Commission Meeting #7 Minutes

July 28, 1999 Westwind Community Center, Ontario

Synopsis

1. Call to Order/Introductions:
Chairperson David Abel called the meeting to order at approximately 10:15 a.m.

In attendance:
David Abel
Carl Anthony
Amy Dean
Bob Foster
Joel Fox
Lee Harrington
Norman King
Lily Lee
John Maltbie
Rich Morrison
Chuck Nathanson
John A. Perez
Kevin Scott
Dwight Stenbakken
Steven Szalay
Carol Whiteside

Welcome: Commission Chair David Abel welcomed the Commission to Ontario and introduced Assemblymember Nell Soto. Assemblymember Soto, who represents the Ontario area, thanked the Commission for coming to the Inland Empire and said, that as a member of the Assembly Local Government Committee and a former local government official, she was very interested in the work of the Commission. She then sat in as an ex-officio member of the Commission for about an hour before leaving to attend the memorial service for the late Congressman George Brown.

Frank Stallworth, field representative to State Senator Joe Baca, also welcomed the Commission to Ontario. He said the Senator is looking forward to seeing any proposals the Commission develops.

2. Presentation: State and Local Government Finance from the Legislature's Perspective: The Changing Economy and its Impact on Communities: Steve PonTell, president of the La Jolla Institute (LJI) of nearby Claremont, gave a presentation on the work of the Institute. He described its focus as being the relationship between the economy and communities. He further noted that the recession of the early '90s had brought fundamental change and restructuring to the California economy.

Mr. PonTell then discussed LJI's "Main Street 2020" study on the future of retail business in California. Retail has taken on a new dual personality, split between the physical and the electronic. He stated that the retail business is undergoing constant rationalization as it seeks to increase efficiencies. Some examples of this are the rise of so-called "category killer" stores (big box retailers) and Internet sales, both of which have the effect of eliminating middlemen, lowering prices to the consumer and centralizing activities while shifting some power to the individual consumer.

PonTell predicted that both category killers and the Internet would impact commodities and hard consumer goods before anything else. He cited toys and automobiles as examples. Later on during the meeting he added that the arrival of e-commerce could be a watershed event and noted that Moody's, the bond-rating firm, has been re-evaluating bond ratings for retail developments in light of the growth of e-commerce. He then made the important assertion that a modest 7% shift to e-commerce could result in a 50% decrease in profitability. This level of setback would "destroy" real estate pro formas, according to PonTell, disrupting project financing and leading to either stagnation or deterioration of the local situation. He predicted that it won't be long before sales and property taxes will no longer be good indicators of economic growth, with income taxes becoming more reliable.

3. Presentation: California Cities and the Local Sales Tax: Presenter Dr. Paul Lewis of the Public Policy Institute of California (PPIC) presented the findings of the study he and Elisa Barbour recently completed for PPIC. He described the study as having two primary thrusts: exploring the effect of sales taxes on cities' land-use decisions, and which types of communities are doing better or worse in the quest for sales tax revenues?

Dr. Lewis mentioned several pieces of unsuccessful legislation that would have impacted the sales tax strategies (arguably for the better). He said that about 10% of total municipal revenues come from sales taxes, but about 27% of general revenues. The rest come from property taxes, utility users taxes, the vehicle license fee (VLF) and other sources. But, he noted, the sales tax tends to be the major source of discretionary revenues to cities.

Lewis discussed the "fiscalization of land use." He mentioned six key examples of fiscalized decisions: Zoning excessively for retail, using the redevelopment process to assemble land and improve infrastructure, rebating taxes to retail developers, waiving or reducing developer fees or Community Facilities District taxes, expediting permits, and actively marketing to retail uses.

He then described polling he and Barbour had done in conjunction with his study. They conducted a mail survey of city managers and other top administrative officials in California's 471 cities (circa 1998). The survey revealed a clear bias toward retail uses and verified that the local desire for sales taxes was motivating the bias.

In the survey, retail was ranked number one by about 75% of respondents. Office was second, mixed-use third, then light industrial, single family residential, multi-family residential and heavy industrial.

