March 19, 2004
Dear Attorney General Lockyer:
Pursuant to Elections
Code 9005, we reviewed the proposed initiative relating to local government
finance, the “Local Government Property Tax Protection Act” (File No. SA2004RF0011).
This measure amends
the California Constitution and state statutes to:
Change
how revenues from three major taxes are allocated among cities, counties,
and K-14 districts.
Reduce
the state’s authority over local government finance.
Expand
the state’s obligations to reimburse local agencies for mandated costs.
Under existing law,
cities, counties, and K-14 school districts receive revenues from the property
tax, but only cities and counties receive vehicle license fees (VLFs) and sales
taxes.
Vehicle License Fees. The Constitution requires the state to
allocate to cities and counties VLFs paid by California vehicle owners. The
Constitution, however, does not specify a VLF rate or allocation methodology.
Under current law, Californians are charged annual VLFs at an effective rate of
.65 percent of vehicle value. The state supplements these vehicle owner
payments so that cities and counties receive VLFs as if the rate were imposed at
2 percent of vehicle value. This state supplement is referred to as the
“VLF backfill.” Under current law, about three-quarters of VLF revenues
(including backfill revenues) are allocated to cities and counties for
general-purpose use and are referred to as “base VLF.” The remaining
one-quarter of VLF is referred to as “realignment VLF” and is allocated to
counties to support certain health and social service programs. Over the years,
some cities and counties have pledged their VLF revenues as repayment of bonded
indebtedness.
Sales Taxes. Cities
and counties currently have authority to impose sales and use taxes for general
purposes at the rate of one-cent per dollar of taxable sales. Beginning in
mid-2004, city and county authority to impose sales and use taxes will be
reduced by one-quarter cent until certain state deficit-related bonds
(authorized by Proposition 57 on the March 2004 ballot) are repaid,
from 9 to 14 years from now.
Revenue
Shifts From Cities and Counties to Schools. This
measure shifts the allocation of base VLF and any related VLF backfill revenues
(except VLF revenues pledged for bonded indebtedness) from cities and counties
to newly created countywide funds for the support of K-14 education—the School
Assistance Fund for Education (SAFE). The measure also reduces permanently, by
one-half cent, city and county authority to impose sales and use taxes. The
measure creates a replacement sales tax for deposit to SAFE: a one-quarter cent
SAFE sales tax would be established in the near term and another one-quarter
cent SAFE sales tax would be established after the state’s deficit-related
bonds are repaid. Given the wording of the measure’s provisions, it is not
clear whether there would be a short-term reduction to the overall state-local
sales tax rate during 2004‑05.
Revenue
Shifts From K-14 Districts to Cities and Counties.
To offset city and county ongoing tax losses associated with (1) the VLF
and sales tax swaps and (2) any statutory change to property tax
allocations enacted between January 1, 2004 and the measure’s effective date,
the initiative—beginning in 2005‑06—directs county auditors to
permanently reallocate to each city and county a share of the property
tax—collected within the local agency’s borders—that otherwise would be
allocated to K-14 districts. Auditors would implement this tax share change over
a two-year period. If K-14 district property taxes are not sufficient to fully
offset a local agency’s losses, the measure specifies that it shall receive
funding to mitigate its losses from the county SAFE. Within three years, county
auditors would increase a city or county’s property tax share if the local
agency demonstrated that it would have received additional sales taxes from
properties under development at the time this measure passed. The measure is not
clear (1) whether revenues allocated from SAFE would be provided on an
ongoing basis, (2) how SAFE funding would be allocated if demands on the
account surpass its revenues, or (3) as to how much local agencies with VLF
debt obligations would receive in property tax transfers.
Existing law and the
Constitution give the state broad authority over major local tax revenues,
including the property tax, sales tax, and the VLF. For example, the Legislature
may enact a law that changes (1) the allocation of property taxes among
local recipient agencies (K-14 districts, cities, counties, and special
districts) and (2) the rate and allocation methodology for the sales tax
and VLF. The state also has some authority to modify or eliminate other local
taxes, such as the business license tax, utility user tax, and transient
occupancy tax.
This measure prohibits
the Legislature from enacting any measure that:
Reduces,
reallocates, suspends, or delays a city or county’s share of the property
tax or requires a city or county to remit property taxes to a state-created
fund or another local government without the consent of the local agency.
