DATE: JUNE 19, 2007 CMR: 265:07 REQUEST TO INCREASE THE CITY OF PALO ALTO S TRANSIENT OCCUPANCY TAX

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1 TO: ATTENTION: HONORABLE CITY COUNCIL FINANCE COMMITTEE FROM: CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES DATE: JUNE 19, 2007 CMR: 265:07 SUBJECT: REQUEST TO INCREASE THE CITY OF PALO ALTO S TRANSIENT OCCUPANCY TAX RECOMMENDATION Staff recommends that Council direct staff to authorize a vote of the electorate at the November 6, 2007 election to increase the City s Transient Occupancy Tax (TOT) from 10 to 12 percent. In addition, staff recommends that Council consider funding of promotional activities, such as Destination Palo Alto, that support tourism. BACKGROUND California Revenue and Taxation Code (7280) authorizes the legislative body of any city or county in the State of California to levy a tax on the privilege of occupying a room, hotel room or other lodging establishment for a period of 30 days or less. This tax is commonly referred to as a transient occupancy tax (TOT) or hotel tax. Palo Alto s TOT was originally adopted as a general tax by Ordinance No in July The tax is assessed by hoteliers on behalf of the City on transients who stay in Palo Alto for 30 days or less. The tax is imposed on all occupants except officers or employees of a foreign government who are exempt by express provision of federal law or international treaty, as well as state and federal workers on official business. The initial 5 percent TOT was increased to 6 percent in 1976 and was last increased in 1983 to its current rate of 10 percent. In 1986, Chapter 2.33 of the Palo Alto Municipal Code was amended to reflect various administrative changes to the TOT ordinance. Palo Alto s tax rate of 10 percent is within the median range statewide and slightly above the median rate of 9.75 percent locally. As illustrated in the chart below (see attachment D for full survey of Bay Area cities), most local cities, with the exception of East Palo Alto, have TOT rates of 10 percent. Statewide TOT rates range from 8 percent to a high of 15 percent. CMR: 265:07 Page 1 of 6

2 CITY TOT RATE San Jose 10 % Mountain View 10% Sunnyvale 9% (9.5 effective Jan. 09) Menlo Park 10 % E. Palo Alto 12% Redwood City 10 % San Francisco 14% The number of available rooms in Palo Alto has decreased by 21 percent over the last 5 years. Two hotel closings contributed to the decrease in availability. The Craig Hotel, a 63-room lodging establishment, closed in However, the most significant decrease occurred in when the Hyatt Hotel closed its 350-room Palo Alto location. Palo Alto has 28 lodging establishments representing 1,865 available rooms which generated revenues of $6.24 million in Although TOT revenue decreased significantly in recent years, it remains a major source of funding, accounting for more than 5 percent of the City s total General Fund revenue. Palo Alto s proximity to the international port city of San Francisco, its vibrant downtown, Stanford Research Park, and its association with world renowned Stanford Hospital and University, make Palo Alto an attractive destination point for business and leisure travel. DISCUSSION The passage of Propositions 13, 62 and 218 made distinctions between types of taxes and the voter approvals required to enact them. Tax categories determine when elections are held, how the revenue can be used and what percent of the vote is required for passage. For voting purposes, all taxes are categorized as either general or special taxes. Revenue from general taxes may be used for general governmental purposes. Revenue from special taxes is earmarked for a specific purpose. This distinction determines whether a tax must be approved by a majority vote of the electorate (general tax), or a two-thirds vote (special tax). Assuming a TOT tax increase would be used for general government purposes, it must be submitted to the electorate at a regularly scheduled general election at which members of the Council or governing body will be elected, unless, by unanimous vote, the Council finds that there is an emergency that justifies placing the proposed tax before the voters at a special election. The tax will take effect if approved by a 50 percent + 1 simple majority of voters voting in the election. Timetable A general tax ballot measure must be submitted to the County of Santa Clara 88 days before the scheduled regional general election. If this deadline is not met, the City s next opportunity to place a measure before the voters will be in November Staff has outlined the critical procedures and timelines that must be met for the TOT ballot measure to qualify for the November 2007 general election. CMR: 265:07 Page 2 of 6

3 Responsibility Required Procedure Timeline Finance Committee Make a recommendation to the full Council regarding adoption of the TOT Ordinance City Council Pass Finance Committee recommendation to submit TOT tax increase to voters (2/3 Council vote required). Approve the resolution submitting ballot measure to voters, designate ballot argument authors and authorize the City Attorney to prepare an impartial analysis. Ballot arguments approved. June 19, 2007 July 9, 2007 July 9, 2007 August 6, 2007 Upon completion of the required actions, the City Clerk will file the resolution with the County of Santa Clara and manage the ballot measure argument process. These actions must be completed no later than the August 6, 2007 Council meeting for the ballot measure to qualify for the November 6, 2007 general election. Chapter 2.33 Administrative Changes The use of technology in the hotel industry has expanded to include on-line registration. Internet travel sites such as Expedia, Orbitz, Hotels.com, Priceline.com and Travelocity are becoming increasingly popular with business and leisure travelers. There are two basic models used for Internet room sales. The first model does not present a collection problem for the City, but the second model can result in underpayment of TOT. The first model simply charges a rate for the hotel and the hotel tax is remitted to the City on that rate. Under the second model, the hotel and the Internet travel company negotiate a discounted rate for the hotel room. The on-line provider then marks up its inventory of rooms to sell to the public, adds a service charge to the room rate and offers it at the higher price to the customer. It charges and collects taxes from travelers based on the marked-up rate, but only pays taxes to cities based on the lower, negotiated retail rate charged to the customer. The Internet providers argue that the added service charge should not be subject to occupancy taxes because it is not part of the room rate. The Internet companies contend that the service charge reflects the cost associated with operating and marketing their services. Nationwide, municipalities are suing the Internet travel companies alleging substantial underpayment of transient occupancy taxes. Municipalities are responding to this problem through vigilant enforcement as well as clarifying legislation. Staff recommends that the City s ordinance be amended to clarify that the TOT shall be applied to the full hotel rate paid by the actual transient. CMR: 265:07 Page 3 of 6

