ITEM #6b – FY 2026-27 Budget Supplement Preview & Discussion of Operational Initiatives Page 4 Per the Fiscal Health Contingency Plan, the purpose of the plan is to establish a framework and general approach in responding to adverse fiscal circumstances.
The FHCP identifies circumstances that may trigger the activation of a FHCP, including:
Adverse fiscal circumstances as determined by the City Manager, such as:
o Natural or human-made disasters
o State budget takeaways
o Large, unexpected costs
o Economic downturns.
Whenever there are two consecutive quarters of adverse fiscal results in one or more of the City’s top five General Fund revenues:
o Sales tax
o Property tax
o Transient occupancy tax (TOT)
o Utility users tax
o Vehicle license fee (VLF) “swap”
Adverse results include:
o Actual declines in revenues
o Significant variances from projected revenues
9) Besides allocating money for Fire station #5 from the General Fund, are there grant possibilities, development impact fees, bond funding or other cost sharing sources available?
Staff will apply for and utilize all available funding sources to offset the cost of operations. Staff intend to apply for the Federal Emergency Management (FEMA) Staffing for Adequate Fire and Emergency Response (SAFER) grant. This grant provides funds to help organizations increase the number of trained firefighters on staff. FEMA Assistance to Firefighter Grant (AFG) is another opportunity that could potentially offset one time equipment expenditures. Because funding under these programs is not guaranteed, the forecast assumes the full cost of operations will be paid for by the City, including the Community Facilities Districts where allowable.
ITEM #6b – FY 2026-27 Budget Supplement Preview & Discussion of Operational Initiatives Page 5 10)Is the City identifying alternate funding sources for CAT and MCU services? If yes, from which entity?
The City has participated in five national opioid settlements since 2021 and has used settlement funds to support the cost of two Licensed Psychiatric Technicians (LPTs) contracted through the County of San Luis Obispo. The LPTs are assigned to the City’s Community Action Team (CAT) and Mobile Crisis Unit (MCU) programs, operated by the Police Department and Fire Department, respectively.
As noted in the September 2, 2025 Council Agenda Report, the City’s opioid settlement funds are decreasing and beginning in FY 2027-28, the annual cost of the contracts with the County will exceed the ongoing opioid settlement revenue.
The City does not have alternate funding sources, apart from the General Fund, to support the LPTs for the CAT and MCU and it is unlikely that another entity would take on this cost, as the City’s opioid settlement funds are currently used to support programs that benefit the City-specific programs. As part of development of the 2027-29 Financial Plan, staff will seek direction from Council on whether or not the General Fund should support the cost of the LPTs, in the absence of sufficient opioid settlement funds.
11)How could the City simplify budgeting for the CalPERS liability paydown additional discretionary payments (ADPs)? Would eliminating the 115 Trust allocation help in this regard? Why has the City “forecasted” but not actually budgeted ADPs in the past?
The City has made some progress in simplifying the paydown of its pension debts.
Ideally the forecast and budget should be aligned, but the previous Financial Plan incorporated a difference in how these payments would be made. They were forecasted, or had funding set aside, but were not budgeted, so could not be made without additional Council action, typically with the Second Quarter Budget Report.
With the 2025-27 Financial Plan they were removed from the forecast, simplifying the paydown in line with the discretionary nature of the payments. Going forward and in line with policy, CalPERS ADPs will remain a priority for use of unassigned fund balance.
Elimination of the amount assigned for deposit into a 115 Trust would have little impact on ongoing payments to CalPERS since such an action would be one-time in nature.
Item 6b
Department: Finance
Cost Center: 2002
For Agenda of: 3/3/2025
Placement: Business
Estimated Time: 180 minutes
FROM: Whitney McDonald, City Manager
Prepared By: Scott Collins, Assistant City Manager; Greg Hermann, Deputy City Manager; Emily Jackson, Finance Director; Natalie Harnett, Policy and Project Manager; Riley Kuhn, Principal Budget Analyst
SUBJECT: FY 2026-27 BUDGET SUPPLEMENT PREVIEW AND DISCUSSION OF
OPERATIONAL INITIATIVES
RECOMMENDATION
1. Review and discuss the FY 2026-27 Budget Supplement Preview; and
2. Provide direction to staff regarding the draft expenditure reductions to be recommended as part of the FY 2026-27 Budget Supplement in June 2026; and
3. Provide direction to staff on funding of the City’s Section 115 Pension Pre-Funding Trust or an alternate use of the funding currently assigned for this purpose
POLICY CONTEXT
The City’s Budget Policies that are reviewed and adopted every two years with adoption with the bi-annual Financial Plan require that the City maintain a balanced budget over the two-year period of the Financial Plan. Specifically, policy requires the City Council to pass a balanced budget where operating revenues fully cover operating expenditures. As demonstrated by the long-term forecast for the General Fund, expenditure reductions will be necessary to achieve a balanced budget in FY 2026-27. Pursuant to Section 804 of the City Charter, the City Council must adopt the FY 2026-27 Budget by June 30, 2026, for the appropriations to be in place when the next fiscal year begins.
Development of the 2025-27 Financial Plan was guided by the City’s Fiscal Policies and Budget Balancing Strategies, both of which were reviewed by the City Council as part of the Budget Foundation item in January 2025 and formally approved with adoption of the 2025-27 Financial Plan in June 2025.
DISCUSSION
Background
The report is organized in the following sections:
Item 6b
Overview
This section provides a high-level summary of the report, including important contextual information. It includes a discussion of the relevant actions taken with development and adoption of the 2025-27 Financial Plan, a preview of the actions to be recommended with the FY 2026-27 budget, and an updated long-term forecast for the General Fund. It also includes discussion of upcoming initiatives which will require additional investments from the General Fund. Some of these initiatives, like the opening of a fifth fire station, have been discussed at length and are factored into the long-term forecast. Others are new, and will have cost implications for the General Fund, like the use of dwindling opioid settlement agreement funds to pay for Licensed Psychiatric Technicians.
Recommendations
This section includes and seeks City Council input on the draft budget reductions recommended by the City Manager which were carefully crafted to minimize impacts to service levels, the community, and the organization. This section also includes discussion on the Fiscal Health Contingency Plans currently in place, as well as discussion on the $2 million in funding set aside for deposit into the City’s 115 Pension Pre-Funding Trust, the City’s pension funded status, and certain improvements to the budget process and document which are intended to increase transparency for readers.