Restricts
the authority of any local government to impose a sales and use tax, alters
the sales tax base without compensating local governments for any associated
revenue losses, or changes the method of distributing sales and use tax
revenues.
Appropriates,
reallocates, suspends, or delays revenues from taxes imposed by local
governments, including but not limited to the business license tax,
transient occupancy tax, and utility users tax.
The Constitution
requires the state to reimburse local agencies (cities, counties, special
districts, and K-14 districts) for the cost of implementing a state-mandated
“new program” or “higher level of service,” unless the mandate pertains
to a crime or infraction or other conditions apply. This measure expands the
circumstances under which the state must provide reimbursement to local
agencies. While the range of state actions that would require reimbursement
under this measure is not clear, it would include state laws or other
requirements that transferred from the state to a local agency an increased
share of costs for a jointly financed program.
Under existing law, local agencies must implement a state mandate during times when the state’s reimbursement is delayed. This measure requires the Legislature to (1) appropriate annually funding for mandated costs and (2) appropriate funding for mandated costs in 2004-05 and 2005-06 no later than the date by which the 2006-07 budget is enacted. In addition, with certain exceptions, this measure authorizes local agencies to suspend performance of mandates created on or after January 1, 2005 if the state does not provide timely reimbursement.
This measure makes
major changes in state and local finance. It shifts tax revenues among cities,
counties, and K-14 districts; reduces the state’s authority over local
finance; and modifies the state mandate reimbursement process. The fiscal effect
of this measure on state and local governments would depend, in part, on future
revenue performance of the affected taxes and the interpretation and
implementation of several key provisions in the measure. We summarize the likely
major fiscal effects of this measure below.
The measure
reallocates local tax revenues by shifting (when fully implemented):
About
$7 billion of city and county VLF (about $4.7 billion) and sales
taxes (about $2.5 billion) to K-14 schools, generally replacing these
lost city and county revenues with increased property taxes.
About
$7 billion of K-14 property taxes to cities and counties, generally
replacing these lost education revenues with funding from the sales tax and
VLF.
The past revenue
performance of the VLF, sales tax, and property tax has varied substantially.
Thus, it is not clear whether local governments as a group would realize
increased or decreased future revenues due to the measure’s swap of VLF and
sales tax revenues for increased property taxes. Given the great variation in
the economic characteristics of specific cities and counties, however, it is
likely that some local governments would receive higher overall revenues from
the existing local government tax base (which includes substantial VLF and sales
tax revenues) than from a tax base with increased reliance upon the property
tax, while others would receive lower overall revenues.
In addition, depending
on (1) the date this measure is placed before the state’s voters and (2) the
interpretation of the measure’s provisions relating to SAFE revenues, sales
tax rates, redevelopment, and property tax allocation, this measure could result
in local government revenues that are greater—or lower—than otherwise would
be the case, possibly by up to several hundreds of millions of dollars.
Under the terms of
this measure, every city and county would qualify for an increased share of
property taxes within three years if it demonstrated that developments underway
in 2004 would have yielded sales taxes. Given the number of property
developments underway at any time in California, many cities and counties would
qualify for such an increase in their property tax shares. Conversely, the
measure does not provide a comparable downward adjustment for cities and
counties experiencing declines in sales tax activity over the three-year period.
Because of this “one-way” recalculation provision, we estimate that the
level of property taxes that cities and counties receive from K-14 districts may
be hundreds of millions of dollars higher than the amount of sales taxes and VLF
cities and counties shift to schools.
In terms of K-14
districts overall, this measure’s provisions do not appear to alter the
required level of state-local support required under the Constitution by
Proposition 98. Thus, most K-14 districts probably would not experience a
direct fiscal effect from this measure. In the case of “excess tax” K-14
districts (those receiving little or no state support for general program
operations because they receive high levels of property taxes), these districts
likely would experience reduced property tax revenues over time because the
measure shifts part of their tax share to cities and counties in the tax swap.
While the measure initially offsets these excess tax district property tax
losses through allocations from SAFE, these allocations are phased out over ten
years.
