HomeMy WebLinkAboutExhibit 3• •
1. Introduction
Proposition 13's proponents argued that it was a simple property tax reform. Yet its effects
were not simple, altogether expected, or always benign. To better understand the consequences, both
intended and unintended, this paper will briefly discuss the implementation of Proposition 13 and the
subsequent changes in local finance. It will then identify three major unanticipated consequences of
the proposition and suggest some policy options that might be considered in dealing with them.
Chapter 2 provides an overview of the events that led to the adoption of Proposition 13 and
reviews the actions of the state government in establishing the new local finance system. Chapter 3
describes three consequences that were not part of the debate on Proposition 13 or a central focus of
the legislature's implementation actions. Chapter 4 suggests a policy agenda for addressing these
unintended consequences.
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2. The Adoption and Implementation of Proposition 13:
A Chronology
The Adoption of Proposition 13
Rising home prices, leading to an increase in property taxes, coupled with legislative inaction,
were trends that generally existed through much of the five years predating Proposition 13. When
the California legislature adjourned in the fall of 1977 without passing any significant property tax
reforms, even though 22 different reform plans were proposed, voters quickly signed the circulating
initiative petitions for the Jarvis -Gann proposition (Jarvis -Gann became known as Proposition 13
because of its number on the 1978 ballot). Proponents argued that the proposition was both a
property tax relief measure and a necessary constraint upon the size of government. The legislature
reconvened and passed a potential reform (which necessitated a constitutional change) that would
appear along with Proposition 13 on the June ballot. Proposition 13 easily passed. The legislature's
plan did not.
Although poorly written, the basic rules of Proposition 13 were relatively straightforward. The
maximum property tax rate was set at 1 percent of the value of the property. The value of the
property was set at its 1975-76 level but was allowed to increase by the rate of inflation, up to 2
percent each year. Property could be revalued only upon a change of ownership. No new ad
valorem property taxes could be imposed. Any special taxes (which were not defined) needed to be
approved by two-thirds of the voters. Finally, the distribution of the property taxes that were
collected was to be done "according to law," and since no such law existed, one had to be created.
Prior to the adoption of Proposition 13, local agencies established their own separate property tax
rates and received the proceeds of the tax. For the first time in the state's history, the state was put
in charge of allocating the proceeds of the locally levied property tax, with the rate and base defined
by the statewide initiative,
Implementing a New State -Local Finance System
The election that included the passage of Proposition 13 was only three weeks away from the
beginning of the 1978-79 fiscal year. Facing a reduction of over $6 billion in property tax revenues
for school districts and other local governments, the legislature and the governor responded quickly,
passing SB 154. Although this was a one-year implementation statute, it instituted two actions that
affected future state responses. First, it increased the state's role in delivering and financing local
services by providing block grants to cover the revenue losses of local governments that experienced
a reduction in their property tax revenues. Since counties acted as agents of the state, in addition to
providing local services, the state also "bought -out" parts of various state -mandated programs,
reducing county costs. Second, SB 154 established a formula for the distribution of the remaining
property taxes. Prior to Proposition 13, a property tax payer paid different tax rates to the local
agencies providing services, including several special districts, one or more school districts, a city, and
the county. Proposition ] 3 mandated one tax rate—1 percent of the assessed value of the property,
Since there was one countywide tax rate, the legislature was confronted with the dilemma of
allocating a smaller property tax pie to the same number of governments.
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Following a year of study and legislative hearings, the legislature, in 1979, adopted AB 8, a long-
term response to the fiscal austerity introduced by Proposition 13. AB 8 is still the basic operating
legislation, although it has been amended several times. Much of AB 8 is based on SB 154, although
the bill is a very complex piece of legislation covering a multitude of topics, including retirement
contributions, one-year adjustments, deflator components, and new ways of allocating the collected
property taxes.
There were four principal parts of AB 8, three of which are still important:'
• A guarantee to cities, counties, and special districts that they would receive their SB 154
property tax allocation plus an adjusted amount of the block -grant aid they received in
1978. The funding for this allocation came from a shift of about one-third of the school
property taxes to other local governments. In addition, revenues from assessed value
growth in a jurisdiction were allocated proportionally to local governments and schools,
based on where the growth occurred. This allocation formula quickly became very
complex and is still continually subject to tinkering.
• The state totally bought out the county share of many of the major health and welfare
programs, with partial buy-outs of others, such as AFDC.
• State aid to schools was increased to offset the property tax shift to the other local
governments. This was used as a way of equalizing school expenditures.
Proposition 13 and AB 8 generated two important outcomes. First, the property tax is no
longer a local tax. Proposition 13 sets the rate and base; AB 8--a state law —allocates who gets the
receipts. The amount of property tax received by a local agency is a function of its relative share of
property tax levied prior to Proposition 13. For example, a city that previously had a relatively high
tax rate receives a larger share of the fixed countywide 1 percent property tax rate. Aside from
annexation or incorporation, the only way that local governments can affect property tax receipts is
through economic development, and even in these cases, they receive only a portion of the
revenues. Second, there is a large amount of variation in the allocation of the tax. As Table 1 shows,
in 1996-97, cities, on average, received II cents out of every property tax dollar collected, counties
received 19 cents, schools 52 cents, and other districts 18 cents. Compared to 1977-78, counties get
a good deal less while "other" districts get much more. The inter -county range of shares among local
governments has generally increased since 1977-78; for example, school districts now receive, on
average by county, between 27 and 76 cents out of every dollar. In 1977-78, they received between
34 and 64 cents.'
Of course, social institutions continually evolve in response to changing constraints,
opportunities, and preferences. And such has been the case for the system of state and local finance
in California over the twenty years since the passage of Proposition 13, with the occurrence of at
least ten specific fiscal decisions by the legislature and voters.' Table 2 illustrates the variety of fiscal
The fourth element, a trigger mechanism to cut state aid if funds were not available (called the
"deflator") was never used.
'Within each county, there is a wide range among the specific jurisdictions; for example, the no and
low tax cities receive a much smaller share of the property tax allocation than ocher cities.
John J. Kirlin, Jeffrey 1. Chapman, and Peter Asmus, 1994, "California Policy Choices: the
Context," in John J. Kirlin and Jeffrey I. Chapman, eds., Ca/(lbrnia P&icy Choices, Vol. 9,
Sacramento and Los Angeles: University of Southern California.
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decisions and events that have influenced this evolution.' Two themes} however, underlie nearly all
of these events: first, a sense of ongoing fiscal constraint imposed by voters attempting to limit
government taxing and spending; and second, an increase in state control over local finance that has
occurred because of the imposition of many of the voter restrictions. These restrictions included
Proposition 13 and Proposition 4 in 1979, which established a system of spending limits. The
increase in state control was possible because of the ability of the state to raise revenues at a time
when the ability of local governments to raise general purpose taxes had become Limited.
1978
1979
1982
1986
1988
1988
1988-93
1990
1991-92
1992-93 and
1993-94
1993
1995
1996
1997
1998
Table 1
Allocation of General Property Tax Dollar
(in cents)
1977-78
1985-86
1996-97
City Average
10
13
11
Range
0-15
0-23
0-20
County Average
30
33
19
Range
17-74
18-71
10-64
School Average
53
37
52
Range
34-64
9-61
27-76
Other Average
7
7
18
Range
2-20
3-30
2-29
All averages are statewide averages; all ranges are among counnes.
Source: State Board of Equalization, Airnth9/ Reparl, miscellaneous years, Table 15
Table 2
Chronology of Fiscal Events
Passage of Proposition 13; passage of SB 154
Passage of AB 6; passage of Proposition 4 (Gann Limit Initiative)
First Certificate of Participation issued; passage of Mello -Roos Act
Passage of Proposition 62 (tax limit), initially held unconstitutional
Passage of Proposition 98
Peak of defense expenditures in California
Major droughts, earthquakes, and fires affect California
Passage of Proposition 111; peak of illegal immigration
Realignment of functions and revenues among state and local governments
Property tax shift to help state budget (establishment of ERAF)
Trough of unemployment from recession; passage of Proposition 172 (sales tax);
redevelopment reform, blight defined
Proposition 62 upheld by California Supreme Court
Passage of Proposition 218 (tax limitation strengthening Proposition 62)
Trial Court financing reform
Vehicle license fee reduced in a complex manner
During this time, California has experienced droughts, freezes, floods, forest fires, urban fires,
earthquakes, riots, military base closures, and a recession that was the worst in the state's history
since the depression of the 1930s.
