After falling into a deep funk in spring 2020, Palo Alto's economy is starting to show signs of life, with hotel and sales tax revenues now exceeding the city's projections, a new revenue analysis shows.

The report, which is based on economic activity through June 2021, indicates that the city's sales tax revenues are now projected to exceed budgeted levels by between $2.5 million and $3.5 million. Hotel tax revenues, which plummeted by more than 90% at the onset of the COVID-19 pandemic, are now expected to be $1.1 million more than the city had anticipated when it approved the budget in June — though even with this welcome jolt, they remain about 60% below the prepandemic levels.

Property taxes are also on the rise, with the city expecting between $1.7 million and $2 million from the state as part of settlement between the state and Santa Clara County municipalities on the distribution of the funds, according to a report from the Administrative Services Department that the City Council is scheduled to discuss on Monday night.

The new report offers a glint of economic good news to a council that has spent much of the pandemic cutting staff positions and exploring new tax measures to avoid further service reductions. Last year, the city adopted a budget with about $40 million in cuts, entailing a reduction of 83 full-time positions and 107 part-time positions. According to staff, the city's employee count is now 11% lower than it was in March 2020.

While the budget cuts were less dramatic in the current fiscal year, that was largely due to assistance from the federal government. The city was allotted $13.7 million through the American Rescue Plan Act, money that the council is splitting between the current fiscal year and the next one, which begins on July 1. The council also received $900,000 in CARES Act funds and withdrew $1.8 million from its Budget Stabilization Reserve to balance the books and obviate the need for further cuts.

At the same time, city staff continue to feel budget pressures. The Fire Department lost five firefighter positions thanks to budget cuts, though it is now trying to recruit new employees thanks to funding that the city received through a Staffing for Adequate Fire and Emergency Response (SAFER) grant. The Police Department, which saw at least seven officers depart this year, currently has 10 vacancies in police officer positions and has identified "retention and recruiting" as a critical challenge.

The Public Works Department has about 34 vacancies, according to the new report, including five in the 12-employee group that handles street and sidewalk repairs. And the Planning and Development Services Department, which has seen an uptick in building and planning applications, is "oversubscribed when new Council initiatives are assigned" and "challenged in responding to emerging issues," such as new housing laws.

In addition, the city is fighting a shortage of labor and supply. Supply chain issues have forced the city to delay opening the new bike bridge over U.S. Highway 101, according to the report, and to postpone the opening of the reconstructed Junior Museum and Zoo because of delays in transportation of animals. In some instances, the report states, vehicle replacement contracts have been canceled due to the lack of inventory from vendors. City planners, meanwhile, are having a hard time finding consulting firms with enough availability to assist with plan reviews. This, according to the report, has "led to planning staff carrying several projects beyond the recommended number of projects per staff person."

While the recent revenue increases and the federal aid will help the city balance its budget in the near term, council members are banking on a new business tax as a long-term solution for restoring and potentially expanding city services.

The effort to place a business tax on the November 2022 ballot advanced on Tuesday night, when the council's Finance Committee officially dropped from consideration the pursuit of a parcel tax, which would have applied to landowners and required approval from two-thirds of voters. The committee's decision all but ensures that the measure that will end up on the ballot will be a business license tax based on square footage. The committee also favored possible exemptions for retail and for businesses that occupy buildings with square footage of less than 20,000 square feet, details that the full council will discuss on Nov. 8.

While the details of the business tax will be ironed out in the coming months based on council direction and results of polling, the Finance Committee agreed that the rate should range somewhere between 5 cents per square foot and 20 cents per square foot per month.

The council has yet to determine how the funding would be used, though past discussions had focused on affordable housing and transportation as key focus areas. Now, another key area is restoration of services that had been cut during the pandemic.

To gauge residents' appetite for a business tax, the city is preparing to commission a survey by the firm FM3 Research, which had worked with the city on prior ballot initiatives. The survey will measure residents' spending priorities, their interest in the proposed tax and their level of confidence in local government, according to David Metz, president of FM3.

Metz told the Finance Committee that other cities are finding it harder now to get support for new tax measures than in the past.

"We're seeing a lot of measures polling 5 percentage points lower than they do typically and two-thirds is a hard sell even in a politically advantageous climate," Metz told the Finance Committee on Tuesday. "At this point around the region, 'wrong track' numbers are up. The level of confidence in local government pretty much across the board is lower."

The difficulty of gaining two-thirds support was a key factor in the Finance Committee ditching the option of a parcel tax, which it had previously considered. Chair Alison Cormack said she supports a business license tax, which as a general tax would require majority support. Her colleagues agreed, though there was some debate over what types of exemptions the measure should include. While Vice Mayor Pat Burt favored basing exemptions on business type, Cormack and council member Eric Filseth supported the simpler approach of exempting businesses with 20,000 square feet or less. All three committee members felt that retail should be exempt.

Committee members also acknowledged that it might be hard to accurately gauge public opinion about the new tax given the rapidly shifting economic climate and the council's inability to clearly define exactly how the money would be used. Filseth suggested that if voters don't pass the tax, the city will have to cut staff. But even if that's the case, Burt noted that the extent of the potential cuts is far from clear at this time.

"We don't have a consensus that we're going to have major cuts to services absent this business tax," Burt said.