Today, the City is faced with not one or two threats to its financial stability, but three. Combined, these threats are projected to outstrip our capacity to respond without structural changes in our services, levels of service, and workforce. This report describes:

• The scope and nature of the budget crisis.
• A 6-point action plan to respond to the crisis and restore the City’s financial well-being.
• The important roles that the City Council, the community, the City’s workforce, and I will assume in developing and implementing our response.
• An implementation timetable.

The 6-point plan represents a financial strategy for dealing with this budget crisis. Detailed tactics, action steps, and results will be presented at future study sessions on budget issues. The overall intent of this plan is to establish a set of City services that are provided by a workforce that is sustainable for the foreseeable future. Second, this plan will provide a careful, measured implementation strategy that minimizes the effects on existing employees as much as possible. This is essential since our workforce is made up of dedicated, productive individuals who have consistently provided City services to the community at the highest levels.

All cities, counties, and school districts in Silicon Valley are facing similar budget crises. Some are much more severe than ours. Our planning and financial management system gives us two tools that many other cities and counties do not have – cash reserves and time. Both tools will allow us to develop and implement our response to the crisis in a planned, phased manner. We did not create this crisis, yet we are required to solve the problems that have been created. We do not have to totally solve this crisis within the next six months. However, we must begin working now to cut costs, increase revenues, and take steps to reshape our services, levels of service, and workforce. If we can begin this work now, we can avoid the more drastic steps that other nearby cities and counties are being forced to implement immediately.

In late October 1991, three weather systems combined to create one the most intense storms to hit the northeastern Atlantic Ocean in nearly 100 years.

A late season hurricane called Grace formed in the tropics, and began to move up the United States' eastern seaboard. Rather than make landfall somewhere in the Carolinas, an unusually strong and early cold front forced Grace northward. An Arctic cold front formed in northern Canada, and moved rapidly south. It hit the Atlantic Ocean east of Nova Scotia and Newfoundland, at the same time that the most intense weather of Hurricane Grace crosses its path.

Meteorologists called this event the perfect storm. Commercial fisherman that heeded warnings and their past experience survived. Those who did not died.

I. Economic and Financial Conditions

This storm of the century provides some interesting parallels to the economic and financial conditions that the City is facing, and their effects on the City's budget. The current fiscal crisis developed in a short time period. At the beginning of 2000, the national economy was still expanding. This economic expansion was the longest in our nation's history. Local economic conditions were even rosier, powered by the technology and telecommunication sectors and the dot.com boom. City revenues in FY 1999/2000 and FY 2000/2001 continued to climb, with some revenue sources such as Sales Tax and Transient Occupancy Tax reaching all-time highs.

Then things changed, and rapidly. The dot.com boom turned into a bust. The local and regional economy began to lead the rest of the national economy into a long, precipitous downturn. The economic downturn was felt especially hard in Silicon Valley, given its reliance on the high tech and telecommunications industries. The State of California was faced with an unprecedented energy crisis, and then a steep drop in its revenues. The terrorist event of September 11^th further weakened a fragile economy. City revenues were effected as businesses stopped investing in high tech and telecommunication products. A budget "perfect storm" began to form.

The City's planning and financial management system began to pick up the first tell tale signs of the crisis in the second half of FY 2000/2001, and the City began to react. As staff worked on revenue projections for the FY 2001/2002 budget, several key revenue sources were revised over the planning period to reflect the downturn in the economic cycle. Total General Fund revenue for FY 2001/2002 was projected to drop 6%, as compared to FY 2000/2001, and an additional 4% for FY 2002/2003. In fact, the economic downturn occurred in the time predicted but more rapidly and more severely. During the first quarter of FY 2001/2002 staff noticed further signs that the decline was steeper than expected, and had begun reviewing economic assumptions shortly before the September 11^th events accelerated the decline. The Future Fiscal Issues Study Session in January 2002 focused on the significant change in the City’s economic environment and its impact on our planning assumptions. The budget for FY 2002/2003 reflects our belief that we will hit the bottom of the current downturn in late FY 2002/2003 with revenues slowly returning to their normal levels by FY 2007/2008.

Fortunately, in following the Sunnyvale long range planning model, the City continued to "live at the trend line" during the economic boom years and built up its reserves to be used during the inevitable economic downturn. As the downturn materialized, the General Fund Long Term Financial Plan reflected a drawdown of reserves beginning with FY 2002/2003 and extending through FY 2009/2010 in order to continue to provide existing services and programs at established service levels. The power of the Sunnyvale planning and financial management system is reflected in the fact that we were able to incorporate revenue reductions of unprecedented size and term, and still maintain existing service levels.

However, two additional assumptions were included in our planning model: expenditures would increase at or moderately above inflation and future state legislative actions would not add to the problem. Unfortunately, neither assumption appears to have come true.

As will be discussed in more detail in section III, it now appears that the City’s projected costs for personnel will be substantially higher than originally anticipated over the foreseeable future. Staff anticipated sharp increases in the areas of worker’s compensation and medical insurance for FY 2002/2003 and beyond. While increases beyond inflation were anticipated for retirement costs and base wages, recent data has been received that indicates the increases will be much more severe than originally projected.

