Valley City Is Viable, But Without Mitigation Split Will Harm L.A.

By: Larry Calemine, LAFCO

PURPOSE

Pursuant to the Cortese-Knox Local Government Reorganization Act of 1985 (the "Cortese-Knox Act") the executive officer of a local agency formation commission is required to review each application for a change of organization or reorganization filed with the commission and prepare a report to the commission, including his recommendations on the application.

FISCAL FINDINGS

Comprehensive Fiscal Analysis

[T]his section provides a review of fiscal issues that deviate from the assumptions used in the CFA. There are three types of deviations. First, there is the issue of the documentary transfer tax revenue loss and certain minor discrepancies noted by the State Controller. Next, there are recommended terms and conditions which were developed subsequent to the CFA's release and which deviate from the assumptions used in the CFA, such as the debt allocation factors. Third, there are recommended changes in the boundaries of the proposed Valley city that present minor changes in the new city's fiscal outlook.

Documentary Transfer Tax Reduction

Previous staff reports and the supplemental CFA report have pointed out that the CFA overstated the proposed Valley city's revenues by approximately $31 million due to the proposed city's legal inability to levy the documentary transfer tax at its current rate.

As a general law city, the proposed Valley city cannot levy a documentary transfer tax in excess of the tax authorized by Revenue and Taxation Code section 11911. [$1.10 per $1000 in value of property on deeds transferring property] State law does not limit the City of Los Angeles' levying authority for a tax on the sale of property due to its status as a charter city. The City currently charges $4.50 per $1000 in property value transferred.

As a general law city, a new Valley city would only be able to collect one-half of the tax or $0.55 per $1000. This means that the City of Los Angeles would lose approximately $35.1 million in documentary transfer tax revenue if the Valley detaches, and the Valley city would only be able to collect $4.3 million in documentary transfer tax, based on its statutory entitlement

Recommendation: The Exec. Officer recommends that the new city's fiscal mitigation payment include the $30.8 million negative fiscal impact of the City's loss of documentary transfer tax revenue.

Transition Period Services

[T]he Applicant's transition plan envisions the new city providing only a limited set of services directly during the first six months of operation, and does not identify significant cost savings during this period.

Debt Allocation

The Exec. Officer recommends that the Commission adopt debt-related terms and conditions that deviate from the assumptions used in the CFA.

The Subcommittee approved staff recommendations that debt paid from general fund resources should be allocated to the Valley based on its recent contribution to the general fund. Subsequently, the Controller took issue with the CFA's approach to allocating City of Los Angeles debt on the basis of the proportion of employees allocated to the San Fernando Valley rather than the Valley's contribution to the City's general fund. The Controller argued that $4.0 million in lease obligation and judgment obligation bond debt should be allocated on the basis of the City's loss of general fund monies.

The Subcommittee addressed not only the debt items raised by the State Controller, but also addressed Convention Center debt, worker's compensation and liability claims. This had the effect of removing $25 million from the fiscal mitigation payment, and classifying it explicitly as a debt payment owed by the new city. The parties agreed to separate this debt from the mitigation payment due to concerns about the Valley's debt payments being phased out if included in the mitigation payment.

The State Controller concluded that the CFA's under allocation of debt "would virtually eliminate the projected new Valley city general fund reserves." The Exec. Officer, does not agree with the Controller's logic regarding the connection between debt under-allocation and reserves. Because the under-allocation of annual debt payments is less than the fiscal mitigation, the Commission's decision to allocate the debt at a higher rate to the Valley area would simply reduce the fiscal mitigation payment. On net, the debt reallocation would have a negligible effect on the Valley city's reserves or fiscal viability.

Reserves

After examining the reserve practices of other cities, the Exec. Officer concurs with the State Controller that no authoritative basis exists for establishing reasonable reserves. The most reasonable standard for the Valley's reserves is the City of L.A.'s undesignated reserve ratio, which has averaged 1.7 percent of general fund revenues over the past five years. The Exec. Officer concludes that the City of L.A. has weathered the last five years with an average undesignated reserve ratio of 1.7 percent annually, a figure slightly lower than the expected reserve ratio of the proposed city. Accordingly, the Exec. Officer recommends that the proposed reserve ratio be deemed reasonable, given that the proposed city is allocated a share of the City's existing reserve and the proposed city is not expected to draw from that reserve fund.

