Courtroom, Legislative, and Ballot Box Strategy Response to the State s Fiscal Problems

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1 Courtroom, Legislative, and Ballot Box Strategy Response to the State s Fiscal Problems Betsy Strauss Special Counsel League of California Cities 1595 King Avenue Napa, California (707) fax: (707) munilaw@aol.com 1

2 Courtroom, Legislative, and Ballot Box Strategies: Responding to the State s Fiscal Problems Introduction This story begins in To date four chapters have been written. The purpose of this paper is to discuss the fourth chapter and preview the fifth. The voters wrote the first two chapters; they may likewise write the fifth. First let s review the first three chapters: Chapter One: The voters lower property tax rates by adopting Proposition 13. The maximum amount of any ad valorem tax on real property shall not exceed One percent (1%) The one percent (1%) tax to be collected by the counties and apportioned according to law to the districts within the counties (emphasis added). Article XIIIA, section one, added to the Constitution by the voters in 1978, caps the property tax rate on real property and directs the Legislature to determine how the tax is distributed within each county to the various taxing jurisdictions. Chapter Two. The voters make funding public education the fiscal priority of the State s General Fund by adopting Proposition 98. From all state revenues there shall first be set apart moneys to be applied by the State for support of the public school system and public institutions of higher education. Article XVI, section 8, added to the Constitution by the voters in 1990, obligates the State to fund the public school system at a specified annual amount. Chapter Three. The Legislature uses its Proposition 13 authority to meet its Proposition 98 obligation. Faced with less State revenue but required to maintain funding to the public school system, the Legislature requires cities, counties, and special districts to contribute a portion of their property tax to the county educational revenue augmentation fund (ERAF). The Legislature lowered the State General Fund s contribution to the public schools but reached the constitutionally mandated amount by augmenting the General Fund s contribution with local property taxes. 1 1 Before the adoption of Proposition 13, each local government established its property tax rate based upon the funding needed to provide local services and programs. In 1978, frustrated with the lack of Legislative property tax reform, the voters took the rate-setting process into their own hands and set a 1% maximum property tax rate for all local governments. Distribution was left to the Legislature according to law. The Legislature established a property tax allocation system based upon each agency s proportionate share of property taxes in the mid-1970s (commonly referred to as AB 8 shares. With the exception of relatively minor changes, the state did not alter these AB 8 shares until the early 1990s. The system reduced the share of property tax revenues allocated to educational local agencies from a statewide average of 54 percent to 39 percent and increased the share of property taxes allocated to cities, counties, and special districts. Proposition 98 required the State to replace the school funding with General Fund dollars. 2

3 Chapter Four was written in the session of the State Legislature. Chapter Five may very well be written in November 2004 voting booths. Chapter Four: The VLF Trigger and the Triple Flip: The Legislative Session The Vehicle License Fee All revenues from taxes imposed pursuant to the Vehicle License Fee Law, or its successor shall be allocated to counties and cities according to statute. 2 The State imposes a license fee on any vehicle which is subject to registration under the Vehicle Code for the privilege of operating the vehicle on the public highways in this state. 3 The annual amount of the license fee is 2 percent of the market value of the vehicle as determined by the Department of Motor Vehicles. 4 In 1998, the Legislature wanted to reduce the amount of VLF paid by the vehicle owner but did not want to lower the 2 percent rate. The State s general fund surplus allowed the Legislature to pay a portion of the total amount of the vehicle license fee otherwise required to be paid by the vehicle owner (2% of the market value of the vehicle) with State general fund money. The vehicle owner paid a lower VLF and local governments were made whole with State general fund money. The VLF paid by the vehicle owner was gradually reduced between 1998 and Since July 1, 2001, section 10754(a)(3)(A) has directed the Department to offset the total amount owing by an amount equal to 671/2 percent of the amount owing pursuant to section When fees are paid to the Department for deposit into the Transportation Tax Fund, the Controller transfers the required offsets from the General Fund into the Transportation Tax Fund. The offsets constitute successor tax revenues to the vehicle license fees for purposes of Section 15 of Article XI. 5 This means that the VLF plus the offsets, which equals the 2% vehicle license fee, must be allocated to cities and counties in accordance with Article XI, section 15. The money for Faced with significant budgetary deficits in 1992 and 1993, the state twice enacted major changes to the State s AB 8 system to direct larger shares of property tax revenues to public schools and reduce state General Fund spending for education accordingly. These changes reduced cities, counties, and special districts shares of the property tax from a statewide average of 65 percent to 48 percent. These shifts are referred to as ERAF shifts after the name of the fund into which each county auditor deposits the shifted property tax for subsequent distribution to K-14 districts. The property taxes shifted to K-14 districts total about one sixth ($5 billion) of total property taxes ($29 billion). Additional information on this subject may be found in the Legislative Analyst s analysis of the Budget Bill called Another Property Tax Shift? available at 2 Cal. Const. art. XI, sec Revenue & Taxation Code Revenue & Taxation Code Revenue & Taxation Code and