Operational Initiatives
In order to adjust to slower revenue growth while continuing to meet emerging needs, staff recommend a multi-pronged approach. This section includes discussion of how the City can support its workforce and modernize operations, balancing workload and exploring new initiatives, and alignment through a longer-term strategic framework.
Next Steps
This item serves as a preview of recommendations to be included in the FY 2026-27 Budget Supplement. Any input provided by the City Council as a part of this item will be incorporated into staff’s formal recommendations for consideration at the FY 2026-27 budget hearing on June 2, 2026.
Previous Council or Advisory Body Action
With adoption of the 2025-27 Financial Plan, the City Council adopted a set of Budget Balancing Strategies. The recommendations in this report operationalize those Council adopted strategies.
During the April 2025 Special Meeting, the City Council discussed the need to better align the City’s long-term commitments, shorter-term goals, emergent priorities, and essential “core” services. This item is responsive to that request.
Public Engagement
Public comment on this item can be provided to the City Council through written correspondence prior to the meeting and through public testimony at the meeting.
Item 6b
CONCURRENCE
All departments participated in development of the draft budget reductions and concur with the recommendations.
ENVIRONMENTAL REVIEW
The California Environmental Quality Act (CEQA) does not apply to the recommended actions in this report because the actions do not constitute a “Project” under CEQA Guidelines Sec. 15378.
FISCAL IMPACT
Budgeted: N/A Budget Year: 2025-26 and 2026-27
Funding Identified: N/A
Fiscal Analysis:
Funding
Sources
Total Budget
Available
Current
Funding
Request
Remaining
Balance
Annual
Ongoing
Cost
General Fund $0 $0 $0 $0
State
Federal
Fees
Other:
Total $0 $0 $0 $0
There is no direct fiscal impact associated with staff’s recommendations to receive, discuss, and provide staff with direction. Council direction on this item will be incorporated into future budgets at which point there will be a fiscal impact.
ALTERNATIVES
Council could direct staff to modify the budget reduction recommendations. The purpose of this item is to seek direction from Council and requested changes to the recommendation will be incorporated with the FY 2025-26 supplemental budget.
ATTACHMENTS
A - Budget Update
1 Introduction
The primary purpose of this item is to provide a comprehensive update on the City’s General Fund budget in advance of formal budget adoption in June 2026. As noted during development of the 2025-27 Financial Plan, the June 2025 Long-Term Forecast for the General Fund identified a deficit in future years due to general economic conditions which have caused a slowing to the revenue growth and known future costs (particularly, the need to staff a new fire station). Action was taken with development of the 2025-27 Financial Plan to address the immediate revenue/expenditure imbalance, but additional changes are needed in order to balance the budget for FY 2026-27 and the 2027-29 Financial Plan period. This item provides an overview of the budgetary position of the General Fund, including an updated Long-Term Forecast for the General Fund, and a preview of staff recommendations for modest expenditure reductions to be considered with adoption of the FY 2026-27 Budget Supplement in June 2026.
While expenditure reductions are necessary to maintain a balanced budget in the current and next Financial Plan, staff are taking a more holistic approach to balancing the budget to ensure the overall fiscal and organizational health of the City and continued pursuit of community goals in the long-term. In addition to presenting draft expenditure reductions for the City Council’s input in advance of the June 2026 Budget Hearing, this item also includes an overview of changes that staff are making to the budget to improve transparency and other work being done to ensure that the organization is well positioned to address evolving community needs. Lastly, staff are seeking Council input on funding of the Section 115 Trust and consideration of termination of the Fiscal Health Contingency Plans activated in 2023 and 2025. Additional information for each item follows.
Overview
Development of the 2025-27 Financial Plan and General Fund Long-Term Forecast
2025-2027 Financial Plan Development
The 2025-27 Financial Plan includes a balanced budget of $117.6 million in expenditures for the General Fund despite slowing revenue growth, rising costs, and rapid shifts in federal policy with significant expected impacts on economic conditions. Achieving a balanced Financial Plan required changes to how the City develops its budget, both in terms of how revenues were forecasted and expenditure budgets were developed. Revenue forecasting methodology was changed, especially in property taxes, to more accurately predict results. Salary savings
2 assumptions were slightly increased to better align with recently observed trends. Departments were asked to submit base budgets that constrained non-staffing costs to FY 2024-25 adopted levels, requiring staff to more accurately forecast expenditures and, in some cases, to reduce funding for discretionary items. Notably, this constrained base was also applied to the second year of the 2025-27 Financial Plan despite continued observed cost increases. These changes in the City’s budgeting methodology should be expected to result in lower end of year unassigned fund balance, while increasing the risksthat revenue targets may not be attained and expenditure budgets may be exceeded if unanticipated expenses arise during the year.
The City also reallocated $1.0 million of Local Revenue Measure (LRM) funding from the capital budget to the operating budget to maintain funding for ongoing operations. This recommendation was made because the City has had difficulty delivering on a very ambitious Capital Improvement Plan since the passage of Measure G-20 due to ongoing staffing challenges as a result of a national shortage of engineers and competition with neighboring agencies for engineers and project managers. The Capital Improvement Plan (CIP) included in the 2025-27 Financial Plan was adjusted to more accurately reflect the City’s current capacity to deliver projects, and minimal impact is expected as a result of the modest reductions in CIP funding.
The table below provides a high level view of the General Fund Long-Term Forecast included in the 2025-27 Financial Plan:
Table 1. Financial Plan Long-term Forecast
Planning for 2027-29 Financial Plan
While these changes were sufficient to deliver a balanced budget for the current Financial Plan period, the Long-Term Forecast for the General Fund still indicated a deficit beginning in FY 2027-
28. This deficit was largely driven by the addition of the projected costs to open and operate a fifth fire station at the south end of the City. The requirement for a new fire station (Fire Station 5) comes from the development agreement for Avila Ranch which the City entered into in 2017 and obligates the City to open the station once the development is more than 50% complete, anticipated to occur in the second half of FY 2027-28.
