Breaking down the impact of two new municipal finance laws
Betsy Strauss is special counsel to the League of California Cities. She has been the city attorney of the cities of Napa, Fairfield, and Rohnert Park. She can be reached at email@example.com.
As we settle into the new year, two new municipal finance laws need your attention. The first involves the Gann Limit and has a March 1 reporting deadline. The second adds new requirements for calculating and adopting development impact fees — monies that cover the costs of services and facilities, such as increased roadway capacity, required to serve the new development.
Historical background: The Gann Limit
Before the adoption of Proposition 13 in 1978, local governments authorized to impose property taxes would annually adopt local property tax rates. The only limitation was that they had to be imposed based on the value of the property rather than in flat dollar amounts.
One purpose of Proposition 13 was to reduce property taxes. It did so by converting hundreds of locally imposed property tax rates of differing amounts into a single statewide rate of 1%. Two immediate consequences occurred: Property tax revenues were reduced by half statewide and the state Legislature gained control over the allocation of property tax among local governments.
In 1979, California voters followed up on Proposition 13 with an amendment to the California Constitution to limit the growth of government spending. Commonly known as the “Gann Initiative” after anti-tax advocate Paul Gann, Proposition 4 provides a formula for calculating annual spending limits for the state and local governments.
Where Proposition 13 was generally aimed at controlling property taxes, the Gann Initiative placed certain limitations on the growth of appropriations at both the state and local level. In particular, Proposition 4 placed a limit on local and state government’s annual authorization to spend “proceeds of taxes” known as the Gann Limit. Some revenues are “proceeds of taxes.” Others are not. The Gann Limit only affects “proceeds of taxes.”
“Proceeds of taxes” include, among other types of revenues, tax revenues and state subventions — monies that the state sends to local governments. The Legislature defined “state subvention” to mean money sent to local governments that could be used for general purposes. The appropriation of these monies is subject to the local government’s Gann Limit. State funding sent to local governments for certain specific purposes and programs was not “state subventions.” Therefore, it is subject to the state’s Gann Limit.
In other words, if the state sent funding to local governments and directed how, where, and what to spend the money on, this funding was not subject to a local government’s Gann Limit.
Each year, the state and local governments calculate their Gann Limit — the previous year’s limit adjusted for the cost of living and growth in population. Proceeds of taxes that exceed the state’s Gann Limit must be returned to taxpayers and spent on schools. Proceeds of taxes that exceed a local government’s Gann Limit must be returned to taxpayers.
New March 1 reporting deadline for local Gann Limits
In 2022, the state was unable to accommodate all its “proceeds of taxes” within its Gann Limit. This was in part because growth in personal income tax revenue — the state’s largest revenue source — exceeded the appropriations limit’s growth rate. Constitutionally required school spending has also increased faster than school limits. Since the state absorbs appropriations above school limits, this trend has resulted in less spending in the state’s Gann Limit for other state projects and programs.
When “proceeds of taxes” cannot be accommodated within the state’s Gann Limit, the state must return tax revenues to taxpayers and increase school spending over a two-year period. To avoid reaching its Gann Limit and returning money to taxpayers and spending more on schools, the Legislature redefined “state subvention” so that money received from the state that includes direction for how, where, and what to spend the money on, is subject to the city’s Gann Limit.
This change was made by identifying 47 state programs as state subventions, such as CalFresh and Project Roomkey. Funding for these programs now counts under the recipient city or county’s Gann Limit up to the amount representing the difference between the city’s appropriations, subject to limitation without the new definition, and the city’s appropriations limit.
By March 1, 2023, a city must report the amount of funding from the newly identified state subventions that cannot be appropriated within its Gann Limit. The amount that cannot be appropriated within a city’s Gann Limit will be included within the state’s appropriation limit.
Cities should email this information to California Department of Finance representatives Susan Wekanda and Matthew Westbrook. The Finance Department’s website includes a spreadsheet listing the dollar amount of appropriations from the newly identified state subventions for each city in California.
Cities are not required to recalculate their Gann Limits. A city is only required to report how much of the identified funding sources can fit within the city’s existing Gann Limit.
Adopting or increasing development impact fees
Before Proposition 13, infrastructure for new developments was often financed by community-wide, broad-based taxes and debt. After Proposition 13, there was a movement away from these methods that raised revenues from the new development itself. One way of internalizing these costs are development fees.
Cities may charge fees to pay for the costs of the public facilities related to the development project. These fees can fund a variety of vital public services, such as transportation infrastructure, parks, libraries, and flood control. The rise in development impact fees was one reason leading to the Mitigation Fee Act in 1987. The law requires local officials to demonstrate a “reasonable relationship” between the fees and public facilities funded by the fees, and the development project on which the fees are assessed through a nexus study.
New requirements for calculating and charging development fees took effect on July 1, 2022. The new procedures are intended to increase transparency in the adoption process; ensure the reasonableness of the fees; and calculate the fees using square footage to support smaller and multifamily developments. If your city is adopting a new developer fee or increasing an existing fee as part of the budget process, be aware of these changes:
- The nexus study must be adopted by the city council at a public hearing with 30 days’ notice, prior to the adoption of the new fee or a fee that supports a new level of service.
- The study must explain why the new level of service is appropriate.
- A new fee imposed on a housing development must be calculated proportionately to the square footage of the proposed units of the development unless the study explains why that method is not appropriate.
- Cities within a county with a population of at least 250,000 must adopt a capital improvement plan as part of the nexus study.
Many cities have recently adopted or are in the process of adopting their sixth cycle housing elements under the state’s housing element law. These housing elements must include “an analysis of potential and actual governmental constraints upon the maintenance, improvement, or development of housing for all income levels … including … fees and other exactions required of developers. …”
The analysis must also demonstrate local efforts to “remove governmental constraints.” Cities may wish to consider this section of their housing element in the process of adopting new development impact fees or increasing the level of service for an existing fee.
As always, cities should consult their legal counsel with any questions regarding any laws, including the Gann Limit reporting requirement and the new development impact fee requirements.