Municipal governments have for years chased down every retail project in sight, even going so far as to poach big-box retailers and auto dealers from neighboring cities. As a result, many parts of L.A. now have strip malls and big-box discount retailers on nearly every corner, while there is virtually no room or political will for much-needed new housing or manufacturing facilities.

Clearly, the system is out of whack. So how did it get that way? And what’s being done to fix it?

In short, the problem – and the potential solution – lies with the state’s tax code, which restricts local property tax revenues and yet allows cities unlimited revenues from retail sales.

“Our state and local tax structure encourages local jurisdictions to emphasize the generation of retail sales taxes in their land-use planning and decision-making,” said former Assembly Speaker and L.A. mayoral candidate Antonio Villaraigosa.

This is not a new problem – it began in 1978 with the passage of Proposition 13, which not only capped local property tax rates but also removed control over property taxes from local governments and gave it to the state Legislature. With no ability to tap income taxes and very limited ability to capture property taxes, local governments went after the only unlimited source of income left to them, namely retail sales taxes.

The result, called the “fiscalization of land use,” is the sprouting up everywhere in the form of shopping malls, auto dealerships and, more recently, big-box retailers. Meanwhile, the region is short tens of thousands of housing units and it’s nearly impossible to site new manufacturing facilities.

“This was the big unintended consequence of Prop. 13,” said David Abel, publisher of The Planning Report, who also chaired a state commission that released a report on local government finance earlier this year.

“There’s no question that this has led to an oversupply of entertainment centers and big-box retailers,” added Larry Kosmont, an L.A.-based economic development consultant.

Yet despite countless studies about the harmful effects of these tax code provisions, no one has been able to muster the political will to change them in the 22 years since the passage of Prop. 13.

In part, that’s because for so many years, Prop. 13 was regarded as a sacred cow: changing a single word of it was tantamount to political suicide.

What’s more, any tinkering with the tax code to de-emphasize retail development opens up what many regard as a Pandora’s Box, forcing lawmakers to confront many other complex and controversial issues, such as sprawl and the financing of local government.

“Changing the structure of how local government is financed is an enormous task that no one seems to have much stomach for,” said Paul Shigley, managing editor of the California Planning and Development Report.

Worsening situation

In the meantime, the situation has only grown worse. In the depths of the last recession in 1992, the state began taking away $3 billion in property tax revenues from local governments each year, to help balance its budget. This forced cities and counties to rely ever more on retail sales taxes.

Even this year when the state registered a record budget surplus of $14 billion, only $212 million of that money was returned. And meanwhile, changing the tax code to restore balance in land-use planning has gone nowhere.

“It all comes down to the golden rule of politics: ‘He who has the gold makes the rules,’ and right now, the state has all the gold,” Abel said. “That’s why there’s no real incentive for state lawmakers to change this.”

Some small changes have been made at the margins. For example, last year, a bill did pass that made it much more difficult for cities to poach big-box retailers from their neighbors. The bill, AB 178, authored by Tom Torlakson, D-Martinez, requires any local jurisdiction that does lure a big-box retailer from a neighboring jurisdiction to share the sales tax revenues with that local government.

“We called it the ‘Act to End Retail Extortion,'” said Torlakson spokesman Robert Oakes. “And so far, it’s working. Since this took effect in January, we’ve heard about only one instance in Ventura County where one city tried to take away a Costco store from another city.”

But Oakes said, the bill does nothing to prevent a big-box retailer from playing one locality off against another in deciding to site a new store. And it doesn’t even begin to address the underlying problem of cities having to rely on retail sales taxes.

“This was essentially a quick-fix,” said economic development consultant Kosmont. “But there’s only so much you can do in quick fixes, and I think we’ve reached the limit. What’s left is rebuilding the state and local tax system.”

Over the years, many proposals have surfaced to restructure the state and local tax codes. Two such proposals were on the table this past legislative session. One, put forward by state Controller (and L.A. mayoral candidate) Kathleen Connell, would reallocate sales tax dollars on the basis of population. In other words, Los Angeles and other major population centers would end up with the lion’s share of sales tax dollars. This proposal is opposed by smaller cities that feel they would end up with the short end of the stick.

Bills going nowhere

The other proposal, put forward by the Commission on Local Government Finance (chaired by David Abel) would allow local jurisdictions to return one-half-cent of sales tax they now get from the state in exchange for an equivalent amount of property tax. The commission reasoned that as more property tax dollars come in, the incentive to change land-use decisions would increase.

Both proposals went before a special legislative committee set up to address the problems of state and local government finance, co-chaired by state Sen. Steve Peace, D-San Diego, and Assemblyman John Longville, D-San Bernardino. But, in a case of unfortunate timing, Peace found himself under siege this summer as his 1996 legislation to deregulate the electric utility industry backfired and his constituents saw their electric bills double and triple. With his attention diverted to that crisis – and salvaging his political career – local government finance issues took a back seat and the proposals died in committee.

One bill did make it out of the Legislature: SB 1637 by Senate Majority Leader John Burton, D-San Francisco, which would reduce and cap the amount of property tax dollars the state could take from local governments. By allowing more property tax dollars to stay in local hands, cities could rely less on retail sales taxes.

But Gov. Davis vetoed the bill. In his veto message, Davis said that cities have been receiving more tax dollars from the state in the form of transportation spending and other measures.

He also said he wants to see a more comprehensive reform of state and local government financing.

“The state-local fiscal relationship should be approached more broadly and comprehensively and not be restricted to an examination of the property tax only,” Davis said in the veto message.

However, even though such restructuring was part of his campaign proposals two years ago, the Davis administration has not put forward its own proposal yet. And some observers are skeptical that he’s going to, despite his pledge in the veto message to have his staff members “open a dialogue” with local government and legislative leaders on the issue.

“This is an issue where no matter what you do, there are going to be winners and losers,” said one legislative aide. “What’s more, to really solve the underlying problem, more dollars have to go to local governments while less go to the state, which is not something that an extremely fiscally cautious governor like Gray Davis is prone to do.”

But some observers do see some hope that the political will to change the tax code will finally reach critical mass, thanks largely to term limits on the state and local levels. Many state lawmakers are now coming from the ranks of local government and have experienced first-hand how difficult it is to avoid chasing retail projects.

Also, this year for the first time, Joel Fox, head of the anti-tax organization that launched Prop. 13, has publicly acknowledged that some portions of the law may have had unintended consequences that need to be addressed. (That does not include the portion most cherished by homeowners that limits property tax assessments to 1 percent of total assessed value and 2 percent annual growth.)

Proponents of changing the state tax code look upon these developments as a sign that the dam blocking reform may be about to break.

“We may see a critical mass where more state government officials recognize the need to change the system so that California doesn’t become an endless stretch of freeways surrounded by strip malls, Costcos and auto dealers,” said Torlakson spokesman Oakes.