The City typically updates its Long-Term Forecast every six months. Table 2 below provides a revised Long-Term Forecast for the General Fund and includes many of the changes incorporated
3 with the 2025-27 Financial Plan, in addition to new items that reflect current understanding of the City’s economic outlook. The 2025-27 Financial Plan assumed that the $1.0 million reduction in capital expenditures would be temporary, and that this funding would be restored to the capital budget in FY 2027-28. Based on the fact that the $1.0 million decrease to CIP funding has resulted in minimal impact to City projects, and in order to avoid significant impacts to City services through deeper reductions to the operating budget, staff recommend continuing to fund capital expenditures at this lower level going forward. The CIP has been built to accommodate this funding shift, so no impacts are anticipated to the funding levels or projects included in the current CIP.
The revised Long-Term Forecast also reflects lower than previously forecasted City payments to CalPERS thanks to strong investment returns in recent years. For each year that CalPERS generates investment returns in excess of its target rate, the City should see savings relative to the projected annual increases. It is important to note that the converse is true when CalPERS experiences poor investment returns which cause City contributions to increase more quickly than projected. Other updates to the Forecast include increased Transient Occupancy Tax revenue based on recent strength in tourism, increased development fee revenue based on an uptick in permitting activity in the last twelve months, increased franchise fee revenue based on recently implemented changes to solid waste fees, and a reduction in cannabis tax revenue based on a sharp downturn observed in FY 2024-25.
This revised Forecast also reflects modest changes to the timeline for the opening of the fifth fire station. Previous versions of the forecast assumed that all operating costs for the station would be incurred for the entirety of FY 2027-28 but based on the buildout of Avila Ranch to date, staff now expect only a partial year of operating costs will be necessary.
The net impact of these changes is a significant improvement to the forecasted deficit, decreasing from the June 2025 forecast of $3.0 million in FY 2027-28 down to $1.2 million and effectively eliminating the forecasted $1.9 million FY 2028-29 deficit, as detailed below:
4 Table 2. Updated Long-term Forecast
The forecasted deficit shown above is projected to be reduced over time as revenue eventually grows more quickly than expenditures, as has typically been the case for the City. This assumes continued growth in consumer spending, tourism, and property values, and also assumes no new programs or other costs outside of those identified below. The forecast above still indicates a need for expenditure reductions, and those reductions will be factored in with the development of the FY 2026-27 Supplemental Budget (identified below in the recommendations section).
Consistent with historic forecast methodology, the Long-Term Forecast for the General Fund reflects known expenditure changes from the current year, most notably the addition of $2.0 Actuals Financial Plan Forecast
FY 2024-25 FY 2025-26 FY 2026-27 FY 2027-28 FY 2028-29
Tax & Franchise Revenue
Sales Tax $ 54,357,111 $ 55,470,441 $ 55,766,497 $ 57,439,492 $ 59,593,473 Property Tax 24,923,847 25,944,966 27,112,490 27,925,865 28,973,085 Transient Occupancy Tax 11,417,888 11,099,705 11,495,652 11,830,022 12,310,522 Utility User Tax 7,501,436 6,605,306 6,671,359 6,871,500 7,129,181 Business Tax 3,138,271 3,230,170 3,262,472 3,360,346 3,486,359 Franchise Fees 2,622,351 2,242,429 2,793,556 2,862,363 3,050,951 Cannabis Tax 814,502 1,000,000 800,000 850,000 900,000
Total Tax & Franchise Revenue 104,775,406 105,593,017 107,902,026 111,139,587 115,443,571 User Fees
Development Review 5,697,332 4,606,812 5,806,435 6,047,628 6,317,295 Parks & Recreation 2,643,907 2,280,283 2,320,590 2,390,207 2,473,865 Fire 3,331,998 1,759,183 1,774,654 1,827,894 1,891,870
Police 834,584 690,200 690,200 710,906 735,788
Business Licenses 792,548 632,470 732,469 754,443 780,849 Total User Fees 13,300,370 9,968,947 11,324,348 11,731,078 12,199,666 General Government 7,778,702 1,669,077 1,778,568 1,703,801 1,739,494 2023 Storm Reimbursement 909,090 - - - -
Total Fees & Other Revenue 21,079,071 11,638,024 13,102,916 13,434,879 13,939,160 Total Revenue 126,763,568 117,231,041 121,004,942 124,574,466 129,382,731 Operating Expenditures
Staffing 75,489,526 76,242,202 80,215,937 84,661,616 87,655,863 Other Operating Expenditures 18,291,470 24,124,355 18,222,995 18,385,360 18,757,109 Cost Allocation (5,367,608) (5,671,069) (5,552,675) (5,830,309) (6,121,824) Total Operating Expenditures 88,413,388 94,695,488 92,886,257 97,216,667 100,291,148 Debt Service 1,757,889 1,724,965 1,512,468 1,515,354 1,513,783 Financing Activity - - - - -
Capital 26,010,000 25,523,604 25,574,676 26,602,020 27,154,060 Other Transfers 7,231,653 1,132,074 792,339 429,911 466,671 Total Expenditures 123,412,930 123,076,132 120,765,740 125,763,952 129,425,662 Revenue - Expenditures 3,350,638 (5,845,090) 239,202 (1,189,486) (42,931) Use of Fund Balance 9,167,831 5,845,090 246,000 - -
Surplus / (Deficit) $ 12,518,469 $ - $ 485,202 $ (1,189,486) $ (42,931)
5 million in operating costs related to Fire Station 5 coming online in the out years. In addition to costs that have been factored into the forecast, it is also important look ahead to upcoming known initiatives that will require an investment of staff time and/or financial resources. This exercise provides important context for the budgetary decisions made on an annual basis, as it is important that the budget will be able to support new initiatives in the coming years.
New Initiatives (Forecasted and Not Forecasted)
Forecasted Initiative. In addition to Fire Station 5 operating costs which were included in the forecast presented with the 2025-27 Financial Plan, staff has also added a “one-time” cost estimated at $375,000 in FY 2027-28 to support an update to the City’s Housing Element of the General Plan, to maintain compliance with State law (California Government Code §65585 requires that local governments update their housing elements every eight years; the City last updated the housing element in 2020).
Non-Forecasted Initiatives. Other upcoming changes and new initiatives that are currently NOT factored into the revised General Fund forecast include, but are not limited to following:
Decrease to Opioid Settlement Funds currently supporting County Licensed Psychiatric Technicians assigned to Community Action Team and Mobile Crisis Unit. Licensed Psychiatric Technicians (LPT) from the County that support the Community Action Team and Mobile Crisis Unit are currently paid for with Opioid Settlement Agreement funds.