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In addition to AB 8, 1979 also saw the passage of the Government Spending Limit —Proposition
4 (Gann Limit Initiative). This initiative restricted appropriations for governments, attempted to
force the state into paying for imposed mandates, and implicitly encouraged the use of fees for new
services because these would not be included under the limit. The limit is less important now because
the 1990s recession slowed the growth in tax revenues, while the spending limitation itself continued
to grow! In addition, the legislature quickly found ways around the mandated funding provision.
Nonetheless, the legitimization of the use of fees became important for local governments.'
As tax and expenditure limitations on local government were added in the late 1970s, and as the
state influence over local government continued to grow, it is not surprising that the composition of
county and city revenues and expenditures would change.
The Changing World of City and County Finance
To understand how the implementation of Proposition 13 has changed the way cities and
counties do the public's business, the importance of revenue sources as components of total revenues
and the importance of expenditure decisions as components of total expenditures for each level of
local government must be examined.
Counties
Counties have multiple roles in California. Since they are the administrative arm of the state,
they are responsible for public assistance, public protection, and health. Counties are also responsible
for delivering local services and providing local facilities to their unincorporated communities,
including law enforcement, waste collection, and roads and parks. At times, counties contract with
cities or other public, non-profit, or private agencies to provide some of these services. Counties
also perform countywide activities such as assessing and collecting property taxes and operating jails.
Table 3 shows the changes in importance for the components of county revenues, As expected,
the role of the property tax has diminished, falling from 33 percent to 12 percent of aggregate
county revenues. Almost entirely offsetting this percentage change has been the .increase in
importance of state funds, which now constitute 42 percent of county revenues. Perhaps as
interesting is the fact that there has been no change in the importance of user charges over this
period, although the "other" revenue category has more than doubled and now exceeds the property
tax component of the budget.' One claim that counties often advance is that a very high percentage
of their revenue is uncontrollable---i.e., much of the revenue is already earmarked for state- or
federally -mandated programs, with the counties having little say in how it will be spent. If this is
true, then Proposition 13, which essentially made the property tax uncontrollable at the county
level, led to an increase in uncontrollable revenues from about 50 percent of county revenues in
1978 to nearly 76 percent in 1996."
3 Four out of 470 cities and none out of 58 counties were at their spending limit in 1995-96.
An unintended but beneficial consequence of Proposition 4 was that it encouraged jurisdictions to
establish sinking funds for depreciation and replacement purposes for some of their capital stock.
This occurred because depreciation is a legitimate service delivery expense and so could be part of
the foundation for establishing a fee,
Other revenues consist of licenses and permits, fines, interest revenues, and miscellaneous revenues.
" This is obviously a very simplistic cut. Some state and federal revenues have some elements of
controllability if counties took full advantage of accepting the responsibilities of control.
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Table 3
Revenue Source Importance, Counties
% of Aggregate County Revenue
1995-96
Category
1977-78
Property Tax
33
12
Other Taxes
3
3
State Funds
24
42
Federal Funds
26
22
Charges
9
9
Other
5
12
TOTAL
100
100
Source: Author's calculations from State controuers
Table 4 shows the changes in various expenditure categories for the total of the counties. The
two obvious changes are the decline in general government expenditures and the increase in
protection expenditures. Proposition 13 passed, in part, because voters believed that the
government used resources inefficiently and had a bloated bureaucracy that could be eliminated.'
General government expenditures include this bureaucracy, and the decline in expenditures in this
category reflects a formal response to the desire of voters. However, while the general government
overhead category has fallen in importance, nothing much is known about the internal bureaucracy
of the service delivery functions of the county. For example, although the importance of the
protection function has increased, we cannot know (at least without undertaking case studies)
whether the entire increase is an increase in direct service delivery or whether there is now some
additional administrative overhead included in the service.
Table 4
Expenditure Importance, Counties
% of Expenditures
1995-96
Category
1977-78
General Government
19
9
Protection
19
28
Health and Sanitation
14
14
Public Assistance
40
40
Other
8
9
TOTAL
100
100
Source: Author's calculations from State contro
The decline in importance of general government overhead might have unintended
consequences. A decline in general government can be easily translated into such events as slower
permit processing, poor tax administration, or weak responses to regulatory needs. Or if a citizen
attempts to contact the county for help with a particular problem, because of the cutback in general
Jack Citrin, 1979. "Do People Want Something for Nothing: Public Opinion on Taxes and
Government Spending," N/o/ion°I Tax Iowa !, Vol. 32, No. 2 (supplement).
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government support it may be more difficult for him to access the system or, once accessed, to find
the correct individual to solve the particular problem. If these difficulties multiply, the extent of
citizen discontent with county government increases and citizens become either alienated or angry.
The first may lead to lower voter turnout at elections; the latter may lead to more voter constraints
on government or pressure for micromanagement by legislators, who are anxious to appear to be
responding to upset citizens and particular special interest groups.
Cities
Cities are a powerful component of government in California, reflecting the strong belief of the
1879 California Constitutional Convention that cities' home rule capabilities should be protected."'
California cities focus on ensuring the provision of local services and facilities, with the provision
either directly undertaken by the city or contracted for with the county or other public, not -for -
profit, or private agencies.
Table 5 compares the sources of city revenues in 1977-78 and 1995-96." In contrast to the
counties, the property tax was for cities a less crucial although not unimportant element of local
revenue in 1977-78. By 1995-96, the property tax had dropped behind all other sources of revenues
in importance for cities. But there were also major shifts in other revenue sources, with declines in
the importance of sales taxes and intergovernmental revenues compensated for by increases in
service charges and other revenues.' Together, service charges and enterprise revenues were the
most important sources of revenue in both of these time periods. By 1995-96, over 68 percent of
city revenues came from service charges, enterprise income, and other revenues, much of which are
under the control of the city. it is reasonable to conclude that city residents are paying for a
substantial portion of their services through the price system composed of fees and charges rather
than through general citywide taxes such as the property tax.
Table 5
Revenue Source Importance, Cities
°/9 of Aggregate C
tv jevenue
1995-96
Category
1977-78
Property Tax
16
8
Sales Tax
11
9
Intergovernmental Aid
24
14
Service Charges
6
11
Enterprise Income
26
29
Other
17
29
TOTAL.
100
100
Source: Author's calculations from State Controller's Reports
"' Alvin D. Sokolow and Peter Detwiler, forthcoming, "State -Local Relations in California," in
Plato Rigos, Dale Krane, and Mel Hill, eds., Home Rule in America.. AFif/ySraieh'ondlook
Washington, D.C.: Congressional Quarterly Press, p. 9.
" Several adjustments were made to the basic Controller data to enable comparisons between these
two years. This was necessary because the Congo/%r :r Reporlr' changed format in 1980-81,
Contact the author for details.
Other revenues include such items as franchise taxes, licenses and permits, interest earnings, and
sales of property.
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Table 6 illustrates the changing importance of city expenditure components. Cities, like
counties, have also dramatically cut general government expenditures. They have also cut library
and parks, water, gas, and electricity expenditures. Perhaps most surprising is the fact that the
percent spent on police has barely changed —it was 15 percent of city expenditures in 1977-78 and
16 percent in 1995-96. Together, however, the public utility/enterprise set of activities now
accounts for about 36 percent of total city expenditures, an increase from the 30 percent of 1977-
78. It may be that the public prefers city expenditures on these activities; it may be that there are
earmarked funds for at least some of the infrastructure (for example, gas tax money for roads and
sales tax money for transportation systems) that encourage cities to divert additional resources to
these projects; or it may be that because so many of these activities also generate revenue they just
grew without conscious decisionmaking.