Lewis added that the are major sales tax disparities from city to city, but they have not gotten worse over the last couple of decades. Cities tend to hold roughly their current and long standing position in the hierarchy. As a general rule, he added, larger cities and cities near freeways tend to be doing better, while cities with high growth rates are doing worse.

Dr. Lewis cited a relationship of sales tax receipts to household size, with small families buying more per capita. He also noted that poor cities (cities with a high low-income population) tend to do poorly in sales taxes, and rich cities do too because they tend to zone out commercial businesses. Another finding of the study is that land in redevelopment areas tends to generate more sales taxes.

The study acknowledges that sales tax revenues tend to be cyclical but also found that, in 1996, when adjusted for inflation, the level of revenues in California was the same as it had been in 1971. Lewis noted that this may be partly due to some important exemptions that now exist, including cattle feed, the Internet and others. He added that central cities have clearly lost ground to suburbs and that per capita spending is more or less constant.

Dr. Lewis concluded that local decision making has a tendency to redistribute, not increase, retail activity and sales tax revenues. The competition for these revenues causes some cities to "compete away" the advantage they might otherwise gain by attracting businesses away from other jurisdictions (through tax rebates and other offerings to developers and businesses).

Commissioner Stenbakken asked if the study determined how the local emphasis on retail was making housing and industrial development more expensive. Dr. Lewis replied that the study did not quantify that assumption. He said it is a logical outgrowth of supply-and-demand concepts when applied to using up land for retail purposes. Commissioner King noted that a typical tax rebate agreement these days would kick back 25-50 cents of each dollar to the developer and/or business.

Commissioner Maltbie asked if there needs to be a critical mass of housing to attract retail and for it to be successful. Dr. Lewis unequivocally said there does and that it creates a chicken/egg problem for many cities. Commissioner Szalay asked which cities use bond financing and Dr. Lewis replied that the study did not look at financing mechanisms.

Referring back to the issue of rebates, Commissioner Perez asked if the percentage of rebates affected the placement of businesses. He noted that it is hard to compare retail performance in the abstract. Commission Chair Abel added that there may not be any data on what it costs cities to maintain their revenue position. Commissioner Nathanson mentioned that there appears to be disagreement on the impact of the competition. Some say it is negligible, while others, including the Los Angeles Times, have reported that it has a big impact. Dr. Lewis replied that there is a predisposition to see the competition as wasteful and to not look at the relative stability of the revenue hierarchy over the last quarter century. Commissioner Perez replied that looking at retail in isolation makes it difficult to determine the value of the development that does not take place, the value of what is lost.

Commissioner Lee asked if Dr. Lewis thought the survey results would have been different if he had surveyed policy makers instead of administrators. Lewis said that city managers tend to be caught up in decision making and not lost in theory. Thus, mayors might have answered differently, but not necessarily. Elected officials recognize that, in the current system, residential and industrial development are fiscal losers and that property taxes are insufficient to fund services.

Dr. Lewis added that he felt none of problems commonly associated with the fiscalization of land use are directly the fault of the sales tax alone. He acknowledged that cities need a broader set of incentives for non-retail land uses. If cities could get a larger slice of the property tax, they would have more incentive for balanced development. Lewis opined that this could be done without raising property taxes; a trade-out with other taxes could accomplish the goal. He also said that changing the per capita distribution of sales tax revenues would not solve the problem.

Commissioner Whiteside complimented Dr. Lewis on his study, noting that it presented data and findings that are on the "cutting edge" of the fiscal reform debate and not just looking back at past data and conditions.

Referring back to the discussion on retail tax rebates, Commissioner King mentioned that, the smaller the city, the more motivation to go after a big box retail development, because the resultant sales taxes constitute a bigger percentage of the city's total revenue package. Commissioner Nathanson added that the "border wars" that sometimes accompany the quest for big box retailers can have a significant impact on the distribution of income in the state.

Commissioner Harrington commented that jurisdictions can experience both good and bad impacts from big box retail. He added that there is much less flexibility in urbanized areas when it comes to choosing additional land uses and opting for retail has a greater impact on closing out other options. Dr. Lewis replied that it appeared that urbanized areas are already more balanced in terms of land uses.