The Governor's proposed state budget turns a serious problem into a financial crisis. If adopted, the proposed state budget would reduce funding to Sunnyvale in several major areas. First, elimination of the Motor Vehicle License Fee backfill would reduce our revenues by $2.5 million for the balance of this fiscal year, and more than $5 million annually beginning next fiscal year. These funds are used to support critical General Fund services such as police, fire, library and parks. In addition, Sunnyvale stands to lose an eventual $1.5 million in ongoing redevelopment tax increment if the state legislature approves the Governor’s plan to shift these funds to local school districts to reduce the state obligations to education.

The City’s long range planning system has worked very effectively over the years, generating cash reserves in the good times to allow us to weather corresponding economic downturns and maintain stable service levels. However, the Sunnyvale system was not designed to deal with the financial "perfect storm". We need to do more than rely solely on our cash reserves. Our systems could have absorbed the impact of one or possibly two financial storms. We need to begin taking additional actions now. If this issue is not addressed, the fiscal and budget crisis will overwhelm our ability to deliver programs and services at levels of service set by the City Council.

2. Current City Financial Condition

Reflecting the significant downturn in the local and regional economy, the City ended FY 2001/2002 with less revenue than past years and reduced reserves. However, this was not unexpected and in fact year end results were slightly better than projected. Total General Fund revenues were actually $1.5 million higher than forecast, and General Fund expenses were $800,000 lower than expected. The net result of these two factors was a decrease in the General Fund’s 20-year Resource Allocation Plan Reserve of $1.1 million rather than the projected decrease of $3.5 million.

The City was able to absorb salary increases for SEA, Confidential, and Management employees of $1.5 million over budget on an on-going basis through careful budget cuts that did not effect service levels. We also absorbed salary increases for PSOA, COA, and SEIU of $l.4 million over budget on a one-time basis using the improved financial results from FY 2001/2002 mentioned above.

All City funds, including the General Fund, remained balanced to the twentieth year.

The City began FY 2002/2003 financially strong enough to weather the storm, as long as the storm did not worsen. The City could have continued to follow its fiscal strategy in drawing down its cash reserves to deal with these difficult financial and budget conditions, if circumstances had not worsened. Unfortunately, they have. This new fiscal reality will require the City to develop a new fiscal and budget strategy, and to implement it in a planned, phased manner. The purpose of this new strategy will be to reduce the services provided by the City, to reset the levels of service for remaining City services, and to reshape and reduce the City's workforce. There are simply not enough cash reserves available in order to close a growing gap between revenues and expenses.

III. Causes for the Fiscal Crisis

Three forces are converging to cause the fiscal crisis that Sunnyvale now faces. They are:

• the continuing economic recession could reduce City revenues even further;
• personnel costs are increasing at rates higher than projected; and
• the proposed state budget eliminates revenues that Sunnyvale relies on to pay for basic services and redevelopment activities.

Let's look at each cause in some detail.

The City relies on revenues from numerous sources to provide services and programs to our residents and businesses at levels of service set by the City Council. Some revenues are generated locally through taxes paid by property owners, and fees paid by customers who directly use City services. Other revenues come from the State of California, which collects certain local revenues such as Motor Vehicle License Fees on our behalf. Still other revenues come from administrative activities such as interest income. The six sources that generate the largest amount of revenue annually to the General Fund are: Sales Tax, Property Tax, Transient Occupancy Tax, Motor Vehicle License Fees, Utility Users Tax, and Construction related taxes and fees. Together, these six sources represent 88% of the City's total General Fund revenue.

As stated earlier, as staff recognized the impacts of the economic downturn, revenue projections were revised downward. Over the last two years, revenue declines have been significant. Since reaching a high point in FY 2000/2001, Transient Occupancy Tax dropped more than 41% in the next year. Sales Tax dropped about 28% in the same time period. Overall, these declines have taken more than $14 million from the General Fund. Fortunately, because Sunnyvale budgets revenues on the basis of economic cycles, our 20 year financial plan has already absorbed these large revenue decreases, and the current budget and long range plan reflects the severity of the current economic situation.

However, it should be noted that these revenue losses "thinned-out" our ability to absorb future increased costs or revenue losses. Like an older shock absorber, we can no longer run smoothly on a road with deep, unexpected potholes. The impacts of increased personnel costs and the Governor’s proposed reductions in state shared revenues can not be absorbed without affecting our mix of services and the levels of service that we provide.

As discussed earlier, the FY 2002/2003 budget projects that we will reach the bottom of the economic cycle in late FY 2002/2003. General Fund revenues will slowly return to FY 1998/1999 levels in FY 2007/2008. Staff also believes that the high levels of many of these revenues experienced during FY 1999/2000 and FY 2000/2001 were a result of the technology bubble and do not represent the City’s normal revenue patterns. Consequently, we have assumed that revenue levels experienced in FY 1998/1999 represent our actual revenue base.