Finally, the myriad of "other" expenditures has only slightly increased as a percent of the budget
over 18 years, although it has remained the largest component of expenditures.' What this might be
indicating is that cities are adding expenditure categories in a variety of areas which may benefit
specific interest groups. From a microperspective, these increases may be difficult for the public to
discern; however, they do apparently accumulate to a large sum. They are not hidden, but they are
not the focus of much public attention.
Table 6
Expenditure Importance, Cities
% of Expenditures
1995-96
Category
1977-78
General Government
13
7
Police
15
16
Library/Parks
10
6
Water, Gas, Electricity
23
18
Other Enterprise
7
18
Other
32
35
TOTAL
100
100
Source: Author's calculations from State Controller's Reports
" "Other" expenditures include such items as fire protection, emergency medical services, animal
regulation, streets and highways, storm drains, planning, regulation, etc.
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3. Some Unanticipated Consequences of Proposition 13
As illustrated in the preceding chapter, there were shifts in sources of revenues for counties and
cities and in the way those revenues were spent. But what was not shown, nor could be shown from
the data, are three distinct, unanticipated consequences of Proposition 13. These consequences
resulted from attempts to maintain revenue flows that were sufficient to fund expenditures demanded
by citizens. They reflect the changing nature of public and private institutions over time, and they
also reflect the intelligence of many individuals who have dedicated large parts of their professional
lives to finding loopholes in Proposition 13 and its implementing legislation. Although these three
consequences are listed separately, they are often interrelated and sometimes reflect causality.
Consequence Number One: The Fiscalization of Land Use
Although formally named by Misczynski in 1986, the concept of examining land use decisions in
the context of their revenue and expenditure consequences has certainly been recognized since the
advent of municipal incorporation and zoning laws." Because Proposition 13 reduced the revenues
that would be received from property taxes from any particular development (industrial, commercial,
or residential), local jurisdictions began to pay even more attention to the fiscal outcomes of land use
decisions. In particular, land uses that generated revenues in addition to property taxes became more
important. To the extent that land use decisions are now driven by their fiscal consequences,
fiscalization has occurred. There are at least three specific instances of fiscalization activities that
have been adopted by local governrnent, as discussed below.
The Sales Tax and Land Use Choices
Local governments receive sales taxes based on two formulas. The principal method, which
originated in the Bradley -Burns Sales and Use Tax Act of 1955, generates sales tax revenues as a
function of the dollar volume of sales that occurs in a specific jurisdiction. Under this Act, for every
dollar of sales, the local government in whose jurisdiction the sale occurred, receives one cent, which
goes into the general fund» To the extent that local governments make land use decisions based on
this sales tax revenue, they are acting consistently with the concept of fiscalization of land use.
Those local governments that feel fiscal stress or that desire to maximize revenues pay close
attention to commercial activity. Of course, there are cities that do not like retail activity and
carefully zone out major retail centers, just as there are cities that will do anything in their power to
generate large sales lax revenues. (In 1996-97, per capita sales tax revenues ranged from $2.57 in
Bradbury to $55,504 in Vernon). There are two popular ways (at least among elected officials) of
' Dean Misczynski, 1986, ''The Fiscalization of Land Use," in John J. Kirlin and Donald R. Winkler,
eds., Calfornia Policy Choicer, Vol. 3, Sacramento, California: University of Southern California.
'' Counties only get the one cent if the sale occurs in an unincorporated area. In addition, counties
also receive 1/2 cent for each dollar of sales within the county, which is then divided by formula
among all local governments within that county based on the ERAF shift and which is dedicated to
public safety. See the property tax shift discussion under the third set of consequences for more
discussion of this 1/2 cent.
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generating a large amount of sales taxes from a small area: "big -box" retail and car dealerships.' It
is not surprising, then, to see cities compete for these types of activities. Most jurisdictions trying to
maximize sales tax revenues choose to encourage these types of development over residential
development, which generates sales tax revenue only to the extent that the new residents shop in the
same city in which they live. It is not surprising to observe the owners of big -box retail and car
dealerships attempting to obtain economic incentives for locating in a particular jurisdiction.
Redevelopment as a Municipal Revenue Generator
Beginning in the early 1950s, California became the first state to use the technique of tax
increment financing as a development tool. Under this process, a local jurisdiction first forms a
redevelopment agency, which is authorized by statute under the general provisions of the state
constitution. This agency then declares a section of the jurisdiction to be "blighted." Any increase in
the property tax receipts (the property tax increment) that occurs after this designation is shared by
the redevelopment agency and overlapping jurisdictions (by, formula since 1994). The goal is to
ensure that redevelopment does occur and thus a tax increment will be generated. For this to occur,
debt is issued by the redevelopment agency, with the proceeds of the debt issuance going to improve
the blighted area. As this improvement is occurring, developers are moving in and causing an
increase in property value, which in turn generates the property tax increment. This tax increment
funds the debt.
Although the initial predictions concerning the efficacy of the technique were negative, the dire
concerns were not realized." Rather, the use of this technique expanded: there were 197 agencies in
1980 with 300 project areas; by the end of 1995, there were 399 agencies with 744 project areas.
The total increment generated by the projects was about $1.4 billion.'" It may be that after
Proposition 13, many cities attempted to use tax increment financing to alleviate some of the fiscal
pressures caused by the initiative. I" Certainly, much of the redevelopment was used to attract
commercial activities that would generate substantial sales tax revenues, while new housing was often
not encouraged because it generated less sales taxes and produced a smaller tax increment.
There are at least three reasons for the increasing use of this tool to fight off fiscal stress. First,
until 1993, blight was a very loosely defined concept, and so almost any parcel, whatever its state,
could be deemed blighted and thus in need of redevelopment. Under certain conditions, even
undeveloped land could be considered blighted (for example, if it were in a flood plain)."
16
11
I"
19
211
Shopping malls are also very popular but tend to use more land.
Merrill Lynch Pierce Fenner and Smith, Inc, 1979, California :r Tax Allocation Bondr.. Yictirr�s of
Proposition Li (October), New York: Merrill Lynch Pierce Fenner and Smith, Fixed Income
Research.
Note that if the area were not blighted and the same amount of growth would have occurred with-
out the redevelopment agency, then about $700 million would have gone to the school districts
that included the area since schools get about 50 percent of the collected property tax. Since the
state backfills school finance (up to a specified level), this becomes a very large state redevelopment
program that the citizen never recognizes.
Other studies, using other states as the data source, come to a similar conclusion that
redevelopment activities increase as local public fiscal stress increases. See Joyce Y. Man, 1999,
"Fiscal Pressure, Tax Competition, and the Adoption of Tax Increment Financing," Urban Studies,
Vol. 37, No. 7.
Blight is now more rigorously defined in statute, although the potential for misuse is still clearly
present.
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Undeveloped land, of course, generates very large tax increments as it is developed. Second, the use
of redevelopment debt to finance infrastructure does not need voter approval. Residents are often
unaware of the magnitude of the debt that has been issued or the size of the increment. Since about
80 percent of the total redevelopment projects are greater than 100 acres,11 the projects are Likely
to include vacant or undeveloped land and therefore need new infrastructure. Tax increment
financing helps to provide the financing for this infrastructure. Finally, redevelopment activities can
be used as a weapon in the intedurisdictional fight for economic growth. Companies can be
encouraged to relocate with the promised benefits of new infrastructure to be provided by the
redevelopment agency. To the extent that this is a business relocation decision rather than a new
development decision, it is a negative sum game, simply because of the transaction costs involved.
An obvious question concerning this type of redevelopment activity is whether or not it works
in stimulating economic redevelopment. The few studies that analyze this indicate that the
technique does work —property values do increase faster in redevelopment areas than in non -
redevelopment areas, but one study finds that less than 50 percent of the increase occurs because of
the use of the technique."
