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California Cities and the Changing State-Local Fiscal Relationship

By Curt Pringle, president of Curt Pringle & Associates. He is a former member of the California State Assembly, where he served as speaker, and former mayor of Anaheim.

For related commentaries and content, please visit the Untangling the State-Local Fiscal Relationship page.

One issue that stands out in recent California budget crises has been the negative effect that state fiscal issues are having on local governments. It is clear that as governors and state legislators seek to find funds to pay for state services, the dollars that flow to local governments are opportune targets for diversion back to the state.

But local governments are dependent on these resources to carry out their functions. So as the state budget is challenged, local government budgets are also challenged because dollars from the state are the largest source of most local government funding.

Since Proposition 13 passed in 1978, local governments no longer set their own property tax rates to fund local needs. Before that, local governments relied on property taxes and the ability to annually set the tax rate. These revenues were the largest part of local government funding. Proposition 13 was a defining moment and forever changed the funding relationship between local and state governments.

This notion has become all-consuming to many. "If we could just get back to the pre-Proposition 13 days, then all would be fine” is the mantra. Some may consider those the "good ole days”—when local governments could raise taxes at will, when the cumulative effect of multiple governments raising property taxes on a struggling homeowner was not considered, and when local officials didn’t have to seek voters’ consent to raise taxes or institute new ones. However, voters made a clear choice in 1978, and polls show that they would reaffirm that position today. Today state and local leadership must accept that decision—both the protections that have been provided and the challenges that have been created.

But to those who point to Proposition 13 as the catalyst that changed local governments in California: you are right. It did change the revenue side of the equation. What some may miss is that after 1978, the legislature dramatically affected the principle of local control by further limiting local revenues and by mandating programs and services to be performed at the local level.

Not only was the revenue side of the local government equation altered, so was the expense side: the services provided, how they are delivered, and how local governments manage them. Over the last 30 years cities, counties, and school districts have all lost significant autonomy.

Therefore, in discussing the fiscal relationships of state and local governments, the first step is to understand that counties and school districts are not really local governments but "quasi-locals” in today’s definition of government in California.

For instance, urban counties in California receive the lion’s share of their annual funding from state sources for the purpose of managing programs with direct state and federal mandates for service, such as social services. Similarly, school districts have their revenues set by state legislative action, while state education standards, textbook decisions, employee benefit options, graduation requirements, and teacher staffing are restricted by state law.

In contrast, cities are the local governments that have maintained the greatest degree of autonomy from state control—despite significant state mandates. California cities are what should be preserved as true local government in this state.

Cities provide primarily property-based services that their residents want: police protection, fire protection, parks and libraries, streets and roads, and planning and development services. These services have been less battered by legislative mandates, but funding for them is still very much a creature of state government direction.

By and large cities in California today receive the majority of their operating dollars from a share of property taxes allocated to them, a share of sales taxes collected in their jurisdiction, and a share of Vehicle License Fees.

Even though these may seem like local city revenues, they are revenues that the state controls.

Each city’s share of property tax is directed by state legislative action. Most cities’ property tax share is determined by the post-Proposition 13 legislation known as AB 8, passed in 1979. Before Proposition 13, each city, county, school district, and special district would set a property tax rate, and the combined rates constituted a homeowner’s property tax bill. To implement Proposition 13, AB 8 took the newly set property tax rate of 1 percent of assessed valuation and created a distribution matrix of those to the cities and districts within each county.

However, these proceeds varied tremendously from county to county and city to city, based upon a number of circumstances—from the amount of property taxes jurisdictions collected prior to the passage of Proposition 13 to more politically inspired considerations.

In addition, AB 8 was not designed to take into account population and demographic changes, and the disparities that were part of the original 1979 formula have a tremendous impact today. For example, in the 2008-09 budget year allocation of property taxes, San Francisco received $1,114 in property taxes per resident, Los Angeles received $266, San Diego received $234, Anaheim received $97, and Santa Ana received $87. These disparities have a significant effect on how cities perform services, and AB 8’s distribution formula locks in this inequity.

Sales tax is another source of city funds. Cities retain 1 percent of the state-established 7.25 percent sales tax collected in their jurisdictions. Even though this sales tax is collected by the state, the local share—known as the Bradley-Burns share after the authors of the state law—has become an important part of city funding since it was established in the 1950s.

Cities also receive funds from the Vehicle License Fee that is collected statewide and distributed to cities on a per-capita basis. When the state legislature dramatically reduced this fee in 1998, the same state law required the state to "backfill” from the general fund those reductions to local government. And later, those backfilled dollars were funded with an increased share of the property taxes to each of the jurisdictions.

In looking at how to ensure that cities continue to maintain autonomy from the state, it would seem that local revenues should come from a source with a nexus to the service. Cities primarily provide service to property in fire protection and police protection, and enhance a community through parks and libraries, local infrastructure, and planning and development services. Therefore, cities should receive a larger portion of the property tax dollar collected on the property where services are provided. This would give cities an incentive to promote and support the highest and best use for property within their jurisdiction.

Further, a shift of property tax revenue to cities should mean that cities relinquish general tax resources like the Vehicle License Fee or even a portion of sales taxes collected within their jurisdictions. These taxes should be directed to governments that provide general government services, such as education or health and welfare services.

Some of these suggestions will stir opposition among those who defend the status quo. Many local governments have made decisions based upon the rules in place and may feel that any change would negatively affect them.

But we do not succeed by wishing the past never happened—as those who continue to complain about Proposition 13 do. We succeed by living in the present and addressing the challenges of the future.