Commission Chair Abel asked how a tax structure biased toward the sales tax is likely to impact growth patterns in the future. Dr. Lewis responded that it will depend on how a given region perceives its needs. He pointed to the Central Valley, where officials show more interest in job development than any other part of California. He said the region's double-digit unemployment rate and large amount of undeveloped land are prime influences on that. Central Valley cities appear to be willing to do lots of annexation and to site retail uses on the new fringes of their jurisdictions.

Commissioner King added that sales tax is declining as a percentage of discretionary revenues. Dr. Lewis noted that retail is traditionally a low-profit margin sector that is especially vulnerable to disruptions such as e-commerce. He said that, as consumers spend more on non-tangibles and services, government should consider taxing a wider variety of sales.

4. Presentation: Equity Principles for State and Local Government Finance: Commissioner Anthony briefly presented his memo on "Equity Principles for State and Local Government Finance." He laid out several principles: 1) Reduce the gap between rich and poor communities. 2) Empower communities to be involved in decision making. 3) Promote environmental protections and sustainable development.

Commissioner Anthony went on to suggest some mechanisms for implementing these principles: 1) Promote regional cooperation. 2) Incorporate environmental protections and sustainability as goals of new development. 3) Involve the community. 4) Require a socio-economic analysis of development impacts. 5) Raise new public revenues through progressive taxes, fees, etc. 6) Distribute resources according to need.

Commissioner King commented that a threshold question for this discussions is how best to define a community. Is it a neighborhood, a jurisdiction or a region? These distinctions are relevant since they lead to different types of solutions. He added that the distinction is not necessarily urban vs. suburban. He pointed to San Francisco, which he said has more money for services than any other city but still has disadvantaged neighborhoods and would probably lose funds in any kind of statewide redistribution of resources.

Commission Chair Abel mentioned another category of community that needs to be considered. He referred to a recently-coined term introduced by academic Joel Kotkin, the "midopolis." This refers to older, decaying mid-cities that have not been the focus of either urban renewal or suburbanization. Commissioner Nathanson added that the midopolis issue is about resources being sucked out of old neighborhoods. He referred to it as a kind of class warfare, as amenities are channeled to new neighborhoods.

5. Presentation and Discussion: Draft Reform Options Matrix: As promised at the June meeting, presenter Fred Silva of the Public Policy Institute of California in San Francisco delivered to the Commission a matrix of fiscal reform options based on discussions held before the Commission over the course of 1999. The matrix had been distributed to Commissioners several days prior to the meeting. (A copy is attached to this synopsis.) A memo guiding the decision making process prepared by Marianne O'Malley of the Legislative Analyst's Office was also provided to facilitate the process.

According to Mr. Silva, the memo and matrix combination was meant to be an exercise in applying particular policy values to a decision making process. He described the matrix as a list of ideas that did not constitute a list of recommendations. He provided an overview of all the listed options (see matrix). The Commissioners then engaged in a discussion of various of the options and other related issues.

Commissioner Scott, looking at the "home rule" ideas listed in matrix Concept #1, asked for clarification on the existing authority of local jurisdictions. Mr. Silva said that most jurisdictions can set the tax rate but that the State sets the base of taxation. Commissioner Scott then asked about what kind of tools might be available and Silva referred him to point 1.f., which suggests a countywide sales tax or a per-student K-12 education surcharge on the State income tax.

Commissioner Maltbie mentioned that, with regard to education-related revenues, the Serrano decision (mandated rough parity in school funding from district to district) would come into play. Mr. Silva reminded the Commission that, at the long discussion of school funding at their San Diego meeting in the spring, presenters encouraged the Commission to not let Serrano be an impediment. The idea was to look at a system that allows more local choice but looks at it regionwide.

Commissioner Dean pointed to item 1.e., dealing with property tax rates, noting that the public may demand some kind of performance standards (police and fire response time improvements, increased library hours, etc.) before approving such increases. She also mentioned the desirability of protecting seniors from having to pay increases until their property is sold. She then mentioned Concept 2 (encouraging balanced growth in a regional context), suggesting that equity issues and sustainability should be included, as well as affordable housing and economic growth strategies.

