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GG28 - Improve Local Government Finance by Increasing Predictability of Revenues

Summary

The system of financing local government in California does not provide a predictable and sound means of funding. The Governor should work with the Legislature to identify permanent sources of revenue funding for local governments.

Background

State and local governments struggle to meet the needs of the public, sometimes shifting costs without providing revenue to pay for mandated services. Local governments can raise taxes or fees to pay for local priorities or to fund state-required programs, but that flexibility has been reduced. Since 1978, voters and the Legislature have enacted several measures that reduced locally-controlled revenue. Much of this revenue has been replaced by transfers or subventions by the state, rendering local governments vulnerable to fluctuations in the budget cycles of the state and federal governments.[1]

California's local governments have historically relied on three major revenue sources: the property tax, the Vehicle License Fee (VLF), and the sales tax. Before passage of Proposition 13 in 1978, property taxes were the main source of locally-controlled government revenue. Each government entity (city, county, special district, and school district) was authorized to set the local property tax rate in its own jurisdiction and to establish its own spending priorities and limits. Among its provisions, Proposition 13:

  • Set a maximum property tax rate of one percent of the value of property;
  • Required any special taxes to be approved by two-thirds of the voters; and
  • Gave the state power to reallocate the remaining property tax revenues.

Proposition 13 immediately shrank local property taxes by about 50 percent on average, but the impact varied depending on the jurisdiction's reliance on the property tax. Since the property tax was only one source of local government revenue, overall city revenues dropped 10 percent in the first year, while county revenues dropped about 25 percent.[2]

In the years since Proposition 13, voters have approved several ballot initiatives that have taken more and more power away from local governments and given it to the state.[3] Today, local governments have little discretion to generate or spend revenue on programs or services.

Local government grows dependent on the state

In 1978, the Legislature enacted Senate Bill 154, which provided $3 billion in direct assistance to cities, counties, special districts and schools based on each jurisdiction's relative loss of revenues for that budget year. This bill began a series of developments that created a patchwork system of financing local governments that has grown increasingly complex. In 1979, the Legislature enacted Assembly Bill 8, which created a long-term system for allocating the property tax based on the amount local government received in 1979. With the state controlling its allocation and its rate of increase capped at one percent per year, the property tax ceased to be a locally-controlled tax.

In 1992, California faced a budget deficit of $11 billion and enacted legislation that shifted funds from local governments to the Education Revenue Augmentation Fund (ERAF) for disbursement to school districts. Since its inception, the ERAF has resulted in a net shift from local governments to the state of more than $23 billion through fiscal year 2003-04. [4] Governor Schwarzenegger has proposed increasing the ERAF amounts redirected from local governments to schools by $1.3 billion for fiscal years 2004-2005 and 2005-2006. Under the Governor's proposal, the $1.3 billion will go back to local governments permanently after fiscal year 2005-2006.

Lack of clear funding reduces accountability

Before 1978, local taxing and spending decisions were made at the local level. This allowed taxpayers to easily identify taxes paid to local governments and hold local elected officials accountable. The large subventions provided by the state have blurred funding sources for local governments. When subventions are reduced during times of budget crisis, local governments are doubly affected. They must absorb the cyclical reduction in revenues that accompanies an economic downturn but also must deal with a reduction in subventions from the state, which makes their funding even more uncertain. This has led some local observers to comment that local governments are being used as a safety blanket by the state, which makes it harder for voters to know whether to hold local officials or state officials accountable for budget cutbacks.[5]

Recommendation

The Governor should work with the Legislature to identify permanent sources of revenue for local governments that are not subject to redirection to the state.

Fiscal Impact

There would be no change in state revenue because this proposal would not change funding streams provided to or received from local government.

Endnotes

[1] Public Policy Institute of California, "Research Brief Changes in State and Local Public Finance Since Proposition 13", by Michael A. Shires, (San Francisco, California 1999), p. 1. A subvention is defined as "The provision of assistance or financial support", Merriam-Webster's Dictionary Online- http://www.m-w.com/ (Last visited May 14, 2004.)
[2] Public Policy Institute of California, "Research Brief, Changes in State and Local Public Finance Since Proposition 13", by Michael A. Shires, p. 1.
[3] Major limits to raising revenues include:

  • Proposition 4 in 1979 limited local and state spending of tax proceeds to the prior-year amount and required the state to reimburse local entities for mandated costs.
  • Proposition 62 in 1986 required the approval of new local general taxes by two-thirds of the governing body and a majority of local voters.
  • Proposition 98 in 1988 set minimum spending levels for K-14 education, which required shifts from the Education Revenue Augmentation Fund (ERAF).
  • Proposition 218 in 1996 restricted local governments' ability to raise revenues from taxes, assessments, and fees and subjects some revenue-raising methods to increased voter approval requirements.

  • [4] League of California Cities, "Fact Sheet: the ERAF Property Tax Shift," by Michael Coleman, Sacramento, California, pp. 1-2. (Fact sheet.)
    [5] Interview with Steve Szalay, executive director, California State Association of Counties, Sacramento, California (March 15, 2004); and interview with Mark Pisano, executive director, Southern California Association of Governments, Sacramento, California (March 15, 2004).