Cities Face Fiscal Crisis Over Illegal Tax Collections : Finances: Courts have ruled that up to $800 million collected from aerospace firms must be turned over to the federal government. Some hard-pressed municipalities may wind up on edge of bankruptcy.
For Torrance, the figure may run as high as $1 million. Redondo Beach is looking at a $1.5-million bill. Hawthorne could owe $3 million. And El Segundo may end up paying out a whopping $6 million.
Whatever the final figures are, they could add up to serious financial trouble for numerous South Bay cities that have relied on the aerospace industry to bolster their municipal coffers over the years.
They are among 150 California cities and counties that stand to lose up to $800 million in sales tax monies that the state courts have ruled were illegally collected from aerospace firms.
Although city officials say they have no idea how much they may be asked to refund to the federal government, they contend that some municipalities that have been grappling with budget shortfalls--in part due to the economic downturn faced by South Bay aerospace companies such as TRW, Lockheed, Hughes, Northrop and Rockwell--could end up teetering on bankruptcy.
“Under the worst scenario, I’m sure you’ll see some cities that just won’t be able to repay it,” said Don Harrison, assistant city manager in El Segundo and leader of a task force studying the funding problem. “The cities took tax revenues in good faith, and we had no reason to believe that there was any cloud on collecting them. This is definitely not a good thing for any of the cities.”
By Harrison’s estimation, there may have been up to 100,000 aerospace employees in El Segundo each day during the industry’s boom period in the ‘80s, and any sales tax charged on materials bought by aerospace firms must be repaid by the city with interest.
The sales tax problem stems from a little-known lawsuit brought more than a decade ago by Aerospace Corp. of El Segundo charging that it was a violation of federal contracts to tax purchases made in connection with work performed for the Department of Defense. Citing a clause in defense contracts giving the federal government ownership of materials at the moment of purchase, the lawsuit claimed that sales tax charged in localities where the supplies were purchased was akin to taxing the federal government, which they had no power to do.
After the state Supreme Court upheld a 1990 ruling in favor of Aerospace, the Department of Defense ordered all of its California aerospace contractors to file claims. The Defense Department has been the prime mover in the claims process, contending that the contractors must try to recover the funds so they can turn the money back over to the federal government.
Trying to determine the extent of the purchases, a job that state tax officials have called an “auditing nightmare,” is the reason why officials don’t have a better fix on how much the cities must refund. And some city officials are angry that it is taking the state so long to process the claims. State tax officials estimate that they have only audited 10% of all the claims so far.
“We think it may cost us about $1 million, but who knows,” said Ben Murdoch, revenue administrator for the city of Torrance. “It’s a stupid thing. The Supreme Court made a bad decision, and the Department of Defense forcing this thing on the contractors is just asinine. It’s going to cost the state 10% of the total just to make the claims. It’s ridiculous.”
Many of the cities that have been billed by the State Board of Equalization, such as Manhattan Beach, don’t have any major aerospace contractors in their jurisdictions. But funds received from vendors in those towns that charged contractors sales tax on items ranging from toilet paper to rocket components, must be repaid under the ruling.
Board of Equalization officials say up to 60 cities face huge sales tax refunds, including Hawthorne and El Segundo. The two towns, which have an annual budget of $68 million combined, could be forced to pay up to $9 million over the next two years, according to state officials.
“It’s something we’re deeply concerned about, but we haven’t been able to get any firm figures from the state yet,” said Hawthorne City Manager James H. Mitsch.
Other South Bay cities, including Gardena, Inglewood, Manhattan Beach, Lawndale and Carson, face smaller repayments. Manhattan Beach officials predict that their total will be less than $100,000, while Lawndale so far has been billed just $433.
“We have had a lot of activity in purchasing (related to aerospace),” said Manhattan Beach City Manager Bill Smith. “In this case we were lucky that we don’t have the type of aerospace supply firms located here.”
Still, 12 harder-hit cities and representatives of the League of California Cities have established a task force to consider repayment options, such as state legislation or court action to protect themselves from the fiscal quagmire. Harrison said cities that might have to severely cut back police, fire and other municipal services to pay the bills might be subjected to even further liability.
“I think there’s going to have to be some leeway given to cities,” he said. “We’re being asked to make all these payments over two years, which seems extremely unfair, especially since we had no say in the decision nor were we notified early on that we faced this potential liability.
“It doesn’t make much sense, given the state of the economy, that we would be placed in a position of having to raise taxes for those (aerospace) companies in order to pay for this decision. And it’s definitely in no one’s best interest to see a city go into bankruptcy over this.”
