HomeMy WebLinkAbout04/06/2004, BUS. 4 - SUPPORT FOR LEGAL CHALLENGE TO THE ""TRIPLE FLIP""" council D� April 6,2004
j agenda RepoRt
CITY OF SAN LU IS O B I S P O
FROM: Bill Statler, Director of Finance & Information Technology
Jonathan P. Lowell, City Attorney
SUBJECT: SUPPORT FOR LEGAL CHALLENGE TO THE "TRIPLE FLIP"
CAO RECOMMENDATION
Authorize the City Attorney to include the City of San Luis Obispo as a plaintiff, along with
many other cities in the State, in a legal challenge to invalidate the preemption of the one-quarter
cent local sales tax as part of the "Triple Flip."
DISCUSSION
Background
On March 2, 2004, the voters approved a statewide ballot measure to issue $15 billion in deficit
reduction bonds. These bonds will be paid-off over seven to nine years based on the revenue
stream that will fund them from the "Triple Flip." As summarized below, under this unnecessary
and complicated funding scheme, the following three "flips" are supposed to occur:
1. First Flip. The 1/4-cent of the local one-cent sales tax enacted by cities and counties
throughout the State would be repealed. The immediate affect of this will be to reduce the
City's most important revenue source, which funds almost one-third of General Fund
services, by 25%—about $3 million annually. This makes all other State takeaways pale in
comparison.
2. Second Flip. The.State would enact a new, dedicated 1/4-cent sales tax to repaying the deficit
reduction bonds. At this point in the "flip" sequence, the State has grabbed locally-enacted
revenues and used them to finance $15 billion of its budget deficit. Overall, the taxes paid
by Californians will be unchanged—but funding for essential community services like
police; fire, medical emergency services and street maintenance will be radically reduced.
3. Third Flip. This final flip is a promise by the State to backfill the lost local revenues. This
would be funded by a re-allocation of property tax revenues from the Educational Revenue
Augmentation Fund(ERAF). This, of course, is adding insult to injury, since cities, counties
and special districts are already the sole funding source for ERAF—in the amount of $4
billion annually. (The City's annual contribution to this is about $1.5 million). And the
Governor is proposing a 25% increase in ERAF contributions in 2004-05. In essence, even
under the best of circumstances, we're simply repaying ourselves for the "triple flip:" sales
tax losses will be funded from the property tax takeaways.
There are three major problems with this third flip:
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Support for Legal Challenge to the"Triple Flip" Page 2
It's not necessary. A "double flip" under which the State repeals '/a-cent of its General Fund
sales tax (currently 5%) and then adopts a new 1/a-cent sales tax dedicated to deficit reduction,
would work just as well in addressing Proposition 98 and bond security concerns.
It's complicated. This creates a series of complicated accounting, reporting and disbursement
procedures by the State Department of Finance, Board of Equalization and all County-Auditor
Controllers throughout the State. A "Working Group" composed of representatives from these
three groups as well as from the League of California Cities and California State Association of
Counties (CSAC) is already addressing the "mechanics" of implementing the "Triple Flip." The
City's Director of Finance & Information Technology is a member of this "Working Group," and
under the best of circumstances, it will mean arduous and staff-intensive procedures to
implement, without any net revenue gains. Moreover, even if the implementation is relatively
smooth and we are, in fact, reimbursed for the direct losses, there will still be higher
administrative fees; and since we will receive the "backfill" less often than our normal sales
revenues, we will have lost interest earnings. In short, this will be an accounting nightmare with
significant direct and indirect costs, without any offsetting benefits for anyone. Besides "it's
complicated," another official description for this in the public finance profession is: it's stupid.
It's not guaranteed. Under the proposed "Triple Flip," it is certain that we will lose about $3
million annually in sales tax revenue; however, the State's backfill of this loss is not guaranteed.
So, the question arises: if it's unnecessary, complicated and not Fool me once; shame
guaranteed, what is the "Triple Flip's" attraction to the State? on you. Fool me
Our fear, of course, is that the answer is: the "it's not twice; shame on me:
guaranteed"part.
