SR-100-002 (22)
Council Meeting: June 15, 2004 Santa Monica, CA
TO: Mayor and City Council
FROM: City Staff
SUBJECT: Oppose Further State Attempts To Swap Sales Tax for Property Tax As
Part of Restructuring the State Local Fiscal Relationship
Introduction
This report recommends that Council affirm opposition to State budget changes that
limit local financial flexibility including proposals that swap local sales tax for property
tax.
Discussion
The Santa Monica City Council has given staff broad authorization to oppose State
budget changes that limit local financial flexibility, including fiscal policy guidelines
adopted May 13, 2003. The debate on the 2004-05 State budget is beginning to pick up
momentum, and in the next few weeks many, if not all, key decisions on the budget will
likely be made. Central in this debate, from a local government perspective, is the
consideration of a state and local government finance package.
The League of California Cities and the Governor’s office have come to a proposed
agreement that sets the parameters for a local government finance package. This
package gives up $2.6 billion in local revenues over the next two years to help resolve
the State budget deficit. In return, the opportunity is given to place on a statewide ballot
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a proposal to constitutionally protect and stabilize local government revenues in future
years that the Governor will support. This measure will be on the November 2004
statewide ballot.
However, legislative review of this local government finance package will provide an
opportunity by those in the legislature who want to reach too far and add proposals to
the package that are not supported by local governments. More specifically, a proposal
is being pushed to swap an additional one quarter (1/4) cent of local Bradley-Burns
sales tax for property taxes. This is vigorously opposed by cities, including those of our
Westside COG and the League because these revenue swaps deteriorate local control
and weaken fiscal independence. Although no specific language is currently available,
we understand that Assemblyman Darrell Steinberg, Chair Budget Committee, is intent
on pursuing the goal of a swap.
Placing a sales-tax-for-property-tax-revenues swap in the local government package is
a bad idea for a number of reasons:
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Limits Local Government Financial Flexiblity.
Reduced revenue diversity and
concentration on fewer revenue sources makes the revenue structure vulnerable.
For example in Santa Monica, we currently have seven major revenue sources
with sales tax at 14.9% and property tax at 12.6 % Overconcentration leaves the
City more vulnerable to changes in the economy. Santa Monica’s AAA bond
rating is in part due to revenue diversity. In addition, the “flip” would position the
State rather than the City to benefit from 1) any strategic municipal actions to
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encourage business development and enhance the local sales tax base; 2)
Statewide changes to the sales tax structure that may extend taxation to
services; and/or 3) elimination of the tax-exempt status of internet sales.
Sales tax holds the greatest potential in terms of revenue growth, providing the
ability to expand an existing revenue base without implementing new taxes. For
example, extension of the tax to internet transactions and services would help
both the State and localities replace revenue reductions resulting from the
change to a service and electronic transaction economy.
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No Evidence Swap Will Change Decision-Making.
The advocates for such a
proposal contend that a swap of this nature would make local decision-making
less reliant on the approval of retail development to fund city services, but no
credible studies have been done to confirm this speculation. Moreover, cities
have supported legislation that has passed in recent years to limit local tax
incentives for large retail projects. There is no compelling reason to give up a key
local government revenue source simply to experiment with this untested theory.
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Doesn’t Solve the State’s Structural Deficit.
The State predictably turns to local government, diverting revenues that should
be returned to the community, to “patch” its own budget gap. We anticipate a
minimum of two more years during which Santa Monica and other California
communities will experience revenue decline as the State retains, “borrows” or
diverts local funds. Whether by reducing or eliminating the portion of sales tax
that is returned to the communities in which it is generated or by substituting
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higher proportions of property tax revenue, the State’s structural deficit remains
untreated.
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Built Out Cities Have Different Needs .
“Built-out” cities such as those on the Westside of Los Angeles have different
goals and challenges than developing cities in regard to the fiscalization of land
use and the management of local resources. It is critical that built out cities
retain the benefits of revitalizing economically lagging areas in order to maintain
a robust local economy as well as generate revenue for basic services. For
example, property tax on a major retail mall will remain relatively constant over
time while revitalization of its retail uses has the potential to generate significant
increases in sales tax and could incorporate mixed-use housing.
The swap of property tax for sales tax is more than an exchange of one revenue source
for another. It could impact the quality of life and character of cities. Public opposition
to increasing density in built out communities is significant and City Councils would face
public resistance to revising density ordinances for residential and commercial property
so that property tax revenues and development fees would adequately support needed
services. In essence, cities may have to increase development (density and floor area)
in order to increase the value of the property just to offset the loss of sales tax revenue.
This approach has the potential of dramatically altering the scale and nature of the
urban environment. It is not a choice in built-out cites between “big box” development
or residential development but rather a preference for smart growth redevelopment
consistent with the local community’s character.
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Administration Package Exchanges Local Revenues.
The local government
finance package agreed to by the Administration already shifts about $4.1 billion
in property tax revenue to local government in exchange for vehicle license fee
revenues. This change in local finance is significant. As a result, beginning in
2006-07 cities on a statewide basis will be receiving more revenues from
property tax than sales tax for the first time since before Proposition 13 in 1978.
No further changes are needed until the impact of this shift in local finance can
be adequately assessed.
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The Numbers Don’t Add Up.
A sales-tax-for-property-tax-revenues swap, on
top of the current “triple flip” swap (1/4 cent for an equal amount of property
taxes) passed through Proposition 57, drains ERAF property taxes around the
state and requires the State to give greater shares of the property taxes now
going to schools to local governments. There is not enough property tax money
in ERAF accounts to finance a further tax swap.
Over the past 10 years, the ability of local government to carry out its service
responsibility has been eroded by the increasing shift of local fiscal decisions to the
State. The result of this shift is a destabilization of local revenues which has hampered
the ability of local governments to adequately deliver mandated services and fulfill legal
responsibilities. Rather than robbing “Peter to pay Paul”, we encourage dialogue that
will bring alternative revenue sources to resolve the State budget dilemma. This
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includes discussion about commercial property assessments, business personal
property tax, “sin taxes” and tax on manufacturing equipment.
Budget impact
Opposition to the swap of sales tax for property tax does not have an immediate budget
or financial impact. However, how the current State budget deficit is resolved, and how
the existing State-local fiscal relationship is changed will have significant long-term
fiscal impacts on the City.
Recommendation
The proposal to further swap local sales tax for property tax is the most important
legislative decision affecting the financing of local governments for the next 20 years.
Staff recommends opposing this proposed swap or other measures that limit the
financial flexibility of cities.
Prepared by: Susan McCarthy, City Manager
Steve Stark, Director of Finance
Kathryn Vernez, Assistant to City Manager, Government Relations
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