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08 May 2020

'Everything Happened All at Once'—California Cities Face Enormous, Sudden, Unexpected Budget Crises

Written by  Ben Christopher, CalMatters
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Ever since the end of the Great Recession, Rancho Cucamonga has been on a tear.

New retailers and restaurants have sprung up to serve the residents of its gated ‘burbs. The city’s population has swelled with Angelenos in search of cheaper housing. And at last count, its unemployment rate sat at just 4 percent. The city earned an upgraded credit rating earlier this year.

But now that shopping and dining have been deemed non-essential activities, the good times are gone, said Rancho Mayor Dennis Michael.

“Since we recovered from the Great Recession, we generated about $9 million in new sales tax revenue,” he said. “We’ve lost all of that gain. We’re basically starting from square one.”

For local governments still sporting the budgetary scars of the last “once in a generation” recession, this downturn is at once familiar—forcing elected leaders to cut, furlough and delay—and entirely new. Never before in state history has so much economic activity ground to a halt so quickly.

“When we came through the Great Recession, we were able to use reserves to have a softer landing over a period of years,” said Michael. “This is worse than the Great Recession, because everything happened all at once.”

Rancho has it better than most cities. It has healthy reserves, low debts and a relatively wealthy population.

In San Pablo, a city just north of Richmond in the Bay Area with a median income just more than half of Rancho Cucamonga’s, City Manager Matt Rodriguez “is bracing for a ‘Worse Case Budget Scenario,’” he said in an email.

San Pablo relies on the local casino run by the Lytton Band of Pomo Indians for 60 percent of its discretionary funds. Since state and county officials declaredshelter-in-placeorders in mid-March, the city has been hemorrhaging $2.3 million every month, said Rodriguez. That’s about 5 percent of the city’s annual general fund every 30 days.

City managers aren’t known for their colorful language, but municipal leaders across the state are now facing economic conditions that seem to define hyperbole.

“Staff estimates that the COVID-19 pandemic will devastate the city’s general fund,” wrote Monterey’s City Manager Hans Uslar last month. The city then voted to ax up to 84 jobs.

Down the coast in Anaheim, home to Disneyland, Mayor Harry Sidhu offered a sober reminder to his colleagues on the council last month: The Magic Kingdom and its ancillary hotels and shops provide half of the city’s jobs and half of the city government’s revenue.

“As to when Disneyland Resort will open, I don’t know. I don’t believe anyone knows,” he said.

And in Yountville, the town of roughly 3,000 in the heart of the Napa Valley wine country, the decline in hotel and sales tax revenue has resulted “in about a 74 percent loss in revenue,” said Mayor John Dunbar, who is also president of the League of California Cities, in a live-streamed discussion with CalMatters.

That’s 3 out of 4 of the city’s expected tax dollars now gone.

“Yes, unfortunately you heard me correctly,” he added. 

Cities without much fiscal wiggle room heading into the pandemic will do particularly poorly, said Bill Statler, a municipal finance consultant who spent decades working for the city of San Luis Obispo.

“The roots of fiscal trouble are in the good times,” he said. “If you have strong revenues during the good times, build reserves, pay down unfunded liabilities, and invest in capital projects, then when the inevitable bad times come, you’ll have more resilience and flexibility.”

Still, in ways that highlight just how unusual the current economic downturn is, there are clear exceptions.

With a strong tourism and hospitality sector, “I would have used Santa Monica as a poster child for how some cities have really good financial DNA,” said Statler.

Last month, Santa Monica’s city manager was pushed out of his job after his proposed budget cuts elicited massive public outcry. Now the city is considering laying off 337 workers.

If there is any type of California city best suited to weather the current recession, it’s bedroom communities.

“Those cities that are highly reliant on property taxes and not sales—it’s not to say that they won’t suffer, but their treasuries won’t get depleted immediately,” said Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago.

That’s because while sales taxes and tourism-dependent revenue sources like hotel taxes are paid into local coffers with each transaction, property taxes are paid twice a year. Property-tax revenues tend to be stable from year to year, too, because California law assesses residential or commercial buildings based on purchase price rather than current market value.

“For cities that rely on sales,” said Pagano, “it’s not like a downturn that we’ve ever experienced before. This is just an immediate shutting off of the spigot.”

The divide between municipalities that rely heavily on property values versus those that do not is a Tale of Two Cities. According to a CalMatters analysis of municipal tax revenue data from 2018, the cities that rely most on property taxes are Mountain View, Pleasanton, Newport Beach and San Clemente—all wealthy.