Fundamentally a Greater Threat than Property Tax and VLF Takeaways
As detailed in Attachment 1, the State has a long track record in using cities as its rainy-day
piggyback whenever it faces budget problems of its own making. In 2003-04, these State budget
grabs cost the City about $3 million, even after accounting for some partial restorations. And
cumulatively, State budget grabs have cost the City about $22 million over the last 16 years.
The takeaways of greatest concern over the past several years have been ERAF, which costs us
about $1.5 million annually; and the continuing threat of cuts to vehicle license fee (VLF)
backfill, which is worth $1.8 million annually to the City (and costs the State $4 billion annually
to fund).
However, aside from the fact that it has a much larger dollar impact, by its fundamental
nature the sales tax takeaway under the "Triple Flip"poses a much graver threat to cities
than ERAF and VLF takeaways.
Why? Simply stated, because sales tax is a locally-enacted revenue source, not a "shared
revenue" by the State.
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Support for Legal Challenge,to the"Triple Flip" Page 3
The fact is that for over 70 years, VLF has been a"shared revenue." When the State pre-empted
local property taxes on automobiles in the 1930's and replaced them with a statewide, uniform
VLF, this became a State revenue source; which it promised to dedicate to cities and counties.
And property taxes are not a local revenue source, either. Since passage of Proposition 13 in
1978, property taxes are now effectively State revenue sources, since it can re-allocate them at-
will, and reduce the State's General Fund contribution to schools accordingly.
In short, no city since the 1930's has locally enacted a vehicle license fee; and no city since 1978
has locally enacted property taxes. But the City has enacted its own local sales tax (via
Ordinance No. 45 in 1957, which is now Chapter 3.12 of the.Municipal Code); and it is only
under this locally-enacted authority that the City generates about $11 million annually in sales
tax revenues.
And this is why the local sales tax component of the "Triple Flip" poses a much greater
fundamental threat to the City's long-term fiscal health than the other grabs that have previously
been on the State's piggybank radar: if the State can take away a locally enacted revenue source
like sales tax, then no city revenue source is safe from State raids.
In short, if 25% of our sales tax revenues, why not take 50% of our transient occupancy taxes?
Or 67% of our utility user taxes? 75% of our business taxes? Or 90% of our franchise fees?
In short, a case can be made that in the State's ethics calculus, shared revenues are "fair game;"
however, grabbing locally-enacted revenues takes the ethics of State budget grabs to a
fundamentally new—and much lower—level.
Joining the Legal Challenge Already Underway
In December of 2003, the City of Cerritos began soliciting support fora constitutional challenge
to the "Triple Flip." Since then, they have filed a law suit on March 4, 2004, which has been
joined by over 40 cities as plaintiffs in this challenge. A listing of participating cities as of
March 19, 2004 is provided in Attachment 2; and a Memorandum from one the law firms hired
by the City of Cerritos that analyzes how a "triple flip" is not necessary to support the deficit
reduction bonds is provided in Attachment 3. A full copy of the Petition for Writ of Mandate
that discusses the legal basis for the challenge is on file in the Council Office.
If successful, this legal challenge will not impact the sale of the deficit reduction bonds nor
disrupt the State's budget-balancing plans (which is why it was not filed until after the March 2
election), but it will prevent the "triple flip" portion for charter cities—like San Luis Obispo.
(And since charter cities constitute such a large portion of local sales tax revenues, many General
Law cities hope that the State would administratively extend the preemption to them as well,
which is why several General Law cities have joined this legal challenge.)
What is the relationship of this legal challenge to the proposed "Local Tax Payers and Public
Safety Protection Act?" As the Council is aware; a coalition of the League of California Cities,
CSAC and special districts is currently working to collect signatures to place a constitutional
Ll
A
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Support for Legal Challenge to the"Triple Flip" Page 4
initiative on the November 2004 ballot that will require voter approval of any State takeaways
from local government. While the "triple flip" would be covered by the proposed initiative, it
does not address the fundamental issue of the State's ability to grab locally-enacted revenue
measures, which can vary significantly throughout the State. Moreover, the successful
placement of the measure on the November 2004 ballot, let alone its passage, is not guaranteed.