4 the offsets does not require an annual Legislative appropriation because it is the subject of a continuous appropriation of funds. 6 In 1998 when the offset began, the Legislature anticipated that at some point in the future the General Fund would be unable to support the required offsets. Section 10754(a)(3)(C) provides: During any period in which insufficient moneys are available to be transferred from the General Fund to fully fund the offsets required by subparagraph (A), within 90 days of the reduction of funding, the department shall reduce the amount of each offset by the ratio of the amount of moneys actually available to be transferred to pay for those offsets to the amount of moneys that is necessary to fully fund those offsets (emphasis added). Since the general fund was paying a portion of the vehicle owner s VLF and since it was possible that an economic downturn would mean that the general fund would not be able to support this obligation in the future, the Legislature provided this safety valve in the event that insufficient moneys were not available to offset the vehicle owner s VLF. Unfortunately, the statute neither defined insufficient moneys nor identified how this determination was to made and who would make the determination. The future arrived in the Spring of 2003, when Governor Davis Director of Finance determined that there were insufficient moneys to fund the required offsets. The Controller was directed to reduce the amount of the offset to $0. The vehicle owner s fee obligation returned to the full 2%. The Legislature responded by Deferring ninety days of offsets due in the Spring and Summer of 2003 until August 15, 2006 except for offsets to cities and counties that could demonstrate hardship to the Controller who then may advance monies up to a total of $40,000, Including Line item in the Fiscal Year Budget which provided for an appropriation of $1,000 for local assistance, Tax Relief, for vehicle license fee offsets as allocated by the Controller to cities and counties. 8 6 Government Code Revenue & Taxation Code 10754(a)(3)(D). Section 10754(a)(3)(D)((ii) defines hardship. SB 1057 introduced by the Senate Committee on the Budget and Fiscal Review on February 18, 2004 proposes amendments to this section. 8 The appropriation also contained the following language: Notwithstanding any other provision of law, the appropriation made by this item shall be in lieu of appropriation for the same purpose contained in 4

