This staff report is intended to discuss the fiscal cliff that exists in the County's future fiscal forecasts as it pertains to property tax revenues but also to describe potential opportunities for a new property tax related revenue source to begin to prepare the County for its impacts in accordance with disciplined long-term financial planning.
The staff report is broken into several sections: (1) Discussion of Redevelopment History as it affects Yolo County, (2) Fiscal Cliff, (3) Chula Vista decision, and (4) Recommendations.
1. Redevelopment History
The County of Yolo has four former redevelopment agencies that were formed in the 1980’s which include one for each incorporated city (Davis, West Sacramento, Winters, and Woodland). Redevelopment Agencies (RDA) define an area within each city which is determined to be “blighted” and focus on directing resources in order to improve those respective areas. To finance these improvements, the property tax base in the defined tax rates areas is frozen at a base level. All property value growth above that base is deemed to be attributable to the RDA’s efforts and that revenue called “tax increment” is redirected to the redevelopment agency to pay for expenditures or financing that was obtained to make those improvements.
At the formation of a Redevelopment Agency, the agency was required to notify and negotiate with taxing entities that would be affected on any revenue sharing. These revenue sharing agreements are called “Contractual Pass-through Agreements” as they define how any tax increment may still need to be passed back through to taxing entities. The County negotiated contractual pass-through agreements with each respective RDA which required them to pass-through the tax increment attributable to the County at its respective AB8 tax factor. These are considered to be favorable agreements as the County negotiated terms that avoided any County revenue loss. However, the agreements also include some concessions to the Cities mainly related to land use (ex. urban development boundaries) and restricted some of the County’s ability to perform economic development activities.
In 1992-93, the State of California experienced significant budget difficulties. As part of the state’s budget balancing solutions, the State created an Educational Revenue Augmentation Fund (ERAF) which shifted property taxes from local governments to the State in order to relieve the state of its obligation to fund school districts and other local educational entities. This shift disproportionately affected Yolo County, as the County was required to shift 65% of its property tax revenue to the ERAF Fund. One of the key reasons for this disproportionate shift was that newly formed cities after Proposition 13 (in 1978) were exempted from paying into ERAF II (the largest of the 3 ERAF shifts). Thus, the County of Yolo was required to pay the entire share that otherwise would have been assigned to the City of West Sacramento. The County had been generous (rather than punitive) in the tax sharing agreement with West Sacramento at incorporation which meant the County lacked the revenue to absorb this without major budgetary cuts and expense reductions. Some of this impact was later mitigated through the voters passing Proposition 172 in 1993-94 which is a ½ cent sales tax that comes back to Counties to provide funding for public safety. However, the unrestricted source provided to the state (i.e. Property Taxes) is only partially offset by the restricted source provided by Proposition 172.
Counties were required to adjust all of their tax rate areas in order to add the ERAF as a school entity and implement allocation factors to shift property taxes to ERAF. However, in Tax Rate Areas with a Redevelopment Agency, all taxes collected above the RDA base were shifted to the Redevelopment Agency. As a result, the original ERAF law did not provide a clear statutory direction on whether ERAF needed to be added in RDA tax rate areas as ERAF was not a previous jurisdiction that lost revenue to the RDA. Yolo County thus did not implement ERAF factors into the RDA Tax Rate Areas in 1992-93. In the 1993-94 fiscal year, the legislature passed “AB 860 (1994)” which clarified that Counties that had not implemented ERAF as a taxing entity in RDA Tax Rate Areas were not required to do so.
However, this effectively led to the County receiving pass-through payments from the Redevelopment Agencies at the Pre-ERAF rates and the RDA’s having not experienced a revenue loss, having the financial ability to continue to make these payments at the contractually agreed to levels. Redevelopment Agencies and these contractual payments continued generally undisturbed for a number of years. However, the State began to recognize that the RDA’s throughout the state were capturing an increasing amount of property tax revenue and it was unclear (in certain jurisdictions) whether the revenue increases were truly related to the efforts of the RDA or whether the increase was more attributable to cost escalation affecting land values in the State. As a result, the State found itself having to increase its general fund contributions year after year to meet its Proposition 98 Minimum Education funding level.