The annual allotment of settlement funds is less than the annual cost of the LPT contracts, and this shortfall has been offset with prior year Opioid Settlement balances which are forecasted to run out in FY 2027-28. Absent additional settlements, the General Fund would need to subsidize or fully support the cost of the contracts if the City determines that they should continue absent an identified alternative funding source. The City’s current cost for both positions is $235,063 and increases by 2.5% - 7.5% annually per the contracts with the County. The table below details the projected revenues and expenditures:
Table 3. Opioid Fund Balance
Development Impact Fee Study. Per Government Code 66016.5(a)(8), Development Impact Fee studies are required to be updated at least every eight years, from the period FY 2024-25 FY 2025-26 FY 2026-27 FY 2027-28
Settlement Revenue $ 333,073 $ 183,212 $ 129,808 $ 121,188 LPT Contracts 127,303 235,063 246,816 259,157
Surplus / (Deficit) 205,770 (51,851) (117,008) (137,968) Opioid Fund Balance $ 205,770 $ 153,920 $ 36,911 $(101,057)
6 beginning on January 1, 2022. The City initiated a Development Impact Fee Study in FY 2023-24, but that effort was tabled due to turnover in staff leading the effort and some identified issues with fee policy and program administration that needed to be addressed before the study could be finalized. Work is underway to address some of the identified issues, but the City will need to move forward with a new Impact Fee Study to be adopted by 2030 in order to comply with State law. In FY 2025-26, the City Council approved a Significant Operating Budget Change (SOBC) in the amount of $190,136 for consultant expense to conduct an impact fee and Infrastructure Finance program analysis and Impact Fee Study. Staff is using a portion of the funding currently through work with a consultant to develop a funding plan for the construction of the Hwy. 101/Prado Road Interchange project. That effort in part will also support the future impact fee study. In addition, staff is working to identify a consultant to assess and make recommendations for administration of the fee program. It is expected that these efforts will fully utilize the available funding and that an additional $100,000 may be needed in the 2027-29 Financial Plan timeframe to support the Impact Fee Study.
User Fee Study. Per the City Council's adopted policy related to User Fee Cost Recovery, the City should conduct a User Fee Study every three years. The last User Fee Study was accepted by the Council on July 2, 2024. Staff will need to initiate the next User Fee Study in FY 2026-27 for adoption by the City Council in Spring 2027 to comply with the User Fee Cost Recovery policy. Based on the cost of the last User Fee Study, staff estimates a $50,000 cost for consultant support for this effort in FY 2026-27. Additional potential future costs. Beyond the items noted above, the forecast also does not include:
o The potential addition of staff positions as recommended in the Police Department Staffing Study and Public Works Maintenance Division Staffing Study (both presented to the City Council on January 14, 2025). The cost to add all of the positions recommended in the Police Department’s staffing study is estimated at over $2.8 million a year, based on current position costs (note that with adoption of the 2025-27 Financial Plan, the City Council approved the addition of
2.00 FTE Police Officers at a total cost of $324,282, which was partially supported by COPS Hiring Program funding which covers up to 75% of the entry-level salary and benefits for each position for a three year period). The cost to add all of the positions recommended in the Public Works Maintenance Division staffing study is estimated at $727,996 annually, based on current position costs. To date, the City Council has approved three of the positions recommended in the staffing study; the annual cost for the remaining positions is estimated at $259,522 based on current position costs. Although not included in the staffing study
7 recommendations, it is also worth noting that development of new facilities will require additional staff resources to maintain those assets. o The potential creation and administration of a Rental Housing Registry program (to be discussed during the upcoming Rental Housing Registry Study Session on February 24, 2026).
o Cal Poly on campus fire service needs.
o Ongoing implementation of new fire hazard severity zone maps. o Additional investments in Downtown including economic development funding set to expire at the end of the current financial plan. o Ongoing work to address Oracle ERP related issues identified as part of an upcoming system “health check” that is designed to ensure that business processes are stable and that the City can maximize use of the system.
While the costs of these upcoming efforts are only estimated at this time, staff are tracking these important initiatives to ensure proper planning so that the budget is well positioned to support these costs when or if the City will incur them.
The Path Forward: Summary of Next Steps
In order to address the forecasted deficit, staff plan to recommend budget reductions with the FY 2026-27 Budget Supplement. These reductions have been carefully selected to minimize community and organizational impacts, but some impact is inevitable. In addition to these reductions, staff also plan to implement several operational improvements to maximize transparency and service delivery in a constrained funding environment. This multi-pronged approach will both address the structural deficit and set the organization on a course for future success.
First, staff have identified several improvements to the budget process that should help achieve greater efficiency and transparency goals. The potential changes, which may require additional funding and take multiple years to accomplish, are detailed in additional sections below and are summarized as follows:
Ensuring that the budget and the long-term forecast for the General Fund are consistent and utilize the same methodology, continuing improvements implemented in the 2025- 27 Financial Plan.
Revising and more clearly communicating the City’s revenue forecasting methodology.
8 Clearly communicating that the ability to make additional discretionary payments (ADPs)1 to CalPERS relies upon the availability of unassigned fund balance at year-end, which is largely generated through salary savings and conservative revenue forecasts. Potentially changing the General Fund’s reserve calculation methodology. Historically, the City has excluded the City’s annual Unfunded Accrued Liability (UAL2) payments to CalPERS from its calculation of overall General Fund operating reserve amounts. The assumption has been that an amount equivalent to a 20% reserve for the UAL payments has been held in assigned fund balance and therefore excluded from operating expenditures for purposes of calculating the reserve requirement. The amount held as assigned fund balance for this purpose has been steady at $2.0 million for the past several years. As the annual UAL payment for the General Fund will be $15.3 million in FY 2026- 27, this methodology does not provide a true 20% General Fund reserve. A General Fund reserve that incorporates current UAL payments would be approximately $3.1 million higher in FY 2026-27.
More accurately budgeting for Public Safety overtime, which has been underfunded for years. Typically, overtime budget exceedances have been absorbed within the Fire and Police Department budgets by staffing vacancies, but increased service demands, such as increased police presence at special events and mutual aid support requests, have put additional strain on these budgets. As a result, staff plan to recommend that all public safety budget reductions discussed below are re-allocated to overtime to more closely reflect actual expenses.
