California Redevelopment: Its Abrupt Termination and a Texas-Inspired Proposal for a Fresh Start

This paper describes how redevelopment in California came to an end with the California Supreme Court’s decision in California Redevelopment Association v. Matosantos and how redevelopment could be resuscitated. In includes a detailed analysis of how the legal issues should have been assessed by CRA’s counsel prospectively and how CRA as a plaintiff compromised the outcome urged by the California’s Chief Justice (dissenting in CRA v. Matosantos).

The importance of decision going forward is clear.  The Court “threw hundreds of redevelopment agencies out of business in a ruling that will benefit state budget coffers but hobble local economic development and housing programs.”

I. Highlights of the Precipitating Context

D. The Text and Politics of D. Proposition 22

The primary thrust of Proposition 22 was to safeguard from state expropriation the local governments’ share of the gas and other transportation-related taxes, hence the title: “Local Taxpayer, Public Safety, and Transportation Protection Act of 2010.” As one of the amicus briefs pointed out, “[a]lmost all of its terms and the ballot arguments in its favor addressed transportation funding.”

The uncodified portions of the Proposition (the parts that did not amend or change the law) referred broadly to the earlier voter initiatives that local governments had succeeded in adopting as a means of resisting state raids on the traditional revenue sources of local governments. Scattered throughout the proposition were more than a dozen significant but highly technical amendments codified into the state constitution. Constitutional additions were shown in italic type. Deletions to the present constitution appeared in strike out type.

A Proposition 22 voter in a hurry could easily have overlooked the single pertinent five-line passage concerning redevelopment. It was summarized as follows by the League of Women Voters: “Proposition 22 would prohibit the state from requiring redevelopment agencies to transfer any of their property-tax increment funds to the schools or any other state agency.”

As many social scientists have long observed, voters deciding on initiatives and referenda rely more on the media than on ballot language or the official arguments for and against that appearin state-distributed materials. Media messages spearheading the Yes on 22 campaign urged voters to “[p]rotect local services” and “[s]top State Raids!”

A reporter for the Orange County Register described the unlikely assortment of supporters and opponents drawn to Proposition 22. Local government officials including mayors and city council members—Democrats and Republicans alike—tended to support Proposition 22, hoping that “[i]f passed Prop. 22 would ban the state from raiding local funds to pay state costs.”

Opponents included liberal Democrats in the Legislature, because the measure would “‘lock in’ constitutional protections for redevelopment agencies to retain the bountiful tax increment funds they collected without having to share any of it with schools and special districts.” Meanwhile, “[s]ome Republicans didn’t like Proposition 22 because they saw redevelopment agencies as the antithesis of the free market.” An Orange County Republican assemblyman opposed Proposition 22 because “[r]edevelopment agencies have encumbered the state of California with about $100 billion in bonded indebtedness and none of that was approved by a vote of the people, which is the normal case with bonded indebtedness.”

Recalling the bitter confrontation symbolized by the widely publicized case of Kelo v. City of New London, some conservatives disliked redevelopment because “under law [redevelopment agencies] have the right [to] seize private property through eminent domain.”

On the eve of the Court’s opinion in CRA v. Matosantos, political activists and the general public were widely divided on redevelopment.

II. The Potential Outcomes and Determinative Arguments in CRA v. Matosantos 

A. The Four Possible Outcomes and Their Implications

There were four possible outcomes to the Matosantos case:
(1) The Court could declare both statutes unconstitutional; (2) The Court could find both statutes constitutional; (3) The dissolution statute could be found unconstitutional and the “pay-to-stay” statute constitutional; or (4) The dissolution statute could be found constitutional and the “pay-to-stay” statute unconstitutional.

(1) The best outcome for redevelopment agencies, and the worst for schools, would have been for both measures to have been declared unconstitutional. This outcome would have decisively protected redevelopment property tax funds against further state incursions. It would also have added $1.7 billion to the state budget deficit, falling hardest on the K–12 school system.

(2) Redevelopment would have survived in California if the Court had concluded that both AB X1 26 and AB X1 27 were constitutional. This would have preserved the “pay-to-stay” option for cities, counties and their RDAs. For schools, this outcome would have been satisfactory, according to the California Teachers’ Association.106 Assuming most RDAs survived, schools would have received $1.7 billion in 2011-12, and $340 million every year thereafter, “no small amount to a public school system that has frozen new textbook adoptions since 2009 due to a lack of funding.”

(3) The friends of redevelopment could have breathed easily if the Court had invalidated AB X1 26, removing the threat of dissolution, and validated AB X1 27, which would have become a toothless tiger. For schools, the results would probably have been the same as if both measures had been declared unconstitutional.

(4) The actual outcome was the doomsday scenario for redevelopment. “[O]nce RDA dissolution occurs, agencies will be unable to complete existing projects; financially strapped cities will face massive new and unanticipated liabilities; RDA assets will be sold; RDA employees will leave; and existing obligations under federal and state grants will be breached, requiring the return of grant funds.”