Thus, in the 2011-12 Budget, facing a challenging budget year, the State passed AB1X26 and AB1X27. AB1X27 was essentially a pay-to-play bill in that RDA’s would be required to make ongoing payments to the State to continue to exist. These payments into the Supplemental Educational Revenue Augmentation Fund (SERAF) would help the state to meet its education obligations but allow RDA’s to continue in a reduced form. However, AB1X27 had a provision stating that if it later was found unconstitutional, that AB1X26 would take effect dissolving redevelopment agencies. Ultimately AB1X27 was found
unconstitutional; thus all redevelopment agencies in the state were dissolved in February, 2012. As part of the dissolution process, each City had to develop an oversight board to wind-down the affairs of their respective redevelopment agency (however later these Boards were consolidated into one County Board in 2018). AB1X26 and subsequent legislation defined a flow of funds process for how to utilize the prior tax increment revenues of the RDA in order to wind down the affairs paying in the following priority:
1) Contractual Pass-through / Statutory Pass-through Agreements
2) Tax Administration / County Auditor-Controller Charges
3) Recognized Obligations approved by the Oversight Board
4) SCO Audit Invoices
5) Residual Distributions (to Taxing Entities based on AB8 Formula)
2. Fiscal Cliff
Each of the Redevelopment Agencies continues to request the amounts needed annually in order to pay their annual obligations. However once all obligations are paid, the redevelopment agencies will be dissolved by the County Oversight Board. Once a redevelopment agency is dissolved, the contractual pass-through payments cease and the County Auditor-Controller (part of role of Yolo County CFO) would implement the Post-ERAF factors and that TRA would become a normal Tax Rate Area (removing prior linkage to RDA).
As a result, the County is presently receiving more revenue from these Redevelopment TRA’s than it would in the absence of redevelopment due to these favorable pass-through agreements . Though this is legally allowed, it sets the County up for a “fiscal cliff” when Redevelopment Agencies finally dissolve. Each redevelopment agency will dissolve when its respective debt has been paid off and so the County really faces four individual cliffs which result in step downs of revenue:
| Redevelopment Agency |
Expected Dissolution Year |
| Davis |
2037-38 |
| West Sacramento |
2045-46 |
| Winters |
2037-38 |
| Woodland |
2034-35 |
The associated revenue losses have been carefully forecast but rely on a variety of assumptions. This forecast is included in Attachment A, which shows the aggregate effect on the General Fund. The other affected fund is the Yolo County Library Fund , which is also a taxing entity that is receiving the favorable pre-ERAF pass through payments. However, the ERAF factor for the Library fund is at 23% compared to the General Fund 65% ERAF loss, meaning the cliff (or size of revenue loss) is much more substantial for the General Fund.
3. Chula Vista Decision
As communicated to the Board in December, 2020, the County is required to implement a Third District Court of Appeal decision (the Chula Vista case) which affects the method for distribution of residual funding (last bucket in the flow of funds) from the Redevelopment Property Tax Trust Funds.
Chula Vista considered two conflicting statutes that created ambiguity in the manner in which residual funds should be distributed.
In the prior method used by the County based on one statute, the County applied a cap that prevented taxing entities from receiving a total amount of pass-through distribution and residual funds exceeding the loss of revenue to the redevelopment agencies. As a result, since the County funds (General and Library) had a pass-through agreement that paid the full amount of the revenue loss to RDA, the County funds were not included in the residual distribution and thus did not receive additional funds. However, the Court of Appeal ruled that the other statute controls in this situation and that, contrary to the County’s approach, the distribution of residuals should not be capped and that residuals should instead be distributed based on the AB8 factor. This provides the County with both a new opportunity and a new risk. On one hand, the County will receive additional residual funding, estimated to be about $1.25 million in the current fiscal year. However, this funding will also go away at the dissolution of redevelopment, and further increases the impact of the fiscal cliff discussed above.
