Suit Targets State’s Use of Sales Tax

Three dozen California cities filed a lawsuit Thursday seeking to block a key part of Gov. Arnold Schwarzenegger’s $15-billion deficit reduction borrowing plan approved by voters earlier this week.

The governments, led by the Los Angeles County suburb of Cerritos, are asking an Alameda County Superior Court judge to bar the state from raiding their sales tax revenues to repay the bond.

Under the plan voters approved Tuesday as Proposition 57, the state would dedicate a quarter-cent of the sales tax, which cities normally would keep, toward repaying the bond. The cities in turn would be reimbursed with a larger share of property taxes that usually goes to the state.

Officials who filed the lawsuit said that they don’t trust the state to reimburse them, after past experiences in which billions of dollars of property taxes were taken to close a budget deficit and never returned.

“We didn’t cause the budget crisis and we shouldn’t be used as a convenient source of money so the state can avoid making the hard policy choices,” said Steven Mayer, attorney for the cities.

State officials said the lawsuit was unlikely to threaten the bond sale.

“While we need to await further study of the lawsuit by our attorneys, it does not appear that the intent of the lawsuit is to interfere with issuance of the” bonds, said California Treasurer Phil Angelides. Even if the court strikes down the sales tax provision, the state could sell the bonds and repay them with other revenue.

Tax experts said the lawsuit appeared to be a longshot.

“It’s just not a serious claim in my view,” said Tom Campbell, dean of the Walter A. Haas School of Business at UC Berkeley. “I don’t think it’s serious.”

Campbell, a former state legislator from the San Francisco Peninsula, said that there is no legal question because the state has the right to control sales tax.

But budget analysts and investors warned that the suit could interfere with the state’s ability to secure the bond money in time to pay off $14 billion in short-term loans due in June. And if the courts decide to block the state from using the sales tax to repay the bond, the risk to investors would increase, and along with it the cost to the state of borrowing.

Many of the cities involved in the litigation have shopping malls or auto dealerships and rely heavily on sales taxes to pay for government services.

Cerritos, which has both, raised $24.4 million in sales tax revenue in fiscal 2001-02, accounting for 37% of its general fund. Fresno, another city that is a plaintiff, collected $52.7 million in sales tax revenue that year, accounting for a third of its budget. Other plaintiffs include Burbank, Cypress, El Monte, Glendale, Irvine, Norwalk, Pasadena, Palm Springs, Pomona and Torrance.

The lawsuit filed Thursday comes at a critical time for state and local governments.

Although the voters approved issuance of up to $15 billion in deficit bonds Tuesday, the state’s fiscal crisis is far from over.

A shortfall of as much as $17 billion remains in the coming fiscal year, and Gov. Arnold Schwarzenegger has proposed taking more than $1 billion in city and county property taxes to balance that budget.

Local officials fear that the financial problems may worsen. Fresh in their minds is the deep recession of the 1990s, when Sacramento raided local property taxes, costing cities billions of dollars in revenue that was never replaced.

“We believe they will leave the cities in the lurch again,” said Art Galluci, Cerritos city manager.

The lawsuit is part of an effort by city and county leaders to mobilize to protect their money. They are hoping to place an initiative on the November ballot that will limit the state’s ability to take money from them.

Galluci argued that the state should use its own share of sales tax money to repay the bond.

But state officials said constitutional restrictions on how different tax monies can be spent forces them to pledge the local sales tax money to investors as part of a complex revenue swap known in the Capitol as the “triple flip.”

The portion of the sales tax that goes to the state cannot be dedicated to bond repayment, they said, because schools have first claim on it under state law. So the state is tapping sales taxes that go to the cities and replacing them with an increase in their share of the property tax.

That property tax money, however, is now going to schools. As part of the deal, the state is pledging to make the schools whole with payments from its general fund.

Department of Finance spokesman H.D. Palmer said the governor would make good on his promise to repay the local governments.

“Everyone was doubting that he would come in and pay back the locals after the car tax was rolled back,” Palmer said of the governor’s vehicle license fee reduction in November, which threatened $4 billion in annual payments to cities and counties. “He did.”

Palmer said that although the lawsuit would not stop the bond from being sold under any circumstances, it could force a quarter-cent sales tax hike in all California cities.

“Unless the Legislature took action to undo that, the cities could get a windfall,” Palmer said.