Cautioning against re-inventing the wheel, Commissioner Whiteside suggested that the Commission's recommendations should be compatible with those of the Constitutional Revision Commission.

Hearkening back to the discussion that took place about his memo, Commissioner Anthony posed a question about what constituted a region. Mr. Silva suggested a region could include a county or more. Commissioner Harrington opined that sub-regions were also relevant, noting that seven have been identified in Greater Los Angeles.

Commissioner Nathanson mentioned item 2.f. and said the user fee approach it referred to does not guarantee balanced growth. Commissioner Whiteside added that 2.g., about allowing gas and sales tax increases by majority vote, could be a growth inducer and the growth wouldn't necessarily be balanced either. Commissioner Szalay said that the income tax should also be an option.

Commissioner Anthony asked if any of the proposals in Concept 2 would lead to more affordable housing. Mr. Silva said that giving local jurisdictions a larger share of the property tax indirectly could have that effect. Commission Chair Abel asked if any measure would demonstrably incentivize housing. Silva suggested that a share of the sales tax could do that.

Quickly segueing, Commissioner Perez asked if there was a way to incentivize industrial uses. Silva said that the sales tax share would also do that, but he noted that it could be more effective with a split allocation, giving a city a larger percentage of the revenue from industrial uses. Jennifer Swenson of the California Research Bureau mentioned that this could incentivize high-end housing as well and that some other mechanism also would be needed.

Commissioner Nathanson noted that many neighborhoods are concerned about the impact of higher density on their quality of life when there is already too little money to provide adequate services. He said there is something about the implementation ideas being presented that is inadequate to deal with this reality. Commissioner Scott opined that local jurisdictions could offer an income tax credit to incentivize preferred activities and uses. The implementation ideas need to go beyond simply allocating tax categories.

Commissioner Anthony asked how these strategies can reach old and midopolis neighborhoods. Mr. Silva said he though that State and local finance strategies could nibble at the problems of those neighborhoods but probably could not solve them. Mr. Anthony asked if it would at least be possible to eliminate disincentives. Incrementally, was the reply; the tax burden for preferred uses and investments could be reduced.

Commissioner Szalay declared the need to focus on Constitutional change that would create predicability. He said that tinkering with mechanisms is a process that is inherently on shifting ground. Silva agreed, noting that there are no less than seven relatively recent instances in which the State granted subventions (funding) to locals and then removed them, leaving the locals high and dry.

Raising the issue of property taxes, Commissioner Scott asked what category multi-family housing fell into, noting that it is the source of most affordable housing. Mr. Silva said it was currently classified as commercial property, but to convert to a split-roll property tax approach and still incentivize affordable housing, multi-family would have to be re-classified as residential.

Commissioner Anthony suggested looking at so-called "sin taxes," as well as the progressivity of the system.

Commissioner Fox raised some structural issues, asking how a regional infrastructure tax would be administered. He wondered if a regional governing board could be made directly accountable. Mr. Silva replied that no institutions exist that would be perfect fits, suggesting that some kind of Joint Powers Authority might be the answer. Commissioner King added that one of the problems in dealing with e-commerce has been that of how best to administer the tax. He said Congress has refused to create a mechanism.

Commissioner Nathanson brought up school districts, saying they don't seem to have political "legs" anymore. He said that Australia abolished school districts a few years ago and "nobody has missed them." He wondered if this could also happen with land use, that problems would become so extreme that the State would step in and take over and the public would not object. Commissioner Whiteside added the recent example of Georgia's governor stepping in to strip locals of certain authority. She suggested that preservation of farmland might prove to be the next issue where such intervention may be contemplated.

Commissioner Fox raised a general question about what gets taxed and how much. Commissioner King responded that some of the taxes that lead to inequities need to be cleaned up. He mentioned a per capita definition of revenues from sales, property and other taxes, and said the State could compensate for inequities.

Commissioner Scott said there needs to be efficiency in the State/local system. State taxpayers pay too much in Federal taxes because of the role of sales taxes. Commissioner Szalay suggested looking at the services provided by cities and counties. Since those jurisdictions are not always comparable in what services they provide, what constitutes "equity" is subject to debate.

