ARTICLE
Sometimes, when people cry wolf, there really is a wolf. The Santa Cruz City Manager’s budget message succeeds in delivering the City’s 2016-17 budget in a well-modulated, nearly–calm tone of voice, but it doesn’t take Little Red Riding Hood to recognize the “big ears” and “sharp teeth” lurking around the corner. The report’s bottom line: “It will take many consecutive years of robust economic growth to return to the same level of services and capital investment that the City once enjoyed.” The budget message highlights many of our collective exposures. The City has no new General Fund monies with which to address the City’s more than $300,000,000 of deferred maintenance and improvements. (streets and roads, park facilities and maintenance, public buildings etc.…) Health and retirement costs have gone from 28% of the General Fund salaries in 2004, to 43% of salary in 2015, to an anticipated 58% in four years (2020). Nearly 30% of current City employees are eligible for retirement in the coming year. How did we become so financially fragile as a community? Are we worse off than other communities in the U.S.? In California? And, could the next decade provide the “robust economic growth” necessary for Santa Cruz to return to “confident prosperity?” Financial Fragility Financial vulnerability in cities and counties is both a state-wide and nation-wide problem. Shortfalls in pension funding and the impacts of Baby-Boomer retirements are commonplace. Deferring the maintenance and improvement of public assets is nearly universal. And volatility in public revenues continues to be the bane of every California jurisdiction and many others throughout the U.S. (See the historic note, below.) It should also be said that this is not the fault of the city staff or the current council. In fact, notwithstanding the City’s left-bank reputation, with few exceptions over the last 25 years it has operated with admirable fiscal restraint. This conservative financial management is reflected in its AA+ bond rating (which, the budget report points out, is the same high standard as the U.S. Government’s). However, there are local forces that have conspired to make our circumstance more troublesome than many other jurisdictions. There are the usual suspects: inability to optimize downtown retail (sales taxes), serious political constraints on new investment in capital projects (real estate taxes), an aged and limited lodging stock, and an egregiously inadequate transportation infrastructure (transient occupancy and sales taxes.) However, Santa Cruz has other economic issues that are more uniquely local: an out-commute of nearly 1/4th of its resident workforce reduces not only local sales taxes but also the real estate, sales, and personal property taxes that would be paid by their employers – if only those employers were located in Santa Cruz. Santa Cruz’s real estate and other operations-related taxes are also reduced by the very large proportion of public sector employment, especially UCSC and other State and Federal research and administrative institutions that are exempt from many local taxes. (However, note that UCSC does pay significant fees to compensate the city for a variety of public services including transportation.) The proportion of Santa Cruz real estate that is owned by retirees and second-home owners coupled with a reduction of the proportion of residents between the ages of 25 and 45 tends to reduce per capita taxable sales and increases expenditures on sales-tax-free health care and other personal services. Are We Worse-off Than Others? The likelihood of Santa Cruz becoming a Stockton or San Bernardino or Detroit – a bankrupt municipality – is infinitesimal. Nor is Santa Cruz a low revenue-per-capita community that doesn’t have the resources to provide basic services. However, it is a “quality-of-life” community that relies on its attractiveness to higher wage businesses and a more affluent workforce. It has little choice in this regard because its baseline for housing costs are established by Silicon Valley out-commuters. As a result the core question is not whether the city is sustainable but the extent to which it is sustainable at the levels of service and amenities to which current residents are accustomed and to which a next generation of home owners and renters, necessarily paying rather much greater mortgages and much higher rents, will expect. “Robust” Economic Growth Of what might the necessary “robust economic growth” consist? How do we both fund existing shortfalls such as pension and health benefits and the sorts of investments that attract and retain both employers and local residents? Property Taxes. Property taxes currently represent 22% of total general fund revenues. There are two principal means for these taxes to increase. The first is through sale of existing properties to new owners or new capital improvements in those properties, increasing the assessed valuation of the real estate. These transitions are gradual and, measured against the property “turnover” in other communities, relatively slow. However, given the aging of the home-owning population, there will be measurable growth of revenues from these transitions over the next decade. However, greater opportunity lies in significant new investments, especially the multi-story projects being proposed in downtown and along the principal travel corridors, and new hotel projects. The addition of housing is also likely to increase other revenues such as sales and admissions taxes, but comes with costs of additional public services. Sales Taxes constitute 21% of general fund revenues. However, the future of retail sales is cloudy at best. Are changes in consumer spending habits since 2007 here to stay? Will online sales continue to grow as a percentage of sales…and, if so, will mechanisms to collect sales taxes by the jurisdictions in which purchasers reside become more universal and enforceable? Will state efforts to tax services succeed? The city has little influence over these factors. What it does have some control over is the retail environment and, to a lesser degree, the attraction of retail tenants. Downtown’s ability to compete with a revitalized Capitola Mall may become the defining coefficient in determining sales tax performance for the City. Charges for Services provide 16% of revenues. Planning and building fees, recreation, and a variety of other charges for services (not including enterprise fund revenues such as solid waste, water, etc.) are a two-edged sword. While they have become a staple of the government funding formula, they can also be significant constraints on the real estate development projects necessary to increase property taxes. On the other hand, the costs of these services are limited to the actual cost of the services. As with any customer relationship, there are balances of cost