Municipal Attorney Michael Colantuono on Local Finance and California’s Broken Fiscal Compact

Michael, it’s been two decades since we last interviewed you, as the first vice president of the City Attorneys Department of the League of California Cities. For our readers, reintroduce yourself.

I’m a local government lawyer and have been since 1989. I’ve served as city attorney for, I think, seven cities over that period. At present, I’m the City Attorney of Grass Valley, which is a little village up in the Sierra foothills north of Sacramento, but my primary role these days is to do appellate litigation for cities, counties, and special districts around California. 

Personally, my particular focus and professional background are on the revenue side of municipal finance: Prop 13, Prop 26, Prop 218, and Prop 62. And, if Howard Jarvis has its way, a proposition will be on the ballot next year.

Related to your above legal work, walk us through your recent case, Thomas v. County of Humboldt. What was at stake, and why have you called it “a bullet dodged” for local governments in California?

In some ways, it’s a completely routine case, an ordinary code-enforcement case in which the County of Humboldt was trying to induce three different sets of property owners to comply with land-use and building-safety laws on properties that had been involved in illegal marijuana cultivation up in the Emerald Triangle. When the logging industry disappeared, people needed to find another way to make a living, and marijuana became a big part of it. Legalizing marijuana has been a challenge, and the County is quite committed to doing it both because the legal industry resents the unfair competition and because people not involved in the industry resent the noise, dust, smells, guns, cash, and dogs that often accompany illegal grows.

These property owners ended up represented by, shall we say, a billionaire-funded public-interest law firm from Washington, D.C., with an agenda. Those folks made an argument, really almost in passing, that the County’s process for enforcing zoning and building-safety codes did not afford a jury trial and therefore violated the Seventh Amendment, which hasn’t been understood to apply to administrative proceedings of this type for a very long time, but we now have the most conservative Supreme Court in Washington that any of us have seen in our lifetimes. Arguably more conservative than any since the 1920s…and that Court recently extended the reach of the Seventh Amendment into federal administrative agencies. The petitioners tried to use our little marijuana case in Humboldt to extend that same logic to state and local governments.

When somebody petitions for certiorari, the rational response is sometimes to just ignore it, because the vast majority are denied, and the U.S. Supreme Court will ask for a response if they have any interest. They asked us for an answer—so we wrote one. It was filed over the summer. The Court has what they call the “long conference” the last week in September, when they deal with thousands of petitions accumulated over the summer. They grant five or six and deny all the rest.

We were not on the denial list from that conference; instead, we were “set over” for a further conference, which was a pretty ominous sign. As it turns out, the reason was that Justice Gorsuch, whose mother was the Administrator of the EPA in the Nixon Administration, wanted to write a separate statement saying we had persuaded him that our case was not what appellate lawyers and judges call a “good vehicle” for deciding this issue, but that he wanted the appellate bar and his peers to know that the issue does need deciding. That’s essentially an invitation for more petitions raising the same theory in cases that are less messy than ours, so the Court might someday reach the heart of the issue.

Our case will now continue in the Ninth Circuit and in the Northern District of California as a fairly routine—if somewhat federalized—dispute about whether these property owners have to do things like fill in the tunnel someone dug under a house without a permit.

To give context to your legal representations, our 2003 interview focused on California’s pressing need to reform its state–local fiscal relationship after the passage of Prop 13. With many local governments again facing fiscal emergencies, explain why local officials continue to confront the same revenue challenges as when we first spoke.

Prop 13 is the root of this problem, in that it capped property taxes at 1% of assessed value and said that that shrunken 1% pie would be apportioned “according to law.” That was Howard Jarvis and Paul Gann’s way of punting the hard question until after the election, because it really was the hard one. The Supreme Court decided in 1979 that “according to law” meant according to statute. 

Now, the Legislature has the authority to divide the property tax pie, and because property taxes fund schools—and the Legislature has a constitutional obligation to fund schools adequately—they have a dog in the fight while they’re mediating the fight. That was the original sin in this area, and we’ve had the State in our business ever since.

It’s not unique. Back in the founding era, the Legislature, under the influence of “the Octopus,” the Southern Pacific Railroad Company, did things like ordering Stockton to build a railroad siding for Southern Pacific with city funds. Lots of things like that happened, which is why the Constitution of 1879 tried to build a wall of separation, if you will, between state and local finance. But Prop 13 really undid a lot of that. 

We’ve had a couple of ballot measures since that have tried to restore some guardrails: Prop 1A and Prop 25, written by the League of California Cities and negotiated with the Legislature. Going back to answer your question, what’s the problem today?