Commissioner Fox stated that he is concerned about what appear to be incentives to raise taxes. He asked if an honest accountability system can be set up. Commissioner Maltbie replied that some work is being done in that direction but that it's not an easy thing to accomplish. Commissioner King noted that New Zealand has adopted some kind of accountability language and granted additional local discretion in exchange for achieving accountability goals. Commissioner Stenbakken said the League of California Cities has some suggestions.

Commissioner Nathanson closed this portion of the meeting by asking how much the removal of negative incentives would help to address inequities. Mr. Silva responded that additional data is necessary to judge how much of an effect incentives have had, and will have.
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6. Discussion: Process Issues, Etc.: Commissioner Whiteside suggested that the Commission could move more expeditiously through the discussion of proposals if individual members were prepared in depth before the August meeting. She suggested that the Commission's various "caucuses" might want to meet or converse ahead of time. This led to Commissioner Morrison's suggestion that the "smart growth" caucus actually meet prior to the August 25 meeting in Fullerton.

The Research Bureau's Jennifer Swenson offered a couple of items of interest. She said a bill had just been signed to instruct the Legislative Analyst to study AB 8 (the 1979 bill that locked in sales tax distribution proportions after the passage of Proposition 13) and any inequities it may have created. The LAO is supposed to report back by January 2000.

Ms. Swenson added that the Commission's discussion had resembled the kinds of discussions held at meetings of the Select Committee on Jobs-Housing Balance chaired by Assemblymember Tom Torlakson, an ex officio member of the Commission. She suggested that the Commission might want to communicate more regularly with that Committee. She concluded by encouraging the Commission to avoid overlooking reform options simply because they have proven politically difficult in the past.

Commissioner Anthony asked for an update on the status of the Vehicle License Fee. Fred Silva opined that it was on its way out as a tax in California. He cited the cuts in the VLF which have taken place as part of the State budget the last two years and pointed to the possibility of a ballot measure in 2000 that would abolish it altogether. Mr. Anthony replied that reducing the VLF has the consequence of encouraging the use of automobiles. Commissioner King agreed and said that the State would have accomplished more and caused less damage by cutting the income tax.

7. Public Testimony: Carolyn Woosley, a recent graduate of UCLA's School of Public Policy, suggested that the Commission should look at the role of Redevelopment Agencies in housing. They are supposed to have set-asides, but is there adequate oversight.

Ms. Woosley pointed to credit unions and industrial development authorities as alternative vehicles for economic development. She questioned whether the requirement on banks to invest in poor neighborhoods has been effective. Woosley went on to opine that taxing land, not capital improvements, could incentivize development in poor neighborhoods. She also suggested looking at the point in time when commercial property can be taxed and the effect of complex post-Proposition 13 ownership schemes have had on the ability of government to collect those taxes. She concluded by noting that sales taxes make the revenue stream vulnerable to economic cycles.

Don Driftmeier, a Certified Public Accountant who is also a past president of the Ontario Chamber of Commerce, raised several local perspectives. Pointing to the presence of several four-year colleges and universities in the Inland Empire, he said the region has had a problem keeping educated workers in the area. Commissioner Anthony suggested that "retail sprawl" might be a reason people don't want to stay in the Inland Empire. Driftmeier related it to the effect of the fiscalization of land use on job formation. He said incentives are needed for better-paying jobs.

Mr. Driftmeier then mentioned how service industries, such as accounting, will react quite negatively to proposals to impose sales taxes on services as part of any reform scheme. Commissioner Szalay asked why this would be a problem. Driftmeier said it would put businesses in the role of being tax collectors, a role they do not relish.

Driftmeier concluded by mentioning that his CPA firm audits some 280 school districts around the state. He observed that they have the ability to control their expenses but not their revenues, and this has created serious problems for them.

***

Commission Chair Abel reminded the Commission that the next meeting was scheduled for Wednesday, August 25 in Fullerton. He also offered to help facilitate meetings of the various "caucuses" prior to the meeting of the full Commission. The meeting was then adjourned at approximately 2:30 p.m.

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