While current economic data appears to support our projections for recovery, it is far from certain. Further, the rate of recovery is still unknown. If the recession continues or "double dips," then the City’s financial position will be worse than anticipated.

Staff continues to closely monitor the major General Fund revenue sources and identify any potential variations from budgeted amounts in our Financial Report that we prepare for City Council each accounting period. As we have indicated in these reports, we are projecting that construction-related revenues will experience a 20% decline from budget this year and Transient Occupancy Tax is trending 5% lower than anticipated. Recent information on Sales Tax for the Third Quarter 2002 and discussions with our Sales Tax consultant leads to a concern that these revenues may fall short of our projections this year, but thus far we do not have enough data to draw a firm conclusion.

In order to budget City expenses over the long term, assumptions need be made as to how much salaries and other operating expenses will increase in the future. Sunnyvale's long term financial plan includes inflation assumptions for future base wages paid to employees, medical costs, retirement costs as well as other operating costs. These assumptions are reviewed annually, and adjusted as needed to reflect current information and trends. If these assumptions are sustained, the City budget contains enough dollars to pay for current City services at levels of service set by the City Council over the entire 20 year period. If future years' costs are lower than expected, these savings can be used to increase cash reserves, pay for new services, increase levels of service, or some combination of all three. If future years' costs are higher than expected, corrective action needs to be taken to ensure that the financial plan remains in balance.

Two factors are driving personnel costs to levels higher than expected over the long term. These factors are: the City's required contribution rates to the State's Public Employees Retirement System (PERS) and future base wage increases for full time and part time employees. Unfortunately, both retirement costs and base wages are expected to increase at rates substantially higher than the assumptions contained in the long term financial plan.

PERS tells the City annually in October or November what the employer (City) contribution rates are for miscellaneous and public safety employees for the following fiscal year. These rates can vary, based on the market performance of PERS assets, the number of City employees covered by the state retirement system, their base wage rates, and other factors. The City is required by contract to pay these employer contributions at the stated contribution rates. In addition, the City current pays the employee contribution rate for SEA, PSOA, COA, and SEIU employees. This benefit is included in memorandums of understanding with these labor groups. These employee contribution rates are set by state law and remain constant.

There are two reasons for this startling increase: PERS investment losses and a higher wage base than originally anticipated for City employees.

First, and most importantly, PERS has sustained significant market losses in its asset portfolio after a number of years of solid investment gains. Losses in FY 2000/2001 totaled 7.23% of portfolio, and in FY 2001/2002, 5.97%. Further, PERS appears to be headed for a third straight year of losses for FY 2002/2003. Additionally, rates are based on the assumption of an 8¼% annual gain in investments, which further compounds the problem. To put this in context, PERS has only sustained market losses for two consecutive years once in its history, and never for three. Since state law requires that PERS be fully funded, participating agencies like Sunnyvale, other cities and counties, and the State government are required to make up market losses through increased employer contribution rates.

In addition, base wage rates for Sunnyvale employees are higher than projected by PERS. Actuarial assumptions include an annual increase in wages of 3.75%, while the City’s wages have increased at a much higher rate in recent years to keep up with Bay Area market conditions. Also, the conversion of many previously temporary employees to either full time or part time status contributed to the higher wage base upon which the PERS rates are applied.

Fortunately, the City has been reviewing and estimating future PERS rates with a consulting actuary for a number of years because of several inherent limitations in the PERS data. Because the actuarial valuations upon which the contribution rates are based are complicated, PERS uses data that is approximately two years old to set future rates. For example, the contribution rates to be used beginning FY 2003/2004 are based on financial data as of June 30, 2001. This causes factors such as investment losses to have a substantial delay in showing up in contribution rates. Recognizing that this delay may cause cities to underestimate future rate increases, PERS for the first time this year included information on rates for one additional year in its valuations. Even this does not fully recognize the investment losses that have occurred so far. For example, the rates received from PERS for miscellaneous employees were .6% for next year and 6.6% for FY 2004/2005. However, factoring in the investment losses and increases in base wages, we were able to determine that in FY 2005/2006 and subsequent years, rates would rise to approximately 11%.

Until the actuarial valuation received in late October 2002, PERS data indicated that our employer contribution rate would be zero for the foreseeable future for both categories of employees. Staff has never used these very favorable rates in our long range projections of cost. Knowing the current economic climate, staff worked with our actuary to modify the rates received from PERS and incorporate both known investment losses and higher wages into projected rates. As more information has become available, the rates included have increased. However, the historic investment losses could not have been fully anticipated, and the rates included in our current budget are still not as high as needed.

The following table indicates the rates that are currently included in our budget for miscellaneous and public safety employees and contrasts these rates with our latest projections of cost.

It is clear, from this table, that there is a significant gap between what has been budgeted and what will be needed. This gap amounts to about $9.7 million annually over the 20 year planning period. It should be noted that future annual employee contribution rates for PERS may be higher still if they continue to have investment losses or do not earn at least 8¼% annually on their assets. Additionally, if our wage base expands beyond assumptions as discussed below, amounts owed to PERS will be directly impacted.