There is also some risk that the taxing entities impacted through this decision may seek legislative action to change the manner of distribution to resolve concerns presented in the Chula Vista case but not accepted by the Court. Financial Services continues to monitor but has not yet seen legislative action emerge on this specific aspect of redevelopment distribution. However, that doesn't mean that it could or would not emerge in the future and thus the County may not want to become dependent on this revenue and use it wisely.
4. Recommendation
In order to prepare for the fiscal cliff, the County should exercise diligent long-term financial planning and utilize the time that exists to adequately prepare. The fiscal cliff (as shown in Attachment A) is approximately $6 million in 2038-39 and another $4 million in 2046-47. A loss of $10 million in revenue today would be equivalent to a loss of 12.5% of the General Fund and would likely cause severe reductions to programs and services that time. This dollar figure may be slightly less when discounted back to today’s dollars but clearly not insignificant, especially if the County doesn't diversify revenue sources or has limited economic growth over the next 15-20 years.
The availability of additional revenue from the San Diego v. Chula Vista decision (residual revenues) gives the County an additional resource to prepare for the fiscal cliff without impacting current operations. There are presently three known strategies that the County may want to employ to prepare and can be used either individually or in combination:
- Reserve accumulation - The County general fund reserve has fallen to 5.7% in the upcoming budget (from 6.5% in 2018-19) and the County has not progressed recently toward the policy objective of achieving a 10% reserve to mitigate against economic and fiscal uncertainty. This use would further the fund the reserve progressing toward the targeted policy level. This would also provide a buffer against a future change in legislation or law related to the apportionment of residual revenues, including if implemented retroactively .
- Debt reduction and avoidance - The County should also evaluate use of the proceeds to improve its financial strength and flexibility to prepare for the fiscal cliff by reducing or avoiding future debt. Debt would include both bonded long-term obligations but also those long-term obligations related to unfunded benefits (ex. Pension and OPEB). The term debt avoidance is also used to provide flexibility to avoid future debts that would exacerbate the fiscal cliff should items materialize that would otherwise result in incurring debt (no other funding source is available).
- Revenue smoothing policy - The County could begin to forecast the level of revenue loss that will occur in 2038 after the first step down in the initially cliff. After forecasting, the County could adopt a policy to exclude revenues received from pass-through above the projected 2038 level from being treated as ongoing revenue in the budget and instead be treated as a one-time resource. This level of budget discipline would need to be adopted by policy and staff are seeking board direction on whether to develop such a policy and bring this type of item back at a later meeting. The earlier this type of policy is adopted, the more effective the policy would be and the more time the County would have to adjust to living within its future means. An example image of this approach is included in Attachment B.
The revenues expected to be generated by the Chula Vista decision between now and 2037 is expected to be $31.6 million over that approximately 15 year time horizon. However, the County currently is about $10.7 million short of achieving its reserve objective of 10% and as of June 30, 2020 (last financial statement), the County has $90 million in bonded debt, $308 million in pension liability, and $65 million in OPEB liability resulting in a total of $463 million in obligations. So while this will improve the County's fiscal position, it is still small relative to all current long-term obligations.
At this time, staff are recommending the board to adopt the resolution included in Attachment C, which would create a separate fund for the Chula Vista proceeds called the Chula Vista Fund and are hoping to receive direction from the Board on any interest in revenue smoothing. After accumulation of fiscal resources in the Chula Vista fund, staff would recommend in the annual budget process whether to apply said funds to reserves or debt reduction, taking whichever approach maximizes this resource and is the best measure to prepare for the fiscal cliff (future revenue reductions). |