0 $7.0 $7.0 $5.8 $2.3 $2.1
7 City Council, January 13, 2025, Agenda Item #12, SR #2412-3846, https://portal.laserfiche.com/Portal/DocView.aspx?id=125154&repo=r-704298fc&searchid=414f71d9-32af-44ed- a9e5-7e982f57164e
FY 2027 FY 2028 FY 2029 FY 2030 FY 2031 FY 2032
CIP Reductions:
FY 2027 Additional Reduction to Capital
(to be determined during FY 2027 budget development)
$1.0 $1.0 $0.0 $0.0 $0.0 $0.0
Pension Cost:
Reduce Additional Discretionary Payment (ADC) $3.6 $3.6 $3.6 $3.6 $3.6 $0.0 Reduce Additional Discretionary Payment (ADP) $0.5 $0.5 $0.5 $0.5 $0.5 $0.0 BUDGET STRATEGY TOTAL: $14.9 $12.9 $15.3 $14.2 $10.7 $6.4 Remaining Surplus/(Deficit) $0.0 $0.1 $0.0 $0.0 $0.0 $0.0 As part of the Committee’s review of the LRFF, several topics were discussed more in depth and staff has provided additional information for context and/or additional data points for reference to the City Council.
•Services/Programs and Council Priorities – Committee acknowledged that given the General Fund deficit the Council would need to consider suspending or discontinuing City services/programs. The General Fund deficit would also impact funding for Council priorities and objectives. The budget balancing strategies include $7 million in General Fund budget cuts and $1 million in capital cuts (i.e. defer/reduce projects and/or fund balance). Staff will work with the Finance Committee and Council through the FY27 budget process; staff will continue identifying service efficiencies before reductions to minimize impacts to the community.
•Property Tax and Sales Tax Projections – Committee discussed the downward projections for property tax and sales tax revenues. The reduced property tax revenue is based on a true-up to actual FY 2026 tax roll, which was lower than estimated and revised outlook to mid-4% growth from low-6% growth assumed in prior LRFF. This incorporates the current economic outlook and HdL property tax guidance. However, the forecast does not consider future housing growth (or its associated increased cost of city services), as timing and fiscal impacts are speculative. The City’s property tax, based on property value, mix is approximately 70% residential and 30% non- residential. As of the most recent County reporting for 2025 countywide property tax appeals, there were 5,659 appeals filed, of which 1,486 are active, totaling $5.8 billion at risk countywide. 9 This is an increase from the same period in 2024, with 4,582 appeals filed. For FY 2026, the county projects tax roll reduction correction totaling $43.3 million (relative to Countywide total tax levy of $6.9 billion) of which the City’s proportionate share is 0.7% (0.007) or $0.3 million. The tax roll corrections are incorporated into the FY 2026 property tax projections and LRFF. The Committee was supportive of the revised property tax assumptions and forecast. 9 Cities Meeting, November 12, 2025,
https://controller.santaclaracounty.gov/cities/cities-meetings The City continues to monitor pending litigation between Marin County and the California State Controller regarding the methodology used to calculate excess Educational Revenue Augmentation Fund (ERAF) distributions, which may affect Santa Clara County. A court hearing on this matter is expected to continue in March 2026. To mitigate potential impacts, the City has retained at-risk amounts in reserve and will update assumptions as new information becomes available.
The Finance Committee also discussed reduced expected sales tax revenue (previously reviewed by the Finance Committee on November 18) resulting from modified regulations used by the California Department of Tax and Fee Administration (CDTFA) in apportioning sales tax revenue from the leasing and new auto sectors. Staff continues to work with the State and business community on this matter.
Furthermore, the Committee emphasized the importance of explaining that property tax and sales tax challenges worsened the City’s finances. •Transient Occupancy Tax (TOT) – Committee requested in-depth information regarding TOT drivers of trends and projections. TOT projections are based on historical revenue performance and hotel operating metrics, including average daily room rates and occupancy. The Q1 FY 2026 results reviewed by the Committee on December 2 were based on information available at the time of reporting and have since been updated. For the completed quarter, hotels reported an average daily room rate of $272.19 and occupancy of 84.19% in Q1 FY 2026, compared to $291.33 and 72.52% in Q1 FY 2025. While average room rates declined year over year, higher occupancy supported Q1 FY 2026 revenues of $7.5 million, an increase of $0.4 million or 5.5%, from the prior year.
Over the longer term, TOT has grown at a Compound Annual Growth Rate of 9.3% (five years) and 5.7% (10 years), respectively. This growth reflects the addition of three new hotels and approximately 400 hotel rooms since 2021, bringing total citywide inventory to approximately 2,500 rooms. The LRFF assumes ongoing TOT growth of approximately 4-5% annually over the forecast period, aligning more closely with long-term growth trends.
Vacancy Rate – The LRFF includes 5% vacancy assumption, which Committee concurred after further review of current data. Available vacancy data reviewed:
- October vacancy: 11.6% ~ as of Q1 FY 2026
- General Fund vacancy rate: 9.6%
- Enterprise Fund vacancy rate: 15%
- General Fund vacancy rate (no public safety vacancies): 6.3% •2019 to current Trends – Where multi-year trends are presented, Committee requested 2019 be included to reference pre-pandemic levels as baseline. Staff completed the historical summary of General Fund staffing by department since 2019 (Attachment B). Also, Staff will gradually incorporate with key charts with historical trends.
•Known Unknowns – Committee clarified that while the LRFF does not include funding from the General Fund for the projects/priorities within the Known Unknown listing, these projects may be funded by other funding source(s) (i.e. Measure B, Measure K, impact fees, etc).
FISCAL/RESOURCE IMPACT
Financial implications from this report and input from the City Council will be considered in the City Manager’s development of the Fiscal Year 2027 budget. Upcoming milestones related to the City’s fiscal standing and the FY 2027 Budget Process include:
• February (Council) – FY 2026 Mid-Year Budget Review and Second Quarter Financial Report
• March/April (Finance Committee and Utilities Advisory Commission or UAC) – Five Year Utility Financial Plans and FY 2026 Utility Rate Recommendations • April/May (Finance Committee) – Citywide Cost Allocation Plan and Municipal Fee Study
• May (Council) – FY 2027 Proposed Operating and Capital Budgets Published • May (Finance Committee) – FY 2027 Proposed Budget Hearings, including Utility Rates, Municipal Fees, and Five-Year Capital Improvement Plan • June (Finance Committee) – FY 2026 Third Quarter Financial Report • June (Council) – Adoption of the FY 2027 Operating and Capital Budgets, Utility Rates, and Municipal Fees.
STAKEHOLDER ENGAGEMENT
The preliminary forecast for FY 2026 represents the beginning of the fiscal year 2026 budget development process. As in previous years, City Council discussion of the LRFF will provide guidance to staff in the budget development process. It is anticipated that conversations with City Council and the community will occur through public budget hearings in Spring 2026, according to the standard budget adoption process. The community can track previous and upcoming FY 2027 budget discussions and information at www.cityofpaloalto.org/budget.
ENVIRONMENTAL REVIEW
Council action on this item is not a project as defined by the California Environmental Quality Act (CEQA) because accepting the LRFF and budget guidelines is fiscal activity which does not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment. CEQA Guidelines section 15378(b)(4).
ATTACHMENTS
Attachment A: FY 2027-2036 Long Range Financial Report (LRFF), CMR 2511-5473 Attachment B: Historical Staffing by Department – General Fund (adopted vs vacant) APPROVED BY:
Lauren Lai, Administrative Services Director