Sales tax used to be one of the most reliable income streams for cities, but its decline over the past two decades is opening questions on how cities can continue to operate with their current budgets and less revenue.
The loss – stemming from online shopping – is hitting Orange County city budgets hard, forcing some cities to examine other ways to patch their revenue. Large shopping malls aren’t producing revenue the way they used to and new mall developments are largely shifting away from traditional retail.
Some cities have mulled over the idea of increasing their sales tax to replace lost revenue, but the idea often gets shot down by voters or the city council.
Westminster and Fullerton both discussed raising their sales tax; the move was shut down by the city council in Westminster and the voters in Fullerton over the concerns of both cities’ staff.
Other cities are trying new ways to get around the losses, but it’s unclear whether or not they’ll make up the same money, including cannabis taxes and new hotel developments.
For decades, sales tax has been one of the most reliable pillars for local governments: while property taxes are strictly controlled under Prop 13, sales tax provides a more direct revenue stream to city coffers.
“The property tax and the retail sales tax are the two big pillars of general revenues for cities,” said Samuel Stone, an associate professor at Cal State Fullerton who studies municipal finance. “The retail sales tax base in California is relatively narrow … if more of the economy is happening outside that base, you’re just not going to generate revenue.”
Stone also pointed out that while property taxes get split between the state and county and moved all over the place, sales taxes stay under city control.
“Cities are not really incentivized to zone for greater property values,” Stone said. “They don’t get to keep any of that revenue, but they’re on the hook to pay for it. The retail sales tax, that’s what they get to keep, that doesn’t get shared … so there’s a strong incentive to invest in that.”
The result was that city governments were more incentivized to encourage retail businesses at the expense of other developments, forcing cities to compete with one another for regional retail opportunities, according to a 2007 report from the California Legislative Analyst’s office.
“The counterproductive aspects of the current system could be addressed through major reforms involving either the local sales tax allocation methodology or changes in local government’s system of taxes,” the analysts wrote. “Both … would require changes to the state’s Constitution.”
Those changes never happened.
But due to increasing numbers of people shopping online, sales tax doesn’t get the job done the way it used to.
Stone said one of the options for cities is to try more sales tax hikes or introduce taxes on new things, but he acknowledged it’s a political “hot potato.”
“They’re kind of dependent on Sacramento to make those changes for them,” Stone said. “Politically that’s very difficult, especially for local governments to do.”
While that’s been tried in Orange County, it hasn’t really solved the problem.
Westminster City Council members opted not to ask voters if they would renew their 1% sales tax increase in 2020 as reelection loomed – a move that city staff said could very well end up bankrupting the city.
[Read: Westminster Council Again Fails to Act on Sales Tax Measure as Financial Crisis Looms]
While Fullerton City Council members voted to put the issue in front of voters, it got shot down, despite city staff warnings that without changes the city would run out of savings by 2025.
While local malls used to be another sure bet for sales tax revenue, developers aren’t building them anymore because they can’t find enough stores willing to set up shop in them.
The Laguna Hills Mall was set for a major renovation that would open up 880,000 square feet of retail for the city, but after the developer realized they couldn’t fill all that space in 2019, they went back to the city with a new project that only provides 250,000 square feet of retail.
“They had the project called Five Lagunas, and it was approved in 2016. They got underway and when JCPenney and Macys closed their doors, the owner … took a look at the plan and the way retail was changing,” said Larry Longenecker, community development director for Laguna Hills in an interview.
“Enclosed malls aren’t as successful anymore,” said Stephen Logan, vice president of development for Merlone Geier Partners, the company redeveloping the mall. “There will be retail, but it’ll be in more of a mixed use setting. Your huge dominant regional shopping center like South Coast Plaza, they’re one of a kind.”
When asked about the city’s benefits, Logan said that while you can always build retail, you have to find a way to fill it.
“The city obviously wanted more retail, sales tax is a big key for them. But if you look around in a five mile radius of what’s happening, there’s three million square feet of retail… you can’t be bigger than the market, you’ve got to adapt,” Logan said. “It was a challenging conversation but I think you know everyone prevailed in getting what they wanted.”
However, Laguna Hills is still looking to bring in some revenue off of the deal.
To offset the losses in sales tax from the retail drying up, Longenecker said the city implemented a series of developer fees on the project and approved the development for a hotel on the land, which opens up transient occupancy tax revenues for the city.
There’s also an expanded residential sector of the property, which went from 988 units to 1500 units, opening up some more property tax for the city as well.
“The council feels good this project will not have a financial impact on the city,” Longenecker says.
Some cities have tried to bring in more revenue by opening up cannabis sales in the city, but it’s proved extremely controversial.
Last week, Mission Viejo City Councilmembers rejected a plan to bring in cannabis stores that would’ve netted anywhere from $250,000-$350,000 in sales tax per store annually.
[Read: Mission Viejo Council Shoots Down Consideration to Allow Cannabis Businesses]
Noah Biesiada is a Voice of OC Reporter and corps member of Report for America, a GroundTruth initiative. Contact him at firstname.lastname@example.org or on Twitter @NBiesiada.
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