Development Fees. Internal/zing the Costs of Public Capita/ and Services
Prior to Proposition 13, infrastructure for new developments was often financed by community -
wide, broad -based taxes and debt. After Proposition 13, there was a movement away from these
methods to those methods that raised revenues from the new development itself. Development fees
were often part of this method of internalizing the costs of the new infrastructure and service needs.
Although development fees have been increasing in importance in both slow and fast growing
areas, their scope is much larger in new, fast growing areas." Because California has experienced such
rapid growth over the past decades, and given the fiscalization constraints, it is not surprising that
development fees have risen rapidly since Proposition 13.
In theory, development fees are strictly regulated in California. Before a fee can be imposed or
increased, the local government must identify its purpose and use, determine how there is a
reasonable relationship between the development project and the fee's use, and determine that there
is a reasonable relationship between the amount of the fee and the cost of the infrastructure financed
by the fee,'° In addition to cities and counties, since 1986 school districts can also impose fees on
21 California State Controller, 1997, CornimmiwRedevelopment Agencies. dnnua/Report,, /99J--96
Sacramento, CA.
22 See Michael Dardia, 1998, Srrbridiri ,g Redevelopren/ in Ca/fornia, San Francisco: Public Policy
institute of California. Further, Joyce Y. Man and Mark Rosentraub, "Tax increment Financing:
Municipal Adoption and Effects on Property Value Growth," forthcoming in Public Finance Review,
find, for Indiana, that median owner -occupied housing values were about eleven percent higher in
tax -increment districts because of the redevelopment activities.
22 See Alan A. Altshuler and J.A. Gomez-lbanez, 1993, Regrrlat,ionforRevernie,• ThePali/iced
Economy of Land Use Fraction. Washington, D.C.: The Brookings Institution; see also Marla
Dresch and Steven M. Sheffrin, 1997a, Who PaysAt' Eract,ions and Development Feet? San
Francisco: The Public Policy Institute of California. The more general term for this type of finance
is eras/ion. Exactions are either developer payments or dedications of specific areas for public use
(for example, parks and streets). The developer offers exactions in return for governmental
approval to proceed with the project.
'I These are the main conditions. There are several other restrictions, including determining the need
for the infrastructure as well as accounting and reporting disclosure techniques. Also note that fees
cannot be based on the ad va/orer value of the property.
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both residential and commercial/industrial new construction. As of July 1996, the maximum for
these fees was $1.84 per square foot for residential projects and 30 cents per square foot for
commercial and industrial developments.'-' In addition, whenever cities and counties engage in
legislative land use activities, such as amending the general plan or changing zoning, they can impose
their own school construction fees in addition to the fees imposed by the school district. The total
of school, city, and county fees faced by some developers, have exceeded $9 per square foot.26 The
controversy surrounding the 1998-99 state budget partially revolves around these fees for schools,
with some proponents of fee mitigation also arguing that General Obligations bonds should have a
lower approval threshold than a 2/3 vote,"
Dresch and Sheffrin have conducted the most detailed analysis of development fees in
California.' Studying fees in Conta Costa County between 1992 and 1995, they found that average
development fees per unit ranged from $252 for community redevelopment purposes to nearly
$13,000 for water and sewage. There are also permit fees, traffic fees, fire fees, park fees, and
school fees imposed by school districts. These fees totaled over $16,000 per dwelling unit in the east
Contra Costa county area and over $24,000 per unit in the west county area." Dresch and Sheffrin
also found variation when they reaggregated the fees by city, discovering a difference of nearly
$7,000 per dwelling unit between the highest and lowest fee -charging jurisdictions in the east county
and a difference of about $8,000 per unit in the west county.'"
A final component of any fee discussion concerns its incidence.31 It is not unusual to find
developers arguing that, on the one hand, fees are eating up their profits and driving them out of
business and then, an the other hand, arguing that the fees will increase the price of the home and
thus the poor mortgage holder will be paying off developer fees (with interest!) over the next thirty
years. The true determination of the incidence is a difficult empirical problem. Again, Dresch and
Sheffrin's study bears citing —they found that in eastern Contra Costa County, for every dollar of
fees, housing prices went up by 25 cents, and for the western county, each dollar of fees generated an
increase in housing prices of $1,88 (although the latter figure was statistically not significantly
different from $1.00). They also found that in the eastern part of the county, a dollar increase in
fees and assessments on new homes increased the price of exiting homes by 23 cents, perhaps because
higher prices for new homes influenced the price of older homes or because the expenditures from
" The legislative intent was to have a threefold way of financing schools —state General Obligation
bonds, local General Obligation bonds, and development fees
'r' See Marla Dresch and Steven Sheffrin, 1997b, "The Role of Development Fees and Exactions in
Local Public Finance," Save TarNoieJ, December 1, 1411-1416.
" The final agreement was that in exchange for putting a $9.2 billion school bond issue on the
November 1998 ballot, restrictions would be placed on developer fees and the 2/3 vote requirement
would be kept intact.
'" Dresch and Sheffrin, 1997b,
The average selling price of an east county house was about $200,000; the average selling price for
a west county house was about $400,000.
"' A City of Davis study, as cited in Dresch and Sheffrin (1997b), found that there can also be
variation of fees within a city, with an 1,800 square foot house paying between $8,600 and $10,000
in major project financing fees, depending upon its location in the city. More importantly, at least
for Davis residents, are the costs of Mello -Roos financing, which range from zero in one section of
town to over $22,000 in another section. See the subsequent discussion of Mello -Roos financing.
" For a sophisticated theoretical incidence analysis of fees and assessment districts, see John Yinger,
1998, "The Incidence of Development Fees and Special Assessments," NorionaITax Journal; Vol.
LI, No. I, (March).
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• •
the fees and assessments provided community -wide benefits which were capitalized into the prices of
older homes. Confounding the analysis was the decline in housing prices throughout California during
portions of the study period.
In any case, it is clear that fees and dedications now play an important role in California's local
finance. These fees are often hidden from the homeowner, and their incidence is at tithes, unclear.
They are controversial, but the increase in their use is closely related to government trying to avoid
a fall in revenues because of the Proposition 13 constraints.
Consequence Number Two: The Growth of Arcane Finance Techniques
Perhaps the most important insight that can be gained from the passage of Proposition 13 is
that blunt initiatives lead to the development of other ways of getting things done. These other
ways are usually more complex, more expensive, and typically are not discussed in public forums in
ways that are intelligible to the public and elected. officials. The world is full of very bright and
ingenious people who delight in ways of circumventing poorly drafted initiatives. The result is a
finance system that is not easy for the public to understand. This next section of the paper will
illustrate this trend, examining five different examples of complex financing techniques.
Assembly BR 8 and the Allocation of Property Tax.
Over the last 19 years, the AB 8 property tax allocation system has become more complex. It
is continually tweaked to take into account particular exigencies of local jurisdictions —for example,
cities with low or no property taxes or enterprise and nonenterprise special districts. In addition, the
numbers within the nine -step AB 8 property tax allocation formula, over time, become
extraordinarily difficult to track, and thus reliability is sometimes questionable. Within a few years of
AB 8's introduction, state auditors found significant discrepancies between what they thought the
allocation should be and what the local governments were actually receiving,"
As noted earlier, parts of AB 8 involved bail -out and buy-out provisions. Over time, while the
costs of these provisions mounted, local governments began to regard these activities as
entitlements. When the state entered a recession in the early 1990s and notified local governments
that the property tax allocation they were receiving was not an entitlement and then shifted the
allocation to fund education, there was great consternation on the part of local governments,
especially counties. The Education Revenue Augmentation Fund discussion under the third set of
consequences will re-examine this particular property tax shift.
The result of this complex and creaky method of distribution is a tendency for local officials to
accept the resulting allocation as an exogenous input into the budgetary process. This further
encourages the belief that the property tax is a state, not local, tax and encourages a continual search
for other revenue streams that are more dependable and controllable. This does not imply that the
property tax is an unimportant source of revenue for localities —it is just to say that the portion
they receive from it is very difficult to determine in a simple manner.