This result was good for schools. Dissolved RDAs had been receiving over five billion dollars a year in property tax revenues that would become available for “cities, counties, special districts, and school and community college districts” after deducting sums necessary to meet RDA legal obligations and administrative costs.

Counsel for the League of California Cities and the California Redevelopment Association (CRA) understood the risk of a split decision, and had re-assured their clients that “the risk was minimal.” Redevelopment officials “bet the ranch” on the lawsuit, and lost. As one litigant aptly put it, “[t]his is a nightmare of CRA’s own making.” The CRA had championed Proposition 22, which boxed the Governor into proposing dissolution to reach RDA assets. Then, the CRA, instead of settling for the “pay-to-stay” option, challenged it under Proposition 22, and won, putting itself and the California redevelopment industry out of business.

B. The Constitutionality of Dissolving RDAs

The Court opinion upholding the dissolution statute (AB X1 26) was in line with well- established tenets of state constitutional law. A bedrock principle of state constitutional law is that state governments possess absolute discretion to create and dissolve local governments, subject only to explicit limitations in the state constitution. It takes a very explicit state constitutional exception to empower a court to deny the state plenary control over local government entities, including RDAs. Petitioners imagined they detected such limitations implicit in the original initiative authorizing the establishment of TIF-funded redevelopment and in Proposition 22. A unanimous Court faulted the “smoke and mirrors” quality of the petitioners’ argument by pointing out that neither initiative even mentioned the possibility of RDA dissolution, nor did either statute explicitly guarantee perpetual existence to RDAs.

III. One Possible Way Forward

In the aftermath of this opinion, could the Legislature reinstate redevelopment, consistent with Proposition 22 and “something the state could afford”?  The answer is yes, on both counts— the Legislature could enact a new redevelopment enabling statute that would be constitutional and affordable to the state.

A. The Court’s Constitutional Criteria for a Redevelopment Revival Statute

The last paragraph of the majority opinion offers three guiding principles for new redevelopment enabling legislation. First, the Legislature retains plenary power to establish and dissolve local governments as it sees fit. Second, if it elects to allow such agencies, it may but need not enable them to receive tax increments. Third, if it authorizes such agencies, and empowers them to collect tax increments, it may not thereafter reallocate such tax increments to benefit schools or other entities.

In sum, the Court extends to the Legislature the chance for a fresh start in re-formulating the basic norms applicable to redevelopment in California. This could be a good thing. According to William Fulton, one of the leading scholars of California redevelopment and a former mayor of the City of Ventura, “The system was so broken that I thought the best way to achieve reform was to blow up redevelopment and start over with a more straightforward and targeted tax-increment financing system.”

The Legislative Analyst’s Office anticipated that some lawmakers might want to revive redevelopment and expressed concerns about the potential costs. Those costs are well within the power of the Legislature to control by the taxing prerogatives it grants or withholds in the enabling statute. As the Matosantos Court observed, the state is not obliged, and never was, to allow redevelopment agencies to capture the tax increments. The enabling provision in the state constitution was entirely permissive. The Legislature could preclude newly authorized RDAs from reaching any tax increments except those of the sponsoring city or county. It could also place limitations on the extent to which a sponsoring city or county could commit its own future tax increments to redevelopment.

B. Tax Increment Reinvestment Zones (TIRZ) in Texas

Many states have TIF-based redevelopment statutes that could serve as models for California. One of the most interesting and successful of those laws can be found in Texas where any city, town, or county may establish a redevelopment project area. These are called Tax Increment Reinvestment Zones (TIRZ). They are authorized by state enabling laws and local ordinances to utilize tax increment financing for infrastructure improvements within the zone. Funding can come from real property tax increments, sales tax increments or both.

Cities and counties throughout Texas have created TIRZ zones. Each of the larger cities— Austin, Dallas,  El Paso, Houston, and San Antonio—boasts numerous TIRZ project areas.

The initiative for a TIRZ can come from a city or county. Private property owners can also start a TIRZ with city council approval of a petition signed by owners of 50 percent or more of the land within the proposed zone, measured by appraised value. As a consequence of this governance arrangement, redevelopment in Texas cities is highly decentralized. Each TIRZ zone is governed by its own board of directors. Most of the directors are designated by the sponsoring initiator, either a city or private property owners. Each participating taxing entity (school, special purpose district, county) is also entitled to name one board member.

There are limits to the authority of TIRZ boards. For instance, they must secure city approval of their boards of directors, of project plans, and of reinvestment zone financing plans. Staffing of TIRZ boards is provided by the sponsoring city or county on the basis of promulgated fee schedules.

Statutory criteria in Texas for establishing TIF-subsidized reinvestment zones are expansive and go well beyond the narrow definition of “blight” found in California and many other states.

In Texas, tax increment money can be used to upgrade marginal areas near downtown that are already showing signs of gentrifying, to facilitate high density transit oriented development, and even in solidly middle income areas, as long as city councils finds property within the project area to be underutilized, and not likely to attract “sufficient market development in a timely manner.” The statutory limitation is only that: “The area’s present condition must substantially impair the city’s growth, retard the provision of housing, or constitute an economic or social liability to the public health, safety, morals or welfare.” 