Actual base wage increases for City employees are determined by several factors. The City has established a policy to provide above average base wages for our employees. This means that the City does not want to be the highest paying city, nor the lowest paying city, in our labor market. Paying fair and competitive wages is important to retain employees, both during economic good times and bad times, especially in a city like Sunnyvale where high productivity is expected.

The policy of paying above average wages to our employees was the basis for negotiating labor agreements with SEA, PSOA, and SEIU. Each memorandum of understanding contains a total compensation formula that determines annual adjustment to base wages. These formulas require that we survey designated cities within our labor market as to various components of compensation, and make adjustments to base wages in order to maintain our position of being an above average payer. SEA's and SEIU's memorandums of understanding also contain catch up provisions to bring base wages up over the course of these agreements because base wages for these employee groups were below average when the labor agreements were negotiated and approved. The compensation policy for SEA employees is to pay market average total compensation plus 2%. SEIU mirrors this approach. For PSOA, the long-standing policy has been to pay 11% above market. Roughly calculated, the SEA policy results in employee wages between the 55^th and 77^th percentile of the market. The PSOA policy results in wages at the 100^th percentile.

The compensation policy for management employees sets base wages at the 75^th percentile for selected benchmark positions. These benchmark positions are used to set base wages for all management job classifications. Base wages are then adjusted annually so that management base wages remain at the 75^th percentile level for similar positions as compared with other cities in our labor market.

In FY 2002/2003, the actual base wage adjustments exceeded the projected increase. Base wage increases for SEA, confidential employees, and management employees were $1.5 million more than budgeted in FY 2002/03. The City Council approved in October 2002 a recommended plan to pay for these increased costs, both in FY 2002/2003 and on a continuing basis. Base wage increases for PSOA, SEIU, and COA employees were $1.4 million more than budgeted in FY 2002/2003. The City Council approved in late November a recommended plan to pay for these increased costs in FY 2002/2003 using one time additional revenues and savings from the prior year. Additional action will be needed to pay for these costs on an on-going basis. Added to the increased expenditures required for retirement costs, about $11 million annually is needed over the long range financial plan.

The significant increases to base wages that were generated by our total compensation formulas were unexpected. In establishing the percentages to be included in the budget for FY 2002/2003, staff took several factors into consideration. First, prior year increases to SEA and PSOA had been significant, bringing them up to market average. Second, current factors such as the economic downturn, low inflationary indexes, and a high unemployment rate in this region led staff to believe that a 3% inflation factor plus the 1.5% over market factor required in the MOU would be adequate. However, the total compensation formula takes into account medical insurance contributions, and it was this element in other cities that increased substantially, driving up our base wages to reflect other employers’ assumption of these increased healthcare costs.

We anticipate that actual pay increases will exceed projections again in FY 2003/2004. Staff reviewed labor agreements for cities within our labor market to estimate the future wage increases that they will be providing for their employees. At this time, estimated increases are 7.06% for SEA and an average of 6% for PSOA. As seen in the table below, this is about 1.3% more than we have included in the long range financial plan for SEA and 3% more for PSOA. If these cities do not reduce base wages for benchmark positions, the $11 million gap will increase.

Governor Davis has released two plans to address the State’s now projected $35 billion budget deficit. In December the Governor convened a special legislative session to consider a FY 2002/2003 mid-year spending reduction proposal. This plan directly affects Sunnyvale by proposing ongoing reductions in State transportation and library funding and suspension of State-mandated cost reimbursement payments. It is estimated that Sunnyvale would lose more than $500,000 in FY 2002/2003 if the mid-year cuts are enacted.

The Governor’s proposed FY 2003/2004 budget contains devastating funding reductions for Sunnyvale, especially with regard to Motor Vehicle License Fees (VLF). The Governor has proposed to eliminate the 67.5% "backfill" that the State provides to California cities and counties. During better economic times, the State provided a "tax holiday" to vehicle owners by reducing vehicle registration costs. Because the State Constitution designates the VLF as a local revenue, the State promised to "backfill" to local governments the reduction in vehicle registration costs. If the VLF backfill elimination is adopted by the State Legislature, Sunnyvale would lose approximately $2.5 million in this fiscal year, increasing to over $5 million annually beginning FY 2003/2004.

The Governor has also proposed a shift of property tax increment revenues generated from redevelopment areas, beginning in FY 2002/2003. In this fiscal year Sunnyvale will lose approximately 3.5%, or around $94,000 in property taxes, due to the previously enacted revenue loss in the FY 2002/2003 State budget. It is unclear at this time what the fiscal impact of the Governor’s proposal will be, as no details have yet been provided by the State on how and when the property tax shift would occur. Over time, Sunnyvale could lose as much as $1.5 million annually.

The proposed reductions for this and future fiscal years represent staggering revenue losses to Sunnyvale. Combined, they represent a 3% reduction in General Fund operating revenues for this fiscal year, and a 5% reduction next fiscal year, for a total of 8% of ongoing yearly revenue reductions. This means fewer dollars available for public safety, public works, parks and recreation, library and other core City services that our residents have come to expect. The table below summarizes the proposed reductions that will impact the City’s General Fund.