FISCAL IMPACT
There are no direct fiscal impacts in joining as plaintiffs in this legal challenge. However, there
will be huge adverse consequences to the City if the triple flip goes forward and the State does
not backfill lost revenues under the "third" part of the flip.
ATTACHMENTS
1. Impact of State Budget Grabs on the City
2. Cities Participating in the Legal Challenge (as of March 19, 2004)
3. Memorandum Summarizing Why the "Triple Flip" Is Unnecessary
AVAILABLE FOR REVIEW IN THE COUNCIL OFFICE
Petition for Writ of Mandate: City of Cerritos v State Board of Equalization
G:Budget Folders/Financial Plans/2003-05 Financial Plan/State Budget Takeaways/Triple Flip/Council Agenda Report
k.4achment .
city of san lulls omspo
IMPACTB-UDGET GRABS
State budget grabs from cities are not new. They began in earnest in 1981-82, when the
State first learned that it could balance its budget shortfalls by taking away revenues from
cities. Interestingly enough, its first takeaway was vehicle license fees (VLF) in 1981-82, in
response to recessionary declines in State General Fund revenues. (This takeaway was
subsequently restored in 1984-85 via a Constitutional Amendment). That same year, the
State also took away subventions for liquor license fees and "bank in-lieu" subventions
(which were provided to cities in light of the fact that it pre-empted any local taxes on banks).
The following summarizes the estimated impact of these grabs on the.City in 2003-04. For
perspective, this chart also shows the estimated cumulative impact of these takeaways over
the last 16 years (even though, as noted above, some of these takeaways go back further
than this *).
As shown below, even after accounting for partial restorations, these takeaways cost us $3.1
million in 2003-04; and $22 million over the last 16 years. This chart also show that these
"takeaways" have clearly been in response to State budget needs (and not some desire to
improve tax equity): it's why they occur in "clumps" that so closely mirror State budget woes.
In short, as the State Legislative Analyst's Office says in their latest report on the Governor's
proposed budget, local governments have become the State's piggybank whenever they face
budget problems (a role the State Constitution does not assign to us).
Fiscal Year Fiscal Year Cumulative
Implemented 2003-04 Last 16 Years
Takeaways
Vehicle License Fees (VLF)"Gap" 2003-04 808,500 808,500
SB 90 Mandated Cost Reimbursements 2002-03 90,000 180,000
Educational Revenue Augmentation Fund (ERAF) 1992-93 1,488,200 12,160,400
Property Tax Administration Fees 1990-91 167,500 1,514,900
Booking Fees 1990-91 180,000 1,557,000
Cigarette Tax Subventions 1990-91 47,000 531,900
Business Inventory Exemption Reimbursement 1984-85 469,900 4,709,900
Bank In-Lieu Subventions 1981-82 248,000 2,510,400
Liquor License Subventions 1981-82 60,000 1,106,000
Hiqhway Carriers Subventions 1 1981-82 1 14,000 1 112,000
Partial Restorations
Booking Fee Reimbursements 1999-00 (105,400) (527,000)
"COPS" grants 1996-97 (100,000) (800,000)
Proposition 172 1993-94 237,500 1,973,800
TOTAL STATE BUDGET GRABS FROM THE CITY $3,130,200 $21,890,200
* What's the magic to sixteen years? It's how long Bill Statter has been the City's Finance Director,
and has had to cope with these shortfalls in balancing the City's budget. It's not that hard to
envision the cool things we could have done over this period with another$22 million.