Staff also plan to invest in the organization to standardize and improve operations. This will include thoughtful reorganizations to realize operational efficiencies and improve service delivery, and the ability to implement new initiatives, such as those discussed above, to address future needs, and the creation of a long-term strategic framework that brings all of the City’s goals, values, and services into one place, helping staff to spot overlaps, streamline work, and stay focused on what matters most to the Council and community. Additional information regarding this strategic framework is included below.
1 Additional Discretionary Payments allow the City to improve its funded status more quickly than required by CalPERS.
2 Annual UAL payments are payments required by CalPERS to pay down the City’s unfunded liabilities over 20 years.
9 Recommendations
Expenditure Reductions
Following adoption of the 2025-2027 Financial Plan in June 2025, staff began a comprehensive budget reduction exercise to develop thoughtful options that would address the identified budget deficit. All departments prepared two sets of budget reduction options equal to 5% and 8% of the departments’ respective ongoing operating budget. These targets were intentionally set higher than what was believed necessary to address the structural deficit and higher than staff expected to recommend to provide flexibility for economic deterioration and to ensure that a sufficient range of options would be developed at one time, rather than over and over again, to minimize disruption and anxiety for the organization. All departments and all major funds were included in the exercise. The one exception was Special Revenue funds, which were excluded since the City has limited ability to control and adjust those budgets. Public Works and Utilities provided lists of reduction options for the City’s four Enterprise Funds (Parking, Transit, Water and Sewer), but staff is not recommending reductions to those programs at this time. The Leadership Team carefully reviewed proposed reductions over several days to ensure that the final recommendations would generate sufficient savings while minimizing impacts to the community and the organization.
The result of this process is a list of expenditure reductions totaling $1,663,973, of which $576,379 is recommended to be re-allocated to public safety overtime, for a net reduction in spending of $1,087,594. The recommended expenditure reductions represent significant effort by staff and deliberation by the Leadership Team to identify a means for reducing expenditures while minimizing impacts to the community and to staff. Consistent with Council’s adopted Budget Balancing Strategies, recommendations do not reflect across the board reductions. While all departments participated in the exercise and reductions are recommended in each department, there is variability in the amounts and types of reductions between departments based on the anticipated service level impacts, ability to address critical items including core services and Major City Goal work programs, and consideration of the existing constraints within departmental budgets.
Budget balancing and reduction exercises can cause anxiety and uncertainty for any organization if not done thoughtfully and transparently. Understanding this, City leadership has prioritized communication on this topic and provided regular updates to City staff through the budget balancing exercise via all staff emails and the City Manager’s bi-monthly all employee briefings.
The City Manager and Finance Director also held a series of “Budget Balancing Listening Sessions” at the Police Department, Fire Department, City Hall and the Corporation Yard through the month of January to provide additional information and answer staff questions. In late January and early
10 February, City leadership also met with represented employee groups to review reduction recommendations, and no significant concerns were expressed.
The proposed reductions by department, including the relative size of the reduction as a percentage of current year budgets, and the proposed Full Time Equivalent (FTE) personnel reductions are detailed below:
Table 4. Expenditure Reduction Summary
Notably, all positions recommended for elimination are vacant or will become vacant3, before they would be eliminated, and those vacant positions will remain unfilled to ensure that they can be eliminated without impacts to existing employees effective July 1, 2026. Recommended reductions do not result in the layoff of any filled positions.
Descriptions of the reductions proposed for each department are included in the tables below:
3 Three Firefighter positions are recommended for elimination in the Fire Department; however, only two are currently vacant. Staff anticipate that at least one Firefighter will pass the Fire Engineer qualification examination before the end of FY 2025-26, which would create a third vacant position. If a third vacancy does not occur by July 1,2026, no current employee will be adversely affected by the recommended position eliminations.
Department
FY 2025-26
Adopted Budget Reductions % of Budget FTE Reduction
Administration/IT $ 10,983,688 $ 175,700 1.60% 0.50
City Attorney 1,657,575 60,853 3.67% (0.15)
Community Development 7,973,537 170,125 2.13% -
Finance 2,770,356 29,935 1.08% -
Fire 18,214,320 453,246 2.49% 3.00
Human Resources 2,037,833 48,200 2.37% -
Police 25,564,923 123,133 0.48% 1.00
Parks & Recreation 6,141,965 90,042 1.47% -
Public Works 17,428,593 506,240 2.90% -
Utilities 1,381,664 6,500 0.47% -
Total $ 1,663,973 4.35
11 Table 5. Expenditure Reduction Detail
12
13
14 Improving Budgeting Practices to Improve Transparency As discussed earlier in this report, development of the 2025-27 Financial Plan and June 2025 General Fund Long-Term Forecast reflected some changes to the City’s recent forecasting and budgeting practices. With the expectation that the budget will continue to be tight in the coming years, staff continue to work to refine forecasting and budgeting methodology to increase accuracy and improve transparency. Following is a discussion of the work being done on budgeting practices, as well as a discussion about the City’s Section 115 Trust to support the City Council in making a determination about whether the Trust should be utilized to support future payments to CalPERS.
Section 115 Pension Pre-Funding Trust
As part of the 2019-21 Financial Plan, the City Council identified establishment of a Section 115 Trust Fund as a work plan item under the Fiscal Sustainability Major City Goal. Establishment of the Trust was to be completed by February 2020 but was delayed due to uncertainty about the budgetary impacts of COVID-19. The Trust was eventually established in early 2023. Prior to its establishment, $2.0 million was assigned in the General Fund reserve to be deposited to the Trust
15 upon establishment. In addition to the $2.0 million assigned for this purpose, staff had planned to recommend allocation of $2.4 million of FY 2022-23 unassigned fund balance to make an initial contribution to the Trust. However, staff instead recommended, and Council approved, allocation of that funding to the Infrastructure Investment Fund to address significantly increased infrastructure costs on projects in motion due to historic inflationary factors.
Despite $2.0 million being designated for the 115 Trust, the City has not made an initial contribution to the Trust. In other words, the Trust has been created, but there is currently no money in it. The $2.0 million remains in the General Fund reserve and could be deposited into the Trust, paid directly to CalPERS, or unassigned and moved into the General Fund budget or unassigned fund balance to support capital or operating costs, subject to City Council direction.