The problem is that local governments around the nation were infused with cash during COVID. The COVID relief and ARPA money were spent on a lot of things, and employees got their share, in MOUs and otherwise. That money is gone, and local governments are now in the same inflationary economy as everyone else. Labor costs are up substantially because a lot of people left the labor market during COVID and didn’t come back. There’s a labor shortage, particularly in white-collar professions, but combine that with the loss of what I call the “sugar high” of COVID incentive money with inflationary impacts, and what looks like a recession that’s being papered over by the AI bubble. Thus, you now have most local governments in California in fiscal straits.

Despite widespread acknowledgment of Proposition 13’s distortionary impacts on local government finance, why has meaningful reform remained stalled?

I think the gist of it is that politics is the art of the possible. 

Propositions 1A and 25 represented a bargain local governments eventually struck with the Legislature. That bargain got substantially unsettled when the Supreme Court unexpectedly allowed the Legislature to unintentionally kill redevelopment. 

The State Legislature had put up two bills: one that killed redevelopment, and another that said, “We’ll keep you alive if you give us some of your money.” Everybody expected both bills to become law and the second one to take effect. But the Supreme Court struck down the second and upheld the first. 

Voilà…redevelopment, which had been its own policy thicket for a couple of generations, was gone. For some cities like Roseville in Northern California and Cerritos in Southern California, it meant a sudden loss of a lot of funding. It’s been a struggle for the most redevelopment-dependent communities around the state, but that’s the law of unintended consequences: things happen that nobody intends, and then we adapt.

In your opinion, do currently elected officials and civic leaders fully understand the significance of what you just shared?

Some of them do…The Legislature passed an interesting bill this year requiring two hours of finance training for local government officials. One wonders if the 120 members of the Legislature would be patient enough to sit through two hours of finance training if someone mandated it for them, but in their wisdom, they’ve mandated it for us. The Legislature is responding to a few embarrassing failures in local government. 

We represent some cities in Siskiyou County that have 800 residents, 3,000 residents, one city has an eight-person police department, and the next town over contracts with that city for law enforcement. You’ve got tiny agencies with limited resources and, not to point fingers, sometimes shallow talent pools. I think this training intends to make those under-resourced agencies just a little more sophisticated about the challenges they face. It’s an odd training because it’s about 40% law, which people like me could teach, and about 60% practical knowledge in budgeting, accounting, that sort of thing…which lawyers aren’t competent to train on. We’re going to have to put together little consortia of finance people and lawyers to go out and train everybody on these topics every two years.

You recently commended on the passage of Senator Durazo’s SB 346. Share your thoughts on its significance and potential impacts on local government revenues.

Before AI became the flavor of the month, what was coming out of Silicon Valley was the “move fast and break things” movement, with a “let’s disrupt economic activity because we can” attitude. All of the short-term rental platforms like Airbnb, VRBO, and HomeAway are examples of disrupting the lodging industry. 

One of the ways disruptors get an advantage over established brick-and-mortar businesses is by not paying taxes. The tax in question here is the hotel bed tax, which most cities in California impose, and some, like West Hollywood and Anaheim, are very dependent on. If you lose 20% of your hotel share to these platforms and their customers, and you’re not getting the bed taxes, not only is the city losing revenue it needs for streets, police, and fire, but the hotels are at a 15% to 20% price disadvantage, depending on what the local tax rate is.

What this bill does is: if a city asks, the platform is required to give us the data we need to identify every rental on their platform in our community so we can confirm that the homeowner is complying with our tax and land-use laws. If they’re not, we can knock on their door and say, “Pay your taxes.”

The industry doesn’t like that. VRBO has already put out its own “here’s what we’ll do for you” plan, and said if you want anything more, you’ll have to sue us. They don’t want anyone moving their cheese. Meanwhile, the hotel industry and cities simply want this economic activity to pay its fair share like everyone else.

Does the voting public appreciate your assessment of this legislation’s impact on localities’ revenue and services?

I’m sure the average Californian hasn’t a clue that part of what they’re buying when they book an Airbnb getaway in Palm Desert is an end run around the bed tax. I don’t think they know it. 

One reason they don’t is that some of these platforms actually impose a “fee” on the bill in the exact amount of the bed tax, and then keep it. There’s no visible price advantage, except to the extent they’re selling a cheaper product or excess inventory, which they often do. But in effect, they’re just skimming taxes for their own bottom line, which is not in society’s interest.

You once, with foresight, called out the League of Cities’ struggle with the State Legislature to find common ground on revenue-sharing reforms. Has that revenue debate evolved, given subsequent sales-tax deals between local governments and online retailers?

