January 23, 2003 - Joint Informational Hearing

Redevelopment and the Governor’s Budget


A Staff Briefing Paper for the
Joint Informational Hearing


Senate Housing and Community Development Committee
Senator Denise Moreno Ducheny, Chair


Senate Local Government Committee
Senator Tom Torlakson, Chair


Thursday, January 23, 2003
State Capitol, Room 3191


Table of Contents

Introduction 1
How Property Tax Increment Financing Works 1
An Indirect Subsidy 4
Three Previous ERAF Shifts 6
Housing Obligations and Performance 7
The Governor’s Proposals 9
Legislative Alternatives 12
Sources and Credits 15
Appendix: Temporarily Suspend the State’s Subsidy to Redevelopment


Redevelopment and the Governor’s Budget


On Thursday morning, January 23, 2003, the Senate Housing and Community Development Committee and the Senate Local Government Committee will hold a joint informational hearing on how Governor Gray Davis’s budget proposals may affect community redevelopment agencies and their housing programs.

This background paper prepares the Senators and the witnesses to explore the Governor’s proposals. The paper also suggests questions that legislators may wish to ask the witnesses.

Following introductory remarks by Senator Tom Torlakson, Chair of the Local Government Committee, and Senator Denise Moreno Ducheny, Chair of the Housing and Community Development Committee, the committees’ staff consultants will describe how property tax increment financing works and explain the affordable housing obligations that redevelopment agencies face. In their briefings and in this paper, the committees’ staff distinguishes among the proposals for the:

  • Current year (2002-03).
  • Budget year (2003-04).
  • Out years (2004-05 and beyond).

Following the staff briefings, the Senators will hear representatives from the State Department of Finance describe the budget proposals that Governor Davis has offered for legislative consideration. Legislators will then hear reactions and recommendations from the Legislative Analyst’s Office, redevelopment officials, and nonprofit housing builders.


How Property Tax Increment Financing Works


Redevelopment has literally changed the way that California looks, mostly for the better. Tens of thousands of affordable housing units, hundreds of thousands of square feet of commercial and industrial space, and hundreds of public buildings exist today because of decades of hard work by redevelopment agencies.

The state has two abiding interests in redevelopment --- substantive and fiscal.

The state has a substantive policy interest in eliminating both economic and physical blight. No neighborhood should be left behind.

The state has a fiscal interest in redevelopment’s success because the State General Fund helps to finance community redevelopment agencies’ projects.

Incremental revenues. A redevelopment agency keeps the property tax increment revenues generated from increases in property values within a redevelopment project area. When it adopts a redevelopment plan for a project area and selects a base year, the agency “freezes” the amount of property tax revenues that other local governments receive from the property in that area. In future years, as the project area’s assessed valuation grows, the resulting property tax revenues --- the property tax increment --- go to the redevelopment agency instead of going to the underlying local governments.

For example. The table on page 3 is a simplified illustration of property tax increment financing. This hypothetical project area is blighted, causing the assessed value of the property to decline from $75 million in 1993-94 to $70 million in 1994-95. In the base year (1994-95), the $70 million assessed valuation of the property in the newly-created redevelopment project area produces $700,000 in property tax revenues. The city government gets $77,000 of those revenues (11%), the county government gets $133,000 (19%), the special districts get $126,000 (18%), and the schools get $364,000 (52%).

In 1995-96, the second year of the redevelopment project, the property values stabilized, and the property tax allocations remained the same as the previous year. Because there was no growth in the assessed valuation, there were no property tax increment revenues --- and the redevelopment agency did not receive any revenue. In 1996-97, the project’s third year, property values grew by $7 million or 10%. That growth produced $70,000 in additional property taxes. The redevelopment agency captured these property tax increment revenues while the other local governments’ receipts remained frozen, as they were in the base year (1994-95). Over the next three or four decades, the redevelopment agency will use the growing property tax increment revenues to finance its work, while the other local governments must be content with their allocations, frozen since 1994-95.