The Constitution
grants the Legislature significant authority over local taxes. Over the years,
the Legislature has used this authority to alter the balance of resources
between local and state programs, reduce overall taxation in California, and
reallocate resources among local governments. During the last 15 years, the
Legislature enacted many laws that would not have been permissible under this
measure. For example, during this period, the Legislature enacted laws that:
Annually
transfer over $5 billion of property taxes from cities, counties, and
special districts to K-14 districts. The increased school property taxes, in
turn, reduce the state’s K-14 spending obligations by a commensurate
amount.
Delay
city and county receipt, in 2003‑04, of about $1 billion of VLF
replacement revenues.
Alter
the allocation of property taxes and VLFs among some cities and counties.
In addition to
these past state actions, the 2004‑05 Governor’s Budget
proposes to permanently shift $1.1 billion of property taxes from cities
and counties to K-14 districts.
Given the frequency,
magnitude, and nature of these past and proposed state actions affecting local
finance, restricting the Legislature’s authority to enact such measures in the
future would have potentially major fiscal effects on these local governments.
Specifically, the state could not enact measures that reduce city and county
revenues from local taxes. As a result, this measure would result in city and
county revenues being more stable—and higher—than otherwise would be the
case. The magnitude of the fiscal effect on city and county revenues is unknown
and would depend on future actions by the Legislature. Given past actions by the
state, however, the level of future city and county revenues affected by this
measure could be in the billions of dollars annually.
In general, the
measure’s provisions limiting the state’s authority over local tax sources
would have fiscal effects that mirror those on local finances. Specifically,
because the Legislature (1) could not enact some measures that were
previously allowed and (2) would need to reimburse local agencies for
revenue losses associated with changes to the sales tax base, this measure could
result in lower resources being available for state programs than otherwise
would be the case. This reduction, in turn, would affect state spending and/or
taxes. For example, because the state could no longer use some local government
property taxes as part of the state’s budget solution, the state would need to
take alternative actions to resolve the state’s budget
difficulties—such as increasing state taxes or decreasing spending on other
state programs. While the magnitude of the fiscal effect on the state would
depend on future actions by the state, the total fiscal effect of this reduced
authority could be in the billions of dollars annually.
Because the measure specifies that any school SAFE revenues would be considered “local revenues” for purposes of calculating state school funding obligations, a trade of K-14 property taxes for an equivalent amount of sales taxes and VLFs may not change overall state spending for K-14 districts. Because the measure shifts additional K-14 district property taxes to cities and counties within three years (as compensation for future developments), however, the measure likely would increase state education costs, possibly by hundreds of millions of dollars annually.
This increase in state education costs may be offset partially by provisions in the measure that appear to reduce the state’s cost under the school funding guarantee. Specifically, under current law, excess property taxes are not counted to meet the Proposition 98 minimum guarantee. This measure transfers some K-14 district excess property taxes to cities and counties to implement the tax shift. All revenue that cities and counties shift to SAFE (in exchange for property taxes) are counted towards the Proposition 98 minimum funding guarantee, provided the revenues are used for education purposes. The fiscal effect of this excess property tax shift—which indirectly replaces a non-Proposition 98 revenue (excess taxes) with a Proposition 98 revenue (SAFE)—may be a reduction in the level of state resources needed to meet the funding guarantee, by possibly tens of millions of dollars annually.
Because the measure expands the circumstances under which the state is required to reimburse local agencies, the measure may increase future state costs or alter future state actions regarding local or shared state-local programs. While it is not possible to determine the cost to reimburse local agencies for potential future state actions, our review of state measures enacted in the past suggests that, over time, increased state reimbursement costs could exceed a hundred million dollars annually. In the case of state education spending, any increase in reimbursement to K-14 school districts probably would be offset by decreases in other forms of state education support.
The initiative would have the following major fiscal effects, the magnitude of which would depend on future actions by the state and local governments and interpretation of the measure’s provisions by the courts.
Annual shift of about $7 billion in VLFs and sales taxes from cities and counties to K-14 districts; offset by a roughly comparable shift of property taxes from K-14 districts to cities and counties.
Higher and more stable local government revenues than otherwise would have been the case, potentially several billion dollars annually. Conversely, significant changes to state finance, potentially including higher state taxes or lower spending on state programs than otherwise would have been the case. The state fiscal effect would be commensurate with the measure’s impact on local governments.