At this time, staff is seeking Council direction on whether or not the City should move forward with depositing the $2.0 million in assigned funding into the Trust. Though the City has not made an initial contribution to the Trust, it is important to note that the City has made a total of $24.8 million in Additional Discretionary Payments (ADPs) to CalPERS since 2019 to paydown its pension liability. ADPs represent payments beyond what the City is required to pay on an annual basis. In FY 2025-26, the City will make a total of $25.6 million in payments to CalPERS, inclusive of the ADP, assuming Council’s modified allocation of FY 2024-25 unassigned fund balance included in the Second Quarter Budget Report on February 17, 2026.
Internal Revenue Code § 115 enables governmental entities to establish a pension prefunding trust to set aside and invest money to pay for pension contributions, unfunded accrued liabilities, and other long-term retirement costs, rather than relying solely on pay-as-you-go contributions.
Any earnings on investment are tax exempt under Internal Revenue Code § 115. In California, there are multiple options that local agencies can choose from when establishing a Section 115 Trust. When the City established a Trust, it did so through the California Employers Pension Prefunding Trust (CEPPT), a multiple-employer trust administered by CalPERS. According to CalPERS, approximately 100 of 3,000 CalPERS agencies have elected to use CEPPT as their pension contribution prefunding trust fund; cities make up 25 of the 100 participating agencies.
In March 2023, staff engaged Foster & Foster, an independent national actuarial consulting firm, to perform a review of the City’s progress in paying down unfunded liabilities. Based on the Foster & Foster actuarial report, the City’s commitment to paying down its pension debt by making additional ADPs has helped to make progress on improving the plan’s overall funded status.
Feedback provided by the City’s independent Actuary was that the City is taking appropriate action to make progress in paying down the unfunded pension liabilities. A negative investment return of -7.5% for CalPERS in FY 2021-22 provides a good reminder that the City’s ability to address unfunded liabilities is heavily impacted by factors outside of the City’s control. The primary recommended strategy coming out of the Foster & Foster report wasto continue to make
16 required CalPERS payments and ADPs. The City Council adopted Fiscal Policies prioritize applying end of year unassigned fund balance toward ADPs and the City assumes that at least the first $2.0 million of unassigned fund balance will be used to make Additional Discretionary Payments annually. Inclusive of the FY 2025-26 payments, the City has made nearly $130.0 million in ADP and UAL payments to CalPERS since FY 2018-19 when the ADP strategy was launched, as detailed in the chart below:
Table 6. Pension Payment History
Despite these investments, the City’s pension plan remains underfunded. As of the most recent actuarial report date, the City’s plans were 66.2% funded with an unfunded liability of $188.4 million as detailed in the table below:
Table 7. Pension Funded Status
At this funded ratio, the City of San Luis Obispo is behind most other CalPERS agencies. The chart below shows the distribution of CalPERS members as of June 30, 2024:
As of June 30, 2024
Plan Assets Accrued Liability Unfunded Liability Funded Ratio Miscellaneous $ 191,435,452 $ 291,293,527 $ 99,858,075 65.7% Safety 178,415,852 266,992,598 88,576,746 66.8%
Total $ 369,851,304 $ 558,286,125 $ 188,434,821 66.2%
17 Table 8. CalPERS Agency Funded Status Distribution
Following is a summary of considerations that staff recommend the City Council make in determining whether or not to deposit funding into the City’s 115 Trust:
1. Trusts help an agency to build a cushion, providing for some level of budget stability.
Contributions to a trust before they are needed allow funding and investment earnings to accumulate over time, which can help to offset future employer contributions. This can serve to reduce volatility in annual budgets by providing a “rainy day” pension fund to support CalPERS payments in years when payments increase or the City experiences budget strain.
2. Deposits are irrevocable and cannot be used for any other purpose. Any funds deposited into a trust can only be used to support paydown of the City’s pension debt. If the City were to need funding for an urgent need, funds deposited in the Trust could not be tapped for other general uses.
3. Contributions don’t reduce the City’s unfunded accrued liability. Contributing to the 115 Trust serves to obligate funding for future payments, but does not actually reduce the City’s unfunded accrued liability until the funds are paid to CalPERS.
4. Investments of deposits into a Trust assume some level of market risk, but could potentially yield higher returns than the City’s managed investments. Currently, the amount assigned to the 115 Trust is invested along with the rest of the City’s cash in low risk, low yielding securities. The City’s pension is managed by CalPERS, which seeks to maximize returns in the long run by taking on additional market risk. A 115 Trust investment strategy would be somewhere in between. The Trust would take on more risk than the City’s managed
18 investments in order to generate higher returns, but would most likely underperform the returns realized by the CalPERS portfolio over time.
5. Funding the Trust does not guarantee a decrease to long-term costs. While trusts can reduce volatility and bolster the ability to make payments to CalPERS, they do not guarantee lower total costs, particularly if investment returns are below expectations.
6. Development of a policy is important to govern use of the Trust. Should Council direct that staff deposit the $2.0 million that is currently assigned for contribution to the Trust, staff recommends that Council consider development of a policy framework to govern contributions to and use of the Trust. Policy considerations to be made include but are not limited to:
a. How and when Trust should be funded
b. Use of funds held in the Trust for future payments to CalPERS c. Roles of the City Council and staff
d. Reporting and transparency
Staff seeks guidance from Council on whether the $2.0 million assigned for deposit into the Trust should be used for that purpose or reallocated for another one-time use.
Budgeting for Salary Savings
In evaluating the City’s financial plan for transparency and ease of use, staff have identified that one point of confusion has come from the City’s practice related to how salary savings are forecasted versus how they are budgeted. The long-term forecast is based on the budget and is used to determine that the budget is balanced in the current year and that it is sustainable in the future. The long-term forecast for the General Fund currently assumes that 4% of salaries and benefits will be unspent at year-end4. This common practice is based on the reality that the City will experience staffing vacancies. However, the budget assumes all positions are fully staffed year-round. Historically, this forecast practice has not been incorporated into the budget. As a result, all departments could finish the year under budget for staffing and benefits and still have spent more than the long-term forecast assumed. In order to address this issue, staff plan to incorporate the vacancy assumption into the budget so that the budget and forecast are aligned.
The table below details the methodology change using FY 2025-26 numbers:
Table 9. Vacancy Assumption
4 This assumption was increased from 3% to 4% with the 2025-27 Financial Plan. Based on a 5 year lookback, the General Fund has typically returned 4-7%. When calculating the vacancy rate, the CalPERS UAL is excluded from staffing costs since the UAL is a fixed cost.