Readers may be puzzled at how business-friendly, regulation-averse Texas would enact such broad enabling legislation for redevelopment. One possible answer is that the business community supports the use of tax increments for economic development and civic improvements, business leaders participate actively in redevelopment projects, often initiate them as Texas law allows, and routinely sit on TIRZ boards.

A second reason that some states limit redevelopment to severely blighted properties is to preclude local governments from taking unblighted property for the benefit of private redevelopers. In Texas, eminent domain reform has not resulted in restriction of the scope of condemnation but has instead focused on improving acquisition procedures to enhance property owners’ chances of being adequately compensated when government does force them to sell. 

A third answer may be that restrictive definitions of “blight” often find their way into state law at the behest of other taxing entities, trying to protect their property tax bases against proliferating intrusions from redevelopment agencies. As we shall see, this is not a concern for taxing entities in Texas.

A leading California attorney who specializes in municipal and redevelopment law advocates that “the remaking of redevelopment in California” should extend beyond “blight elimination” “to build the constituency for the economic development, job creation, infrastructure investments, sustainable/infill development, catalyst projects and affordable housing”.

One of the reasons California redevelopment became so irresistible a target for state budget planners is that during the past 35 years, redevelopment’s share of property taxes statewide grew six-fold from 2 percent to 12 percent (up to 25 percent in some counties) at the expense of schools, community colleges, and other local governments.210 As of 2011, Texas had placed a cap of 15 percent as the maximum amount of a city’s appraised property values that can be included within a reinvestment zone. Without such a constraint, a TIRZ board would have virtually limitless discretion for the amount of future property tax revenue it could requisition for redevelopment.

A property tax cap is worthy of consideration in budget-sensitive California. William Fulton foresees significant hurdles in the implementation of an effective cap: “The state would have to oversee redevelopment more aggressively and ‘allocate’ the ability to use tax-increment funds based on how closely cities hew to redevelopment’s newly targeted purposes. Cities won’t like this, but it’s similar to the system used to allocate low-income housing tax credits, and its common practice in other states.”

Lawmakers drafting a new California redevelopment enabling statute will hear calls to preclude the use of eminent domain for land scheduled for eventual re-use by private owners. As one conservative put it, “[t]hat’s what the U.S. Supreme Court’s Kelo decision was about—cities using eminent domain to take property and give it to wealthy developers so they could generate more taxes from malls, hotels and big box stores . . . while destroying homes, churches and small businesses.” Property owners are threatened, according to property rights advocates, by the “Costco–Ikea– Home Depot–Redevelopment Agency complex . . . that abuses government power and enriches developers at the expense of other people’s rights.”

California legislators could just bypass the issue, and retain the status quo by avoiding the mention of eminent domain in the new statute. Alternately, they could significantly restrict the use of eminent domain, precluding local governments from acquiring private property by eminent domain for re-use by private developers. This would still leave untouched the local government’s power of eminent domain for conventional public improvements that are part of a redevelopment project plan—street widening, sidewalks, transit rights of way, public parking structures, parks and other public recreation facilities.

In practice, most RDAs use eminent domain very sparingly. Its use is politically unpopular. Many private developers of infill sites do not need local governments to assemble land for them because they are quite adept at assembling sites on their own, and often for a lower price than the local government would have paid.

Texas lawmakers in 2011, spurred by an eminent domain ballot measure that passed 81 percent to 19 percent, enacted a major eminent domain reform, Senate Bill 18. Though ostensibly responding to Kelo, the law made only modest changes in the definition of “public use” governing acquisitions of private property for economic development. As one eminent domain scholar concluded, “Texas’ post-Kelo eminent domain reform law includes a very broad definition of ‘blight’ that enables almost any property to be declared blighted and transferred to private parties.”244 In fact, Texas property owners’ groups were less motivated by a desire to avoid condemnation than by a desire for more adequate compensation. Much of the new Texas law focused on improving the negotiation process so land owners could achieve better financial outcomes.

The Last Word. Whether the Legislature will re-constitute redevelopment in California is uncertain. The Governor’s approval would be needed for a legislative compromise and he seems satisfied with the Court’s outcome. Hard-core redevelopment critics oppose it. Public officials are overwhelmed, grappling with the disposition of RDA assets and the resolution of claims against RDAs. Among all the states, this leaves only California and Arizona without TIF-funded redevelopment. With the demise of California’s redevelopment agencies, economic development officials in municipalities nationwide anticipate being better able to attract businesses to their redevelopment projects. Perhaps as commercial and residential real estate markets recover, the complexities of unraveling RDAs are resolved, and California cities turn their attention to attracting jobs and expanding their economies, friends of redevelopment will rally to bring it back. When California cities and counties resume their quest to nurture economic development, they would do well to consider the Texas example.