5 On the date of the recall election November 2004, based upon a finding of insufficient funds, a vehicle owner was responsible for paying the entire 2% VLF and offsets were not required (leading to the in-lieu appropriation). The Department of Motor Vehicles shall reinstate the General Fund offset to the vehicle license fee as soon as possible. Approximately ten days after his election in November 2003, Governor Schwarzenegger issued Executive Order S-1-03 rescinding the letter issued June 20, 2003, reinstating the vehicle owner s obligation to pay the full 2% and eliminating the offset from the State General Fund based upon the Finance Director s determination that there were insufficient revenues to continue the offsets. The Order directed the DMV to reinstate the General Fund offset based upon the Governor s finding that the prior Director of Finance did not provide priority for the VLF offset over other state obligations of equal legal entitlement and that raising the car tax should only be a measure of last resort to relieve the General Fund of the responsibility for payments to local governments when absolutely necessary due to dire economic budgetary conditions. In order to fund the offsets, the Governor decreased the budgeted amount for a variety of programs, and asked the Legislature for a deficiency appropriation of $2.5 billion to augment Budget Act Item (the in-lieu appropriation). 9 He found authority for these actions in Section 27 of the Budget Act of The actions of the Governor to lower the amount of the VLF payable by the vehicle owner; decreasing the budgeted amount for a variety of programs; and relying on Section 27 to spend at rates that will require a deficiency appropriation have been challenged in University of California Students Association, et al. v. Governor Arnold Schwarzenegger, et al.; and Brooks and Gautreaux v. Governor Arnold Schwarzenegger et al. These two cases will be discussed at the presentation of this paper at the Spring Conference. Section 10754, 11000, and of the Revenue and Taxation Code ( in-lieu appropriation ). Chapter 157, Statutes of 2003, Item There are three possible bases for the legal invalidity of the in-lieu appropriation: (1) It precludes the Controller from relying on the continuous appropriation to transfer offsets to cities and counties in violation of Article XI, section 15 of the Constitution; (2) It does not properly amend, reduce, or modify the continuous appropriation; and (3) It violates Article IV, section 9 of the Constitution in that it violates the single subject rule. The Budget Act cannot be used to substantively amend or change existing law. It should also be noted that the State appears to be using the continuous appropriation to fund the required offsets that were pledged to bonds issued in connection with the Orange County bankruptcy. 9 One of these budgeted programs was University of California Outreach Funding, the subject of Univeristy of California Students Association v. Governor Arnold Schwarzenegger. 10 Section 27 provides, in part: (a) Approval by the Department of Finance of the creation of deficiencies pursuant to Section of Government Code or approval to expend at rates that, in the opinion of the Director of Finance, will require a deficiency appropriation, may be granted only in cases of actual necessity. See, Board of Fish and Game Commissioners of California v. Riley 194 Cal.37 (1924); State Trial Attorneys Association v. State of California 63 Cal.App.3d 298 (1976). 5

6 The Triple Flip The Legislature uses the triple flip to support the repayment of the fiscal recovery bond. The first triple flip: In the Spring of 2003 the Legislature decided to issue a bond to meet a portion of the projected fiscal year 2003 budget deficit. The Legislature established the Fiscal Recovery Fund for repayment of the bond through an increase in the State sales tax of one-half of one percent. 11 Not wishing to increase the overall (State and local) sales tax rate, the Legislature amended the Bradley-Burns Uniform Sales Tax Law to suspend one-half of one percent of the local sales tax during the period beginning July 1, 2004 and continuing until the bond was repaid. 12 At the same time the Legislature adopted a statute providing for repayment of the lost local sales tax with property tax that would otherwise have been directed to the county ERAF. 13 The Pacific Legal Foundation challenged the issuance of the bond without voter approval in violation of the Constitutional debt limit. The second triple flip: Budget discussions continued after the election of Governor Schwarzenegger. Shortly thereafter a fiscal recovery bond was proposed supported by a new triple flip and requiring voter approval. This time the bond was to be repaid with one-quarter of one percent of the State sales. One-quarter of one percent of the local sales tax authority was suspended beginning July 1, 2004 and continuing until the bond is repaid. Once again there is to be repayment of the lost sales tax with property tax that would otherwise have been directed to the county ERAF. 14 The deficit reduction bond was approved by the voters in March 2004 as Proposition 57. The triple flip is challenged City of Cerritos et al v. State Board of Equalization challenges the temporary reduction in the local sales tax. It does not challenge the issuance of the deficit reduction bond. As presented to the Court, the fundamental issue this case raises is whether the tax proceeds of charter cities are simply another pocket the State can pick to solve its recurrent fiscal crisis. The plaintiff cities argue that since a charter city s authority to tax derives from the general grant of home rule authority in Article XI, Section 5(a) of the California Constitution, the Legislature may not enact a statute decreasing the authority of charter cities to levy a sales tax. Arguing that the application of Revenue and Taxation Code to charter cities cannot be severed from its application to general law cities, the cities assert that the statute s invalidity must apply to general law cities as well. 11 The Attorney General opined that the bond would not be a debt prohibited by the constitutional debt limit without voter approval and 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 state s General Fund. 12 Revenue and Taxation Code provides for the suspension of sales tax authority. This scheme puts yet another burden on the State s General Fund since the schools loss of property tax must be made up by the State. 13 Revenue and Taxation Code Revenue and Taxation Code