19 Because this methodology is already used in the long-term forecast, which is used to validate that the budget is balanced, there is no expenditure reduction or impact on unassigned fund balance attributable to this change in methodology. The only impact is a more accurate and transparent budget.
Funding Additional Discretionary Payments to CalPERS
The City’s pension plans are less than 70% funded and, with the exception of FY 2020-21 which benefited from strong investment returns, have been since 2008. At this funding level, the City is required to make annual payments towards the Unfunded Accrued Liability as calculated by CalPERS. In order to lower these annual payments and address this pension debt over time, the City has made Additional Discretionary Payments (ADPs) to CalPERS since FY 2018-19. The forcing function for these payments has been a policy that any unassigned fund balance at year-end be used for ADPs to CalPERS, Infrastructure, and Emerging Health and Safety Needs. These payments were set at $2.0 million per year for the General Fund with the 2023-25 Financial Plan, and in development of the 2025-27 Financial Plan Council updated its policy regarding ADPs to increase the annual payment commensurate with staffing cost increases. In the current year, the City will make an ADP in the amount of $3.1 million ($2.5 million from the General Fund). ADPs are entirely discretionary on the part of the City and are not required by CalPERS. The City’s ability to continue to make these payments depends upon sufficient unassigned fund balance, which is often a result of conservative budgeting.
When the City began making ADPs to CalPERS, they were made with unassigned fund balance and not budgeted. With the 2023-25 Financial Plan, $2.0 million each year was set aside in the General Fund Long-Term Forecast for ADPs. This funding was removed from the 2025-27 Financial Plan in order to achieve a balanced budget.
Revenue Forecasting Methodology
The City’s operating budgets are generally funded by anticipated revenue, not previously collected sums. Staff must accurately forecast the amounts reasonably expected to be collected.
If this forecast is too conservative, programs will be denied funding unnecessarily and the excess funds will instead be used for one-time purposes only. If revenue is forecasted too aggressively, the City risks inadvertently dipping into its reserves and creating an immediate need for budget reductions.
Budget Forecast
Staffing $ 78,762,988 $ 78,762,988
(Vacancy Assumption) - (2,520,785)
Net Staffing $ 78,762,988 $ 76,242,202
20 On balance, the City has generally erred on the side of conservatism in revenue forecasting. With the 2025-27 Financial Plan and the updated long-term forecast shown above, staff have developed more granular revenue forecasts intended to accurately predict year-end results. The expected result of this change should be lower unassigned fund balance in good years, or, if economic conditions deteriorate, revenue may underperform against budget.
Staff plan to provide additional commentary in future budget reports to better communicate these considerations.
More Accurately Budgeting for Public Safety Overtime to Increase Accountability The Police and Fire departments’ operations incur a significant amount of overtime pay , but their budgets do not reflect this. Public Safety is required to staff certain positions daily to ensure the ability to respond to the community needs. When these positions are not filled with regular staff, they are backfilled at overtime rates. Overtime needs include coverage of shifts due to vacancies, work related injury absences and illnesses as well as special assignments. In the absence of realistic overtime budgets, service levels have only increased. New overtime assignments have been added for special events like Farmer’s Market and City Council meetings.
In recent years, the two departments combined have exceeded their overtime budgets by approximately $2.0 million per year. Both departments have also experienced vacancies in recent years, and the savings from those vacancies has offset their overtime spending as detailed in the table below:
Table 10. Public Safety Staffing
In FY 2025-26, both departments are on track to modestly exceed their overall staffing budgets.
Without additional funding, the departments will likely exceed their staffing budgets each year with impacts on year-end fund balance. As an initial step towards rectifying this issue, staff recommend that all budget reductions from Police and Fire are re-allocated towards their respective overtime budgets. This results in zero net savings from the public safety departments as detailed in the table below:
Table 11. Public Safety Re-allocations
Public Safety FY 2022-23 FY 2023-24 FY 2024-25
Overtime Variance $ (1,870,837) $ (1,695,569) $ (2,016,962) Salary Savings 2,327,107 1,706,406 2,058,789
Net Staffing Variance $ 456,270 $ 10,837 $ 41,827
21 Fiscal Health Contingency Plans
In October 2001, the City created a Fiscal Health Contingency Plan (FHCP) to establish a framework and general approach to respond to adverse fiscal circumstances such as economic downturns or unforeseen impactful events. Activation of the FHCP does not signal a dire financial condition but is a proactive measure to keep the City’s budget in balance without significant operational consequences. The FHCP has been activated several times in recent years, including in 2020 in response to the COIVD-19 Pandemic, in 2023 in response to the 2023 Winter Storms, and most recently in April 2025 in response to a projected imbalance in General Fund revenues and expenditures. At this time, both the 2023 and 2025 FHCPs remain in effect and staff is seeking Council’s input on next steps on each.
Activation of the FHCP in 2023 was driven largely by the significant anticipated and unbudgeted costs to respond to the damages caused by the significant storm events in January and March of that year. At the time that the FHCP was activated, staff estimated that the impacts of the storms would add about $9.0 million of unanticipated costs to the budget over two years. Activation of the 2023 FHCP included the following components:
1. A hiring chill requiring City Manager approval prior to filling all regular and supplemental positions, as well as hiring consultant services.
2. A purchasing chill which limited purchases to those necessary to support daily operations of essential City services, or related to storm response.
3. Capital Improvement Project deferrals for projects that were not already in construction or design, in order to provide flexibility for adjustments to the Capital Improvement Plan to address cost escalation and emergent projects related to the storms.
At time of activation, the City Manager’s intent was to terminate the FHCP upon having additional clarity about how the unbudgeted storm costs would impact the budget overall, and the timeline for cost reimbursement from the Federal Emergency Management Agency (FEMA). In August 2023, the FHCP was modified to remove the requirement for departments to obtain City Manager approval to fill vacant positions, but the purchasing chill remained in place, focusing purchases to those intended to support operations of essential services, storm response and Major City Goal tasks; limiting food purchases only to circumstances where staff is required to work over the lunch hour or outside or normal business hours; and focusing travel and training expenditure on training needed to maintain required certifications, support public health and safety or other high priority Reduction Re-allocation Net Savings
Fire $ 453,246 $ (453,246) $ -
Police 123,133 (123,133) -
Public Safety Total $ 576,379 $ (576,379) $ -
22 service needs. To date, the 2023 FHCP has not been terminated and is still in place due to uncertainty about the timing of project cost reimbursements from FEMA.