" As a city finance director remarked, in commenting on the allocation of redevelopment revenue,
"..,if you've ever read [Sections 95 through 100 of the Revenue and Taxation Code (R&T)}, you
already know that obtaining a good understanding of the R&T may never be possible," Greg
Johnson, 1998, "County Auditor's Association Changes Guidelines for Calculating Property Tax
Administration Costs," CSA/F0.(I11/»i=MYewr, April,
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! •
Education Finance
Education finance was difficult to understand even before the passage of Proposition 13. Prior
to the Serrano court cases, school funding was a shared state -local arrangement, with the state
guaranteeing a base level of general purpose funds for each pupil and the local districts using their
control of property taxes to raise the per pupil funding to the amount the district wanted to spend.
The Serrano court cases, which began in 1968 and finally concluded in the mid-1980s, focused on the
property tax and its alleged inequities as a funding source for school districts and mandated a
financing plan that was not property tax dependent." Between Serrano and 1978, the state became
more heavily involved in school finance and complex formulas considering both foundation support
and revenue limits. Although school districts did have limited ability to raise the property tax , it was
clear that any property tax reform passed by the legislature would have to deal with a non -property -
tax school finance plan.
After the passage of Proposition 13, educational finance was re -addressed, with school districts
receiving a portion of the property tax (through the AB 8 allocation formula) and direct payments
from the state. Until about 1985, California's spending per average daily attendance was roughly
equal to the U.S. average. Starting in about 1985, California's spending began to increase at a slower
rate, and it actually fell during the early ]990s. In 1988, in an attempt to maintain stability in
school funding, the California Teachers Association sponsored Proposition 98, which established a
minimum floor for funding K-14 schools (at the time of passage, this was about 40 percent of the
state's General Fund). This funding constitutes about three -fourths of overall K-12 funding. Because
it was tied 10 the state's budget, it indirectly affected the state's fiscal relationships with other
entities; as spending on schools increased, less was available for other types of state expenditures. By
1989, the Proposition 98 formula was found to be too binding, and in 1990 the formula was modified
by Proposition 111, which reduced the school financial aid requirements if certain fiscal stresses
existed at the state level, In particular, in no- or low -revenue growth years, the state was allowed to
modify the formula through a complex series of adjustments.
There are now three formulas that can be used to determine the minimum level of funding, with
the largest amount of money calculated by any of the formulas being what the schools actually get.
There are five major factors involved in the calculations: General Fund revenues, state population,
personal income, local property taxes, and K-12 average daily attendance. These factors change
during the year, and thus there are changes in the minimum guarantee. The Governor then must
provide "settle -up" money to ensure that any increase in the previous year's guarantee is funded.
The current minimum, reflecting changes since the original Proposition 98, is about 34.5 rather than
40 percent of General Fund revenues."
Retrospectively, in many of the years since 1988, Proposition 98 has acted as more of a ceiling
than a floor. The minimum was funded and then the state turned to other activities. Even funding
this minimum caused pain during the California recession, and many budget games (some of which
were stopped by the Courts) were played to ensure that the mandated floor would be reached.
Proposition 98 funding and its implications have now become as difficult to understand as AB 8, For
Serrano v. Pries/. 96 Cal. Rptr, (60) (1971). See also Serrano v ?ties/, 135 Cal. Rptr. 45.
The lower minimum reflects the ERAF property tax shifts of 1992-93 and 1993-94, which will be
discussed later in the paper.
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• •
example, the new vehicle license fee tax reduction was implemented partially because it has no
Proposition 98 implications, since it is not a General Fund revenue source.
In the past, local school districts were always heavily dependent on state aid (and faced state
mandates). However, with Proposition 13 eliminating the ability of local school districts to raise
property tax rates for their schools, and with Proposition 98 establishing a floor (or ceiling,
depending on the economy and legislature), for all practical purposes, aggregate school finance is now
almost entirely centralized at the state level, and school districts are now passive recipients of state
revenues.
F/nancing Capita/ Facilities
Prior to Proposition 13, capital finance was relatively straightforward. if a local government
wanted new infrastructure, it would go to the voters and ask for approval of either a General
Obligation bond or a revenue bond. Or, it would save enough money to engage in pay-as-you-go
financing. For the first eight years after Proposition 13, the first option was constitutionally
unavailable; the second option was unpalatable because of the fear of voter revolt; and the third
option was impossible because of shrinking discretionary general purpose revenues, including the
property tax.'' To further complicate matters, there is a difference between the problems of capital
finance in a developed area and capital finance in an undeveloped area. in developed areas, where
little new construction occurs and development fees are not usually large enough to support the
necessary infrastructure, two techniques have evolved. The first has already been discussed —the
increased use of' redevelopment finance through the use of tax increment financing techniques. The
second has been to use Certificates of Participation (COPs). In the decade between 1985 and 1995,
about $28 billion in General Obligation bonds were issued by California state and local government,
compared to about $40 billion in COPs.
The Certificate of Participation has several attributes which make it easy to use. Its issuance
does not require a vote of the general public; it can be initiated and passed by a local legislative body.
Technically, the COP is issued by a non-profit body established by the relevant legislative body. The
non-profit organization then takes the proceeds from the issuance and provides the infrastructure or
other capital (for example, city halls or police cars are sometimes purchased using a COP technique).
The legislative body has previously agreed to rent the asset from the non-profit, and thus the non-
profit receives an income stream to be used to retire the debt, with the COP holder being paid
through a trustee. The money that is used by the legislative body to pay the non-profit for the use
of the infrastructure comes from the General Fund, although there are many cases of jurisdictions
finding other funding sources for this flow of rents. For example, if the jurisdiction has another asset
that is generating an income flow (such as an airport or harbor), that income stream can be pledged
as a revenue source. Because the COP is not a debt instrument, but rather a multi -year promise of
sharing a revenue stream, this instrument does not count against any legal limitations on the amount
of debt that can be issued by the jurisdiction. COPs can become quite complex and are not well
known by the public, but because they are so easy to issue (until recently, some jurisdictions approved
them on the consent calendar), they have become exceedingly popular at all levels of California
in 1986, the voters approved an amendment to Proposition 13 that allowed the issuance of General
Obligation bonds approved by a two-thirds vote.
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• •
government. Approximately $7 billion of COPS were issued in 1996 and 1997.3' Note though, that
ease of issue does not imply ease of understanding, either by the public or legislative body.
Historically, infrastructure for new development was funded by debt issued and paid for by
existing residents through the General Obligation bond process. Now, it is much more likely that the
new development will have to finance its own infrastructure as well as fight off efforts of existing
residents to have the new development provide some goods and services (for example, parks) for the
entire cornrnunity.37
In addition to the previously discussed development fees, another method of financing
infrastructure for new developments is a new type of debt instrument —the Mello -Roos bond. About
$6 billion of Mello -Roos debt was issued between 1985 and 1995,3"
Mello -Roos debt (named after the two legislators who carried the legislation in 1982) is used to
finance any infrastructure or selected services in a geographically defined piece of land called a
community facilities district. This area, which is usually undeveloped, can be irregularly shaped and
may be drawn with "holes" to exclude particular sections (usually, the excluded sections are those
that are developed). Two-thirds of the voters of the area, or landowners representing two-thirds of
the land in the area (who have votes distributed based on the amount of land they own), can vote to
issue debt for capital improvements in the community facilities district (or to finance service
provisions). Upon issuance of the debt, a lien is placed against the property in the area. As the
property is subdivided, each individual homeowner is responsible for the payment of a share of the
debt (which shows up on the homeowner's property tax bill). Initially, this share did not have to be
disclosed when the property was bought, but legislation has been enacted to force disclosure. The
local jurisdiction is not the agency that issues the debt and is therefore not legally responsible for the
security of the debt.