S�
Cities participating in the laws»;t. Page 1 of 2
Aftachment
City Council City Jobs Library A to Z I On-Line servieos Performing Arts Recreation Safety N3
FAQs & News Cities participating in the lawsuit
Maps/Location
Performing Arts Participation in Lawsuit against State of California to Invalidate the
Government Preemption of One-Quarter Cent of Local Sales Tax as Part of the
City Services "Triple Flip"
Community_I_nfo
Cerritos A to Z
City_Jobs CHARTER CITIES
Library Catalog
E-mail to Council Alameda
Businesses Alhambra
Cityyall Qn-Line Arcadia
Public Art/Pho_t_o_s Bakersfield
-Shop/Dine Burbank
N3 On-Line Cerritos
Search Chula Vista
I Site Outline I Culver City
I Contact its I Cypress
Fresno
FAQs&News I= Glendale
Hayward
Irvine
Irwindale
Monterey
Palm Desert
Palm Springs
Pasadena
Placentia
Pomona
Porterville
Rancho Mirage
Roseville
San Marcos
Sand City
Santa Cruz
Seal Beach
Signal Hill
Sunnyvale
Temple City
Torrance
Tulare
Total Charter Cities -32
GENERAL LAW CITIES
Artesia
Bellflower
Camarillo
Chino Hills
http://www.ci.cerritos.ca.us/citygov/lawsuit/cities.htn-d 3/19/2004 y
Cities participating in the laws»it. _ Page 2 of 2
Corona
El Monte
Huntington Park
Norwalk
Saratoga
Total General Law Cities - 9
Please send any comments to webmanager@ci.cerritos.ca.us
This page was updated on March 10, 2004.
Copyright @ 2001,City of Cerritos
http://www.ci.cerritos.ca.us/citygov/lawsuit/cities.html 3/19/2004
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Attachment C
HOWARD Three Erabareadero Center
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MEMORANDUM �Jf�:r.
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TO: Honorable Mayor and Members of
the City Council,City of Cerritos
FROM: Steven L.Ma 1( .✓ �� �yJ /,� /��/, �✓✓, K
Pauline E. Callande
14
DATE: July 25,2003 y
RE: How the State Can Solve Its Budget Crisis Without Impairing Local
Government Revenue.
Under pending proposals to solve the State's budget crisis,$10 billion of the
current state deficit would be paid with the proceeds of newly-issued bonds.. The bonds
would be backed by a new 1/2 cent state sales tax,with the proceeds being placed in a
"Fiscal Recovery Fund."
Because two-thirds of the Legislature is not willing to enact a new sales tax,
the sales tax necessary to fund the revenue bonds must be paid for by a half-cent
reduction in the existing sales tax. There are several proposals to accomplish this. Under
the simplest, a half cent of the existing state sales tax would be eliminated and replaced
by the newly-enacted sales tax dedicated to pay off the deficit bonds. However,the
Senat&seems'po*od to enact a more complex alternative that would require a 1/2 dent
decrease in the local sales,tax, as opposed to the state sales*tax,and a promise by the
State to make local governments whole for loss of their sales tax revenue with a
reallocation of property tax.
For the reasons that follow,this alternative proposal("the tiple flip")is .
legally unnecessary. Simply swapping a half cent of the existing sales tax for a new sales
tax dedicated to payoff the revenue bonds is simple,poses,only minimal disruption of
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existing revenue streams,and does not impair the State's ability to satisfy the
constitutional mandate to fund education under Proposition 98. The Attorney General's
memorandum to the contrary overlooks a key statute and is therefore incomplete at best
and inaccurate at worst.
A. The State Has An Obligation Under Proposition 98 To Provide Minimum
Funding For Education.
In 1988,California voters enacted Proposition 98,which added Article XVI,
Section 8 to the California Constitution. Proposition 98 guarantees-K-12 schools and
community colleges a minimum level of funding. It requires that the State set aside for
education from the General Fund the larger of the amounts calculated under two(sub-
sequently amended to three) alternative methods or tests. The first method(the"per-
'centage-of-revenues"formula) guarantees the schools and community colleges
collectively the same percentage ctf General Fund tax revenues as they received in the
base year of 1986-87. The second method(the"maintenance-of-effort" formula) guar-
antees the schools and community colleges collectively their prior-year funding level
adjusted for increases in enrollment and changes in cost of living. In 1990,the voters
enacted Proposition 111,which changed and subdivided the second funding method
Proposition 98's funding requirements may be suspended for one year by a
two-thirds vote of the Legislature. In that event,Article XVI, Sections 8(d) and(e)pro-
vide for a makeup of the lost funding in subsequent years.
