|Budget Issue:||Administration’s trailer bill proposal related to future “triple flip” unwinding mechanism|
|Finding or Recommendation:||Discusses the proposed trailer bill language that aims to ensure local governments receive the full amount of reduced sales and use taxes related to the triple flip|
Under current state law local government sales tax revenues are reduced in order to repay deficit financing bonds approved by voters in 2004 (Proposition 57). State law also outlines a complex revenue sharing exchange system, commonly referred to as the “triple flip,” that backfills local governments’ reduced sales tax revenue with property taxes. The triple flip continues until shortly after the bonds are fully repaid, which the administration currently estimates will occur in June 2016. The administration proposes budget trailer bill language (displayed on the Department of Finance’s website) that it contends would correct current statute to ensure that local governments receive the full amount of revenue from the reduced sales tax rate during which the bonds were outstanding.
Economic Recovery Bonds and the Triple Flip. In 2004, voters approved Proposition 57, which authorized the state to issue up to $15 billion in deficit financing bonds (also known as economic recovery bonds, or ERBs). $11.3 billion of these bonds were issued in 2004 and an addition $3.3 were issued in 2008. Proceeds from these bonds were used to address the state’s budget shortfall. To repay the ERBs, the state pledged one-quarter cent of the local Bradley-Burns sales tax. In particular, it reduced by one-quarter cent the 1.25 percent Bradley-Burns sales tax, which cities and counties use for general and transportation purposes, and replaced it with a one-quarter cent state special fund sales tax for repayment of the bonds. To hold local governments harmless, the state initiated a complex series of revenue exchanges commonly referred to as the “triple flip,” which we describe below, to continue until the ERBs are repaid.
Flip 1: Shifted one-quarter cent of the Bradley-Burns sales tax to the state to repay the ERBs.
Flip 2: Replaced the diverted local sales taxes, dollar for dollar, with property taxes shifted from school and community college districts—specifically, from county Educational Revenue Augmentation Funds (ERAF).
Flip 3: The school and community college district tax losses from the redirection of ERAF to cities and counties, in turn, are offset by increased state education aid under the Proposition 98 minimum guarantee.
Overall, the intent of this mechanism was that cities, counties, and school and community college districts would not experience any net change in revenue from the triple flip.
Allocating Sales Tax Revenue to Local Governments. Businesses remit sales tax collections to the State Board of Equalization (BOE) at the end of each month. These remittances correspond to sales that occurred during the prior month. The BOE allocates the portion of these revenues from the Bradley-Burns rate to cities and counties, based on the location of the taxable sales, three months after the end of each quarter. So, for example, final allocation for taxable sales that occurred during January, February, and March does not take place until June. On a cash accounting basis, these second-quarter allocations reflect first-quarter sales tax activity. Allocations made over the course of a fiscal year, therefore, are for taxable sales that occurred from April 1st of the prior fiscal year to March 31st of that fiscal year.
Unwinding the Triple Flip Under Current Law. Based on revenue estimates included in the 2013-14 Governor’s Budget, the administration expects the ERBs to be repaid in June 2016. Under current law (Revenue and Taxation Code 97.68), the triple flip would turn off on October 1, 2016, at which point local governments would receive the full Bradley-Burns rate sales tax. At the time the triple flip ends, the Director of Finance is required to allocate the prior quarter’s—in this case, the third quarter’s—sales tax revenue to cities and counties. This revenue allocation to local governments, however, corresponds with taxable sales that occurred during the second quarter (because of the lag between taxable sales activity and the revenue allocation, which we describe above). Because this lag was not incorporated into the original triple flip statute, current law provides no mechanism to compensate cities and counties for taxable sales that will occur in the third quarter of 2016 (assuming that this is the final quarter of the triple flip), for which allocations typically would occur in the fourth quarter of 2016. Current law therefore provides for a final allocation to local governments for one quarter’s taxable sales, when in practice unwinding the triple flip and holding cities and counties “harmless” will require these governments to be compensated for taxable sales that occur in the final two quarters prior to their full Bradley-Burns sales tax rate being restored.
Administration’s Proposal Attempts to Remedy Current Statute. To implement its proposal, the administration has proposed amending Section 97.68 of the Revenue and Taxation Code. As we understand the proposal, it would end the backfill transfer from ERAF to cities and counties in the quarter that the ERBs are fully repaid, and use revenue from the 0.25 percent state special sales tax that was being used to repay the ERBs to compensate these governments for the final two quarters of the triple flip. Revenue from the state special sales tax will continue being collected during these two quarters even though the ERBs would have been, by then, repaid in full. (Specifically, the final allocation to local governments is equal to the whole amount that cities and counties “lost” because of the 0.25 percent sales tax reduction minus the total ERAF transfers to cities and counties under the triple flip that occurred while the Bradley-Burns sales tax rate was reduced temporarily.)
Proposal Appears to Uphold Original Legislative Intent. During the development of the triple flip, the Legislature stated its intent that (1) all local agencies receive funding that fully offset their revenue losses and (2) this funding be provided promptly and outside of the state budget process. In addition, the triple flip mechanism replaces lost sales tax revenue with property taxes on a dollar for dollar basis, indicating to our office that it was the intent of the Legislature to ensure that local governments were fully offset for their lost Bradley-Burns sales tax revenue. The administration’s proposed legislative language attempts to preserve the legislative intent, as we understand it, of the triple flip revenue exchange system.
Current Law Does Not Require This Treatment. The triple flip was developed by the state with active city and county participation and does not contain provisions making the state financially responsible for local governments to receive the full amount of their reduced sales taxes. To our knowledge, there is no legal requirement to change current statute, and allowing the triple flip to unwind under current law (without the changes in the proposed trailer bill) would make available to the Legislature an estimated $410 million for state purposes.
Technical Clean-Up. It is unclear at this point if the trailer bill as currently drafted would achieve its stated intent of ensuring, under all circumstances, full compensation for local government sales tax revenues that were reduced for the period that the ERBs were outstanding. If the Legislature wishes to adopt this proposal in principle, we suggest legislative staff continue to work with the Department of Finance to confirm that the provisions of the administration’s proposed trailer bill meet the intent of the measure. Budget subcommittees also may wish to direct the Department of Finance to consult with county auditors and other local government officials as appropriate.