Simplified Illustration of Property Tax Increment Finance
  1993-94 1994-95* 1995-96 1996-97 1997-98 1998-99 1999-2000
Assessed Value $75,000,000 $70,000,000 $70,000,000 $77,000,000 $84,700,000 $93,170,000 $102,487,000
Annual Increased Assessed Value --- $0 $0 $7,000,000 $7,700,000 $8,470,000 $9,317,000
Total Incremental Assessed Value --- $0 $0 $7,000,000 $14,700,000 $23,170,000 $32,487,000
Property Tax Revenues $750,000 $700,000 $700,000 $770,000 $847,000 $931,700 $1,024,870
City’s share (11%) $82,500 $77,000 $77,000 $77,000 $77,000 $77,000 $77,000
County’s share (19%) $142,500 $133,000 $133,000 $133,000 $133,000 $133,000 $133,000
Districts’ share (18%) $135,000 $126,000 $126,000 $126,000 $126,000 $126,000 $126,000
Schools’ share (52%) $390,000 $364,000 $364,000 $364,000 $364,000 $364,000 $364,000
Redevelopment Agency's Share --- $0 $0 $70,000 $147,000 $231,700 $302,487

* = Base Year

Bonding for capital. To get the capital needed to carry out their projects, redevelopment officials issue tax allocation bonds. Redevelopment agencies repay these bonds by pledging the property tax increment revenues that come from the project area. By capturing property tax increment revenues over the decades, redevelopment agencies gain access to a steady revenue stream. Once the tax increment revenues pay off the redevelopment bonds, the agency ceases to receive its share of tax revenues. The other local governments then enjoy their earlier shares of the now-expanded property tax base.

Allocations. In 2000-01, redevelopment agencies received $2,140,446,000 in property tax increment revenues. The agencies passed-through $330 million to other local governments. This diversion of property tax revenues from counties, cities, special districts, and schools is a major feature of California’s local fiscal landscape. In some counties, redevelopment agencies divert increasing shares of tax revenues:

Redevelopment’s Share of Property Tax Revenues
County 1982-83 1997-98
Riverside 4.0% 19.9%
San Bernardino 4.6% 17.8%
Solano 3.0% 17.4%
San Benito 0 14.4%
Yolo 0 11.1%
Santa Clara 5.1% 11.1%
Butte 1.9% 10.0%
Los Angeles 6.7% 9.2%
Imperial 1.7% 9.1%
Santa Cruz 0.5% 8.4%
Contra Costa 5.9% 8.4%
Orange 3.7% 7.8%
Statewide average 3.6% 7.9%

Source: California Research Bureau from State Board of Equalization data.


An Indirect Subsidy


Because 52¢ of every $1 of property tax revenues went to schools in 2000-01, it’s fair to say that over half of property tax increment revenues came from schools.

But property tax increment financing never harms schools because the State General Fund makes up for the diverted revenues. The State General Fund automatically makes up any difference between what a school district receives in property tax revenues and what the district needs to meet its revenue allocation limit. If a redevelopment agency diverts property tax increment revenues from a school district, the State General Fund pays the difference. In other words, the State General Fund pays about $1 billion a year to school districts to backfill their property tax increment revenue losses. These payments are an indirect state subsidy to redevelopment agencies.

Wide variations. While the schools’ statewide share of property tax allocations is 52%, that figure masks tremendous county-by-county variations. For example, in Alameda County, schools receive 45% of property tax revenues while in San Diego County their share is 63%.


Schools’ Share of Property Taxes for Selected Counties, 2000-01
Fresno 64%
San Diego 63%
Orange 61%
Yolo 58%
San Joaquin 56%
Statewide average 52%
Riverside 48%
Contra Costa 50%
Alameda 45%
Los Angeles 40%

Source: State Board of Equalization

Even within a county, however, there are wide variations among the various tax code areas. A redevelopment agency in a tax rate area that sends a lot of property tax revenue to schools, gets a lot of property tax increment revenues. Because of redevelopment’s fiscal effects, the State General Fund’s backfill payments are higher in those tax rate areas than in a tax rate area where schools receive a relatively low share of property tax revenues.

