City Council
Staff Report
From: City Manager
Report Type: ACTION ITEMS
Lead Department: Administrative Services
Meeting Date: February 23, 2026
Report #:2512-5662
TITLE
FY 2026 Mid-Year Budget Review; and Approve 1) Budget Amendments in Various Funds, and 2) a $10.0 Million Additional Discretionary Payment (ADP) from the PARS Pension Trust
RECOMMENDATION
Staff recommends that the City Council receive the FY 2026 mid-year budget review and:
1. Approve amendments to the Fiscal Year 2026 Budget Appropriation for the funds and capital projects identified in Attachment A, Exhibits 1 and 2 (requires 2/3 approval);
2. Consolidate the remaining $6.0 million in the Uncertainty Reserve with the Budget Stabilization Reserve (BSR) to streamline reserve administration, closing the Uncertainty Reserve; and
3. Authorize the City Manager or their designee to transmit $10.0 million from the City’s PARS Pension Trust to CalPERS as an Additional Discretionary Payment (ADP)
EXECUTIVE SUMMARY
This report provides the financial status of major City funds as of December 31, 2025, and presents strategic actions to manage immediate revenue fluctuations while addressing long- term structural liabilities. Overall, the General Fund is tracking below adopted revenues and within expenditure levels. Significant revenue realignments are necessary to reflect a $9.0 million decline in sales tax and $1.3 million downward revision of property tax. Consistent with data reviewed by the Finance Committee in November 20252. Total General Fund revenue estimates are recommended for reduction by $10.3 million to align with updated county and market forecasts ($6.3 million ongoing, and $4 million one-time). While revenues for charges for services, permits & license, transient occupancy tax and document transfer tax revenue receipts through Q2 are stronger than prior year trends, these sources are less predictable and conservatively these FY 2026 budget estimates are not revised upwards at this time. This hopefully provides revenue opportunities in FY 2027 budget development and staff will closely monitor Q3 and Q4.
To streamline reserve administration and prepare for a General Fund projected $14.9 million structural deficit in FY 20271, staff and the Finance Committee recommends consolidating the Uncertainty Reserve ($6.0 million balance) with the Budget Stabilization Reserve via a technical adjustment. Combined, the BSR balance is projected to end FY 2026 at $54.7 million (17.8%), which is $2.1 million below the Council’s 18.5% target ($56.8 million). This conservatively assumes the consolidation of the reserves offset by the $10.3 million reduction in estimated tax revenues. If the reserve is offset by the ongoing $6.3 million reduction in estimated tax revenues, excluding the contingent one-time sales tax reduction (of $4 million), then the projected BSR would be $58.7 million or 19.1%. There is a lower probability of using $2.0 million BSR previously identified in LRFF for FY 2027 budget balancing with the current projection falling below target levels.
The Finance Committee and staff recommends authorizing a $10.0 million Additional Discretionary Payment (ADP) from the Section 115 Pension Trust (Section 115 Trust) to CalPERS to reduce long-term pension debt and improve future fiscal sustainability. Unanimously recommended by the Finance Committee on November 18, 20252, this proactive step implements the City Retiree Benefit Funding Policy (Policy) and is integral to the FY 2027 budget balancing strategy.
The City remains focused on disciplined resource management across all operations. Charges for services, permits and licensing revenues have come in stronger through December 2025, due to new and enhanced fees, higher volume and development activity. While on the expenditure side, public safety overtime remains high due to department vacancies, these net costs are currently being mitigated through salary savings and reimbursements. Such revenue enhancements and cost-containment efforts are a precursor to continued focus on government efficiency to balance FY 2027 budget and ensure long-range fiscal sustainability.
