May 4, 2004 - From the September, 2003 issue

Historian Decries The Missed Opportunities For Reform of State Budget

One of the deals inserted into this year's state budget is the swap between the state and local governments of sales tax and property tax revenues -an action long promoted by advocates of state/local fiscal reform. Yet, this year's version of the swap fails to reform the state's fiscal arrangement-a missed opportunity for change in the Capitol. MIR is pleased to present this column contributed by a respected California political observer, unidentified, in which he looks back on the fiscal reforms which emerged from past budget crises and laments this year's band-aid solution.

Of the last four major fiscal emergencies the state has faced since in the last 25 years, including the current one, three included major changes to the state/local fiscal relationship.

The first example occurred in 1978, a fiscal crisis brought about from the passage of Proposition 13. Aside from the weakening for local government fiscal power, the implementation of Proposition 13 brought a significant reform in the state/local finance system, particularly county government. Prior to the passage of Proposition 13, local property taxpayers paid a significant portion of a variety of state health and human services programs. To replace reduced property tax revenues, the state made two major changes in the state/local relationship. The state began paying for state programs, formally paid for by the property tax and allocated a larger share of the now state controlled property tax to cities so that residential and commercial development would produce additional revenue for developing cities. Both actions were seen a positive state policies. The state would pay for state health and human services programs administered by counties and, as a matter of state policy, the move toward a higher reliance on the sales tax would be moderated.

The second example came with the short recession in the early 1980s. The fiscal crisis provided an opportunity to further revise the management of the state Medi-cal program. By most accounts, a positive outcome.

When the 1990s recession hit California, another fiscal crisis occurred and another opportunity for fiscal reform arose. In this case, the reform that grew out of the crisis had positive and negative effects on local governments.

On the positive side, a major reform was enacted in the state/county relationship. Prior to the early 1990s, the state financed only a portion of the county's responsibility to provide medical services to "medically indigent" persons. These are people who are working without health insurance but do not qualify for the state health programs. For most of the 1980s, the state provided a declining subvention to the counties. As part of the early 1990s budget solutions, the state levied a half-cent sales tax to finance the county responsibility.

On the negative side of fiscal reform, the state unraveled the Proposition 13 implementation plan to provide more property tax to growing communities by transferring it to school districts, thereby saving the general fund significant expenditures.

By the late 1990s, it became clear that the state budget solutions in the early 1990s had changed the mix of revenues that supported local services. Research consistently showed that cities had developed a higher reliance on the retail sales tax than on the property tax in part due to the 1990s transfer of local government property tax to school districts and the ability of cities to increase their sales tax revenue through approving more retail development.


A variety of groups, including several state commissions, business and environmental groups concluded that swapping a portion of the local sales tax for a larger share of the property tax was an idea that would have a positive influence on local government land use decisions. By 2001, the idea had was taking hold. The groundwork had been laid for another try at state/local finance reform.

In the current budget crisis, the stage was set for a positive fiscal reform. When it became clear the legislature would not increase the state sales tax to provide the revenue to support the bonds sold to finance the 2002-03 deficit, the state looked to the local sales tax as the source of revenue to finance the deficit bonds. A sales tax/property tax swap was in the making. And a move toward an opportunity for fiscal reform was under way.

Alas, positive fiscal reform gave way to expediency and the result is a missed opportunity. The state got halfway there by reducing the local sales tax rate from one-percent to one-half-percent and increasing the state sales tax rate by the remaining one-half cent and crediting the revenue to retire the bonds sold to retire the 2002-03 deficit. So far, so good. This would be an opportunity to replace the lost sales tax with an increased share of the property tax. A fiscal crisis just might bring about fiscal reform.

Instead of completing the swap, the state stopped mid-swap. The state each year will replace the lost sales tax with an equal amount of cash supplied by the schools' share of the property tax. The basic allocation of the property tax will not change and the amount a city will receive will be the amount of sales tax that would otherwise have received if the one-percent rate had applied. The more retail development approved, the more cash from the schools' share of the property tax. Residential and job producing development will continue to produce a small amount of revenue for most growing communities.

The plan adopted by the legislature and signed by the governor will produce a lose-lose situation for local government. Not only did local governments lose one-half of their sales tax, they also lost the opportunity to increase their reliance on the property tax, a goal generally shared by most local governments that look to balance the growth of their communities.

When reviewing the gains and losses for fiscal reform amid a fiscal crisis, the 2003-04 budget will be firmly placed in the loss column.


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