IV. Summary

It is clear that we need to intensify our efforts to address the City's most serious financial problem to date. Luckily, our planning and financial management system is providing us with the cash reserves and time so that we can resolve this problem in a planned, measured way.

State law prohibits deficit spending by local governments. The City Charter requires that the City Manager present an annual budget to City Council for its consideration and final action. The City’s Fiscal Sub-element to the General Plan requires that all funds be balanced to the Tenth year. In addition, current Council policy requires that each fund be balanced to the Twentieth year. For these reasons, and given the financial crisis that the City is facing, I am proposing the following plan.

This plan represents the recommended next steps in responding to a rapidly changing, and worsening, economic, financial and budget crisis. Its intent is to reexamine the current mix of services that the City provides, and to reset levels of service where required to deliver a sustainable set of City services at realistic staffing levels. Of course, the City Council, City Manager, City staff, and City residents will have key roles in reaching this outcome.

The City plans its capital projects over a 10-year time frame. The approved FY 2002/2003 10-year capital projects plan includes a total of 350 projects, with a total cost of $176 million over 10 years. We are reexamining all the projects included in the current 10-year capital plan. This review could result in some or all of the following recommendations:

• Suspension of selected projects where construction contracts have not been awarded;
• Suspension of selected projects at the conclusion of the design phase;
• Suspension of selected projects at a logical stopping point before the complete design phase is finished;
• Suspension of selected projects where no funds have been expended;
• Deferral of selected projects from the 10-year plan;
• Removal of selected projects from the 10-year plan.

We will complete this review, and provide recommendations to modify the 10-year capital projects plan.

It may be tempting to believe that the sheer number and total costs for the 10- year capital plan can solve the budget crisis. Reductions in the capital plan can contribute to the solution. It cannot provide the complete solution. First, in most cases, dropping a capital project provides only a one-time reduction in costs. As described earlier, the City is facing a continuing annual gap between revenues and expenses. Second, many capital projects are funded solely through restricted federal and state funding sources. These funding sources cannot be redirected to pay for on-going City services. Third, suspending or deleting a project that will be required in a future 10-year capital plan will buy time, but not contribute to the long term resolution of the budget problem.

The City's budget includes rental rates or overhead charges to cover support services such as vehicles and equipment, City office space, furniture, and equipment costs, information technology costs, telephone, radio, and pager charges, and similar types of common expenses. These rental rates are charged to each program depending upon usage. City staff will reexamine the formulas and schedules for assessing rental rates to City programs. This review will result in some or all of the following actions:

• Revising replacement schedules for information technology equipment, which could result in delays or deferrals in purchasing new or replacement equipment;
• Revising replacement schedules for telephone, radio, and pager equipment, which could result in delays or deferrals in purchasing new or replacement equipment;
• Delaying or deferring office furniture replacement;
• Modifying vehicle and equipment maintenance practices;
• Revising vehicle replacement schedules to extend the working life of vehicles maintained by the City's fleet operations, with a special focus on high cost, specialized vehicle replacement;
• Re-examining the City's policies and practices regarding 24-hour vehicle assignments.

City staff will complete this review, modify rental rates and schedules, and recommend budget modifications to enact revised rates and schedules for consideration by the City Council either for the balance of this year or in the upcoming recommended budget.

Through these analyses, staff will re-examine the assumptions used in developing rental rate formulas, and preparing rental rate schedules. The intended result will be to extend the working life of vehicles and equipment as far as possible without jeopardizing employee health and safety, significantly increasing maintenance and operating costs, or reducing productivity.

The City’s annual budget includes the hours necessary to accomplish each program. These hours can be translated into authorized positions. The City's workforce includes a total of 986 full-time and 77 part-time authorized positions as of July 1, 2002. The actual number of City employees varies throughout the year, as employees leave City employment to take a promotion or to retire.

It is common to have 5-10% of the authorized positions vacant at any one time throughout the fiscal year. Newly created positions require time to fill. Once a vacancy occurs in an existing position, a supervising manager or department director may delay filling the position in order to examine potential reorganization options. It can then take 3-6 months to fill a vacancy after the go-ahead has been given to the Human Resources Department to begin the recruitment process.

I will be reviewing (along with appropriate City staff) all current recruitments, and all position vacancies. These reviews will determine whether recruitments should continue, when and for which positions hiring offers will be made, and which job vacancies will remain open for the foreseeable future. This review could result in some or all of the following actions:

• Completing the recruitment and hiring process for selected positions;
• Completing the recruitment process, but deferring hiring for selected positions for the foreseeable future;
• Suspending the recruitment process for selected positions for the foreseeable future;
• Holding a job vacancy open for selected positions for the foreseeable future;
• Removing funding from the budget for selected positions.

There are two reasons to carefully review all open positions. First, immediate cost savings may be realized. Second, and perhaps most importantly, this will allow the City the opportunity to re-deploy existing employees to current vacancies and minimize the need for future layoffs. If a decision is made to hold a recruitment or keep a position vacant, the hours associated with this position may be frozen or taken from the budget. Any vacancies not filled that will affect service levels will be taken to City Council for policy direction.

