Public Finance Alert
In December 2017, two proposed state constitutional initiatives were submitted to the California Attorney General concerning the scope and approval process for certain state and local taxes and fees.
The proposals would amend the California Constitution to, among other things, significantly broaden the definition of what qualifies as a “tax” versus a non-tax levy, raise the threshold for approval of most “general” tax and non-tax fee increases (each of which currently requires only a simple majority for approval in most instances) to a two-thirds supermajority, compel new disclosure on the uses of proposed tax revenues in ballot questions submitted to voters, and create new avenues for voters to overturn local non-tax fees and other charges by referenda. In addition, the proposals would nullify all tax increases approved in California since January 1, 2018 that failed to satisfy these stricter requirements.
While each of these tax proposals is currently in the signature-gathering and verification stages of the initiative process, if either qualifies for the November 2018 ballot and is ultimately approved by voters, there could be significant changes in the legal and political landscape for state and local tax increases in California. The Legislative Analyst’s Office (“LAO”) also projects a potentially substantial decrease in the availability of annual tax revenues at the local level.
The Tax Proposals in Detail:
The first tax initiative, A.G. File No. 17-0050, Amendment #1 (the “Statewide Tax Proposal”), would amend Articles XIII C and XIII D of the California Constitution with the following key changes to California local tax laws:
The Statewide Tax Proposal would also amend Article XIII A of the California Constitution with parallel changes to the definitions and voting thresholds applicable to state-level taxes and fees. In particular, the initiative equivalently expands the definition of “tax” for laws enacted by the California Legislature, compels the same binding statement of spending limitations for statewide revenue measures, and prohibits changes to allowable uses of such measures’ revenues unless approved by a supermajority of both houses of the California Legislature. Finally, the Statewide Tax Proposal precludes state regulations which contain increased taxes or fees from taking effect unless the California Legislature passes a separate law approving the regulation by a supermajority.
The second tax initiative, A.G. File No. 17-0051, Amendment #1 (the “Local Tax Proposal”), was proposed by the same initiative proponents as the Statewide Tax Proposal as an alternative set of reforms to California taxes. While the Local Tax Proposal would make identical amendments to Articles XIII C and XIII D of the California Constitution to change local-level tax rules, it would not extend to statewide taxes by amending Article XIII A. Accordingly, the Local Tax Proposal is equivalent in substance to the Statewide Tax Proposal, but narrower in scope and effect.
Critically, both the Statewide Tax Proposal and Local Tax Proposal would nullify any local government taxes passed since January 1, 2018 unless the tax was approved in compliance with the proposals’ supermajority thresholds and other requirements. This would effectively invalidate most local government taxes passed since the beginning of 2018.
Current Status of Each Initiative:
As of May 23, 2018, proponents of the Statewide Tax Proposal report that the initiative has received the 585,407 signatures required to qualify for the November 2018 California ballot. County election officials are currently coordinating with the Secretary of State to verify the signatures submitted through a random sampling process, which must be completed by June 28, 2018 for the measure to qualify for the November 2018 California ballot.
By comparison, proponents of the Local Tax Proposal have yet to certify that the initiative has received even 25 percent of the 585,407 signatures required to qualify for the November 2018 California ballot. If the Local Tax Proposal does not gather the required number of signatures and complete the resulting verification process by June 28, 2018, it will fail to qualify for the November 2018 California ballot.
Tip for Issuers: Consider Potential Impact on Existing Documents:
Issuers of municipal bonds supported by state or local fees or taxes should pay careful attention to the Statewide Tax Proposal and the Local Tax Proposal. Even if neither tax initiative passes and becomes law, many issuers have entered, and frequently enter into, bond purchase contracts, credit and reimbursement agreements, and other financial agreements that contain covenants and representations regarding introduced or pending legislation that could affect the issuer’s financial transactions. In particular, it is common in bank documents containing amortizing “term out” provisions (which effectively constitute an extension of credit by a bank to an issuer, and are generally highly desirable from an issuer’s perspective) to condition the provision on most or all of the issuer’s representations made at the time of closing also being true on the date on which the term out is invoked. Proposed legislation such as the Statewide Tax Proposal and the Local Tax Proposal could, in some cases, arguably render issuer representations inaccurate, which would vitiate the term out and leave the issuer owing the bank a large lump sum on short notice.
Projected Fiscal Impact:
The LAO conducted fiscal assessments of the Statewide Tax Proposal and the Local Tax Proposal, and concluded that, for purposes of local taxes, the combined effect of the expanded tax definitions and supermajority approval requirements under each initiative would limit the ability of local governments and initiative proponents to raise new revenues and could substantially decrease the total amount of annual tax revenues available for local governments. Additionally, the LAO estimated that roughly half of recently enacted local sales, business, hotel, and utility general tax measures could be invalidated in light of the nullification provisions of each initiative.
The impact on state-level revenues under the Statewide Tax Proposal, however, would be more limited, with the LAO projecting only a minor decrease in annual state revenues relative to the overall budget despite the increased number of state revenue measures that would be subject to supermajority approvals by the California Legislature.
Ultimately, the impact of either initiative will depend to a significant extent on how state and local governments adapt to these amendments (e.g. by shifting revenue proposals to majority-vote sources, such as developer fees), as well as state political developments, future legal challenges to the proposals, and court decisions interpreting any changes to the California Constitution.
 For general revenue measures with no specified purpose, the required statement of spending limitations would need to expressly state that revenues can be spent “for unrestricted general revenue purposes.”
 However, the vote thresholds and rules applicable to developer fees and property assessments imposed on parcels would remain unchanged under either the Statewide Tax Proposal or the Local Tax Proposal.
 The LAO noted, however, that the decrease in available revenues under the Statewide Tax Proposal would be more notable for state programs funded primarily by fees.