Cities that are dependent on sales and hotel taxes are more of a mixed bag, with some well-to-do tourism destinations, but also many working- and middle-class towns with below-average incomes or cooler housing markets: South Gate, Hemet, Merced, Redding.

And for cities hoping for a helping hand, very few have been extended.

The state, for one, has its own financial troubles. Gov. Gavin Newsom’s Finance Department is now projecting a $54.3 billion deficit for the coming fiscal year. That’s twice the size of the state’s “rainy day” reserve fund. 

“I’m going to do everything I can to work with these cities and counties,” Newsom said at a press conference last week before the deficit projection was announced. “But I can assure you this: We are not going to be in a position, even as the nation’s fifth-largest economy, to provide for the needs of all the cities and the counties without federal support.”

The federal government has already directed $150 billion to cash-strapped state and local governments through the CARES Act, the financial-relief bill signed into law last month. About $9.5 billion of that went directly to the state government, with another $5.8 billion for cities or counties—though only to those with populations of more than 500,000.

Even for the lucky six California cities that qualify for the help, the funding comes with strings attached, said San Diego Mayor Kevin Faulconer, who was also in the CalMatters live-streamed conversation.

“It has to be COVID-related; it’s not supposed to be used for revenue replacement,” he said. It’s not entirely clear how those guidelines will be enforced, but the intent is clear: the funding is not to be used to plug budgetary holes. While city leaders “try to get clarity” from the federal government, said Faulconer, San Diego is projecting a $300 million deficit.

Though Democrats in Washington, D.C., are clamoring for more federal assistance to state and local governments, Republicans remain divided. Last month, Senate Majority Leader Mitch McConnell of Kentucky likened providing additional aid to a “bail out” for state and local governments and their underfunded pension systems. McConnell has since softened his rhetoric.

Another possible benefactor for desperate cities: the voters.

The California constitution generally requires cities, counties and school districts to receive voter approval to raise taxes or borrow. And while the state electorate has historically been inclined to back most revenue-raisers, it may be feeling less generous this year.

In the March 3 primary, only 40 percent of local fiscal measures—bonds and taxes—were approved by voters, according to an analysis by Michael Coleman, who maintains the California Local Government Finance Almanac. That’s compared to a 77 percent passage rate in 2018, and 81 percent in 2016.

There were many more measures on the ballot this year overall—including a record-breaking $15 billion school construction bond—which may have given voters sticker shock. A recent change in state law governing how ballot measures are described could have also turned some voters off. The coronavirus pandemic was only beginning to register as a national concern on primary Election Day, but that, too, could have diminished the public’s appetite for new costs.

Whatever the reasons, said Coleman, it does not bode well for cities hoping to patch up their budgets via the ballot box this November.

“I think we’re going to continue to have this malaise about what’s going on in the economy, about job security, about how the world is changing. That’s the sort of psyche that causes people to wonder if this is the right time for a tax increase,” he said.

Many in local government—and the campaign staff they hire—are hoping that local budget cuts will have the opposite effect.

In a conference call this week, San Francisco Mayor London Breed championed a statewide ballot measure by framing it as a conflict between necessary government services during a pandemic and commercial property owners.

“Any local official will have a tough time explaining to their constituents why in the midst of this crisis they didn’t support closing corporate tax loopholes,” she said.

Sometimes known as the “split roll” initiative, the measure would change the way that many commercial properties are assessed, resulting in much higher property taxes on some businesses and much higher tax revenue for cities, counties and school districts.

Industry groups and low tax advocates argue—and will likely continue to argue until November—that now is precisely the wrong time to raise taxes on businesses.

Jared Boigon of TBWB Strategies, a consulting firm that helps to pass local bond and tax measures in California, said he’s optimistic that “most voters don’t want to see their community services be completely gutted.” Despite the economic climate, if a local government is thinking of going to voters for money this November, “they shouldn’t just automatically rule it out,” he said.

Not many have yet, said Curtis Below, a partner at the Oakland polling outfit FM3 Research.

“There have been a few more clients who said they want to sit out the cycle, but the vast majority still want to explore this year,” he said. “A lot of our clients are going full steam ahead.”

But both Dunbar of Yountville and Faulconer of San Diego are skeptical that the funds that could be raised at the ballot box would be even remotely enough to fit the pandemic’s fiscal bill.

“We’re not going to be able to tax our way out of this recession,” said Faulconer.

CalMatters.org is a nonprofit, nonpartisan media venture explaining California policies and politics.

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