Activation of the FHCP in 2025 was driven by a forecasted flattening in the City’s revenues and increasing expenditures, driven largely by the requirement to bring a fifth fire station online. As noted earlier in the report, activation of the FHCP was accompanied by development of the 2025- 27 Financial Plan which constrained non-staffing operating budgets to FY 2024-25 adopted amounts. Activation of the 2025 FHCP included the following components:
1. A hiring chill requiring City Manager approval prior to filling all positions.
2. A travel chill requiring City Manager approval of all travel authorizations. An exception is made for travel for trainings necessary to maintain job-required certifications, which can be authorized by department heads.
Over the last several months, staff have been working to update the General Fund Long-Term Forecast to reflect more current fiscal information (discussed earlier in this report). As a result of the improved forecast and the preparation of proposed budget reductions that will address the updated deficit amount, the 2025 FHCP was modified in early January to: remove the requirement for City Manager approval for travel consistent with the City’s Travel Policy; and streamline the process for obtaining City Manager approval to fill vacant positions by reducing the amount of information that departments are required to provide (though the hiring chill remains in place for all positions).
At this time, the City Manager is planning to terminate the 2023 FHCP, due to the significant progress made on high priority storm-related projects. At this point, the FEMA process is well underway, with all of the City’s projects having been submitted to FEMA for review and consideration of reimbursement. While the City has made good progress in navigating FEMA regulations and obtaining a nominal amount of reimbursement, it is unlikely that the City will achieve complete clarity on the amount of total reimbursement or when those amounts will be received given ongoing discussions at the Federal level about budgetary and policy issues. While staff initially expected that reimbursement would be necessary to replenish the operating reserve, strong results in FY 2024-25 replenished the reserve instead.
The FY 2026-27 Budget Supplement will include a net of just under $1.2 million in expenditure reductions, pending input from the City Council as part of this item. In combination with the improved Long-Term Forecast, the expenditure reductions serve to bring the budget into balance over the next three fiscal years. On its face, the conditions that triggered activation of the 2025 FHCP have been mitigated, but it is important to acknowledge that the impacts of Federal Policy changes, such as tariffs, on consumer spending and local economic conditions remain uncertain.
At this time, the City Manager is planning to terminate the 2025 FHCP following consideration of
23 this item on March 3, 2026, given the updated Long-Term Forecast and the planned budget reductions to be incorporated into the 2026-27 Supplemental Budget that are described above.
Operational Initiatives
Supporting our Workforce and Modernizing How We Do Business As the City addresses its current fiscal challenges, supporting the workforce and continuing to modernize internal systems remain essential to maintaining service levels and delivering on the City Council’s adopted work plan. Staffing capacity, effective systems, and clear processes form the foundation of the City’s ability to carry out its responsibilities in a constrained fiscal environment.
Current efforts are focused on strengthening this foundation through targeted workforce investments and process improvements. Examples include developing additional training and support for City staff involved in budgeting and purchasing to maximize opportunities for cost savings, including updates to the City’s purchasing policy, ongoing investments in financial systems that increase efficiency and reduce manual processes, continued refinement of capital project delivery and work-planning practices to better align staff time with Council priorities, and exploring the use of artificial intelligence (AI) to automate basic tasks and increase time available for strategic work. These efforts improve long-term effectiveness, but they require sustained attention and staff capacity to implement successfully. Maintaining progress on existing workforce and modernization efforts is critical to ensuring organizational stability and avoiding overextension.
As the Council looks ahead to FY 2026-27, staff will be closely considering how to balance continued investment in these foundational efforts with interest in new initiatives and/or existing workload.
Balancing Workload and Exploring New Initiatives
The City continues to explore new initiatives in response to evolving community needs and City Council direction, along with existing commitments to implement the City’s plans and policies.
Moving forward, organizational capacity and fiscal constraints require that any new efforts be evaluated carefully alongside existing commitments.
Some initiatives can advance using existing resources and focused sequencing. For example, work is underway to implement a communications and outreach plan related to the Citywide Single Vote method for electing City Councilmembers, and early planning is occurring for renter protections, safe housing strategies, and neighborhood livability standards. Other initiatives, such as new ongoing programs or capital projects, require dedicated staff time, coordination, and
24 follow-through to be successful. Each will need to be evaluated with current resources and existing commitments and will likely require tradeoffs.
During the June 2026-27 Budget Supplement process, staff will return with options that outline potential adjustments, sequencing strategies, or tradeoffs needed to ensure that existing priorities, foundational work, and new initiatives can be delivered in a realistic and sustainable manner. At this time, the recommended changes to workplans are expected to be minor to moderate depending upon on the workgroup.
Alignment Through a Longer-Term Strategic Framework
City Councils have long navigated the challenge of balancing near-term focus areas with the City’s ongoing services and long-term goals for the community, as well as clearly communicating how these pieces fit together for the public, a tension that often surfaces during the goal-setting process. During the February 2025 goal-setting discussions, these questions again emerged, leading to a decision to add the topic as an agenda item for deeper conversation at the April 2025 biennial Council retreat.
During the April 2025 Special Meeting, the City Council discussed the need to better align the City’s long-term commitments, shorter-term goals, emergent priorities, and essential “core” services. While core services are central to the City’s role and frequently support the achievement of Council and community goals, they are not always clearly reflected in the City’s adopted Major City Goals and programmatic service levels and investments have not been systematically identified for the public. To address this, Council expressed interest in developing a longer-term strategic framework or strategic plan that brings the City’s goals, values, and core services into a single, cohesive structure. The framework would organize existing commitments, improve continuity across City Councils, and help both Council and the community understand how City work fits together at a high level.
To support the development of this strategic framework or plan, staff will use the efforts completed as part of the budget reduction exercise to prepare a list of current programs and their respective service levels and/or key performance indicators, as well as the resources that the City is currently dedicating to each program. This list will help inform the preparation of a strategic plan, as well as any future discussions of trade-offs and priorities when considering new programs or work plan items. Staff will present a proposed process for the development of a strategic plan as part of the 2026-27 Budget Supplement staff report.