The City's fiscal crisis is focused primarily on the General Fund portion of the City budget. The three forces creating the crisis--declining revenues, increasing personnel costs, and proposed state funding cuts--primarily affect the General Fund. Additionally, General Fund revenues are used to pay for the basic City services such as police, fire, library services, and parks and recreation.

However it is important to remember that there are many other funds that make up the City's overall budget. State law allows (and sound financial practices require) that inter-fund transfers be made from these funds to the General Fund in order to pay for services provided by the General Fund and used by these funds. In Sunnyvale, these are called in-lieu fees. For example, a portion of administrative costs for financial management, human resource management and overall City Management is paid for by enterprise and other funds through transfers to the General Fund. I will be working with City staff to reexamine the in-lieu schedules to determine whether allocable costs incurred by the General Fund are being appropriately captured through inter-fund transfers. This review could result in some or all of the following actions:

• No changes to existing assumptions, formulas or schedules used in producing the in-lieu fees and in completing inter-fund transfers to the City's General Fund from other funds;
• Increases in amounts of in-lieu costs charged to funds other than the General Fund, which could result in increased fees and charges to support services provided by funds other than the General Fund;
• Transfer of services (either in full or in part) funded through the General Fund to other funds, which could result in increased fees and charges.

Any action would have to be carefully coordinated with both the Finance Department and the Office of the City Attorney to insure that we are adhering to state laws and requirements, and sound financial practices and policies. Revised in-lieu fees and other funding changes will be included in the recommended budget for FY 2003/2004 or brought to the Council earlier to policy consideration as appropriate.

The four previous points focus on potential ways to reduce the cost of delivering City services. It is also important and appropriate to examine the potential for increasing fees and taxes in order to provide a mix of services at the highest levels possible, given the financial and budget difficulties that we are facing. When given the choice between reducing service levels or increasing taxes in the 2002 Resident Satisfaction Survey, 53% of Sunnyvale residents indicated that they would prefer to consider raising taxes.

I will be working with City staff to study the potential and to identify the steps required to adjust City fees, charges, and taxes, or to impose new taxes, in order to increase revenues to pay for essential General Fund services. This review could result in some or all of the following actions:

• Increasing fees or charges within acceptable levels of market tolerance;
• Reducing or dropping programs where the market tolerance for increased fees or charges does not allow for an acceptable level of cost recovery;
• Adjusting fees or charges for services provided through utility or enterprise funds;
• Identifying potential new sources of revenue to finance services provided through the General Fund;
• Determining the potential and steps required to raise existing taxes or establish new taxes that require voter approval;

No new services or expansions to existing services that increase costs will be recommended without a corresponding fee, charge, or tax increase.

The City's adopted Fee Schedule establishes the current fees and charges that can be modified by administrative action. For example, the Parks and Recreation Director is authorized to set fees and charges for many leisure service classes. Other fees and charges, such as utility and solid waste fees, are set by the City Council. State law requires voter approval for tax rate modifications, such as rates for business license taxes. Any recommended action would have to be carefully coordinated with the Finance Department, specific other City departments, and the Office of the City Attorney to insure that we are adhering to state laws and requirements, and sound financial practices and policies. The City Manager and/or his designees will complete this review, identify actions that require City Council approval, and present recommended actions for consideration by the City Council.

6. Point 6: Reductions to Services, Levels of Service, and Staffing

The first five points of this plan will reduce expenses, both now and on a continuing basis. Revenues will also increase, especially from those services and programs where market tolerance allows fees or charges to be increased either administratively or by the City Council. Increased revenues from new taxes or tax increases are much harder to predict. Regardless, it is clear given our current information that the reduced costs and increased revenues generated by the first five points in this plan will not be enough. The size of the budget problem will require a fundamental re-examination of the services provided by the City, a fundamental re-setting of levels of service, and a phased reduction of the size of the City's workforce in order to establish sustainable staffing levels.

The timing for implementing this 6-point plan is critical. It will be very important to focus first on the first five points included in this plan. The amount of dollars saved and revenues increased through the first five points will minimize the amount of cuts required to services, levels of service, and the size of the City's workforce.

The projected gap between ongoing revenues and ongoing expenses in the General Fund is $11 million annually for the next 20 years. It is critical to state that this figure has been annualized over the 20-year time frame of our long-term financial plan. It does not mean that we will have an $11 million deficit beginning in FY 2003/2004. But it does mean that this annualized figure will grow bigger in future years if we don't take steps now to reduce costs and/or increase revenues.

