SR-200-000 (6)
Finance: CMD
Council Meeting of May 13,2003 Santa Monica, CA
TO: Mayor and City Council
FROM: City Staff
SUBJECT: Fiscal Policy Recommendations to Guide Participation in the League of
California Cities Special Meeting May 15, 2003 Concerning Resolution of
State Budget Crisis and Reform of the State-Local Fiscal Relationship,
Confirmation of Voting City Delegate and Alternate, and Recommendation
to Oppose AB 1221 which Proposes to Swap a Portion of City Sales Tax
Revenue for Additional Property Tax Revenue
Introduction
This report recommends that Council consider and approve fiscal policy guidelines
concerning resolution of the current State budget crisis and State-Local Fiscal Reform.
The guidelines would facilitate participation by a representative of the Council and City
staff in a special League of California Cities meeting on May 15, 2003 that has been
called to consider specific proposals, still under development by League staff,
concerning these matters. The report also recommends opposition to AB 1221 which
would adversely impact City revenues.
Background
The State General Fund budget for FY’s 2002/03 and 2003/04 is projected to be in
deficit from about $ 30 billion (current estimate of the State Legislative Analyst) to
almost $ 35 billion (estimate of the State Department of Finance). Deficits of this
magnitude constitute about 40% to 46% of the State’s FY 2002/03 General Fund budget
of $ 75.5 billion.
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Since the Governor’s release in early January of his Proposed Budget for FY 2003/04
and proposals to address the deficit during the current fiscal year, only about $ 3.3
billion in expenditure cuts have been implemented, and no revenue increases have
been approved. Of this $ 3.3 billion reduction, about $ 1.2 billion is essentially a
delaying tactic whereby these funds were moved from FY 2002/03 to FY 2003/04. This
delay and failure to address the deficit appropriately makes it increasingly difficult for the
State to balance its General Fund budget.
When the State Department of Finance releases updated budget deficit estimates in
mid-May, reflecting current State income tax payments and other updated revenue
projections, the magnitude of the budget deficit will likely increase. Closing a budget
deficit of this magnitude will necessarily entail a multi-year State effort incorporating
revenue increases, expenditure reductions and borrowing. The State actions may have
significant negative impacts on local government.
In light of these developments and based on very recent state-wide polling results, the
League of California Cities has accelerated short-term efforts to protect local services
and revenues from State budget cuts, and long-term plans to facilitate changes to the
State-local fiscal relationship. These short-term efforts and long-term plans will be
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presented at a special League meeting in Sacramento on May 15 of representatives
from all cites. Specifics concerning the League’s proposals are not available at this
time. Therefore, City staff has prepared policy guidelines to facilitate City participation
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on May 15.
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Recommended Fiscal Policy Guidelines
Recommended fiscal policy guidelines concerning the resolution of the current State
budget deficit, and long-term change to the State-local fiscal relationship are at
Attachment A. They have been developed by staff based on a review of previous
proposals prepared by the League of California Cities, and State and academic studies
concerning these matters. The recommended fiscal policy guidelines also reflect
existing City policy, where applicable, and what staff believes to be in the best fiscal
interests of the City.
Confirmation of Voting City Representative and Alternate
The League has requested that each City Council designate a voting delegate and
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alternate. The designated delegate or alternate would vote at the May 15 special
meeting on one or more proposals prepared by the League Board of Directors
concerning the State budget and State-local fiscal reform. The City’s past practice is
that the Mayor is the City’s designee as delegate with the Mayor Pro Temp as the
alternate.
AB 1221: Proposal to Swap Sales Tax Revenue for Additional Property Tax Revenue
The most significant proposal now being considered by the State legislature to alter the
current State-local fiscal relationship is AB 1221. This proposal is also likely to be
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discussed at the League’s May 15 meeting. This bill would require that 50% of a city’s
base year (probably FY 2002/03) sales tax revenues be shifted to the pool of property
tax revenue collected in each County and replaced by an equal amount of additional
property tax revenue that would be reallocated from that pool back to the City. So, in
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the base year, each city would be made fiscally whole. Thereafter, each city would
receive a proportionally greater share of the annual growth in property tax revenues,
and only a .5% portion (rather than the current 1% portion) from the current 8.25%
Sales Tax rate applied to taxable sales occurring within the city. A copy of a brief press
release prepared by the bill’s authors and the bill is at Attachment B.
The bill’s authors and its supporters argue that such a revenue swap is beneficial to
local government because:
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Based on State-wide statistics, the property tax is a more stable revenue source
that the sales tax, and property tax revenues have increased more quickly than
sales tax revenues;
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By financing more local services with property tax revenues, local officials will be
more accountable to their citizens as citizens can more easily understand the
linkage between property taxes and local services; and
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By reducing a city’s reliance on sales tax revenues, there will be less pressure to
pursue additional retail outlets at the expense of other types of land uses such as
housing.
Staff’s analysis of these arguments indicates they are flawed and AB 1221 should be
opposed. Both sales and property taxes respond to changes in the economy. Sales
taxes respond rather quickly as purchasers react to perceived changes in job security
and future income prospects. Property taxes respond more slowly as assessment
appeals are filed and processed and/or property sales are completed. The relative
stability of each city’s revenue sources depends upon local factors that could be very
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different among cities. Increased accountability to citizens is more directly related to the
quality of customer service, demonstrated service performance, and adherence to
expenditure restrictions than how services are financed. Individual city needs differ
concerning the appropriate mix of retail and other types of land uses. If additional
housing is a statewide priority, then direct and positive fiscal incentives should be
adopted to stimulate the creation of more housing, rather than discouraging cities from
pursuing an alternative land use.
There are four further reasons to oppose AB 1221:
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AB 1221 will likely have a long-term negative fiscal impact on Santa Monica.
Over the long-term, average annual City sales tax revenues have increased
faster (+ $ 1.1 M/year) than property tax revenues (+ $ .7 M/year), after adjusting
for unique events that have skewed long-term trends. If this trend were to
continue, the City would receive less revenue under AB 1221.
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By reducing the percentage of sales tax revenue, City revenue diversity would
be reduced. Reduced revenue diversity makes the revenue structure more
vulnerable to changes in the local economy.
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During the early 1990’s, the State took about $ 3.0 billion of Property Tax
revenues from cities to help balance its budget deficit. This was done because
the diverted property tax revenue could be reallocated by the State to schools
thereby relieving, on a dollar for dollar basis, the State’s fiscal responsibility
under Proposition 98 to finance the K–12 educational system. The current value
of property tax revenue taken from Santa Monica at that time is more than $ 3.5
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m/year. By swapping sales tax revenue for property tax revenue, cities increase
their vulnerability to similar future property tax revenue diversions.
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In light of the enormous budget deficit now facing the State and the continuing
shift of the economy towards services, it appears increasingly likely that over
time the sales tax base will be broadened to apply to many services. Many other
states already apply the sales tax to services. If this happens, a significant
increase in sales tax revenues may occur. AB 1221 would limit the City’s share
of any such revenue increase.
Budget/Financial Impact
Approval of the attached recommended policy guidelines, and opposition to AB 1221 do
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
It is recommended that the Council approve the fiscal policy guidelines set forth at
Attachment A, confirm the Mayor as the City’s voting delegate and the Mayor Pro Tem
as alternate to attend and vote at the special League meeting of May 15 for the purpose
of voting on State budget and State-local fiscal reform proposals, and direct the City
Manager to take appropriate action to oppose AB 1221.
Prepared by: Mike Dennis, Director of Finance
Kate Vernez, Assistant to the City Manager, Government Relations
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