and quality that must be struck. This balance may not reflect the quality and efficiency necessary to achieve public sector goals, for instance in rental housing regulation and enforcement. Transient Occupancy Tax. There will be three new hotels and likely continued growth and better enforcement of vacation rental taxes. This will be an opportunity for substantial growth in the next decade…but this growth will come with additional costs, especially public safety and transportation. The capacity of the City to thrive does depend upon many-facetted efforts to achieve “robust economic growth.” This requires prudent but dedicated efforts to achieve the “big picture” goals and dogged attention to the details that can derail them. A Short Footnote: A Remembrance of How We Got Here The commonplace reflex is to attribute our financial shortfalls to Proposition 13’s passage in 1978. This roll-back of property taxes was a watershed, but reflects not only the home-owner tax crisis of that era but also government’s failure to address this crisis in time to head off what has proven to be a draconian restructuring of the public sector. It is useful to begin a few years earlier, about 1972, when the post WWII economic boom ended, especially for middle-class Americans. This was the time of the oil crisis, a stock market crash, a recession, and the end of more than 20 years of consistent growth in the standard of living for the American middle class. Between 1972 and 1978 California’s public-sector costs continued to escalate but private sector incomes did not. In 1970 the state had the best education system in the world – including tuition-free university education – the best highways, and enviable financial stability. What didn’t happen when Prop 13 was passed was a serious consideration of public sector revenue and spending and what still hasn’t happened is a meaningful conversation about the equity, stability, and economic viability of the state’s tax system. Property taxes were – and are – relatively stable; that is, business cycles have less effect on property tax revenues. They tax both residential and commercial property, both home owners and, indirectly, renters, and tend to be progressive rather than regressive. Proposition 13 took what had been, at least mathematically, a system that spread the tax burden equitably, to one that rewards long-time property owners and penalizes new investment and new owners. While this is attractive to some – for obvious reasons – it also creates both inequities and a tendency to avoid reinvestment in privately held real estate. However, prior to Proposition 13, the efficacy of this system had already been challenged by a complicated litigation Serrano v Priest, in which the equity of funding public education was challenged on constitutional grounds. To provide the same quality of education, property owners in poorer district had to pay as much as twice the rate of property taxes to raise the same amount of funding for schools. Responding the this litigation, the state “took” a share of the property taxes, supplemented it with other funds, and distributed these “equitably” among school districts based primarily upon days of student attendance. This ended the ability of local residents to determine the quality of the public education system through property tax assessments and changed the balance of the electorates’ willingness to support local property taxes. The key lesson in this equation is the need to identify a political “center” that is willing to support “robust growth” including the public revenues, especially parcel taxes and the transportation “self-help” sales tax necessary to sustain that growth.
Sometimes, when people cry wolf, there really is a wolf. The Santa Cruz City Manager’s budget message succeeds in delivering the City’s 2016-17 budget in a well-modulated, nearly–calm tone of voice, but it doesn’t take Little Red Riding Hood to recognize the “big ears” and “sharp teeth” lurking around the corner. The report’s bottom line: “It will take many consecutive years of robust economic growth to return to the same level of services and capital investment that the City once enjoyed.” The budget message highlights many of our collective exposures.
How did we become so financially fragile as a community? Are we worse off than other communities in the U.S.? In California? And, could the next decade provide the “robust economic growth” necessary for Santa Cruz to return to “confident prosperity?”
Financial Fragility
Financial vulnerability in cities and counties is both a state-wide and nation-wide problem. Shortfalls in pension funding and the impacts of Baby-Boomer retirements are commonplace. Deferring the maintenance and improvement of public assets is nearly universal. And volatility in public revenues continues to be the bane of every California jurisdiction and many others throughout the U.S. (See the historic note, below.) It should also be said that this is not the fault of the city staff or the current council. In fact, notwithstanding the City’s left-bank reputation, with few exceptions over the last 25 years it has operated with admirable fiscal restraint. This conservative financial management is reflected in its AA+ bond rating (which, the budget report points out, is the same high standard as the U.S. Government’s). However, there are local forces that have conspired to make our circumstance more troublesome than many other jurisdictions. There are the usual suspects: inability to optimize downtown retail (sales taxes), serious political constraints on new investment in capital projects (real estate taxes), an aged and limited lodging stock, and an egregiously inadequate transportation infrastructure (transient occupancy and sales taxes.) However, Santa Cruz has other economic issues that are more uniquely local: an out-commute of nearly 1/4th of its resident workforce reduces not only local sales taxes but also the real estate, sales, and personal property taxes that would be paid by their employers – if only those employers were located in Santa Cruz. Santa Cruz’s real estate and other operations-related taxes are also reduced by the very large proportion of public sector employment, especially UCSC and other State and Federal research and administrative institutions that are exempt from many local taxes. (However, note that UCSC does pay significant fees to compensate the city for a variety of public services including transportation.) The proportion of Santa Cruz real estate that is owned by retirees and second-home owners coupled with a reduction of the proportion of residents between the ages of 25 and 45 tends to reduce per capita taxable sales and increases expenditures on sales-tax-free health care and other personal services.
Are We Worse-off Than Others?
“Robust” Economic Growth
A Short Footnote: A Remembrance of How We Got Here