The computation of the State's Proposition 98 obligation is further detailed in
various statutes codified in the Education Code,primarily in Education Code Sections
41200-41208. One of these statutes bears directly on the issues now facing the
Legislature.
B. Education Code Section 41204(b)(1)'Provides That Tax Revenues Reds-
rected From The General Fund To Another Fund.Shall Not Be Included
In The Computation Of The State's Proposition 98 Funding Obligation
Under The"Percentage of Revenue"Method.
Education Cone Section 4I204(b)(1)provides that ji]fthe revenues-of a tax
that were deposited'in the General Fund in the 1986-87 fiscal year are redirected to
another fiord,or level of government,then the percentages of General Fund revenues
required to be applied by the state for the support of. . . [education] shall be recalculated
as if those revenues were not deposited in the General Fund in the 1986-87 fiscal year."
The current state sales tax is 5%today and was 4.75%in 1986/87. Accordingly,that tax
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Memo To; Honorable Mayor.and Members of the City Council, City of Cerritos
July 25,2003
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was"deposited in the General.Fund in the 1986-87 fiscal year." It is therefore covered
by Section 41204(b)(1).
This statute strongly suggests that the Legislature can.repeal a half-cent of the
existing state sales tax and substitute in its.place a new half-cent sales tax dedicated to the
Fiscal Recovery Fund without increasing its obligations under the"percentage of
revenue"formula contained in Proposition 98. To begin with,it is not clear that the
repeal of one tax and the substitution of another tax would amount to a"redirection"of
the revenue raised by the old tax. But even if it were,under this statute the Legislature
can create a new special fundby repealing a portion of the existing state sales tax,and
substitute therefor a new sales tax dedicated to a specific find,without including the new
fund within the General Fund for purposes of determining the state's educational funding
obligation under the`percentage of revenue'method.
While our research has revealed no cases construing Section 41204(b)(1),the
courts have upheld a similar.statutory measure which resulted in reduction of the State's
obligation under Proposition 98. In response to a budget crisis in 1992,the California
Legislature reduced the proportion of property taxes previously allocated to local
governments and simultaneously transferred an equal amount of property tax revenues
into Educational Revenue Augmentation Funds(`T AFs"). See County of Sonoma v.
Commission on State Mandates, 84 Cal. App.4th 1264, 1269-70(2000). As part of the
legislation-implementing the ERAF measures,the Legislature enacted Senate Bill
No. 766(1991=92 Reg. Sess),codified as Section 41204.5 of the Education Code. Id. at
1270. Section 41204.5(b)provides that -
"for the 1992-93 fiscal year and each fiscal year thereafter,the per- .
centage of`General Fund Revenues' appropriatedfor school dis-
tricts and community college districts,respectively in fiscal year
1986-87 for purposes of. .Section 8 of Article XVI of the
California.Constitution,shall be deemed to be the percentage of
General Fund revenues that would.have been appropriated for those
entities if the [ERAF legislation]had been operative for the 1986-
. 87
986-. 87 fiscal year,".
Section 41204.5 thus reduced the State's Proposition 98 obligation in proportion to its
allocation to the ERAFs. M
Section 41204.5 was upheld as constitutional in County of Sonoma v
Commission On State Mandates, 84 Cal.App.4th at 1289-90. In that case,the County of
Sonoma,joined by a number of other counties,asserted that Proposition 98 established a
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wholly state-funded program that the County was forced to finance through the ERAF
legislation,thus triggering the state-mandated cost provisions of Article XIII B,
Section 6. The County asserted that Education Code Section 41204.5 had reduced the
State's.Proposition 98 obligation,and that the counties had been forced to assume the
shortfall through the reallocation of revenues to the ERAFs. Id. at 1289&u.20. Reject-
'ing this assertion,the court held that the counties had misconstrued Proposition 98's
impact on education:
"Proposition 98 merely provides the formulas for determining the
minimum to be appropriated every budget year. The state's obli-
gation is to ensure specific amounts of money are applied by the
state for education. . . . We perceive no intent in Proposition 98's
concern for an appropriate level of funding for education that
would-tie the-hands of the Legislature in meeting that goal,par-
ticularly in years of low revenues. (Id. at 1290)
By analogy, a reduction in the State's Proposition 98 obligation pursuant to
Education Code Section 41204 notoniy appears to be legally permissible,but,as the
court intimated in County of Sonoma,also desirable,"particularly in years of low.
revenues." Id. .
