Despite taking a massive economic hit during the pandemic, Palo Alto's long-term outlook has grown increasingly rosy, with city officials now projecting years of steady growth and budget surpluses.

The projections are included in the newly released Long-Term Financial Forecast, a snapshot of the city's economic climate that covers the period between 2023 and 2032. The long-term outlook suggests that the city is well on its way to economic recovery after a period of a revenue slump and budget cuts.

The hopeful projections are informed by recent trends. A new analysis of tax revenues, which includes both sales- and hotel-tax receipts, indicate that the city's economic performance in the second and third quarters of this year (between April and September) has been strong compared to the prior year, according to Administrative Services Department staff.

While sales-tax receipts declined in fiscal years 2020 and 2021 by 16.3% and 4.7%, respectively, new data shows that the trend is now reversing, with fourth quarter cash receipts in fiscal year 2021 (between April and the end of June) increasing by 28.2% over the same quarter in the prior year, according to a city analysis, which cites significant increases in general retail, restaurants and transportation sectors. Sales tax is now anticipated to generate about $30.6 million in fiscal year 2022, a $2.5 million increase over the budgeted amount. City staff expect this revenue source to rise to $32.3 million in fiscal year 2023.

Hotel taxes, a critical revenue source for funding the city's infrastructure, are also on an upswing. While they remained about 53.15% below prepandemic levels in the first quarter of FY 2022, they were also 229.4% higher (or about $1 million higher) than during the same period in 2021, when the shelter-in-place order was in effect and traveling was significantly restricted.

The city's report on revenues cites the city's strong performance in the second and third quarters of FY 2021 and the city's expectation that "this will continue into calendar year 2022 and beyond, albeit at a slower growth rate, as progress on vaccinations allow economic activity to resume and/or expand particularly in previously shut-down sectors like restaurants, hotels, entertainment, and travel."

According to the report, the city's open hotels had average occupancy rates of 60.1% and average daily room rates of $156.63, according to the report, an increase of 26.5% and 34.8% from the same period in 2020, according to the report.

Altogether, tax revenues remain about $12.3 million — or 9.1% — below prepandemic levels, according to staff. But with just about every tax category showing positive trends, staff projects that the revenues will bounce back to where they were before the pandemic by fiscal year 2024, which begins in July 2023.

Property taxes, which represent about 25% of the general fund revenues (they are, as such, the largest revenue source) are also expected to climb in the next decade, going from $30.6 million in the current year to $32.3 million in FY 2023 and $34.4 million in FY 2024. The growth is expected to continue until 2032, when staff projects $43 million in property tax revenue.

The City Council's Finance Committee, which discussed and approved the forecast at its Dec. 7 meeting, welcomed the new projections, even as members acknowledged that the surpluses in the forecast are unlikely to be achieved. That's because the main scenario in the forecast is based on current staffing levels, an assumption that would not hold up if the council moves toward restoring the services that it reduced during the pandemic. The forecast also does not include the cost of major infrastructure projects, including improvements along the rail corridor, the reconstruction of the city's animal shelter and renovations to Cubberley Community Center.

The biggest wild card, however, is labor costs. The forecast assumes a 2% salary increase for every labor group in every year of the forecast. That projection, however, is based on a hypothetical model rather than actual employee contracts. All of the city's labor groups will see their contracts expire before FY 2023 and actual salary increases will be subject to negotiations.

During the committee's Dec. 7 discussion, both Vice Mayor Pat Burt and council member Eric Filseth said that they expect to see major differences between the numbers in the forecast and those in the budgets that the council adopts every year. Filseth noted that the city's expenditures have traditionally grown at a faster rate than what the long-term forecast projects. And Burt, who has consistently advocated for moving quickly to restore the services that had been cut during the pandemic, suggested that the new numbers only underscore how conservative the council has been in its revenue projections to date.

Burt said it has to be a "deliberate goal" of the council to restore the services that the council had eliminated since 2020, when it cut its budget by $40 million. The reductions, he said, have had a negative impact on the city's ability to recruit and retain its workforce.

"I think these are things we've got to restore to get back to being a Palo Alto that our residents and taxpayers have expected for decades," Burt said.

While Chair Alison Cormack and Filseth generally agreed with that sentiment, both also stressed the need to take a fresh look at the city's traditional spending strategies and consider whether they still make sense. Filseth said that the budgeting process going forward will be "more complex than just adding back stuff we had before." Cormack concurred and said the city will need to be deliberate about what services it should restore.

"If we desire to add back everything that the community used to have … it's worth thinking about: Were those exactly the right things? Do we want more of some things and less of others?" Cormack said. "Because things have changed and the number of people in our community has changed."

The new forecast does not consider the two revenue measures that the council is now exploring, both of which would further supplement the general fund. One is a business tax, which under the council's current direction would be based on square footage and exempt retail. Another is a utility users' tax, which the city is banking on to restore the revenues that it stands to lose because of a lawsuit from resident Miriam Green. Palo Alto has already been ordered to refund about $12 million to its gas customers, a decision that the city is appealing. By going to the voters with a utility tax proposal, the council hopes to reinstate its historic policy of transferring some funds from its gas utility to the general fund, a practice that the lawsuit seeks to invalidate.

While the business tax is almost certain to appear on the November 2022 ballot, the city is less certain about the utility tax. The council recently commissioned a polling firm to measure potential voter support for both measures and is likely to base its decision about the utility tax on survey results.