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The State/Local Fiscal Relationship: A "Taxing" History of Prop. 13

The following appeared in the January, 1999 issue of Metro Investment Report, the insiders' guide to public investment in the region. For subscriptions, back issues or reprints, go to www.ablinc.net/mir , or call (213) 629-9019.

Comments By Fred Silva
Visiting Policy Analyst,
Public Policy Institute of California

With Assembly Speaker Antonio Villaraigosa's new Commission on State and Local Government Finance preparing to convene its first session in Sacramento at the end of the month, MIR is pleased to present the following enlightening history of Proposition 13. It was adapted from the comments of Fred Silva, California Public Policy Institute Visiting Policy Analyst and former California Constitution Revision Commission Executive Secretary, at the recent 10th Annual Envisioning California Conference.

Overview of State-Local Fiscal Tension-Who Controls Local Finance?

The history of the relationship between State and local governments has always been tense. At the center of this tension is fiscal power and how it is shared. One way of understanding this tension is to ask the question, "How much control over financing of local services is vested in communities and how much is vested in the State?" The answer depends on the type of local government. Generally, cities have had more independent authority than counties. Counties have had a dual role in California government. They act as agents of the State, administering State programs, and as local government, providing local services.

Counties, as well as other local governments, maintained control over locally levied taxes including the property tax, in part because, in 1910, a provision was added to the California Constitution known as the Separation of Sources Act. The objective of this action was to separate State taxing power from local taxing power. This separation lasted for 68 years until the passage of Proposition 13. During this period, counties could finance their roles both as agents of the State and as providers of local services because they had control over their principal local revenue source-the property tax. If their citizens wanted a higher level of local services, the counties could fund the increase by adjusting the property tax.

Proposition 13, although better known for limiting the property tax rate, gave the State control over the distribution of the property tax and took away the connection between the amount of property tax paid and the level of local services received.

Reviewing the State-County Relationship And the Control of Local Revenue

County revenue can be categorized as either own-source revenue or a subvention from the State or federal government. Own-source revenue is revenue raised and spent by the agency levying the tax, fee or assessment. Subventions are resources provided by another governmental agency, such as the State, and are generally tied to a particular program. For example, the State gas tax subvention must be spent on roads and a portion of the State sales tax is provided to counties as a subvention to provide health care to indigents.

A limited number of subventions are general purpose such as the vehicle license fee. However, when reviewing the State-county relationship, we find that a significant proportion of general-purpose subventions is pledged to a function that the county performs as an agent of the State. To compensate for the loss of property tax revenue due to Proposition 13, the State increased State subventions for county-administered State programs. Own-source revenue declined. The historic connection between locally raised taxes and the level of local services had been broken.

From the early part of the 20th century until the 1930s, own-source revenues, particularly property tax revenues, were a dominant part of county finance. After the Depression, the role of counties as agents of the State began to crowd their local-government role. By the mid 1940s, roughly half of county expenditures were financed by own-source revenue and the other half by subventions. This split continued until the 1978 passage of Proposition 13, when counties lost the primary component of own-source revenue-control of the property tax. The State increased subventions to counties primarily to maintain funding for services that the county provided on behalf of the State and that counties could no longer fund due to the loss of property tax. The amount of own-source revenue declined to about 35% of total revenue. Today it is less than 25%.

Reducing the Tension-Increasing Own-Source Revenue and the Power to Make Local Service Choices

No one would care about the decline of own-source revenue and the lack of control of the property tax if all that counties did was to act as agents of the State. However, counties are responsible for providing a variety of services that are countywide in nature and that are an essential part of the State's local government system.

They are also the local government in areas outside of cities, although most of these services are provided by special districts. Countywide services include public safety, library, waste disposal, election, property tax assessment and a variety of other local services.

What citizens and their local governments have lost is the connection between the taxes levied and the services received. This state of affairs contrasts with the situation in the "separation of sources" period when the level and the quantity of local services provided by a county would usually bear a relationship to the level of property taxation. A local agency with a high property tax rate generally had a higher level of services. Local agencies with lower tax rates had lower levels of services.

Why the decline of own-source revenue and the lack of control of the property tax are problematic can be seen in the continuing structural deficit in Los Angeles County's budget. Each fiscal year, the County must cut programs or increase a limited set of revenues in order to close the gap made by the State's withdrawal of a portion of the property tax in the mid 1990s.

Another example is the effect of State control of property tax on the fiscal condition of Orange County during the mid-1990s. The seeds of the Orange County bankruptcy were planted in the reduction of County property taxes by the State from 1992 to 1994.

The State continues to argue that the transfer of county property taxes to help make up the State deficit in the mid-1990s has been paid back through a variety of State subventions for public safety and the State trial courts. The State does not see the effect of its action. It replaced general-purpose revenue with revenue dedicated to specific services for which the State had an interest.

Rethinking State Control of the Property Tax

For all practical purposes, the property tax, now controlled by the State, is a State tax with its use determined by the State. If we are concerned about improving the relationship between citizens and their government, it may be time to consider the return of the property tax as a locally controlled tax and to recall the old doctrine that State taxes should be used for State programs and local taxes for local services. This might be preferable to asking local communities to increase local taxes simply because the State does not have enough resources to meet statewide needs.

But how is this possible under existing law? Proposition 13 is unlikely to go away. The fixed one-percent property tax rate and the acquisition-based assessment system are probably here to stay, as are the voter approval requirements for local taxes and assessments.

So how much room could communities have within the construct of the Proposition 13 limits? One place to start is the power of the State to allocate the property tax. Section 1 of Article 13(A) provides that the property tax is to be "apportioned according to law." This phrase turned the local property tax used for local purposes into a State tax used for State purposes, from own-source revenue to a State subvention.

The State fiscal policy agenda might consider going back to the "Separation of Sources" doctrine, allowing local governments to determine distribution and use of the property tax and thereby turning it back into own-source revenue-a local tax to finance local services.




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