4 Business Community Outreach In an effort to determine business community response to the proposed increase in the TOT rate, staff contacted twelve of the City s largest employers. Of the companies that responded, 44 percent indicated that a TOT increase of 2 percent would not adversely affect company business practices. The remaining companies indicated that an increase would make Palo Alto hotels less competitive and could result in their booking reservations at hotels in surrounding communities. Staff has also met with the Chamber of Commerce and made a commitment to continue the dialogue process. Summary of Comments: Pro I m not saying the 2% increase would be critical, but it would certainly go into our calculation. I don t think it would make much difference. It s not that big a deal. It doesn t seem like much. It shouldn t make much of a difference. There are not enough hotels to begin with. Supply and demand is more the issue. The 2 percent increase is not going to break them, put it that way. Con We would worry about the hotels in Palo Alto. The increase would make our hotels less competitive and we d start putting people up in Mountain View. We as a company are not too happy with it. It increases our budget costs, plus hotel rates themselves are going up. Surveyed other cities and found their rates at percent with no plans for increasing them. Therefore, we would be likely to put employees and job applicants up in hotels in East Palo Alto, Mountain View, Menlo Park and Los Altos. Oh, when people visit us, hotel rates are already so high for what we get. We re nonprofit, so it s hard to find something affordable. This wouldn t help. Would book people at hotels in Mountain View. Get quite a few visitors from the East Coast and from Indiawho stay for long periods of time. Two percent would make a big difference, particularly when they re staying at higher priced hotels. Would choose less expensive hotels, with a less expensive TOT, in Mountain View. CMR: 265:07 Page 4 of 6

5 Tourism Funding Recommendation To support visitor outreach, the City Manager is recommending that Council consider funding efforts that promote tourism in Palo Alto. Destination Palo Alto has been established by the City Manager to improve economic growth, by encouraging tourism and visitorship and exploring ways to package and promote marketable attractions in Palo Alto. Through marketing campaigns, these organizations provide an opportunity to simulate the local economy and promote Palo Alto as a destination of choice among prospective business and leisure travelers. Promoting community specific programs and services will give Palo Alto a competitive advantage over surrounding cities, and facilitate tourism by sponsoring events that highlight Palo Alto s flourishing cultural and historical essence. Managed and funded outreach programs will encourage visitors to explore, experience and return to Palo Alto. RESOURCE IMPACT After modest growth over the past two years, transient occupancy tax revenue surged upward by 12.4 percent in The average citywide occupancy rate consistently exceeded 70 percent in the latter half of for the first time since Average daily room rates rose by 9.7 percent in Per Diem rates in exceeded $130, a level not seen since First quarter data show both room and occupancy rates rising further. In the first five months of the fiscal year, average citywide occupancy and room rates rose by 4.4 and 4.7 percent, respectively. An increase in the TOT rate of 1 to 2 percent is predicted to increase net General Fund revenues by approximately $624,000 to $1.2 million annually. The proceeds of the TOT as a general tax will be deposited in the City s General fund and used for general governmental purposes. The past 5 years, , have been the City s most challenging period of fiscal reform. The regional economic downturn resulted in reductions in the City s workforce and reductions to the General Fund expense base of approximately $20 million. As the City develops a sustainable budget and meets the $3 Million infrastructure challenge set as a policy by the Council, it must consider new revenue sources. Without identifying new revenue sources, further cost savings and service reductions will be necessary. As the City evaluates options, among the opportunities for revenue generation is the potential to increase the TOT. POLICY IMPLICATIONS The actions described in this report are consistent with existing City policy. ENVIRONMENTAL REVIEW The actions described in this report do not constitute a project for the purposes of the California Environmental Quality Act. PREPARED BY: JOYCE WHITE Senior Financial Analyst CMR: 265:07 Page 5 of 6

6 DEPARTMENT HEAD APPROVAL: CARL YEATS Director, Administrative Services CITY MANAGER APPROVAL: EMILY HARRISON Assistant City Manager ATTACHMENTS Attachment A: Resolution Calling a General Municipal Election Attachment B: Resolution to Amend Palo Alto Municipal Code Attachment C: Ordinance Amending Chapter 2.33 of Title 2 of the Palo Alto Municipal Code Attachment D: Survey of Bay Area TOT CMR: 265:07 Page 6 of 6