Does redevelopment work? One of the more contentious debates over redevelopment is the extent to which the agencies’ activities stimulate the growth in property values. How much of the assessed valuation growth in a project area is because of what the redevelopment agency does? How much of that growth would have occurred anyway, without redevelopment?

The only independent, detailed study of redevelopment’s effects on property values is Michael Dardia’s Subsidizing Redevelopment in California, published in 1998 by the Public Policy Institute of California. Dardia studied a sample of 38 redevelopment project areas in Los Angeles, San Bernardino, and San Mateo counties. His goal was to find out how much of the redevelopment agencies’ property tax increment revenues was due to their effect on local property values. Dardia explained that, “Any difference between what they received and what they generated can be considered an involuntary subsidy from other jurisdictions.”

Matching his 38 project areas to comparable neighborhoods without redevelopment, Dardia found that, “In dollar value, the projects collectively generated an estimated 51 percent of the tax increment revenues they received.” In other words, redevelopment activities were responsible for about half of the growth in assessed value and the resulting property tax increment revenues. The other half would have occurred anyway. Although redevelopment advocates have criticized Dardia’s matched-pair methodology and challenged his conclusion, there is no other reliable study of redevelopment’s effects.

Half of half. How large is the state’s indirect subsidy to redevelopment?

  • Redevelopment agencies divert about $2 billion in property tax revenues.
  • Because half of property tax revenues go to schools, half of property tax increment revenues come from schools --- about $1 billion.
  • Using the Dardia factor, half of those property tax increment revenues would have occurred anyway --- about $500 million.

The State General Fund indirectly subsidizes redevelopment by funding the unearned half of the schools’ half of the total property tax increment revenues --- about $500 million a year.


Three Previous ERAF Shifts


Faced with serious budget problems in the early 1990s, the Legislature and Governor Pete Wilson faced tough political choices. Some legislators wanted to raise taxes to avoid program cuts; others wanted to cut programs but resisted tax increases. They settled on an expedient third alternative, shifting property tax revenues from counties, cities, special districts, and redevelopment agencies to schools. 

Boosting the schools’ share of property tax revenues eased the fiscal pressure on the State General Fund. Every new dollar in property tax revenues for schools was a dollar that the State General Fund avoided spending on schools. The mechanism for this transfer was the Educational Revenue Augmentation Fund or ERAF.

While the state law continues the shift of property tax revenues from counties, cities, and special districts to schools through ERAF every year, the redevelopment agencies have endured only three one-time annual shifts:

  • $205 million in 1992-93.
  • $65 million in 1993-94.
  • $75 million in the current year (2002-03) with AB 1768 (Oropeza, 2002).

In these prior shifts, the agencies lost money in proportion to their share of the statewide total of property tax increment revenues. For example, in 2002-03, if a redevelopment agency receives 3% of the statewide total of $2.1 billion in property tax increment revenues, then it must shift property tax increment revenues to ERAF equal to 3% of the $75 million obligation.

With each of these three, one-time annual ERAF shifts, however, the implementing bills have given redevelopment agencies some consideration. The bills protected the agencies’ constitutional duty to make bond payments, allowed the agencies to borrow from their Low- and Moderate-Income Housing Funds, and required the underlying city (or county) to make these payments if the agency lacks the funds.


Housing Obligations And Performance


Redevelopment agencies must deposit 20% of their annual property tax increment revenues into a Low- and Moderate-Income Housing Fund (L&M Fund), and spend the money to increase, improve and preserve the community’s supply of low- and moderate-income housing. Several agencies dedicate more than the required 20% of tax increment funds to housing activities. Statewide in 2000-01, this set-aside requirement resulted in the deposit of $225 million in property tax increment revenues into the agencies’ L&M Funds. An additional $337 million came from accrued interest, transfers, and bond proceeds.