7 Chapter Five: Part One: The Legislative Session The Governor s Budget In , the administration proposes to redirect K-14 districts $1.3 billion of property taxes that otherwise would be allocated to cities, counties, special districts, and redevelopment agencies. This shift, if enacted, would bring K-14 s share of the property tax to an overall statewide average of 56% and would decrease state General Fund education spending by $1.3 billion. Similar to the ERAF shifts in the 1990 s, this redirection of property taxes is expected to provide ongoing, growing state fiscal relief. Nine hundred and nine million dollars would be shifted from counties; $188 million would be shifted from cities; $135 million would be shifted from redevelopment agencies, and $105 million from special districts. 15 It is worth noting that although the original ERAF shift was unsuccessfully challenged in 1994 in County of Los Angeles v. Sasaki, there remain several possible challenges to this new ERAF shift: (1) the shift uses a local tax (the property tax) for a State purpose (education funding; removing budget deficits) in violation of Article XIII, section 24(a) of the Constitution; (2) the required redevelopment agency contribution violates Article XVI, section 16 of the Constitution providing for tax increment financing; (3) the contribution of city and county property taxes to K-14 schools is an unconstitutional gift of public funds; and (5) the shift violates the constraints placed on Basic Aid school districts by Serrano v. Priest. Vehicle License Fee Offset Payments SB 1057 (Committee on Budget and Fiscal Review) makes changes to the way in which the August 2006 payment of VLF offsets is calculated; and appropriates $20,365,000 for the hardship cases that are exceptions to the delayed August 2006 payments. Analysis continues to determine if the method of calculation causes a substantive change; and if the amount appropriated is sufficient to transfer offsets to all of the hardship cases. AB 1804 (Dutra) makes clarifying changes to the way in which the August 2006 payments of VLF offsets is calculated; appropriates $3.625 billion for the offsets required in the fiscal year; and appropriates $10.3 million to the Department of Motor Vehicles for the purpose of administering the VLF offsets. Analysis continues to determine if $3.625 billion is the correct figure for the fiscal year. Three comments are worth noting: The author intends the legislation to require the general fund to permanently offset the 2% tax to the vehicle owner. The vehicle owner would continue to pay the VLF at 32.5% of the full amount and the general fund would make-up the difference through payments to cities and counties (pursuant to Article XI, section 15 of the Constitution). The League of Cities and CSAC are supporting Assemblyman Dutra s efforts and working with his staff on language. 15 A critique of the proposal by the non-partisan Legislative Analyst s Office, Another Property Tax Shift?, can be found on the Office s website at lao.ca.gov 7