What we’ve mostly been talking about in local government these days are those sales-tax “kickback” agreements, where a city says to an internet business, “Let’s pretend all your sales happen in our town. You assign all the sales taxes from your transactions to our community, and we’ll pay you back half or some fraction of that money.” 

There’s nobody in the card-lock fueling business who doesn’t have one of these deals with someone, and most major internet players have one too. These arrangements are very controversial because they’re great for the sponsoring city and terrible for everyone else, including California as a whole. A lot of money has been given away to corporations for no apparent good reason.

But it’s very hard to fix, because a few cities are so dependent on these deals that they’d practically have to file Chapter 9 bankruptcy if they lost them. There’s a city in the Central Valley that has the best-paved streets in Tulare County because it’s got one of these agreements. You can tell when you drive in and when you drive out.

Getting progress on this has been a challenge. The City Managers Department of the League has had a committee working on thoughtful principles to move forward with ideas that could keep everyone whole. The Assemblymember Jacqui Irwin from Ventura, who chairs the relevant committee, got a bill through this year requiring cities to report these agreements: how old they are, who they’re with, and how much money is involved. The state collected and published that data for the first time, and it was eye-opening. Smaller than I thought, not a billion dollars, but still significant. It was also more dispersed across industries and cities than expected. But the usual suspects were there: the card-lock guys, the Walmarts, etc.. It was eye-opening, and hopefully, with that information, we can begin to move forward in addressing the problem.

Is state–local fiscalization of land use as prominent an issue today for League members as it was decades ago?

It’s overwhelmed by the avalanche of housing bills. You know, the fiscalization of land use meant that cities and counties had an incentive to zone and approve development that would depress residential uses, which creates service demand without bringing in enough money to cover it, and instead chase sales-tax generators. Because if you do industrial development, the money goes to the state. But if you do sales-tax generation, the local government gets the benefit. Now, we literally get fifty housing bills a year out of the Legislature, and it’s impossible to keep up. I had a conversation with a client yesterday about the fact that, if you declare any land “surplus” and lease it out to a private entity, you need a “Mother, may I?” from the Department of Housing and Community Development.

I’ve got a client who has a regional park, and they want a hockey rink. They’re trying to do a lease-finance agreement with a private party who knows how to build and operate hockey rinks, which the city doesn’t. But they need that Mother, may I? from HCD, which is checking to see if maybe there’s potential for housing in the middle of a regional park. There’s never going to be housing there. And the Surplus Land Act doesn’t protect parklands as clearly as it should. That’s the kind of thing that happens when everybody in Sacramento needs to show voters they’re “doing something” about California’s housing crisis. Fiscalization of land use is yesterday’s story. Today’s story is whether any meaningful local control remains—and how far the Legislature will go in imposing a one-size-fits-all solution in pursuit of housing.

By the way, we’re not actually getting very much housing. Of all the bills they’ve passed, the only one really producing meaningful numbers of units is the accessory dwelling unit law because it’s the only one that doesn’t have a prevailing-wage mandate.

Drawing on your decades of experience, how do you explain the near-total absence, across 50+ housing bills each year, of any attention to the fiscal tradeoffs these mandates impose on local governments—particularly their ability to fund police, fire, libraries, and other essential services?

The politics are inexorable. You’ve got the hard-hat unions, the trades, the development industry, and the housing advocates all lining up in favor of more preemption and a loss of local control. Local governments have become a convenient scapegoat for the imperfections of the status quo. It’s just… we’re never going to get anybody elected on “protecting local government,” but the hard hats, housing advocates, and developers can get people elected.

It frustrates me, but my clients are even more frustrated. Some cities have actually resigned from the League of California Cities in frustration. Shooting the messenger, in my view, but it tells you how deep the frustration runs in places like Calabasas, Encinitas, and other such enclaves.

Address recently enacted SB 79 regarding its potential impacts on local government solvency.

SB 79 is Senator Wiener’s latest incursion into what used to be local control. It says you must allow something like six stories of density along transit corridors in the fifteen largest counties in California, by population. So: the Greater Bay Area, the LA region, the Inland Empire, and the few big-city counties in the Central Valley—Fresno, Sacramento, Stockton.

In those fifteen counties, it’s now likely that there’ll be zoning to permit wall-to-wall apartments along freeways and rail corridors. You can picture the BART route through North Berkeley as a kind of residential canyon, as they’re well on their way to building those units now. 

I’ll tell you, I spent some time in Europe this summer. You see a lot of very high-density multifamily housing along transit corridors. It’s not necessarily bad public policy, but there’s a certain sameness to it that might work better in tiny little Denmark, with its homogenous outlook, than in a state like California with forty million people and at least fifty million opinions.