C. Because The Attorney General's May 29 Letter Ignores Section
41204(b)(1),It Does Not Accurately Describe The Effect That Redirecting.
General Fuad Revenues Would have On The State's Proposition 98
Obligation.
On May 29,2003,the Attorney General's office wrote Steve Peace,the
Director of Finance,regarding a legislative proposal to issue bonds to meet a portion of
the current deficit. .1d. at 1. Among other issues,the Attorney General addressed whether
the"Fiscal Recovery.Fund"out of which the bonds would be paid"would be a special
fund(outside the General Fund) for purposes of calculating the state's constitutional
obligation io the schools"under.Proposition 98. Id. In addition,the letter addressed
whether the Attorney General's answers to this question"would change if the Fiscal
Recovery Fumf wercto iie-funded-bythe.-redirection from the General F.und.Qf.a RQztion
of existing sales tax revenue." Id at 2.
In answering these questions,the Attorney General stated that"the Fiscal
Recovery Fund should not be used for purposes of calculating the state's constitutional
obligation to the schools,or meeting other claims against the General Fund." Id. How-
ever,the Attorney General qualified this conclusion by stating in the summary of the
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opinion that"if the Fiscal Recovery Fund were to be funded by redirection from the Gen-,
eral Fund of an increment of existing sales tax.revenue . . . . the redirected funds would
have to be used to calculate the state's Proposition 98 obligation,and it is not clear that
these funds would be immune from claims to meet General Fund obligations" Id.
The text of the Attorney General's letter—as distinguished from the sum-
mary—makes no effort to support this conclusion, and we believe it is incorrect. Indeed,
it is squarely contradicted by Education Code Section 41204(b)(1), As noted above,that
statute provides that a special fund created by the redirection of existing sales tax reve-
nues would retrospectively change the computation of the State's obligation under Propo-
sition 98. Yet the Attorney General's.letter does not mention this portion of the stande.
Nor does it attempt to calculate what the state's Proposition 98 obligations would be .
under various revenue projections giving force to the plain language of Section
41204(b)(1)•
Without detailed revenueprojections,which are not contained in the May 29,
letter,it is impossible to quantify the precise impact that redirecting General Fund
revenue.would have on the state'-s Proposition 98 obligation under Section 41204(b)(1).
But the Attorney General's conclusion that Proposition 98 prevents the state from.simply
repealing a half-cent of the existing sales tax and substituting in its stead a dedicated tax
to fund.the Fiscal Recovery Fund is not supported by the letter's reasoning. In its haste to
enact a budget,the Legislature should not discard this simple option on the basis of the
Attorney General's truncated analysis.
The Attorney General's May 29 letter also concludes that redirection of
existing sales tax revenues from the General Fund to a special fund might give rise to liti-
gation by those claiming priority rights in the General Fund based on the contracts
clauses of the federal and state constitutions. But the Attorney General cites no case sug-
gesting that any such litigation would be successful. And while the Attorney General
argues that the more threat of litigation"is likely to negatively affect the state's ability to
access the capital markets for an extended period of time"(May 29,letter at 7),the"triple
flip"tax shift currently under consideration is far more complex,wide-ranging, and likely
to spur litigation-than.the-sirnplexedirectionof state sales.tax.revenue.mistakenly dispar-
aged6yt-he-Attbffi6+Geneial:Mdreov`6r;because Cliff red1mettoanfsates tax reveii
and the"triple flip"would both net the same ultimate reduction in general.Amd revenue, ,
it is illogical to suggest(as the Attorney General does)that one option would be more
likely to lead to litigation by creditors of the General Fund than the other.
wn on503/1-1360001 W1092474M
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