The council voted 4-2 Monday to raise both rates after it heard from staff that PG&E's higher electricity costs and Santa Clara County Water District's steeper pumping bills made the action necessary unless the city wanted to deficit spend even more. The council also approved the current budget last June with the rate increases in mind, City Administrator Tom Haglund said. Councilwoman Cat Tucker was absent.

The hike means the average family of three will pay about $31 per month for sewer service and about $18 per month for water beginning Jan. 1.

But Councilmen Craig Gartman and Perry Woodward voted against the higher rates because the city should get its water and sewer books in better order before taxing residents, Woodward said. The city has not collected more than $20 million in outstanding water and sewer fees from dozens of businesses that have overused Gilroy's water and sewer systems throughout the years.

"If you were doing a better job collecting what you're owed, you wouldn't need 5 percent more from residents," Woodward said Tuesday.

He pointed to the fact that the money from users' bills finances the maintenance and operations of pipes and other infrastructure, but "staff indicated that the money (from higher rates) was needed not just for operations, but needed for improvements."

In a memo to the council, Haglund wrote, "A 5 percent increase in sewer rates will be necessary to avoid (further deficit spending) and to fund increased improvement costs that will be necessary in the next few years to maintain the sewer system."

The difference between maintenance and improvements is in the bookkeeping. The sewer fund, which is set to run a nearly $1 million deficit, raises money for maintenance from users who flush toilets and take showers, but it also borrows money from a separate sewer account that developers pay into when they build new houses and commercial buildings that require new pipes.

The developers' money along with grants run the city's share of the waste treatment plant and pay for sewer improvements that come with more people living in the city. But because nobody is building - and because this separate account also helped pay for Gilroy Gardens and millions worth of securities that recently lost value as the stock market tumbled - it is running dry. So much so that it will have a balance of negative $1.68 million next fiscal year, down from more than $10.5 million in the black last year. Finance officials also expect the separate, developer-funded water account to run a $2.6 million deficit next year; the water fund that residents pay into is set to run a $1.2 million deficit.

What Woodward spoke about were the developer funds that, he said, would have money if the city would only collect the outstanding water and sewer fees.

When a business comes to town, it agrees with the city on a one-time "impact fee" and then the business pays its separate, much-lower water and sewer bills each month based on actual usage. But throughout the past two decades, more than 120 businesses, ranging from medical facilities to restaurants, have exceeded their agreed-upon usage, effectively using more than they promised.

Since the issue came up almost a year ago, City Engineer Rick Smelser has said his department will begin collecting the money once the council clarifies the "overuse penalties" in the old ordinances that need to be rewritten. The engineering department is spending about $30,000 this year helping to rewrite the ordinances and coming up with a new automated monitoring system to better track over-usage in the future. The council also approved this year's budget with an expected $1.5 million in revenue from collecting a portion of the owed fees. So far none have been collected.

That uncollected money could pay for the improvements that residents are now being asked to foot, Woodward said.

"We have been told, 'Don't worry. There's plenty of money, and we'll eventually collect all this debt.' But now they're saying we have to raise rates on individual consumers at a time when it's very difficult for a lot of people, and that to me seems inappropriate," he said.

Despite the controversy, City Clerk Shawna Freels only received 48 letters of opposition to the rate increase, which amounts to less than 1 percent of property owners. If a majority of the city's 12,500-plus water and sewer customers had written, rates could not increase, according to the state Supreme Court.

Collecting the money in this economic climate could hurt businesses that also pay sales and property taxes. The city's largest debtor, West Coast Linens, recently filed for bankruptcy. It owed the city more than $2.2 million.

In the meantime, the city has been trying to save money by pumping water at off-peak hours to avoid the higher rates, which Haglund said have increased by more than 15 percent since September. Haglund also reminded residents that the city has a tiered rate structure, so folks who use less water pay lower rates.