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On the Chopping Block

Author: Karen Hart
December, 2011 Issue

California’s budget-inspired cutbacks face another legal challenge.

 
In case you haven’t heard, California has a whopping $26.6 billion budget deficit, and Governor Jerry Brown intends to do something about it. One of the proposals that he presented earlier this year is to dismantle California’s redevelopment agencies.

California redevelopment agencies were first authorized in 1945. Their goal was to restore blighted, decaying areas in our communities. This includes building and upgrading roads, water systems and other public works, cleaning up hazardous sites, revitalizing rundown neighborhoods and more. The idea behind redevelopment is to rejuvenate downtrodden areas to reduce crime and help struggling communities, which in turn will raise the value of surrounding property, which in turn creates more tax revenue.

By 2011, the state had nearly 400 redevelopment agencies, which, the governor contends, are ineffective in generating new economic development and drain more than $5 billion in property taxes each year. These funds could be better used for critical local needs such as K-12 schools and public safety services, according to H.D. Palmer, deputy director and spokesperson for the State Department of Finance.

In June, the governor signed two trailer bills to implement the state budget for the 2011-2012 fiscal year, which address redevelopment. AB 1X 26 eliminates redevelopment, and AB 1X 27 allows agencies to continue to exist if they agree to pay their share of $1.7 billion this year and $400 million annually.

In July, the state Supreme Court halted the plan to dismantle redevelopment agencies after the League of California Cities, the California Redevelopment Association (CRA) and the cities of San Jose and Union City filed a petition. The court said it would decide by mid-January whether the state’s plan to eliminate the economic development program is legal, and permitted redevelopment agencies to continue operating while the case is pending. It also barred the agencies from starting any new projects, issuing bonds or purchasing or transferring property until the suit is resolved.

How redevelopment agencies work

Redevelopment agencies must make the initial investment to redevelop an area. In return, they’re allowed to take a portion of future tax increases as payback for the initial investment. The idea is you have to invest money to make money. The problem today is, there’ isn’t money to invest. Redevelopment agencies were created to issue bonds and other debt instruments to generate revenue that would provide investors with a level of certainty that their investment would be paid back—and they’d make some money in the process.

Redevelopment agencies are guaranteed a portion of future incremental taxes. Here’s how it works: Take your baseline property tax and subtract the amount that the area currently generates in its blighted condition. Then subtract that amount from the amount of taxes generated when the area is redeveloped. That final tally is your incremental tax increase, which keeps redevelopment agencies going.

For the last 66 years, this was how redevelopment activities were funded to keep communities vital and thriving. The problem is, Governor Brown would now like to have this money to help balance the budget, starting with $1.7 billion in property tax revenue from 2011 to 2012.

Why is this a California budget issue? The administration says this money is needed to fund schools, public safety and other local services. But John Haig, redevelopment manager for the Sonoma County Community Development Commission, says people are misinformed on school funding.

“Schools are guaranteed their money under their share of baseline taxes and state backfill. People think if redevelopment goes away, the schools will get more money, but this isn’t true for fiscal year 2011-2012. Schools are getting money from the baseline plus their portion of incremental taxes through the state backfill for fiscal year 2011-2012. If redevelopment goes away, the state doesn’t have to backfill. That’s the trade-off.

“For fiscal year 2012-2013 and future years, schools in project areas would get more money based on a future surcharge. But in those years, the state would continue to backfill the baseline amounts from the general fund, so it wouldn’t help the state budget situation.”

Redevelopment activities can benefit schools by increasing the tax base and the taxes that are paid by private property owners in a designated area in the long term. In the short term, while the redevelopment plan is in effect, on average, 22 percent of these increased taxes are paid to schools, counties, cities and special districts, according to the CRA. In addition, redevelopment agencies often engage in financing facilities for schools and taxing districts—for example, financing school construction or renovation, rebuilding fire stations, replacing infrastructure and the like.

When redevelopment improves and revitalizes blighted communities, the property tax base increases and all local entities get a share of that increase. Not only that, but school children also benefit from redevelopment activities, since blighted areas are often characterized by incidents of violence, gangs, poverty and crime. Redevelopment, with its focus on blight removal, can assist in eliminating these activities.

Abolishing redevelopment activities would have long-term effects that would undermine communities. “Communities have to continually reinvest in themselves,” says Jim Kennedy, interim executive director of the CRA.

So why would Governor Brown want to eliminate redevelopment agencies?