BACKGROUND
The City of Palo Alto’s financial reporting cycle provides the City Council, Finance Committee and the community with regular, transparent evaluations of the City’s fiscal health. This mid- year review follows several foundational reports previously presented to the City Council including the Fiscal Year (FY) 2025 Annual Comprehensive Financial Report (ACFR), the first- quarter fiscal status for FY 2026, and the acceptance of the FY 2027-2036 Long-Range Financial Forecast (LRFF)3. These reports provide the technical baseline for the City’s current operations 1 City Council, January 13, 2026; Report #2511-5473,
https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=84151&dbid=0&repo=PaloAlto&searchid=87b8885 8-9fbd-4c06-82ac-9564f9076e1b
2 Finance Committee, November 18, 2025; #2511-5392,
https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=83886&dbid=0&repo=PaloAlto&searchid=643b9fb0 -0e06-4d6d-9fee-6c01ce0f9094
3 City Council, January 20, 2026; #2512-5601: FY 2027-FY 2036 Long Range Financial Forecast, https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=85271&dbid=0&repo=PaloAlto&searchid=a0926757 -5af0-466d-b59c-ae4de17e166d
and serve as the "starting point" for developing a structurally balanced budget for the upcoming fiscal years7.
Building on this baseline, the Finance Committee reviewed a major tax revenues and Section 115 Pension Trust updates on November 18, 2025, which highlighted significant reductions in sales tax receipts. The Committee thoroughly reviewed and recommended forwarding a proposal to the City Council for a $10.0 million Additional Discretionary Payment (ADP) from the Section 115 Pension Trust to CalPERS to implement the City Retiree Benefits Policy and proactively address long-term pension liabilities to improve fiscal sustainability8.
Additionally, the City continues to monitor the evolving economic context, particularly State (CDTFA) regulation changes impacting sales tax allocations within the leasing and auto sectors.
Further context was provided through the Finance Committee review of General Liability in late 2025, which culminated in Council direction on January 20, 2026, to align increased insurance costs within the General Liability Fund as part of this mid-year review9.
ANALYSIS
The Mid-Year Budget Review provides a comprehensive assessment of the City's fiscal performance through the second quarter of the fiscal year and recommends specific adjustments to maintain a balanced budget and long-term sustainability. The analysis is organized into the following sections:
I. General Fund Mid-Year Budget Adjustments: A review of revenue realignments and the strategic use of reserves to address immediate fiscal fluctuations.
II. Pension Liability Management: An update on payment from Section 115 Pension Trust to CalPERS.
III. Enterprise and Other Fund Adjustments: Technical and operational alignments for non- General Fund operations.
IV. Future Outlook and Government Efficiency: A summary of multi-year outlook and increased governmental efficiency.
7 City Council Staff Report, January 13, 2025; #2412-3846, https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=83197&dbid=0&repo=PaloAlto&searchid=d5f2eb36 -85a1-47b6-91e4-e6ebf0093346&cr=1
8 Finance Committee, November 18, 2025; #2511-
5392https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=83886&dbid=0&repo=PaloAlto&searchid=5f89 f3e9-39ff-4f54-b84c-1bdb84a084ff
9 City Council, January 20, 2026; Report #2510-5352,
https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=85264&dbid=0&repo=PaloAlto&searchid=51ce8927 -a6eb-4f27-966a-aecc716263c4
I. General Fund Mid-Year Budget Adjustments
The Fiscal Year 2026 General Fund Mid-Year Budget Review aligns the City’s budget with updated financial information while preserving the long-term stability established in the January 2026 Long-Range Financial Forecast (LRFF). While General Fund expenditures are tracking within adopted levels, significant adjustments are required on the revenue side to account for a projected $10.3 million reduction in sales tax ($9.0 million reduction) and property tax ($1.3 million reduction). This sales tax realignment results from State (CDTFA) regulation changes impacting the leasing and auto sectors and updated property tax projections. The conservative $9.0 million reduction in sales tax reflects both an estimated ongoing loss of $5 million in annual receipts as well as a contingent one-time loss estimated at $4 million for prior year adjustments. Depending upon CDTFA determination, the prior year adjustment could range between $0 and $4 million. Consolidating the General Fund reserves is a technical adjustment yielding a projected combined BSR balance of $54.7 million or 17.8%, which excludes the full revenue reduction $10.3 million in FY 2026. If the $4 million prior year sales tax adjustment does not occur, then the revenue reduction may be $6.3 million in FY 2026, resulting in projected BSR of $58.7 million or 19.1%.