Redevelopment officials spend their L&M funds for a variety of housing activities, including land acquisition, financing for the acquisition, rehabilitation, or new construction of multifamily housing developments, on- or off-site improvements, first-time homebuyer assistance, and home rehabilitation loans. While most redevelopment funds must be spent within the redevelopment project area that generated the revenues, officials can spend their L&M funds outside the project area if the use benefits the project area.

Excess surplus. An redevelopment agency that accumulate large unencumbered balances in its L&M fund must spend the funds within a certain time period or face sanctions. Funds are defined as excess surplus if they exceed $1 million or the combined amount of tax increment revenue deposited in the L&M Fund during the previous four fiscal years. An agency must spend its excess surplus within three years or transfer the funds to the local housing authority after one year. If officials don’t spend the funds by the three year deadline, the agency cannot encumber or spend money, except for debt service, until the agency encumbers 150% of its excess surplus. The 50% penalty must be paid for with the agency’s non-housing revenues. Redevelopment officials call this statute the use-it-or-die-rule.

According to the State Department of Housing and Community Development, (HCD), 31 redevelopment agencies reported $29 million in excess surpluses as of July 1, 1999. The three agencies with the largest surpluses were Inglewood ($4.7 million), Tustin ($3.9 million), and Livermore ($3.2 million).

Housing production. Besides the 20% set-aside requirement, redevelopment agencies must also follow statutory housing production requirements. An agency must ensure that 15% of all housing units privately built within a project area, or substantially rehabilitated with agency assistance, are affordable to low- and moderate-income households. If the agency develops housing units directly, 30% of the units must be affordable to low- and moderate-income households. These provisions are known as the inclusionary housing requirement. An agency may satisfy the inclusionary housing requirement by providing two affordable units outside the project area (but within the city) for every unit required within the project area.

Other housing obligations. Redevelopment agencies must also replace all housing units destroyed in the project area within four years at affordability levels that are equal to or less than the income levels of the displaced households.

If redevelopment activities displace residents, officials must provide them with relocation assistance. This requirement includes relocation assistance advisory services, payments of up to $22,500 to homeowners to buy or finance a comparable home, and payments of up to $5,250 to tenants to lease or rent a comparable dwelling for up to 42 months. In addition, displaced low- or moderate-income households receive priority to occupy any units that were built with the agency’s assistance.

Performance. Redevelopment agencies contribute significantly to California’s affordable housing stock. In 1998-99, redevelopment agencies assisted 18,589 households, including:

  • Producing 6,619 new units.
  • Substantial rehabilitating 2,869 units.
  • Replacing 2,118 units.

In San José alone, redevelopment officials assisted in building 2,077 new housing units that year.

Effectiveness. Beyond the issue of spending L&M funds by the statutory deadline is the question of how effectively redevelopment officials spend these funds. Many agencies report spending more than 50% of their L&M income on planning and administration. HCD’s audits of redevelopment agencies have uncovered other problems. For example, the redevelopment agency in Grand Terrace (San Bernardino County) underfunded its L&M Fund by $1.2 million, plus interest. Grand Terrace officials used their L&M funds to construct and rehabilitate city offices, and to pay for the entire payroll and equipment costs of the City’s code enforcement office. Over a seven-year period, Santa Ana redevelopment officials spent 79% of their L&M funds ($33.5 million) on planning and administration costs and off-site street and sidewalk improvements. In those seven years, the agency helped just 159 households with down payment or home rehabilitation assistance. 


The Governor’s Proposals


Governor Gray Davis has offered budget proposals affecting redevelopment spending for three separate time periods:

  • Current year (2002-03).
  • Budget year (2003-04).
  • The out years (2004-05 and beyond).

The Current Year. The Governor’s original mid-year reduction plan would require redevelopment officials to send all unencumbered balances in their L&M Funds to the State General Fund. Unencumbered is defined as any funds not legally committed on December 1, 2002, the strictest possible definition. The Administration believes that redevelopment agencies are holding about $500 million. For 1998-99, HCD reported that the redevelopment agencies held $674 million in unencumbered L&M funds, of which $499 million was both unencumbered and undesignated. As of June 30, 2001, the Controller reported unencumbered L&M Fund balances of $514 million, but only $113 million was undesignated.

