Palo Alto is a charter city. As such, it has special rights only insofar as those rights are delegated to it by the state of California. California has every right, legally and morally, to change the current arrangement. As things stand today, Palo Alto enormously benefits from economic growth caused, not primarily by its residents and policies, but by the residents and policies of other portions of the state of California. As such, the residents of California have every right to tell the residents of Palo Alto that they must rezone to allow denser housing. The state has the upper hand both legally and morally.
Palo Alto is happy to see the economic benefits of increased commerce to the Bay Area, but it doesn't feel any responsibility to aid in housing the many thousands of new workers that increased commerce requires. A tiny minority of wealthy homeowners benefit at the expense of a great mass of residents. This is not a tenable situation long-term. Small municipalities in the Bay Area cannot internalize the benefits of economic growth while externalizing the costs indefinitely.