The recommended adjustments for the General Fund include a combination of additional funding for operational needs and technical alignments to reflect actual fiscal activity.
Additional funding is proposed for the Public Works Department (PWD) to address critical equipment needs for the Urban Forestry section. Realignment of the grant award to the Chamber of Commerce as the fiscal sponsor of the former 3rd Thursday event series to the Palo Alto Recreation Foundation which is now coordinating an event series on California Ave.
Technical adjustments include the prior revenue adjustments mentioned for major taxes and the consolidation of the Uncertainty Reserve with the BSR. Additionally, the Utilities Department (UTL) requires a true-up of the Electric Equity Transfer, while the Fire Department (FIR) recognizes revenue related to strike team deployments and the annual funding reconciliation with Stanford University. These technical actions also include an expenditure realignment for Fire to offset strike team costs and a bank fee adjustment in the Planning and Development Services Department (PDS) to align with current volume. These items are summarized in the Table 1.
Table 1: General Fund Mid-Year Adjustments and Balancing Solutions Summary of General Fund Adjustments Net $ Impact
(Cost)/Benefit
Technical Adjustments:
Sales Tax Projection Update - Revenue Reduction $(9.0) M Property Tax Projection Update - Revenue Reduction $(1.3) M Uncertainty Reserve Consolidation w/BSR $6.0 M
UTL: Electric Equity Transfer (Technical adjustment) $0.2 M FIR: Stanford University FY 2025 Reconciliation Revenue $0.1 M PDS: Gas Water Heater Subsidy - Revenue Reduction $(0.1) M Subtotal Technical Adjustments: $(4.1) M
Use of Budget Stabilization Reserve $4.1 M*
(BSR at 17.8% and $2.1 M below the 18.5% target level)
Total Net Impact General Fund Mid-Year Adjustments $0.0 M II. Pension Liability Management
As part of implementing the City Retiree Benefit Policy and managing pension liability, staff recommends authorizing a $10.0 million Additional Discretionary Payment (ADP) from the Section 115 Pension Trust to CalPERS. The remaining Section 115 Trust and planned future contributions and earnings are projected to achieve the Policy outcome of reaching 90% funded status within 15 years of the approved Policy. This proactive measure, reviewed and recommended by the Finance Committee on November 18, 2025, aligns with the Policy and is integral to the multi-year financial plan.
The Section 115 Pension Trust was established to provide the City with a dedicated vehicle to manage pension volatility and reduce the Unfunded Accrued Liability (UAL). By transferring these funds to CalPERS as an ADP, the City effectively reduces the principal balance of its pension debt, leading to long-term interest savings and lower annual required contributions in future years. This action is particularly critical given the projected $14.9 million structural deficit beginning in FY 2027, as it helps flatten the trajectory of rising benefit costs.
III. Enterprise and Other Fund Adjustments
Beyond the General Fund, the Mid-Year Budget Review includes a series of technical and operational adjustments across the City’s Enterprise, Internal Service, Special Revenue, and Capital funds. These actions are required to align appropriations with updated revenue sources, ensure compliance with grant timelines, and accurately reflect Council-directed changes to capital projects. A summary are included in Table 2.
Within the Enterprise Funds, the most significant financial adjustment occurs in the Fund 526 Wastewater Treatment Fund, where staff recommends recognizing $17.0 million in revenue from the City of Mountain View. This revenue reflects Mountain View’s proportional share of the Advanced Water Purification System (AWPS) capital project, based on a funding agreement executed following the adoption of the FY 2026 budget. Additionally, this fund requires an increase in operating appropriations to address higher-than-anticipated chemical costs for treatment and laboratory operations, driven by rising vendor prices. In the Fund 530 Airport Fund, a minor adjustment is proposed to resource the Unleaded Fuel Transition Plan, providing necessary consultant services to monitor aircraft lead emissions and track the transition to unleaded fuel in alignment with City Council priorities.