8 VLF Offset Payments: The Legislature s appropriation of only $1,000 in the State Budget for VLF offsets payments, is not sufficient to support the administration s decision to offset the reduction in the VLF to the vehicle owner with State General Fund payments to cities and counties. One of the following must occur for the payments to be made: (1) the Legislature enacts the deficiency appropriation requested by the Finance Director in December; or (2) the Administration relies on the continuous appropriation of the offsets found in????? This issue is worth watching. Triple Flip Clean-Up Proposed legislation (1) confirms that the reinstatement of the full Bradley-Burns Uniform Sales Tax after repayment of the Fiscal Recover Bond is not an increase within the meaning of Article XIIIC of the Constitution that requires voter approval: (2) requires each county auditor to make the required transfer of property tax to backfill the sales tax loss in January and May of each year; (3) makes technical changes to the manner in which the backfill payments are made; and (4) states that the purpose of the local sales tax suspension is to allow the state sales tax to be increased without any fiscal impact to the taxpayer. As of the writing of this paper a bill number was not available for this legislation. Chapter Five: Part Two: The Ballot Box Sacramento political operatives explain that public policy in California is influenced by two characteristics of the people who vote in this state: A dislike of tax increases; and a love affair with the ballot box. Signatures are being collected to place several measures that impact local government revenue on the November 2004 ballot. The Local Taxpayers and Public Safety Protection Act The Property Tax, Sales Tax, and VLF: The Act addresses the three local revenue sources that the State has used to fund State programs: property tax, VLF and Bradley- Burns Uniform Sales Tax. In particular, it is a response to: (1) the ERAF shift of the early 1990 s and the new ERAF shift that the Governor proposes for ; (2) the suspension of one-quarter of one percent of the Bradley-Burns Uniform Sales Tax during the period that the Fiscal Recovery Bond is outstanding; (3) the possible failure to fund VLF offsets; and (4) the obligation of redevelopment agencies to contribute tax increment to the State. The Act would have required voter approval before any of these Legislative enactments could have taken effect. Voter approval will be required before A city, county, or special district s share of the 1% property tax is reduced; Property taxes of cities, counties, special districts or redevelopment agencies are reduced, suspended or delayed by mandatory payments to ERAF or another statecreated fund; 8

9 The Legislature may reduce, suspend or delay property tax payments that backfill the sales tax reduction that supports the Fiscal Recovery Bond; The Bradley-Burns Uniform Sales Tax is reduced, suspended or delayed; The Legislature continues the suspension of one-quarter of one percent of the Bradley-Burns Uniform Sales Tax after the Fiscal Recovery Bond is repaid; VLF revenues based upon the current 2% rate are reduced either through a reduction in the rate or a failure to offset a reduced rate to the vehicle owner. 16 If an act requires voter approval, it must be approved by the same Legislative vote as is required to adopt the State budget. Any statute enacted between November 3, 2003 and November 4, 2004 that would have required voter approval if the measure had been in effect, will be suspended when the measure is approved until the voters approve that statute. 17 State-Mandated Programs and Services. Article XIIIB, section 6 of the Constitution would be amended to: Require reimbursement for mandates within 180 days of the enactment of the statute or a final adjudication that a subvention of funds is required; Allow a local government to suspend performance of a mandate during a fiscal year in which the Legislature fails to appropriate the required reimbursement; Require reimbursement when the Legislature creates a new program; requires services not previously required to be provided; increases the frequency or duration of required services; increases the number of persons eligible for services; or transfers to local government complete or partial financial responsibility for a program for which the State previously had complete or partial financial responsibility. 18 Suspension of performance is not allowed if the mandate provides or modifies any form of protection, right, benefit or employment status for an employee or retiree; or provides or modifies any procedural or substantive right for any local government employee or employee organization arising from, affecting, or directly relating to future, current, or past local government employment. 16 The amount of VLF revenue appropriated in adjusted by the Article XIIIB growth rate may not be reduced, suspended or delayed. Voter approval is also required if the Legislature establishes classifications or exemptions to the property tax or sales tax without including a continuous appropriation of funds to offset the losses that result. 17 If the State Budget Bill for includes an action that would have required voter approval if the measure had been in effect, only that action not the entire State Budget Bill will be suspended until the voters approve the action. 18 The last basis for reimbursement is included in response to the California Supreme Court s decision in County of Sonoma v. Commission on State Mandates which held that a contribution required to be made by a county to the ERAF is not a reimbursable mandate because school funding has historically been funded by a combination of State general funds and local property taxes. 9