  • What’s the state’s authority for requiring redevelopment officials to transfer money from their L&M Funds directly to the State General Fund?
  • Did the Administration use the wrong definition for idle housing funds?
  • Did the Administration use old data for its estimate?

Redevelopment agencies’ L&M funds are often the last source of financing committed to affordable housing projects. They are the “gap” financing that makes the project “pencil out” after builders have used all other sources. As a result, redevelopment officials often commit their L&M funds to a project early in the process, but do not legally encumber the money until shortly before construction begins. Nonprofit builders worry that the Governor’s proposal would stop current affordable housing projects; many that have been in the pipeline for years, some close to fruition.

The California Coalition for Rural Housing, one of the state’s four trade associations for non-profit housing developers, reports that its members are involved with over 45 projects or programs proposing to build, acquire, and renovate at least 1,650 units that would be shut down immediately by this proposal.

In Santa Barbara, for example, the Governor’s current year proposal jeopardizes the largest and most affordable project in local history. The $40 million project, sponsored by Mercy Housing California and St. Vincent’s, would provide 75 apartments for low-income families at rents of $500 to $700 per month, and 95 apartments for low-income seniors. Santa Barbara’s redevelopment agency planned to provide $10.6 million in gap financing for the project, but those funds are not yet legally committed.

A recent survey by the California Redevelopment Association (with 52% of its members responding) found at least $318 million in commitments that officials have made to projects but which are not yet legally obligated. The Association also found that the responding agencies had over-committed their L&M Funds by a net total of nearly $176 million. Nevertheless, a few agencies reported large balances --- $23.5 million in Irwindale. Many said that they have committed their L&M Funds to projects without formal agreements.

For example, as of December 1, 2002, Arcadia (Los Angeles County) reported:

Total in L&M Fund $3,493,086
Funds committed with binding agreements $4,045,715
Balance, after obligations ($552,629)
Funds committed without formal agreements $1,800,000
Balance in L&M Fund ($2,352,629)

Source: California Redevelopment Association survey data

  • What is the policy rationale for taking money from the L&M Funds and not from the funds used for other redevelopment activities?
  • Is it appropriate to transfer funds that have been committed to projects, even if those funds have not yet been legally obligated?
  • Will sweeping up unused L&M Funds reward the communities that have dragged their feet, unwilling to spend money to promote affordable housing? 

The Budget Year. The Governor’s Budget for 2003-04 proposes to shift $250 million in property tax increment revenues from redevelopment agencies to ERAF, saving the State General Fund the same amount.

This proposal may be similar to the three previous ERAF shifts. In the current year, state law requires county auditors to transfer $75 million from redevelopment agencies to ERAF (AB 1768, Oropeza, 2002).

  • Is there a policy or fiscal rationale for the $250 million amount?
  • What is the proposed formula for computing each agency’s shift?
  • Will redevelopment agencies receive the same statutory considerations?

The Out Years. The Governor’s Budget also proposes making the $250 million ERAF shift permanent, and increasing it until the full schools’ share of property tax increment revenues is recaptured. In 2000-01, when property tax increment revenues were $2.1 billion, about half of that money came from schools. So the Governor’s proposed shift would eventually cost redevelopment agencies half of their tax increment revenues, more than $1 billion a year. While the Administration has not spelled out the details of its proposal, some reports say that state officials want to increase the $250 million shift by 5% a year until the shift is fully realized.

Redevelopment officials say that the Governor’s proposal comes close to gutting redevelopment law. Cities and counties use redevelopment because it increases their funding for infrastructure, economic development, and housing in blighted neighborhoods. If the schools’ share of property taxes disappears from the property tax increment revenues, more than half of the benefit also disappears. 