Internal Service Funds require adjustments to address rising fixed costs and technical carry- forward corrections. The Fund 689 General Liabilities Insurance Fund requires a $0.9 million increase in appropriation to cover a significant 30 percent rise in excess liability insurance premiums, a trend consistent with the broader municipal insurance market. In the Fund 682 Information Technology Fund, staff recommends a technical re-appropriation of $230,000 to complete public safety radio infrastructure upgrades. These funds were not correctly carried forward from the previous fiscal year, and this action ensures the department has the authority to satisfy active purchase orders for critical public safety communication equipment.
Additionally, the Fund 687 General Benefits Fund includes a technical true-up to align PARS supplemental pension contributions with actual departmental allocations, resulting in a $83,000 reduction to the fund balance.
Adjustments in the Special Revenue and Capital Funds focus on grant management and project closeouts. The Fund 253 Local Housing Allocation Fund and Fund 248 Law Enforcement Services Fund require technical re-appropriations to restore expense authority for the Permanent Local Housing Allocation grant and Automated License Plate Reader (ALPR) technology, respectively, ensuring that previously awarded grant funds remain available for their intended purposes.
Finally, the Fund 471 General Fund Capital Improvement Fund reflects a net positive impact driven by the return of unspent funds to reserves. This includes savings generated by scaling back the Foothills Nature Preserve project scope to focus primarily on safety improvements and disencumbering unneeded funds from the Parking Management System project, which are being reallocated to the University Avenue Parking Fund for non-capital needs.
Table 2: Enterprise and Other Fund Mid-Year Adjustments Fund Name Net $ Impact
(Cost)/Benefit
Enterprise Funds:
Fund 513 Electric Supply Fund (Equity Transfer) $(157) K Fund 523 Electric Fund (Cap and Invest Transfer to CIP) $(258) K Fund 526 Wastewater Treatment Fund (AWPS Revenue & Chemical Costs) $16,843 K Fund 530 Airport Fund (Unleaded Fuel Transition Plan) $(20) K Internal Service Funds:
Fund 681 Vehicle Replacement & Maintenance Fund (Bucket Truck Rental) $(72) K Fund 682 Information Technology Fund (Radio Infrastructure) $(230) K Fund 687 General Benefits Fund (115 Trust Transfer/PARS True-Up) $(83) K Fund 689 General Liabilities Insurance Fund (Excess Liability Costs) $(900) K Special Revenue & Capital Funds:
Fund 231 Gas Tax Fund (Revenue/Transfer True-Up) $10 K
Fund 232 Community Development Block Grant (Return to Fund Balance) $63 K Fund 233 Housing In Lieu / Residential (Housing Program) $(114) K Fund 236 University Ave Parking Fund (Parking Services) $0 K Fund 248 Law Enforcement Services (ALPR Grant Cleanup) $(36) K Fund 253 Local Housing Allocation (Grant Re-appropriation) $(244) K Fund 471 General Fund Capital Improvement Fund (Project Savings & Transfers) $200 K
Total Net Impact Enterprise and Other Funds $15,002 K
IV. Future Outlook and Governmental Efficiency
The FY 2026 Mid-Year Budget Review balances the General Fund, closing the projected revenue gap through the limited use of the reserves and technical realignments. During FY 2026, budget reductions were made by Council on September 8, 202513 to improve the structural deficit by reducing FY 2026 budget spending by approximately $6 million with $3.4 million on-going for 3 years (reduce $2.4 million General Fund and $1 million CIP) and $2.8 million one-time (reduce $0.6 million General Fund and $2.2 million CIP). This fiscal discipline and more solutions are required to balance the additional forecasted FY 2027 structural deficit of $14.9 million, which continues through FY 2032.
Increased government efficiency will be a greater focus in FY 2027 budget development, transparency and management in alignment with the 2026 City Council priority. Staff are working to identify, develop, and implement governmental efficiencies including but not limited to: streamlining operations, reducing professional service costs and improving contract management, increasing revenues, and improving facility utilization. Priority initiatives will be reported in the Council Priorities and Objective updates, City Manager budget transmittal, and budget presentations.
