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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 The 1/4-cent of the local one-cent sales tax enacted by cities and counties throughout the State would be repealed.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: J 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. yz 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 j 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 •;7-�--"',--JUL 25. 2003 11:05PM „SWARD, RICE, ET 1#96609nt 3 Attachment C HOWARD Three Erabareadero Center Seventh Floor � 1? WE San Francisco,CA 94111-424 t�T 1 V EMMV SO� Telephone 415.434.1600 �L I Facsimile 4151175910 FALKwww.howmdrice.com Writer's Information: &ASK V Direct 399.3039 A Profeuional Corporation Email; smayaQa hricacom kPle= 7As Irl s.S .hamS MEMORANDUM �Jf�:r. ��,.s�-!fin^ -,��✓l. 3M 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 . JUL-25-2003 FRI 10,57 PM G3 P 02 JUL. 25. 2003 11:OSPM _ ,RD, RICE, ET NOM66hMent Memo To: Honorable Mayor and Members of the City Council,City of Cerritos July 25,2003 Page 2 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 JUL-25-2003 FRI. 10:57 PH G3 P. 03 JUL. 25. 2003 11 06P AD, RICE,.ET NA"pcpqWnt3 Memo To; Honorable Mayor.and Members of the City Council, City of Cerritos July 25,2003 Page 3 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 JUL-25-2003 FRI, 10:57 PH 03 . P. 04 , �i�'0 $ JUL. 25. 2003 11;06PM n„dARD,'RICE, ET N a ���6 i3 Memo To: .Honorable Mayor and Members of the City Council,City of Cerritos July 25,2003 Page 4 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 JUL-25-2003 FRI 10:58 PH G3 P. 05 JUL, 25. 2003 11 06P h,,..,,RD, RICE, ET NAVJ&Chdf6nt 3 Memo To: Honorable Mayor and Members of the City Council, City of Cerritos July 25,.2003 Page 5 . 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 JUL-25-2003 FRI. 10;58 PM G3 F. 06