FISCAL VIABILITY

[T]he Exec. Officer projects that the Valley would need to either increase its revenues or decrease its expenditures by approximately $18 million annually during the transition period . This needed budget adjustment represents only 1.7 percent of the Valley's baseline expenditures. If the Valley does not implement an $18 million revenue increase or cost reduction plan during the transition period, then the Valley would need to borrow approximately $30 million during the course of the eighteen-month transition period (to be repaid with interest over the five years subsequent to the transition period) to sustain current spending patterns.

Potential Valley Revenues

The new city would have several alternatives for increasing its revenues on a permanent or temporary basis without seeking voter approval. These potential revenues involve franchise fees and offer the new city the opportunity to raise up to $27 million in additional revenue. Public Utilities Code section 6201, et seq. authorizes general law cities to impose a two percent franchise fee on electric, gas, water and oil utilities. Franchise fee imposition does not require voter approval.

Potential Cost Savings

Another method of addressing the $18 million projected revenue shortfall during the transition period involves reducing service costs. This Report has recommended that the City of L.A. be authorized to reduce service costs and levels in the Valley in the event of revenue shortfalls. A 1.7 percent reduction in service costs appears to be achievable within a relatively short time period if a six-month hiring freeze were implemented relevant to employees servicing the San Fernando Valley. The City's natural employee attrition rate of 7 percent annually would easily accommodate the needed cost reductions within the first six months of incorporation.

Revenue Neutrality Finding

The CFA determined that current revenues accruing to the Valley would exceed current expenditures that would be assumed by the Valley by $65.8 million. After factoring in the effects of removing the eastern portion of Cahuenga Pass, readjusting the debt allocations, and accounting for documentary transfer tax reductions, the current revenues accruing to the Valley would exceed current expenditures that would be assumed by the Valley by $25 million. Thus, the proposed Valley Special Reorganization would not be revenue neutral.

As discussed earlier, the Valley Special Reorganization would still result in an annual negative fiscal effect on the City of L.A. of $55.8 million if the City's loss of documentary transfer tax revenue in the amount of $30.8 million is taken into consideration. Based on the above, the Exec. Officer recommends that the Commission find that the Valley Special Reorganization would have an annual negative fiscal effect on the City of L.A. of $42.4 million that should be mitigated.

Mitigation Payment

The Exec. Officer has reviewed available evidence on the relationship between city size and municipal government cost efficiencies, and found that the City of L.A. should be able to provide services relatively more cheaply after a reduction in its size. Thus, the Exec. Officer concludes that the City of L.A. would be able to accommodate the recommended phase-out of the mitigation payment through gradual cost savings.

Based on these adjustments, the Executive Officer finds that the negative fiscal effect on the City of L.A. would be $55.8 million.

Stranded Costs

The City of L.A. has alleged that the CFA ignored a $310 million fiscal impact that the City would face at the end of the transition period when the Valley is no longer paying for a share of centralized and non-divisible costs. The City asserts that the CFA understated the fiscal mitigation payment by approx. $310 million in "stranded costs."

The City has classified its central service functions predominantly as stranded costs. [T]he City considers its costs associated with executive management to be unrelated to the scale of its constituent or revenue base. The City considers its costs associated with the Personnel Dept. to be entirely fixed and unrelated to the size of the City workforce. Similarly, the City considers its computer staffing to be unrelated to the size of the City workforce.

The City has classified a significant portion of costs associated with direct service as "stranded costs" that would not decline if the size of the City were reduced. The City views 1/3 of its policing costs to be unrelated to the volume of crime, and over 1/3 of its street lighting costs to be unrelated to the number of street lights being maintained. The City views nearly half of its planning costs to be unrelated to the size of the city or the number of buildings therein.

Recommendation: The Exec. Officer concludes that available academic and empirical evidence indicate that in the areas of public safety and general administration, the City of L.A. would be more likely to benefit financially from a reduction in its service area. The evidence indicates that larger cities tend to spend relatively more resources on public safety and administration than do smaller cities. This would imply that both the City of L.A. and the proposed Valley city would be more likely to deliver services more cheaply than to lose economies of scale by being separated into smaller cities. This evidence is inconsistent with the City's allegations that one-third of its policing costs are unrelated to the size of the city, and that nearly all of the City's central service costs are unrelated to the size of the city. The evidence does indicate that in the area of street maintenance and, possibly, sanitation, there are likely economies of scale. The Exec. Officer encourages the parties to consider a long-term contractual relationship in such areas with clear efficiencies from a large-scale operation.