In addition, many agencies must pass-through some of their property tax increment revenues to counties and special districts. One result is that a redevelopment agency would not capture much more than the city government’s own share of property tax revenues. While some cities may still seek the eminent domain and bonding powers of redevelopment agencies, there would be little to no fiscal benefit to property tax increment financing if the schools’ share permanently disappears. Community revitalization of California’s most blighted neighborhoods would slow and deposits to L&M Funds would drop drastically.

  • What is the policy rationale for eliminating the schools’ share of property tax increment financing? 
  • How will redevelopment officials meet their constitutional obligations for bond payments if they lose the schools’ share of property tax increment finances? 
  • Is withdrawing the state’s indirect subsidy of redevelopment a retreat from the state government’s historic partnership in funding local redevelopment efforts?


Legislative Alternatives


Those who criticize have a political obligation to propose alternatives. To help legislators examine their alternatives to the Governor’s proposals, the staffs of the Senate Housing and Community Development Committee and the Senate Local Government Committee offer the following alternatives:

The Current Year. The Administration’s proposal appears to use the wrong method and the wrong data for the wrong year in an attempt to gain $500 million from redevelopment agencies’ L&M Funds for the State General Fund. The actual amount that might be available is closer to $113 million. Removing money from the agencies’ L&M Funds will immediately halt the production of affordable housing developments and hurt local economies. Further, there is no clear constitutional authority to shift the money directly to the State General Fund.

The Committees may wish to consider taking no action in the current year.

The Budget Year. The Administration’s proposal lacks a policy rationale other than helping the State General Fund by $250 million.

The Committees may wish to consider:

  • Suspending the state’s subsidy to redevelopment agencies in the budget year, saving the State General Fund about $500 million in 2003-04. 
  • Requiring county auditors to shift half of the property tax increment revenues that a redevelopment agency would have diverted from schools to ERAF.
  • Protecting the agencies’ constitutional duty to make bond payments.
  • Allowing redevelopment agencies to borrow from the L&M Funds.
  • Requiring the underlying city or county to guarantee the agency’s payment.
  • Extending the flow of property tax increment funds beyond the current deadlines by a year, allowing the agencies to recoup the lost revenues in the future.
  • Declaring a temporary moratorium on creating, expanding, and merging redevelopment project areas, increasing debt ceilings, extending deadlines, adding capital projects, approving or selling more bonds (except for refinancing). This temporary moratorium prevents additional, future costs to the State General Fund and gives state officials a political window to consider the future of redevelopment.

(The draft text of the Committees’ staff proposal appears in the Appendix.) 

The Out Years. The Administration has provided no policy rationale or details for eliminating the schools’ share of redevelopment agencies’ property tax increment financing.

The Committees may wish to consider taking no action for the out years, using the temporary moratorium on new projects and bonds to consider structural changes.


Sources and Credits

These sources were useful in preparing this briefing paper:


David F. Beatty, et al., Redevelopment In California, Second Edition, Point Arena, California: Solano Press Books, 1995. 

California Redevelopment Association, “Status of the Low & Moderate Income Housing Fund,” January 15, 2003.

Michael Dardia, Subsidizing Redevelopment in California, Public Policy Institute of California, January 1998.

Senate Housing and Land Use Committee, Ends or Means? Redevelopment Agencies’ Housing Programs, November 1996.

Senate Local Government Committee, Redeveloping California: Finding the Legislative Agenda for the 1990’s, December 1989.

Senate Local Government Committee, Property Tax Allocation, September 1999.

State Board of Equalization, 2000-01 Annual Report, May 2002.

State Controller, Community Redevelopment Agencies Annual Report, Fiscal Year 2000-01, April 2002.

State Department of Housing and Community Development, Redevelopment Housing Activities, Fiscal Year 1998-99.

Mark Stivers, consultant to the Senate Housing and Community Development Committee, and Peter Detwiler and Jennifer Swenson, consultants to the Senate Local Government Committee, prepared this briefing paper.

Production assistance came from Elvia Diaz, committee assistant to the Senate Local Government Committee and Joy Traylor, committee assistant to the Senate Housing and Community Development Committee.

Committee Address