The shortfall marks the fifth consecutive year of such imbalances.

Town Manager Debra Figone, finance director Steve Conway and other staff members presented the proposed budget to the town council on May 16. Though they inquired about the specifics, council members did not ask that any changes be made to the budget, as they did last year.

Department managers were asked to reduce expenditures by 4 percent, which hit some departments harder than others. The community development department, for example, will increase fees for building inspection, plan checking and other services. In contrast, the police department will freeze two vacant sworn officer positions and eliminate some non-sworn personnel.

Conway said that the tax revenue increase of about 3 percent is helpful, but that other challenges remain. Personnel costs have risen, most notably the town's contributions to the Public Employees Retirement System. The town is also including raises for some employees in order to remain a competitive employer.

The state's dismal financial picture has also made balancing the town budget difficult, he said. Though voters approved Proposition 1A in November, limiting the state to two years of property tax revenue "takeaways" from local governments, the coming fiscal year is the second of those two years.

Additionally, the state legislature can still declare two fiscal emergencies in 10 years. In that event, the takeaways can continue. Conway said he has received information that 2006-07 will be a difficult year for the state, causing speculation that an emergency will be declared for that fiscal year.

"I don't think we can ever say that we are immune from the state budget," Conway said.

Included in the budget is the creation of a new revenue stabilization fund. At the end of each fiscal year, the town would put half its undesignated fund balance (only 98 percent of the budget is typically expended) into the stabilization fund. It would be used to offset temporary revenue reductions that would likely recover in time. For example, the money could be used to make up for revenue losses from a car dealership moving of town if a new one is expected to take its place several months later.

Figone said the fund would not be like the town's reserve for economic uncertainty, which is maintained to provide funds in the event of an emergency. That fund is currently at $3.7 million, while the new reserve would start with $1.4 million from unspent 2004-05 funds.

"Our intent is for this to be an actively usable reserve," Figone said.

Other budget-balancing measures include an overhaul of customer service operations at town offices. A customer service center will be created and run from the town clerk's office to handle inquiries for the town clerk, town attorney, town manager, finance and human resource departments.

The library department will also restructure its staff. The department's principal librarian is leaving that position, which will be eliminated. An associate librarian will be converted to a circulation supervisor with a slight pay increase and some part-time employees will add hours to their schedules. While cuts to library hours were originally planned, the library will remain open 7 days a week for a total of 54 hours.

The police department, though, was of greatest concern to the council. Los Gatos-Monte Sereno Police Department Chief Scott Seaman explained that two officer positions have been vacant--one since last year and one since February--and they would not be filled. He said those vacancies have already contributed to officer fatigue, but other temporary absences due to injury or pregnancy have also caused some of that recent strain.

The department will attempt to compensate by switching from a schedule of only 10-hour shifts to one with a combination of 10- and 12-hour shifts. Seaman said he expects it will take about six months to evaluate that shift structure, but council members said they wanted to hear from him before that if it appeared to be too challenging.

"If you feel this is not working and it's not February ... don't feel shy in waving," Vice Mayor Diane McNutt said.