Pivoting to Ezra Klein’s abundance thesis, how, if at all, does it relate to this exchange?

Ezra’s trying to say that we can achieve economic justice and advance the traditional liberal agenda of uplifting poor and working-class people by deregulating the economic system and encouraging it to produce more goods for them. In some ways, it’s an attractive package. In some ways, it’s a mirage. 

It’s a political speech that may not really be grounded in the world we live in. Look at what’s happening in Sacramento. We’re getting a lot of housing laws, but we’re not getting a lot of housing, because we can’t overcome the power of the trades.

Moving now to your utility-legal work, you’ve written about the ongoing challenges local governments face in collecting utility fees. Briefly, give readers the issue’s background, and on any reforms you believe could stabilize local governments’ financing.

Proposition 218, passed in 1996, was sponsored by Howard Jarvis, and it restricts our ability to collect taxes and assessments on land. But it also restricts our ability to impose utility charges. If you remember that Howard Jarvis shares staff and a building with the Apartment Association, you’ll get a sense of where their incentives are. It also created independent judicial review, de novo review, of our rate-making judgments. The problem is that rate-making is really complex. We have to predict the future and manage a whole lot of state and federal mandates while still getting water to your tap 24/7, 365 days a year, rain or shine.

Courts are made up of lawyers, and lawyers are made up of people who don’t like math or science—because if we did, we’d be doctors. You end up with very complex reasoning built on math and tables being reviewed by English majors in black robes with little wooden hammers, and bad things happen. We’ve had some really consequential cases: an $80 million award against San Diego, a $27 million award against the Otay Water District down near the border. In that case, the trial judge actually asked the two lawyers to write his statement of decision for him, and he picked one, the plaintiff’s version, lock, stock, and barrel.

That statement includes things that, from the perspective of anyone in the industry, are just felony stupid. For example, it says we can’t use the concept of “peaking factors,” the tendency of water users to contribute to peak demand on hot summer afternoons when every pump is running, unless we have time-of-use data. As you know, time-of-use data is a very current, big-data capability that only the largest, most resourceful agencies can afford; the rest of us can’t even dream of it. Peaking factors have been used in the water industry in California since we’ve had a water industry. There’s nothing in the 1996 ballot materials for Proposition 218 suggesting that such basic rate-making concepts were off the table, but because they’re hard to explain and they involve math, the judge struck them down.

The Court of Appeals later reviewed that decision deferentially, as though all these were questions of fact rather than questions of law, and the Supreme Court denied review. What’s San Diego to do? Either go to flat rates because they’re easier to defend, or spend a fortune on lawyers trying to preserve the ability to make rational rate-making policy that serves multiple objectives. It’s a conundrum, and the Supreme Court’s refusal to take review in a series of these cases is deeply disappointing. It’s left substantial uncertainty in the law, and we’re going to be living with that for a while.

Lastly, in our last conversation, you remarked that structural reform can not happen by ordinary legislation and that “the system” is truly broken.” What then is a practical and best endgame for local government finances?

I think we probably need a fundamental fix, maybe a constitutional convention, which is probably pie in the sky. More likely, a series of thoughtful constitutional amendments. More likely still, a series of politically possible constitutional amendments, whether thoughtful or not. Howard Jarvis has one of those headed for the ballot next year. If it qualifies, it’ll be because Mayor Bass hasn’t found a way to defuse the politics of Measure ULA.

For context, elaborate on the ULA issue.

ULA was dubbed the “mansion tax.” It’s a progressive documentary transfer tax on real estate escrows, intended to charge those who have mansions something they can afford, to fund housing and homeless programs. But as it turns out, and I was involved in the drafting, so I’m not throwing stones here, it also applies to nonresidential escrows. Most apartment buildings, industrial, and commercial properties fall into the price range that triggers these high costs, which are substantial in the broader marketplace.

Remember, Los Angeles has a ragged border with indentations called Santa Monica, West Hollywood, Culver City, Glendale, Pasadena, and so on…and none of those cities have this tax. We’ve seen real distortions in the real estate market, or at least claims of them, and the oxen that got gored have well-moneyed owners, who are willing to fund Howard Jarvis’s measure if they can’t get relief another way. A lot of people recognize that funding housing and homelessness programs is vital, and that the wealthiest members of society, in an age of Gilded Age–level inequality, should help pay for it. The debate is whether Measure ULA distorts the real estate market in ways that need fixing.

Negotiations are underway now to find a solution that both preserves funding for those programs and relieves pressure on the real estate market.

And your position, Michael?

I’m a lawyer with clients. My clients have positions—I don’t.