Despite recent growth in revenues, Palo Alto is bracing for another year of budget challenges and uncertainties, with pension costs climbing and the COVID-19 omicron variant threatening to slow down the city's economic recovery.

The city's new long-term financial forecast, which covers the years 2023-2032 and which the City Council approved on Monday night, offers some hope to city leaders who have spent the past two years slashing dozens of positions and cutting the general fund budget by more than $40 million. Tax revenues, which constitute almost 60% of the general fund, are now projected to be about $11.6 million — or 10.5% — higher in the current fiscal year than in the city's adopted budget. With sales-, property- and hotel-tax revenues all climbing higher than expected, the new forecast also projects a $9.1 million in revenues in fiscal year 2023, which begins on July 1. And by fiscal year 2024, overall tax revenues are projected to reach pre-pandemic levels.

Yet as the recent surge in omicron cases suggests, the city's economic recovery remains fragile and prone to unexpected setbacks. And even the projected surplus won't be enough to allow the city to fully restore all the services that council cut in the summer of 2020, Chief Financial Officer Kiely Nose said during Monday's discussion of the city's financial outlook.

The forecast represents the first step in the council's process for adopting its annual budget, an exercise that typically concludes in June. In discussing the document, the council agreed that even despite the mostly positive projections, the city should continue to look for ways to save money. Mayor Pat Burt and council members Tom DuBois and Greg Tanaka all supported identifying ways to make city operations more efficient by adopting new technology or contracting out services.

Significantly, the forecast does not include major capital projects such as grade separation at railroad crossings, improvements to the municipal animal shelter or implementation of the parks master plan. It also does not involve any major spending relating to the city's Sustainability and Climate Action Plan, an ambitious effort to cut local carbon emissions by 80% by 2030, with 1990 as the baseline year. Nor does it include the potential influx of revenue that the city would receive over the next decade if voters approve a business tax in November.

Nose said that while the expected revenue will not allow the city to bring back all of the services it had cut during the pandemic — the upcoming budget discussion will involve restoration of some of the recently slashed positions. The cuts included about 70 positions in City Hall, which included 32 positions in the Police and Fire departments. They also entailed elimination of the community shuttle program, the reduction in library hours and reduced staffing at Fire Station 2 in College Terrace.

"After talking with departments … there are certain areas where we just went too far," Nose told the council Monday. "We did it in a way to Band-Aid for what we hoped was a short period of time. It's just not sustainable."

The council's ability to restore services is also circumscribed by the city's gaping pension obligations, which amount to more than $40 million in fiscal year 2022. The percentage of the city's payroll that is devoted to pension payments is projected to climb. For public safety employees, the percentage of the payroll going to retirement is set to go from 69.6% in the current year to 71.1% in 2023, to 72.9% in 2024 and to 74% in both 2025 and 2026 before it starts do go down.

Altogether, salaries and benefits in the general fund are projected to increase by $7.2 million, or 5.2%, in the next fiscal year, going from $131.5 million to $138.8 million.

Council member Alison Cormack noted that despite the positive projections, the city is actually faring worse than other cities in the area when it comes to property taxes, which represent the largest tax revenue category in the general fund. She cited a recent report from the Santa Clara County assessor that rates Palo Alto 15th out of 16 cities in the county when it comes to growth rate in property tax.

"We're growing more slowly than the vast majority of the cities, in terms of property tax," Cormack said.

Burt attributed the city's relatively poor showing on property tax growth to its ongoing efforts of capping office space.

"Of course, additional offices would add additional property tax," Burt said. "It will also add and exacerbate the jobs-housing imbalance and worsen those problems and congestion and a whole bunch of other things. … We could go back to big office growth and expand our property tax base and bear the consequences of that."

Tanaka, who voted against accepting the forecast, argued that its projections of growing revenues are too rosy. He pointed to growing labor costs, worsening inflation and the growing number of retail vacancies in the city's commercial districts as signs that conditions may get worse.

"I see some storm clouds," Tanaka said. "Hopefully some bright points as well, but (there are) some storm clouds on the horizon. Some of them are big and treacherous and I'm worried about that."