It is clear that the action items generated and ultimately implemented by the first five points of the plan will not be enough to resolve the budget crisis. Local government must live within its means and cannot deficit spend. Therefore, it is critical that we begin now, even as we implement and refine the first five points in the plan, to examine the range and scope of services that we offer. This examination will reduce the number and/or scale of services we currently provide, the resetting of service levels for remaining services, and establishing smaller staffing levels to deliver a reduced set of City services to our residents and businesses. This review could result in some or all of the following actions:

• Permanent hiring freeze
• Restricted use of temporary employees
• Reopened memorandums of understanding to reduce costs
• Restricted use of overtime
• Reduced workweeks
• Reduced hours of operation for non-public safety services
• Allowable incentives to encourage voluntary employee retirements
• Delays in potential future base wage increases
• Reduced retirement/medical benefits for new City employees

This step will result in potential cuts to the "basket" of services provided, levels of service, and staffing levels. The downside of developing this point in the plan now is that it will assuredly be disruptive and upsetting to employees and the community. However, the downside of not doing this now is that even deeper cuts in service will be required in the future. Further, beginning now will allow us sufficient time to do the planning and analysis for an orderly and well thought out implementation.

Sunnyvale's planning and financial management system provides the means to undertake and complete this required planning. Our system allows us to continually monitor changes in revenue and expense patterns, and proposals and actions being considered at the state level. Therefore, in the schedule of budget work to be undertaken during the next six months, staff will develop this 6-point plan. We do not want to cut more deeply than we have to. We cannot afford to not cut deeply enough if available revenues are not sufficient to pay for service costs.

The process used to develop, review, and enact the City's response to this fiscal crisis is as important as the response itself. City Council members, City staff, City residents, and the City Manager will need to play key roles as the response is developed, refined, implemented, and communicated. This will reduce the potential for one segment of the community to believe that its' interests and priorities are being sacrificed to save others.

I. The City Council

The City Council will continue to address all policy questions and issues that arise as the City addresses this fiscal crisis. It can be expected that policy issues will come up as the 6-point plan is fully developed and enacted. Specific recommendations involving capital improvement plans, reviews of vacant positions, and potential new funding sources or tax increases will need to be considered, and policy direction provided by the City Council. Minor changes in services and levels of service that are generated by the 6-point plan, or more wholesale service and level of services reductions from future efforts, will need to be decided by the City Council. The City Council also will be involved in helping to shape the 6-point plan, especially as new financial or economic conditions require refinements to the plan.

The City Council can also play a vital role in communicating the 6-point plan's purpose, contents, and intended results to individual residents, business interests, community groups, and the public in general. For example, a press conference will be held on Wednesday, January 29^th at 8:30 a.m. City Council members, business and community group leaders, and representatives from the local school districts will be on hand to discuss how the budget crisis will affect the entire community. Constituent meetings, neighborhood meetings, study sessions, workshops, Council meetings, and media coverage all provide opportunities for the City Council and individual Council members to help educate and inform the community about the City's response. Finally, the City Council can provide the means for public participation as the City develops its response. In addition to the informal methods listed, public comments taken at regular meetings and study sessions will provide residents, business interests, and representatives from other types of community groups the opportunity to provide their input to this issue. It will also be recommended that the City Council convene a series of "town hall" meetings to allow the public to learn more about the budget crisis and the City's response, and to share their ideas, opinions, and suggests for addressing it.

II. City Residents, Businesses, and Community Groups

The budget crisis and the City's response to it will affect our residents, visitors, businesses, and community groups. These individuals and groups rely on the City to deliver high quality public services at reasonable, predictable costs. Every attempt will be made to minimize the negative effects the 6-point plan and potential future responses will have on the public, while insuring the long term financial stability of the City. Regardless of whether the effects of our efforts are minor or major, the public needs to be kept informed and needs to feel that it will have opportunities to participate as policy issues are decided. News releases, articles in the Quarterly and Annual Reports, presentations at neighborhood civic group meetings, and a series of regular scheduled workshops on the budget crisis will provide the opportunity to communicate, educate, and inform the public. Study sessions, regular City Council meetings, and a special "town hall" series of meetings are examples of ways for the public to participate in shaping the City's response to this issue.

III. City Staff

City staff will contribute in several ways in developing the response to the budget crisis. Beginning in January, a new feature was added to the City's intranet to collect and respond to suggestions made by staff on ways to reduce expenses and increase revenues. City staff is in the best position to develop cost saving ideas as they deliver City services on a day-to-day basis. Staff can also use their networks and contacts in other local governments to learn about revenue generation ideas that other cities or counties are using and could be applied here. City staff will also fully develop the action steps that will make up the 6-point plan, identify steps that require policy direction, and implement action steps. Equally important, staff will evaluate the results achieved in saving costs and increasing revenues through the 6-point plan, and revise the plan as needed to response to new economic or financial threats.

IV. The City Manager

Finally, the City Manager has several key roles as the City responds to the budget crisis. The City Manager needs to develop and present a recommended response to the budget crisis. These steps have been taken. It is also important that the City Manager (through his staff) monitor the results that will be generated by the plan, and report these results to the City Council. The City Manager will also monitor the proposed state budget and local economic and financial conditions to determine if and when additional responses beyond the 6-point plan are required to response to a larger than expected financial and budget crisis.

Finally, it will be vital to keep City employees informed about the budget crisis and the City's response to it. A comprehensive communications strategy has been developed. For the balance of this fiscal year and into the next, employees will be kept informed through

• a series of letters from the City Manager,
• regular articles in the Harbinger (the employee newsletter),
• all hands meetings, special briefings provided by the City Manager and Executive Leadership Team members at division and department meetings,
• updates included on the City's electronic systems.