“He had $1.7 billion reasons to make that decision,” says Haig. “There’s only so much money and something has to give. I don’t think Governor Brown thought new taxes or draconian program reductions were acceptable.”

Pros and cons

Is it a good idea to eliminate California redevelopment agencies? There are reasonable arguments on both sides of the issue. On the upside, redevelopment agencies keep communities in good shape and thriving. They create jobs, expand business opportunities, help reduce crime, improve infrastructure and public works, and lead the cleanup of environmentally threatened and rundown areas. According to the CRA, redevelopment agencies support more than 300,000 jobs annually, and provide more than $40 billion in local economic activity. What’s more, at least 20 percent of redevelopment activities must be devoted to creating affordable housing. More than 98,000 units of affordable housing have been constructed or rehabilitated since 1993 in California.

Redevelopment agencies have their success stories. In Sonoma, for example, Highway 12 was transformed into a modern roadway with lighting and sidewalks, and businesses had access to funds for better signage, paint and landscaping. Another example is the North Bay Innovation Hub, known as the iHub, at Sonoma Mountain Village in Rohnert Park. The city committed $800,000 of redevelopment funding for capital improvements to create the regional business incubator. Currently, more than 20 startup businesses are located there.

Even Governor Brown once saw the value of redevelopment. When he was mayor of Oakland, he used redevelopment law to advance his vision of creating specialty charter schools and adding thousands of housing units to bring life and commerce to downtown Oakland, according to a February article in the San Francisco Chronicle.

However, critics of redevelopment claim these agencies are inefficient. Others believe CRA funds have, on occasion, been used to pay for golf courses and expensive shopping centers instead of cleaning up blighted neighborhoods. “Some feel redevelopment is a tool for developers and doesn’t serve the greater good,” explains Haig. “Some believe areas got redeveloped that didn’t need it.”

Open fields, for example, don’t really qualify for classic redevelopment. “It may not be economically developed, but it’s hard to argue that a never-developed open field is blighted,” says Haig. “The clear winner, as an example, is always going to be an inner city developed area—taking an environmentally contaminated area [labeled by the EPA as a “brownfield”], making it new and vibrant and eliminating an eyesore.”

The impact on business

Putting a halt to redevelopment could have a major impact on California businesses. That’s because redevelopment agencies also administer enterprise zones and give businesses tax incentives to move into blighted areas or opportunities to earn credits by installing new equipment or hiring employees in those zones. However, because of the economy, many businesses have lost money or have declining revenue, so they can’t currently use their credits. Now Governor Brown wants to get rid of the zones and wipe the credits off the state books, according to Rob Babek, a CPA and partner-in-charge of the Los Angeles office of Marcum LLP, a New York-based CPA firm.

“We have more than 1,000 clients with tax credits up and down the coast of California,” says Babek. “Some have $800,000 to $900,000 in tax credits, which they may lose. If that happens, these companies may have to rethink their long-term strategies. My clients may have to move or decide they can’t hire new employees or have to cut back on their existing ones. I understand what the governor is trying to do, but by balancing the budget in this fashion, we could lose jobs and businesses in California.”

One of Babek’s clients, a manufacturer, strategically built in an enterprise zone and took advantage of the manpower there. “It planned to use earned credits, which add up to approximately $900,000, to save a significant amount in California income taxes. With those savings, it intended to purchase new equipment and hire new employees,” says Babek. “If those credits are lost, my client will have to rethink its business plans going forward and may have to cut back or eliminate the purchase of new equipment and the hiring of additional employees. Short term, this will help the governor adjust his budget. Long term, it appears it will hurt local businesses throughout California.”

However, Babek notes, if enterprise zones continue to exist in the future, there should be some reform in this area. “As a CPA, I saw that whenever they came out with an enterprise zone, they let existing businesses qualify for the credits. So, many existing businesses were able to benefit without doing a lot.”

In the spirit of redevelopment law, enterprise zones were created to draw new businesses in to keep communities vital and to hire local citizens, says Babek. However, many existing businesses were getting significant credits for purchasing equipment they’d already had plans to purchase, and they weren’t hiring new local employees. “Redevelopment agencies benefit both citizens and businesses, but the rules weren’t defined well enough,” says Babek. “Enterprise zones should be all about giving incentives to new businesses to move in and put people to work.”

How cities are responding

Cities can either disband their redevelopment agencies and distribute assets in a manner that’s complex and ambiguous, or redevelopment agencies can make defined payments to the state, says Bill Arnone, chairman of the Santa Rosa Redevelopment Agency.