Operationally, Mello -Roos debt has replaced at least some of' the property tax that the
homeowner might have faced prior to Proposition 13 (the part that related to General Obligation
financing). Since Mello -Roos debt is more expensive than General Obligation debt because of its
higher risk, the payment by the homeowner is higher than what would have been faced prior to
Proposition 13. Anecdotally, there are stories of homeowners making Mello -Roos payments that
are larger than their property tax payments, and there are billboard signs for new developments that
advertise "No Mello -Roos." In 1996, $600 million of Mello -Roos debt was issued; in 1997, $677
million was issued.
Assessment Districts
Another method of financing government activities is the establishment of an assessment
district that has the ability to levy a charge that pays for a public facility or service in direct
relationship to the benefit that the facility or service confers on the property. These charges or
assessments are authorized by more than a dozen specific laws, and nearly every type of
governmental jurisdiction can use one type of assessment district or another. Since the benefits of
For a case study on the misuse of COPs in California, see Craig L. Johnson and John L. Mikesell,
1994, "Certificates of Participation and Capital Markets: Lessons from Brevard County and
Richmond Unified School District," Pah/c.Biidgeiing and Finance Vol. 14, No. 3,
Construction taxes are legal in California and have been used to finance community -wide benefits.
See Dresch and Sheffrin, 1997b, op. cil.
Mello -Roos debt can be used in developed areas but seldom is because of the difficulty of approval.
the investment or service financed by the district precisely equal its costs, there should be no net
effect on the prices of either land or housing because of the district.
There are apparently thousands of different assessment districts throughout the state. They are
used to finance everything from landscape development to flood control infrastructure to the
maintenance of sewers. Citizens typically see assessments once a year on their property tax bills and
then attempt to figure out what the cryptic notations really mean. Slightly over $l billion in special
assessment debt was issued during 1997; however, only about $250 million was issued during the first
six months of this year, possibly reflecting the impact of Proposition 218.'' Before the passage of
Proposition 218, property owner protests were the only traditional way to stop the formation of
assessment districts. Now, an affirmative vote of the property owners is needed to begin the
district's implementation, which might possibly lead to even longer ballots." And, with the reduced
number of people voting and with supermajorities being demanded, there is a greater likelihood of a
slowdown in benefit assessment financing.
Entrepreneurial Activities
The fiscal stress associated with the decline of property tax revenues gave rise, at least in some
jurisdictions, to the implementation of public entrepreneurism. With the publication of the Kirlin
and Kirlin seminal volume in 1982, being called a public entrepreneur became legitimate and Iocal
administrators throughout California began to publicly call themselves such." Public entrepreneurs
are willing to take more risks and are more aggressive in undertaking activities that increase the
revenue flows in their jurisdiction.
One set of entrepreneurial activities revolved around generating new economic development.
The increase in redevelopment finance activities has already been mentioned, but there are several
other ways in which a jurisdiction can stimulate development and reap the benefits of increased sales
taxes, employment, and at least some property taxes. There are at least three different (but often
interlocked) methods through which This can be accomplished.
I. Become a partner with a private developer. At least one jurisdiction in California partnered
with a private developer in building a shopping mall. As the profitability of the shopping mall
changes, the city receives a changing revenue stream. In exchange for this revenue stream, the city
helped change some of the zoning restrictions and provided some of the infrastructure. If the
shopping mall makes no profit, there is no revenue stream, so the city is taking a legitimate risk.
2. Give a direct tax subsidy to a private firm or developer. In these cases, tax abatements are
used either to entice a firm to locate in a particular area or to ensure that an existing firm does not
leave the area." There are instances in which public utility rates for some firms have been slightly
California Debt and investment Advisory Commission, 1998a and 1998b, Debi Zinc, Vol. 17, Nos. 7
and 8, July and August. Proposition 218 is the most recent tax limitation measure passed by
California voters.
Assessment ballots do not require a supermajority vote; however, the votes are weighted by the
dollar amount of the property owner's assessment liability.
"' See John J. Kirlin and Anne Kirlin, 1982, Pi6tic Choices•—Prit'o/e Resources. Sacramento, CA:
California Tax Foundation. It is interesting that the term "civic entrepreneur" is now being used by
private sector individuals who are attempting to solve public problems.
The debate is still ongoing as to the efficacy of these techniques. See William F. Fox and Matthew
N. Murray, 1998, "Incentives, Firm Location Decisions and Regional Economic Performance," in
-19•
increased in order to lower rates for a firm that the city wanted to keep.'' In other cases, the
jurisdiction hopes that the economic growth that tax subsidies stimulate (or at least maintain) will
offset the initial loss in tax revenues. To the extent that these subsidy techniques work to attract a
firm from within the state, this is a zero (or even negative) sum game, since one jurisdiction's gain is
another jurisdiction's loss." Redevelopment financing is often utilized as part of the attraction
process.
3. Enter into sophisticated public -private development agreements. These are neither full-
fledged partnerships nor direct tax subsidies. Rather, they are complex contracts in which the
jurisdiction negotiates with a developer or series of developers. The jurisdiction agrees to provide
certain services, help finance others, perhaps through assessment districts or tax increment
financing, and ensure adequate zoning for the needs of the developers. In turn, the developers
contract to provide specific types of housing and industry. One goal of many of these agreements is
to ensure that lawsuits will not stop the development.
In all three of these activities, the contracts and agreements are very complex, technical, and
not easy for the citizen to accurately analyze. In many cases, hundreds of millions of dollars are
committed through these agreements and subsidies. in some cases, they may not work out as initially
intended; for example, the arrangements between the City of Oakland, Alameda County, and the
(then) Los Angeles Raiders football team has already generated several unexpected short-term fiscal
consequences.
There is another type of fiscal entrepreneurship that rarely occurs, but when it does, chaos
erupts. This is when the jurisdiction's treasurer uses high -risk sophisticated products that are
available for investment purposes (Chapman, 1996). in Orange County, for several years the
Treasurer generated returns on investments that far exceeded the returns obtained by other County
Treasurers. He was able to do this through the use of some very complex derivative products made
available by some investment firms. The revenue flow certainly helped the county avoid some of
the fiscal problems generated by Proposition 13; however, since other counties did not follow Orange
County's lead, it is difficult to attribute this investment strategy to Proposition 13 fiscal stress. In
any case, interest rates did not follow the pattern that the Treasurer forecasted and the county lost
over $1,6 billion.°s It is not altogether clear that the Orange County elected officials or the
participants in the investment pool (school districts and some other special districts) completely
understood the types of investments that the Treasurer was making. Nor is it clear that they knew
what investment strategies were being followed.
Helen F. Ladd, ed., Loco! Government Tax and Land (he Policies in the United States
Northampton, MA: Edward Elgar.
Mike McCarthy and Lynn Graebner, 1997, "County Subsidy of industrial Utility Rates Violates
Proposition 218," Sacra/nen/o Irsinese ✓o;,inal, Vol. 14, No. 8, May 12.
" Some of these techniques might now be illegal under Proposition 218 (see McCarthy and Graebner,
op.
°j For a detailed examination of this, see Mark Baldassare, 1998, When Government Fails. e
Orange CountyBankruptcy Berkeley: University of California Press and the Public Policy
institute of California.
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• •
Consequence Number 3: increase in State Control over County Finance
Because the state had a large surplus in 1977-78, it was able to institute a series of financing
shifts that allowed it to buy-out, bail -out, and otherwise help local governments. Over time,
sometimes intentionally and sometimes unintentionally, the state has made a series of decisions that
has led to it being a dominant financial player in local governments' financial decisionmaking. As
illustrated earlier, this is especially true in the case of counties. The state reached this position
through a myriad small decisions and the two major ones discussed below."
Contra/ of the Property Tax
The first sign of a new era in state -local relations came in 1979 when the state established a
long-term fiscal relief plan that involved the transfer of property tax from school districts to other
local governments. Then, in 1988, as part of' a realignment of the financing of the trial courts, the
legislature shifted property taxes from counties to selected cities that had either no shares or very
small shares of the property tax (these are known as the "no and low" property tax cities).