10 The California Home Rule Act (CHRA) The Act is based upon a finding that making property taxes the principal source of local government revenues will require new residents in a community pay their fair share of police, fire, parks, health care and other municipal services. 19 In addition to exchanging VLF and sales tax for property tax, the Act proposes amendments to sections of the Constitution relating to reimbursement of state mandates and local taxing authority. Exchange of VLF for Property Tax Through a variety of Constitutional and statutory amendments, the Act exchanges the following sources of revenue between cities, counties, and school districts: City and county proportionate shares of the property tax are increased by an amount equal to (1) one-half of one percent of the Bradley-Burns Uniform Sales Tax and (2) the VLF for the fiscal year based on the 2% rate; and (3) the VLF payments required to be made by August 1, The VLF that would otherwise be transferred to cities and counties is dedicated to each county s School Assistance Fund for Education (SAFE) for use by K-14 schools; An increase of one-quarter of one percent of the State sales tax is dedicated to each county s SAFE for use by K-14 schools. Each city and county would have the opportunity to identify one of three fiscal years as the basis for calculating the amount of sales tax that that is exchanged for additional property tax. Although the Act increases the state sales tax by one-quarter of one percent, the local sales tax is reduced by one-half of one percent. Although the triple flip statute suspends one-quarter of one percent only during the period the Fiscal Recovery Bond is outstanding, the Act makes the suspension of one-half of one percent permanent. 20 State-Mandated Programs and Services. The changes proposed to Article XIIIB, section 6 of the Constitution are identical to those proposed by the Local Taxpayers and Public Safety Protection Act except that the CHRA provides that section 6 does not require the State to reimburse for the costs of certain county welfare programs currently funded with a portion of the VLF. Local Taxing Authority. The Act adds Section 24(c) to Article XIII of the Constitution to prohibit the Legislature from taking any action that: Reduces, suspends or delays any city or county s proportionate share of the property tax; 19 Section 2(f) of the Act. 20 This is a conflict between Proposition 57 adopted in March 2004 and the California Home Rule Act. 10

11 Requires any city or county to remit property tax to ERAF or another statecreated fund or to another local government without its consent; Restricts the authority of a city or county to impose the Bradley-Burns Uniform Sales Tax; Appropriates, reallocates, redistributes, etc. taxes imposed by local governments such as a business license tax, T.O.T or utility users tax. Conflicting Measures. The CHRA provides that if a measure on the November 2004 ballot directly conflicts with the provisions of the CHRA, each measure is approved, but the CHRA receives more affirmative votes, then the provisions of the Act prevail over the conflicting provisions of the competing measure. 21 Legislative Reform SCA 22 (Johnson and Torlakson) and SB 1774 (Johnson and Torlakson) propose their own structural changes to the state-local fiscal relationship. If approved by the Legislature, SCA 22 would be submitted to the voters in November, The purpose of these companion measures is to provide local governments with an adequate, reliable, and guaranteed source of funding to finance public services and facilities. The measures increase the state sales tax by ¼ of one percent and make permanent a one-half of one percent decrease in the local sales tax. The loss of local sales tax is made up with additional property tax. Improving Classroom Education Act The Act imposes an additional property tax at the rate of.55 percent of full cash value of that property on commercial real property, including commercial residential rental property. The revenues from the new tax are deposited into the Improving Classroom Education Fund. Two-thirds of the fund must be used for the support of K-12 educational programs and one-third to provide voluntary universal pre-school for children one year prior to kindergarten. The funds dedicated to K-12 educational programs may not be used to pay administrative costs and may be used only to reduce class size; to purchase textbooks and instructional materials; to provide teacher salaries and benefits; and to provide teacher training. All elementary and unified school districts will b required to provide a program of free, voluntary preschool for children one year prior to kindergarten. The revenues received from the additional property tax are not considered State general fund monies for purposes of the Proposition 98 education funding guarantee. Other measures in circulation provide funding for new police, sheriffs, and firefighters from gaming revenue. Information about these and other initiatives in circulation can be found on the Secretary of State s website 21 Section 26 of the Act appears to reflect the holding of Yoshisato v Superior Court of Orange County 2 Cal.4 th 978 (1992). 11

12 Conclusion The future of the property tax, sales tax and VLF will be determined by a combination of the actions taken by the Legislature in both the 2003 and 2004 fiscal year; policies of the Governor and his administration; pending litigation challenging the administration s reduction of the VLF; and measures considered by the voters in November. The year 2004 is likely to produce a significant change to the State-local fiscal relationship. 12