Haig adds, “When a city or county doesn’t have redevelopment money, it makes it difficult to fund the rehabilitation of a blighted area such as our shopping center area. It will continue to deteriorate. The real question is this: If the money goes back to a general pot, how much would come back into the community to be reinvested?”

According to Palmer, these are property tax dollars that will be reinvested locally in schools and public safety services. “So the money isn’t going to a general fund, it’s staying local,” he insists.

But the question being put to redevelopment agencies regarding the continuation payments, is, Will there be enough money left over after payments to the state to maintain our communities through redevelopment? If the state takes $1.7 billion in redevelopment project money this fiscal year, the shift in funds would take $22.1 million from agencies in Sonoma County, $1.5 million from the one agency ion Napa County and $3.2 million from agencies in Marin County, according to the CRA.

The CRA conducted a survey shortly after the trailer bills were enacted, according to Jim Kennedy, interim executive director, and found that 75 to 80 percent of cities were inclined to make the payment, even if they didn’t like it. The remaining 20 to 25 percent of the cities surveyed either didn’t have the financial resources to make the payment or didn’t feel it was appropriate to do so. Those on the redevelopment side of the issue, view these voluntary payments as ransom.

Santa Rosa, for example, is planning to pay $2.7 million to the state to keep its redevelopment agency alive. “To maintain the availability of redevelopment tools in Santa Rosa, we agreed to make state-mandated payments under protest,” says Arnone. “We protested, because we believe it’s illegal and violates the California constitution.”

The city of Napa also plans to make the payment from the redevelopment agency’s property tax increment funds, which adds up to $1.5 million for the 2011-2012 fiscal year. In future years, that means Napa would pay about $362,000 per year to keep redevelopment alive. “It depletes our resources,” says Jennifer La Liberte, redevelopment and economic development manager for the city of Napa. “We’ve been saving this money for capital projects.”

However, the loss of redevelopment funds will have very little impact on the county of Marin. “Marin county has only one project in the unincorporated area, which is set to expire. However, San Rafael and Novato will be severely impacted,” says Leelee Thomas, principal planner for the Marin County Community Development Agency.

The future of redevelopment

As governor, Brown is determined to fix the state deficit, and there’s probably no one who knows the arguments for and against redevelopment better than he does, since he’s been an advocate of both sides of the issue.

The state Supreme Court has agreed to hear the case directly and rule by January 15. “Redevelopment agencies were created by an act of legislature and can be dissolved by an act of legislature,” says Palmer.

“Keeping redevelopment agencies in place is in the best interest of our state and its citizens,” according to Robert Eyler, Ph.D., professor of economics at Sonoma State University. “It’s one of the few government expenditures that forces government to think and act like a business, where we redistribute dollars as a society to provide a mechanism to create entrepreneurship, jobs and businesses.

“The more redevelopment focuses on identifying which qualifying areas have the most economic pain and then trying to solve that problem is one strategy, but it takes the residents and current businesses of the qualifying area to buy in,” Eyler continues. “In many ways, redevelopment is one of the few revenue-driving expenditures of local government…. Redevelopment needs to be revisioned as generating both current businesses and a culture around business creation in these areas so the government doesn’t need to come back again to redevelop the same areas.”

Until the California Supreme Court makes a decision in January, no one really knows what’s likely to happen, but, says Eyler, “There will be pressure on both sides of the issue—social equity and budget efficiency.

“On the social equity side, redevelopment is focused on areas with more low-income households, high vacancy rates in commercial real estate and maybe little sense of future business possibilities. Redevelopment is meant to create jobs and work for these areas—in a sense, to revitalize them. The problem is that local and state government still needs to make a return on their investment, so government reaps the benefits through more tax revenue. ”

This is the third time the state has tried to take redevelopment money, according to the CRA. The other two attempts were in 2008 and 2009. The 2008 attempt was ruled illegal by the Sacramento Superior Court. The 2009 attempt was upheld by the same court, but the ruling is still under appeal by the CRA and the League of California Cities.

No matter what the Supreme Court ultimately decides, North Bay redevelopment agencies predict change ahead. “Redevelopment will likely continue in a modified way. It will be different—and it will be more expensive than it is today,” says Haig. “I don’t think current legislation is the final form.”

Adds Thomas, “I think there will be a lot less funds available for affordable housing across the state.”

“Redevelopment agencies need some certainty,” says La Liberte. “If we need to overhaul, then let’s roll up our sleeves and do it. Let’s reform it and get it done. But we need to find a solution that works for everyone.”

 

 

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