This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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If you were a city official in the early 1990s, the weaknesses of the state-local fiscal relationship were painfully clear to you in a way that may not be as easy to understand in today's robust economy. At that time the flaws of the system were readily apparent, as cities were forced to cut support for libraries, human services, parks and recreation, street maintenance and planning when local property tax revenues were reallocated by state government to fund schools.

Today, however, there's a cautiously hopeful wind blowing through city halls around the state. What's new is the fact that there is a growing commitment by a number of state leaders to find a more balanced system for financing local governments. What makes discussions possible, now more than in years past, is the leadership on this issue by certain state legislators (many of whom formerly served in local government) and the good fortune of the state's strong fiscal standing. Whether these factors will be sufficient to see us through a transition to a more balanced system for financing city governments over the next few years will become clearer as the legislative session progresses.

Some Background: How Cities Got to Where They Are Today
The dissatisfaction with the current state-local fiscal relationship has its roots in a series of decisions made by both the Legislature and the public, beginning in the 1970s. These decisions have substantially narrowed the municipal revenue base and emphasized state control over municipal revenues at a considerable cost to the citizens of California. These decisions included:

• Losses in city property tax revenues due to Proposition 13 in 1978, and loss of control over distribution of the remaining property tax;
• Elimination of local subventions in the 1980s totaling more than $300 million per year (liquor license fees, highway carrier's uniform business tax, financial aid to local agencies, cigarette tax, etc.);
• Cuts in motor vehicle in-lieu tax revenues in the early 1980s of more than $230 million; and
• Additional and ongoing cuts, beginning in the early 1990s of local property tax revenues to fund schools (ERAF, or Education Revenue Augmentation Fund). These "shifts" in local property tax dollars to schools came at the expense of cutting vital local services.

Add to the above mix a growing tendency of state government and the public to mandate functions on cities while further limiting their ability to raise taxes and fees (Proposition 218 of 1996, requiring voter approval of tax increases), and there can be little doubt why state and local leaders are troubled by the current state-local fiscal relationship. Moreover, there is growing concern that the narrowing revenue base of cities has created a system of undesirable fiscal incentives that are driving land use decisions (often referred to as the "fiscalization" of land use).

What Cities Need and Want: Permanent, Constitutionally Protected Solutions
With the passage of legislation last year calling for the development of a proposed constitutional amendment to restructure the state-local fiscal relationship, the Board of Directors of the League of California Cities appointed a special task force charged with charting a reform package to provide a basis for future discussions with state policymakers. The task force worked diligently to identify the issues and concerns of cities, and to develop a set of preliminary recommendations that respond to them. Key issues they sought to address include the following:

Chris McKenzie is executive director of the League of California Cities. Several detailed reports on the fiscal pressures facing cities can be found on the League of California Cities Web site, www.cacities.org, click "Member Services," then "Features," then "Financing." The League's fiscal reform recommendations can be found at http://www.cacities.org/
memserv/features/
Fiscal_Reform/
fiscal_reform.htm.

• Unpredictability in City Revenues. Declines in federal, state and county aid to cities (down from 21 percent to 13 percent of revenues since 1974-75) and major reductions in property tax revenues since the early 1990s have substantially undermined the stability of city revenues. Since 1992-1993, cities have lost $2.8 billion in property taxes (net of Proposition 172's sales tax increase for local public safety programs) that was diverted to fund schools. These losses led to service and program reductions in cities across the state mentioned earlier.
• Increasing Reliance on the Sales Tax. In the face of unreliable funding from intergovernmental sources as well as the property tax, cities have become even more reliant on the local sales tax (i.e., Bradley Burns 1 percent sales tax) and fees and charges to fund essential services. Sales and use tax revenues are by far the largest source of general fund revenue for cities today, providing more than 50 percent of the general fund revenues in many cities.
• Possible Effects on Land Use Decisions. With the sales tax being the last remaining general revenue source with potential growth for cities, some legislators, city officials, county officials and other observers are concerned that cities and counties may place undue emphasis on the sales tax potential of certain retail land development proposals in comparison to other competing and desirable uses such as industrial and residential development (e.g. "fiscalization" of land use decisions). This charge has not been the subject of extensive study, but for those who believe that tax policy drives land use decisions, there is anecdotal evidence to suggest this may be happening.
• Unfunded State Mandates. While the California Constitution contains protections for cities from unfunded state mandates, the obstacles cities experience in the lengthy process required to secure reimbursement of an unfunded mandate can lead to years of delay and expense. Moreover, the appointment of the members of the Commission on State Mandates without local government input may predispose the commission against reimbursements.

A package of recommendations developed by the task force to respond to these issues was recently approved in principle by the Board of Directors. It contains the following elements:

1. Protect existing revenues constitutionally in order to prevent further narrowing of the local revenue base without voter approval.

2. Address concerns about the fiscalization of land use decisions and the narrowing of the local revenue base, by taking two interdependent actions:

• Increase the allocation of the property tax to cities, counties and special districts; and
• Retain the "situs" rule (e.g. revenues remain in the jurisdiction in which the sale occurred), but consider exchanging part of the local sales tax derived from future retail projects with state government for an increased share of the property tax derived from such projects.

3. Provide additional constitutional protection against unfunded state mandates.

Keeping Cities Whole: Where We Go From Here
In the midst of the discussion on reforming the state-local fiscal relationship it is essential to remember that it really is all about accountability and responsiveness to the people of California, 83 percent of whom live in cities. When city officials are elected they are expected to lead by setting spending priorities for city revenues. When those revenues cannot be assured for more than a year at a time because of the decisions of another level of government, desirable long-term planning grinds to a halt and the quality of local government and our communities are affected.

The League will continue to refine the elements of this package in conjunction with its member cities. We are committed to working with our intergovernmental partners to craft a fiscal reform plan that produces long-term benefits for California's cities and people.

At the end of the debate, cities want a new state-fiscal relationship that will be based on reliable, permanent solutions. Experience has shown us that only fundamental, constitutional reform can begin to correct the shortcomings of our current system. We stand ready to engage in the debate necessary to accomplish that goal.