The set of state activities that indicated increased state control of local finance were the two
formula changes in the property tax allocation, one in 1992-93 and the other in 1993-94. The net
result of these changes was an ongoing shift of property taxes away from cities, counties, and special
districts to schools,47 The increase in the schools' property tax revenues decreased the obligation
from the state's General Fund to the schools. The absolute level of school finance was not affected,
but the state's responsibility was reduced, while counties and cities felt the pain.
The rationale for this shift can be traced back to AB 8. In that legislation, as earlier noted, the
state gave relief to local jurisdictions to offset losses suffered under Proposition 13. AB 8 reduced
county health and welfare costs by increasing state aid and also shifted some of the property tax
revenues from schools to cities, counties, and special districts. The state backfilled the schools'
property tax loss with money from the General Fund. The state computes that the current value of
this annual AB 8 relief to local governments exceeds $6 billion. When this is compared to the new
property lax shifts which are now about $3.4 billion per year, the state's rationale is understood —
local government is still receiving a net bail -out from the state for Proposition 13.°" Of course,
those local governments that had spent the last fifteen years using this money believed that it would
never end, and they were deeply affected when the shift occurred.
This shift was not simple. County auditors are required to deposit some of the property taxes
that had previously gone to the local jurisdictions into a new, countywide fund for schools called the
"Educational Revenue Augmentation Fund" (ERAF). The ERAF funds are then distributed, by
formula, to schools. The shift of property taxes into this fund essentially reflects the AB 8 benefits
that local jurisdictions had received and, as such, it led to a wide variety in the distribution of the tax
money —for example, almost Twenty percent of the cities saw no shift in 1993-94 because they were
incorporated after 1978 and so never received any AB 8 assistance. The average county lost about
°" As mentioned earlier, the state has also continued to enact a series of Trial Court financing
reforms, with the latest, enacted in 1997-98, generating about $350 million in relief to cities and
counties beginning in 1998-99.
'' Redevelopment districts also initially lost some property tax revenues; however, this loss was
quickly phased out.
" Legislative Analyst's Office, 1996a, "Reversing the Property Tax Shifts," April 2, Sacramento,
California.
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40 percent of its property taxes (about $50 to $70 per capita), although some counties lost
considerably more —for example, Los Angeles County lost about $100 per capita."9
Some mitigating measures were passed that helped local governments accommodate at least a
portion of the shift, The 1/2 cent sales tax that the state imposed to help solve the 1991-92 budget
gap and that was to sunset in July 1993 was ultimately retained (it took a statewide vote in November
1993 to do so) and was given to the counties to re -allocate to the cities and the county based on the
extent of property tax transfers. in 1995-96, this 1/2 cent sales tax raised about $1.5 billion for
counties and about $90 million for cities, offsetting about half of the ERAF shift. There is a good
deal of variation among counties in these replacement revenues —for example, Alpine County had
about 99 percent of its ERAF shift replaced, Sierra County had about 30 percent replaced, and Los
Angeles County had about 40 percent replaced." This sales tax is earmarked for public safety and
now has a maintenance of effort requirement. There were also some increases in the vehicle license
fee subventions to cities and counties and a mandate relief bill that allowed counties to reduce General
Assistance by about 25 percent if the county could demonstrate that it was in significant financial
distress.
Again, note the centralization of fiscal power in this history. Clearly, the property tax is now
really a state tax---combiined, cities and counties now get only 30 cents out of every dollar paid in
property taxes. Further, the state ignored chances to lessen the shift in property tax revenues and
has continued with its own agenda. Even in its mitigating help, the state has mandated how the sales
tax revenues are to be spent.
Sorting Out the State -County Re/ationshlo
Although Proposition 13 highlighted the controversy between state and local control, the issue
of the state -county relationship has been with us since the adoption of the 1849 constitution. As
mentioned earlier, counties act as agents of the state for a variety of health and social service
programs. This relationship varies on a program by program basis and changes over time. For
example, the 1991-92 state budget initially faced a $14.3 billion gap between expected revenues and
ongoing expenditure requirements. As part of the solution of this deficit, the state "realigned" some
responsibilities between the state and the counties. The counties would receive extra revenues and, in
return, would absorb extra responsibilities from the state. This was a formal response to a series of ad
hoc cost and revenue shifts from the state to the counties during the 1980s that led to a complex
system of health and welfare finance.' Realignment was an attempt to sort out this system in a
more rational manner.
Realignment had three components: program transfers from the state to the counties; changes
in some cost -sharing ratios between the state and the counties, and increases in the state sales tax and
vehicle license fees that were earmarked for the transferred programs. The major activities
transferred included mental health, public health, and indigent health programs. The cost -sharing
changes, some of which were quite dramatic, were nearly all in the social service area. For example,
" Legislative Analyst's Office, 1996a, Ibid
" These are 1993-94 numbers, after Proposition 172 had taken full effect. For 1997-98, Alpine had
dropped to 57 percent of its ERAF shift, Sierra had risen to 57 percent, and Los Angeles had about
46 percent of its losses replaced. Also note that Trial Court funding relief is not included in these
calculations.
See the Legislative Analyst's analysis of realignment in "Making Government Make Sense", 1993,
The I993-P1Budge/: Perrpec//wes andJssiier. Sacramento, California: Legislative Analyst's Office.
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• •
AFDC -Foster Care went from 95 percent state -funded to 40 percent. state -funded, In -Home
Supported Services went from 97 percent state- funded to 65 percent state -funded, and the state
welfare -to -work program (GAIN) went from 100 percent state -funded to 70 percent. The state did
increase its share for AFDC -Family Group and for county administration. The state did not
relinquish its authority to set eligibility criteria for these programs, so counties did not recognize an
increase in control for the crucial elements. The total increase in county expenditures was estimated
to be slightly more than $2.2 billion."
To cover this cost increase, the state raised its sales tax by 1/2 cent and increased the revenues
to the counties from vehicle license fees, increasing the depreciation schedule so that higher valued
vehicles paid more in fees for a longer time. The revenue stream that the counties received from
these sources was generally earmarked for specific programs, and they had only a limited ability to
transfer revenues among programs. Originally, it was anticipated that there would be enough money
raised by these increases in taxes and fees so that the counties would be held harmless. However,
principally because of the recession, there was an immediate shortfall of about $150 million, and this
would grow to about $229 million in the following year."
Realignment did provide a steady stream of revenue to the counties, and a degree of flexibility
in its use. Some also claim that it was a beneficial change for the counties, even if the revenues were
not as high as anticipated, because the state did not take the opportunity to make severe cuts in
social services. Some mental health practitioners believe that the new-found stability in the revenues
for their programs have led to better resource allocation planning. In addition, some of the more
expensive interventions in the foster care programs have deciined.'
There has been no formal evaluation of realignment, although several years ago the Legislative
Analyst gave it generally acceptable reviews, with the caution that it was still evolving and careful
oversight was necessary (LAO, 1993). This caution needs to be re-emphasized today —some of the
programs no longer exist (for example, AFDC has been replaced by TANF) and with the expanding
economy, revenue flows have obviously changed. Overall, realignment is a positive step in helping
define state -county relationships. It illustrates that unexpected changes can be positive as well as
negative. However, the underlying relationships, while perhaps clarified, have not changed: the
county is still the agent of the state in providing services, the state still sets eligibility criteria for
most welfare programs and sets the formula for how services are to be financed; for example, as the
counties discovered this year, the state can change the vehicle license fee. Since it is unlikely that
any county could successfully increase its sales tax rate to fund health and welfare programs, and
since property taxes are immutable, the counties are still controlled by the state.
" Legislative Analyst's Office, 1992, The /991--93 &edge%' PeispecI/Pes aridlsrues, Sacramento,
California, p, 107.
" Karen Coker Kesslar, 1994, "Realignment Data Project Report fl," March 6. (Unpublished).