Staff will return to the Finance Committee and City Council in May 2026 with a balanced Proposed Budget with solutions ensuring that Palo Alto maintains its fiscal health while delivering high-quality services to the community.
FISCAL/RESOURCE IMPACT
Approval of the attached transactions is required to amend the FY 2026 budget appropriation.
With the approval of these amendments, the projected ending balance of the General Fund Budget Stabilization Reserve (BSR) is $54.7M, or 17.8% of expenditures. While this is within the 15% to 20% policy range, it is $2.1 million below the City Council’s 18.5% target of $56.8M.
Notably, if the $4M one-time sales tax adjustment does not occur, the ending BSR balance is projected to reach $58.7M, or 19.1%.
13 City Council, September 8, 2025; Agenda Item#18; 2506- 4818,https://recordsportal.paloalto.gov/WebLink/DocView.aspx?id=83564&dbid=0&repo=PaloAlto&searchid=0cb 9ea95-968d-4d59-8d45-249d0c4401e3
The projected changes to the fund balance for all other funds including Capital Funds, Enterprise Funds, Internal Services Funds, and Special Revenue Funds are outlined in Attachment A and accompanying exhibits and impacts to fund balances in these fund types are summarized in the table below.
Table 3: Summary of Impacts to Fund Balances (Non-General Fund) Fund Type / Fund Name Net Impact to Fund
Balance
Enterprise Funds
Fund 513 Electric Supply Fund $(0.16) M
Fund 523 Electric Fund $(0.26) M
Fund 526 Wastewater Treatment Fund $16.84 M
Fund 530 Airport Fund $(0.02) M
Enterprise Funds Subtotal $16.40 M
Internal Service Funds
Fund 681 Vehicle Replacement & Maintenance Fund $(0.07) M Fund 682 Information Technology Fund $(0.23) M
Fund 687 General Benefits Fund $(0.83) M
Fund 689 General Liabilities Insurance Fund $(0.90) M
Internal Service Funds Subtotal $(1.20) M
Special Revenue Funds
Fund 231 Gas Tax Fund $(0.01) M
Fund 232 Community Development Block Grant Fund $0.06 M Fund 233 Housing In Lieu / Residential $(0.11) M
Fund 236 University Ave Parking Fund $(0.00) M
Fund 248 Law Enforcement Services Fund $(0.04) M
Fund 253 Local Housing Allocation Fund $(0.24) M
Special Revenue Funds Subtotal $(0.34) M
Capital Funds
Fund 471 Capital Improvement Fund $0.20 M
Capital Funds Subtotal $0.20 M
Total Net Impact to All Other Funds $14.98 M
STAKEHOLDER ENGAGEMENT
The process of developing this mid-year review has been built on a foundation of transparency and regular reporting to both the City Council and the public. Much of the financial data and the strategic outlook presented here originated from public discussions held with the Finance Committee in late 2025, as well as the most recent update to the City Council in January 2026 on the Long Range Financial Forecast. During those sessions, staff provided detailed updates on tax revenue trends and the long-term forecast, allowing for a collaborative review of the challenges we face and the maneuvers proposed to keep the City’s finances in balance.
In addition to these financial briefings, several of the specific programs are the direct result of community outreach and public hearings where residents and stakeholders shared their perspectives. By keeping these channels open, we ensure that the budget remains not just a technical document, but a reflection of the community's priorities and a transparent account of how public resources are managed.
ENVIRONMENTAL REVIEW
The proposed Council action is not a project as defined by the California Environmental Quality Act (CEQA) Guidelines section 15378 because it is a government funding mechanism which does not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment.
ATTACHMENTS
Attachment A: FY 2026 Mid-Year Budget Amendments
Attachment B: FY 2026 Second Quarter Financial Status Report Attachment C: FY 2026 Public Safety Overtime Report
APPROVED BY:
Lauren Lai, Administrative Services Director