This on-going communication with our employees will be vital in keeping employees informed and in keeping rumors and speculation to a minimum.

The City's planning and financial management systems have been crucial in identifying the nature and extent of the budget crisis that is facing the City. More important, these systems are providing the cash reserves and the time needed to develop a measured, planned response to the financial and budget problems. While the City does face a significant budget crisis, it is a crisis that can be addressed in a planned, phased manner over the next several fiscal years. It does not have to be solved by next fiscal year; but it does need to be addressed now while we have the time to take planned, measured steps.

Between now and May 2003, City staff will determine the cost savings and revenue increases that can be included in the proposed FY 2003/2004 budget. In addition, by July 1, 2003, staff will identify and propose the specific action steps that will need to be implemented through future budgets to eliminate the gap between expenses and revenues in the City’s General Fund. The proposed FY 2003/2004 financial plan will be balanced. All funds will be balanced to the 20^th year in the long range financial plan. To accomplish this, a combination of spending reductions and revenue enhancements will be included in future proposed budgets, beginning with the FY 2004/2005 budget and continuing. The reductions and revenue enhancements will be reviewed and adjusted annually to insure that all funds continue to be balanced to the 20^th year.

I. Current Fiscal Year

As described at the December 10, 2002 study session, "belt tightening" steps to reduce spending could have allowed the City to get through FY 2002/2003. However, if the Governor's proposed take back of vehicle license fee backfill revenue for this fiscal year and other revenue reduction proposals are approved, this will create a projected gap of up to $3 million between City revenues and expenses. Spending reductions will be proposed this fiscal year to begin closing this gap. "Belt tightening won’t be enough.

City staff will continue to carefully monitor Sales Tax, Transient Occupancy Tax, state shared revenues, licenses and fees and other key revenue sources for the balance of this fiscal year. Staff will also track the proposed state budget and legislative reactions to it as the budget works its way through the review and approval process. A series of budget issues workshops have been scheduled through the Study Issues Calendar process. They are February 26, 6:30 p.m., March 25, 6:30 p.m., and April 29, 6:30 p.m. Updated information and potential revisions to the 6-point plan will be presented at these meetings, and at the May 20, Budget Workshop, the June 3, FY 2003/2004 Budget Public Hearing, and the June 17, FY 2003/2004 Budget Adoption meetings.

II. FY 2003/2004

Based on current information and revenue/expenditure projections, the size of the City's budget crisis is approximately $11 million annualized over the 20 year planning period. It should be emphasized that this assumes revenues and wage adjustments will hold as budgeted. This figure will grow by an additional $6.5 million annualized if revenue cuts contained in the proposed state budget are enacted. Cost savings and/or fees, charges, and tax increases will need to be implemented during this fiscal year in the amount of $4.5 million, or 40% of the gap. These savings or revenue increases will be generated through the 6-point plan, or by additional responses to the budget crisis. These additional responses will be developed and presented to the City Council during the fiscal year.

III. FY 2004/2005

In order to continue to close the annualized gap of $11 million, cost savings and/or fees, charges, and tax increases will need to be implemented during this fiscal year by an additional $4.5 million, to cover a total of 80% of the gap. These savings or revenue increases will be generated through the 6-point plan, or by additional responses to the budget crisis. These additional responses will be developed and presented to the City Council during the fiscal year.

4. FY 2005/2006

The remaining $2 million, or 20% of the gap, will be implemented in this fiscal year through cost savings and/or fees, charges, and tax increases. These savings or revenue increases will be generated through the 6-point plan, or by additional responses to the budget crisis. These additional responses will be developed and presented to the City Council during the fiscal year.

V. Future Fiscal Years

The implementation plan will be in place for the FY 2004/2005 Budget and fully executed by the end of FY 2005/2006. As can be seen, the 6-point plan will require three and a half years to be fully implemented. The Sunnyvale planning and financial management system provides for this phased approach for reducing the gap between revenues and expenses. This phased approach will allow the mix of City services and levels of service to remain as high as possible. It will also minimize the negative affects of the 6-point plan on employees as much as possible. During the initial implementation, more cash reserves will be used to reduce the gap than spending reductions and/or revenue increases. This ratio reverses during the middle and end of the implementation period.

It has been extraordinarily difficult to propose the steps included in this plan, especially to begin planning for reductions to services, levels of service, and staffing levels. No one on staff can remember when the City was required to implement a reduction in the size of our workforce. Yet, the severity of the City’s budget crisis will require that we resize the services that we provide, reset levels of services for remaining City services, and reduce our workforce.

I believe that it will be essential to avoid creating the sense that there will be "winners and losers" as this plan is implemented. There will be no "winners", as we strive to share the burden that this plan will create. It will be important for the community, the City Council, and the City’s workforce to stand together in seeing our way through this budget crisis. I am confident that the community, Council, and workforce have the ability, willingness, and commitment to do just that.