Jeffrey 1. Chapman, 1995, "California: The Enduring Crises," in Steven D. Gold (ed.), The Firca/
C'-,serof/heS'aies Washington, D.C.: Georgetown University. Press.
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• •
4. Conclusion: Dealing with the Unintended Consequences
The three sets of consequences identified in this paper (fiscalization of land use, development of
arcane finance techniques, and the increase of state control over local finance) were not immediately
anticipated when Proposition 13 passed. Taken together, these consequences have had dramatic
effects on governance in California. Land use decisions are often based on fiscal effects, the public
finances of the state are impenetrable to citizens as well as many experts, and cities and counties
have found themselves with less fiscal autonomy and thus are less likely to be able to respond to
citizen needs and preferences. Outlined below is a policy and research agenda that policymakers and
interested citizens might consider for addressing these consequences.
Public Policy Reform Agenda
The core provisions of Proposition 13, the 1 percent tax rate limit, the acquisition -based
assessment system, and the vote requirements for state and local taxes will not be repealed in the
foreseeable future. Any public finance policy reforms must take place in that context. Further, if a
closer connection between the government and the citizenry is to be made, any reforms must also
deal with the system design questions of how legitimate decisions should be made and carried out.
The following, non -mutually exclusive policy agenda should prove useful in confronting some of the
unintended consequences of Proposition 13.
Dealing with the F/sca/ization of Land Use
Any reforms in this area should recognize that economic growth, job creation, and
environmental protection should be considered in land use decisions. Raising the level of discussion
to include more than simply the local budgetary benefits of a particular land use choice would be an
important first step.
1. Review develapnen/projects in o troaa'er contest,
Because of the increased importance of sales taxes for cities, there is a tendency for local
governments to encourage retail over residential construction. Yet, California's population
continues to increase, and somehow these new residents must be housed, Developing a regional
context for making choices between competing land uses would be a step toward balancing the
economic and environmental needs of California's urban regions. For example, instead of focusing
on where development cannot occur, focus on where it should occur.
2 Revise the current local vales tax a/loco/ion
To prevent each jurisdiction from doing everything it can to attract retail commercial
development, often at the expense of alternative land uses, the fiscal effects on land uses could be
reduced by distributing a portion of the locally levied sales tax on a basis other than the situs basis as
it is now. For example, if in an urban county an increment of the local sales tax was distributed on a
countywide basis, this increment could be allocated according to local agreements among the cities
and the county based on local needs. A new system for allocating a part of the approximately $4
billion in locally levied sales taxes could go a long way toward ending the competition that has
developed over retail commercial development,
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3 C learl ,, define the role of 'redeuelopmeni..
Redevelopment activities and the role of redevelopment agencies are still controversial. Part of
this controversy comes from the agencies' initial charge to eliminate blight ---a concept that
apparently is very difficult to define. Part of the controversy comes from the difficulty in
determining whether the agencies actually increase development, and part stems from the fiscal pass-
throughs and indirect (and hidden) state role in their financing. The precise task of redevelopment
agencies must be clarified; for example, should they continue to be constrained to deal only with
blight or should their mission be broadened to include the stimulation of new economic development.
Arcane Finance Questions and Options
Government needs money to do things, and somehow the money comes in. The system, at least
today, does work —but at a cost. This cost is that of confusion —public finance is a mystery to most
citizens in California. In the long run, this constellation of confusion and mystery cannot exist
without leading to undesirable governance consequences. The inhabitants of California need to have
some understanding of how this finance system works. Under the current system, this is nearly
impossible.
/ Rewre lheproperry fax a/loca/ion sysvem.
The property tax allocation system contained in AB 8 needs to be reconsidered in light of the
fact that the mix of local agencies and the services they provide and finance is different from what
existed when the allocation system was designed 20 years ago (part of this .change has occurred, of
course, because of the existence of AB 8). Certainly a principal objective of a new system should be
simplicity. A more comprehensive solution could be developed if a new property tax allocation
system were developed along with a revised sales tax allocation system.
2 Ensure that nen, deb& instruments are underrlood and ijjued within reason
Certificates of Participation, Mello -Roos districts, and other financing instruments are all part.
of contemporary development finance. People in office should be challenged by voters to explain
publicly what they are doing when they vote to issue COPs or allow developers to issue Mello -Roos
debt. Legislative actions that issue debt should be publicized and a running total of issued debt should
be released to the press after each legislative hearing. However, there is no need to go to the voters
every time a new issue is considered. A policy of "reasonableness" is worthwhile in this area.
3 Revise the X-! 'finance swiem 61,providing more local discretion.
K-14 education is financed in an extremely complex manner. There has been some movement
toward simplifying some components of this system through the increased use of block grants, but
the system itself is a true "black box." K-14 education finance should be simplified and then
explained. The ultimate goal of a reconsideration of the financing mechanisms should be to increase
discretion at both the district and individual school levels. To hold the education system accountable
for its product without giving it the ability to make choices is inherently unfair. Part of the ability
to implement change revolves around financial discretion.
State -Local Finance Questions and Options
State and local governments are entwined in a complex system. There are two aspects of this
system that merit attention. One is the control of locally levied taxes by the entity that levies the
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tax, and the other is the alignment of state programs that need local administration, The latter issue
principally involves the state -county relationship.
1. Esra6/ish aforum for state -loco/ relations.
There needs to be a formal and public recognition of the financial interdependencies of the state,
counties, cities, school districts, and special districts. California should, like a majority of other
states, establish an independent State Advisory Commission on Intergovernmental Relations. The
California Council on Intergovernmental Relations served such a role until the mid 1970s when it was
terminated. This commission could do everything from keeping data in an accessible format to
conducting special studies on particular subjects. Any major legislation that has an
intergovernmental fiscal aspect should be analyzed by this commission.
In order to continue the sorting out of the state -county relationship, the commission would also
serve as a forum to continue the discussion of the "realignment" of state and county financing and
program responsibility. In addition, this forum would be the proper place to develop a
comprehensive reallocation of state and local government responsibilities. This recommendation is
similar to that of the California Constitution Revision Commission, which called for the
development and adoption by the legislature of a State -Local Realignment Plan.
2.. Enhance loco/ control over local ) once.r.
There is a constant dynamic tension between the state and local governments. In some respects,
this benefits the people of California because it ultimately forces each unit of government to justify
its actions, However, this tension has also led to a decline in the ability of the governments in
California to act for the benefit of residents. Further, residents have become disconnected from the
taxes or charges they pay and the local officials spending their money. This situation could be
improved by ensuring a greater degree of local autonomy that is still responsive to state goals. Local
governments need a revenue source that is stable, predictable, and controllable; and the use of that
source must be accountable to the citizens. Before Proposition 13, that source was the property tax.
A revenue source for local governments that would better connect the taxpayer and the
governmental agency would go a long way toward restoring community -based decisionmaking and
mitigate the negative effects of the state-controlled local finance system.
Policy Research Agenda
There is limited research dealing with the growing disconnection between citizens and their
governments. If the public finance system is the major determinant of development, if the local
finance system is not easily understood, so that it is unclear how taxes and fees are used, and if local
governments cannot respond to differing or changing citizen preferences because of state control of
local finances, then citizens can easily develop a profound distrust of government, It is not that the
voter believes that government is inherently evil; rather, the citizen simply doesn't understand how
government relates to the individual and may believe that it is out of control, irrelevant, or
unthinking and unperceptive. A research agenda focusing on the effects these unintended
consequences have on citizen behaviors should be developed, centered around the following informal
questions:
• Does the distrust and constraints faced by elected officials as well as public administrators
result from these fiscal effects?
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• Is the decline in voting participation rates related to these same effects?
• Are there specific projects that are not undertaken because of the lack of understanding
as well as distrust of the finance system?
The unanticipated consequences of Proposition 13 increased the complexity of the public
finance system, and the implications of this financial complexity affect our entire system of
governance. These implications need to be examined.
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