Faced with rising operating costs, nearly no growth in the residential and commercial sectors and sharply reduced revenues, Oak Bluffs officials will have to cut spending even more this year as they begin to draft the town’s next operating budget.

Town administrator Michael Dutton on Tuesday told selectmen the town faces a $1 million deficit at the start of this budget season. Although it is early in the process, he noted, and that figure is expected to shrink, the early shortfall is a telling indicator of the tough economy facing the Island.

“This year is kind of a perfect storm of reduced revenues and increased expenses,” he said.

Mr. Dutton said there were scant additions to the town tax rolls and a significant drop in the excise tax for motor vehicles from the county. He said the cost of health insurance is projected to increase by 10 to 12 per cent while other fixed costs, such as heating oil and the annual county retirement assessment, are expected to climb as well.

“This may be a bombshell to some people, but this is the reality of the situation,” chairman Kerry Scott said. “Every year we talk about cutting costs — but this year it’s especially pressing. It’s not a question of whether we make cuts this year, but where we cut and how much.”

Town officials were faced with a $600,000 deficit at the start of the budget season last year, but managed to cut that figure down and craft a balanced budget that did not require an override of Proposition 2 1/2 — a state law that restricts annual increases in the town’s property tax levy.

But the $1 million deficit this year is the largest in the town’s history, and even surpasses the $900,000 deficit of 2001 when, among other things, officials implemented a hiring freeze at the Oak Bluffs school and considered ending town trash collection.

Mr. Dutton said the $1 million deficit was a conservative estimate, and could increase substantially. An accounting rule change adopted in 2004 by the Governmental Accounting Standards Board may force the town to set aside approximately $600,000 in unfunded retirement benefits, a figure yet to be added to the $1 million figure.

Further complicating matters is the recently completed compensation and classification study which recommends raises for certain town employees who are paid below the average wages of employees in other towns.

“This year is especially tough,” said selectman Roger Wey as he took stock of the town’s finances. “It’s not like we have to cut $200,000 or $300,000 here. We’re talking about well over $1 million.”

Mr. Wey said town officials should work to reduce the budget instead of asking voters for a Proposition 2 1/2 override.

“We’ve got our work cut out for us. I don’t think the people of this town will accept an override because a lot of them are just getting by right now by the skin of their teeth,” he said.

The dire financial forecast prompted selectmen to revisit some old ideas about raising new revenues and driving down the deficit.

Selectman Ron DiOrio suggested the town negotiate with the Martha’s Vineyard Hospital for payments in lieu of taxes. He cited agreement requiring the Massachusetts General Hospital — which owns the Martha’s Vineyard Hospital — to the pay the city of Boston $1.5 million in lieu of taxes last year.

Although it is unlikely Oak Bluffs would receive that kind of compensation, Mr. DiOrio said any amount would go a long way towards offsetting the deficit.

“I have consistently said there are no free rides in this town . . . and we need people to recognize that having that facility in our town and off our tax rolls is not fair or equitable,” he said.

Ms. Scott later appointed a delegation headed by Mr. DiOrio to get in touch with and perhaps meet MassGeneral administrators about some type of an agreement.

In other developments, selectmen tabled a proposal to transfer a business license held by Cheryl King, owner of King’s Rentals on Circuit avenue extension, to Jason Leone, the owner of Island Hoppers in Vineyard Haven.

Mr. Wey and Ms. Scott said they wanted more time to perhaps convince Mr. Leone to reduce the number of mopeds at King’s Rentals, which now is permitted to rent 50 mopeds, six cars and five motorcycles.

Mr. DiOrio said he had safety concerns about the interplay with the adjacent movie theatre, and worried the business’s customers might block the theatre’s exit when they dropped off mopeds and cars.

“I worry we are creating what could be a very dangerous situation here,” he said.

Selectmen also heard a proposal from Vernon Welch and James Sanfilippo, owners of the newly formed Vineyard Green Tours. The businessmen said the tour company, which would use buses that run on bio-fuel, would pick up customers at the Oak Bluffs ferry terminal and bring them out to the Gay Head Cliffs in Aquinnah.

Several selectmen said they liked the idea, but asked the fledgling tour company to gather more information about where the buses will pick up customers and what routes they will take through town.

“I think everyone who visits the Island should go and see the magnificent cliffs at Gay Head, but we need more information before we can allow this,” Ms. Scott said.