What Is Revenue Neutrality?

This is an article that I have revamped for purposes of Nipomo’s potential incorporation. It was originally written by
Glenn Robinson a founding director of the Carmel Valley Forum (incorporation committee). Glenn originally wrote this article as part of his involvement with the Carmel Valley incorporation movement. Much of it is applicable to Nipomo, with some of the modifications I have made. I hope it will be instructive in helping educate people about what revenue neutrality is, and how the process relates to incorporation. Feel free to leave comments or ask any questions.

The 2,000 pound gorilla hindering incorporation of new cities in California is something called “revenue neutrality.” Amended to a 1985 law in 1992 and currently listed as Section 56815 of the Cortese-Knox-Hertzberg Local Government Reorganization Act of 2000, revenue neutrality has caused incorporations across California to grind to a virtual halt. Prior to revenue neutrality (1992), California averaged about four incorporations per year, which was natural given the rapid growth in the state. Since revenue neutrality was adopted, there has been less than one new incorporation per year in California on average. In fact, since 1992 only eight cities have actually incorporated. Revenue neutrality was enacted in 1992. It took an additional five years before the first city, Citrus Heights incorporated in 1997. Since then, seven additional cities incorporated, the last of which, Rancho Cordova was in 2003. No other cities have incorporated in California since that time.

This unnatural restriction on self-government has predictably led to strange developments. For example, San Fernando Valley has thus far been unsuccessful in its long struggle to incorporate even though if allowed to it would be California’s second most populous city.

Section 56815 appears rather innocuous at first glance. It says that an incorporation “should result in a similar exchange of both revenue and responsibility for service delivery among the county, the proposed city, and other subject agencies.” In reality, it has had a stifling effect on self-government in California. Instead of self-determination being the principle underlying incorporation — which should be the case — the welfare of county budgets has become the overriding factor. The revenue neutrality process in incorporations has become what I call alimony payments in the disolution of an unhappy marriage, i.e., the county and the new city.

There is an old saying that the two things you never want to see being made are sausages and legislation. Revenue neutrality is a good example of this truism. The legislation was written by a paid lobbyist of the counties’ lobbying arm in Sacramento (CSAC, or the California State Association of Counties) as a form of the worst kind of “special interest” pork. It was then tacked on to other legislation, had no public hearings, and was passed almost without notice or discussion literally in the middle of the night during the annual Sacramento flurry of legislation typical at the end of a session.

The state had recently raided county budgets for educational expenditures, so at the time revenue neutrality passed in 1992 county budgets were in desperate straits; however, it is doubtful that counties still need wrong-headed props like revenue neutrality to meet their own budgetary requirements. But, once a special interest law has been passed, its benefactors fight vigorously to defend it. CSAC has thus far successfully fended off attempts to revisit the question of how proper revenue neutrality really is.

How Revenue Neutrality Works in Practice.

In reality, there is no standard mechanism to implement revenue neutrality. The law does not specify any formula for satisfying revenue neutrality. It does state that the county can agree to the incorporation without insisting on revenue neutrality, or that revenue neutrality can be satisfied through “tax sharing agreements, lump-sum payments, payments over a fixed period of time, or any other terms and conditions. . . .” In short, whatever deal the county and new city strike satisfies the law.

Revenue neutrality may very well be unconstitutional, but it has yet to be fully litigated–and doing so would likely be costly. Citrus Heights — the poster child for the abuse of revenue neutrality — began litigating revenue neutrality when the County of Sacramento tried to prevent it from incorporating through an exorbitant revenue neutrality demand of over $5 million per year indefinitely. However, before the suit was decided, Citrus Heights cut a deal with the county to lower the payments to $2 million per year with a cap of 25 years. Remember: this money does not purchase any services for Citrus Heights; it is merely a ransom that Citrus Heights had to pay to get its freedom.

The single most important factor in determining whether revenue neutrality will be a barrier to incorporation is the particular county’s attitude toward incorporation. Counties across California have taken very different approaches to implementing revenue neutrality. Frankly, if a county is dead set against incorporation, it will be nearly impossible for any community to incorporate. So far, all my dealings with San Luis Obispo County officials, including LAFCO officials have been positive.

A great contrast in county attitudes toward incorporation is evident between the counties of Sacramento and Orange. Sacramento county is infamous for opposing incorporation in any of its fast-growing communities. A more recent example than Citrus Heights is Rancho Cordova, which has pushed for incorporation for several years. What prevented it from incorporating for many years was the revenue neutrality demand of the county. The county estimated that it collected $20 million in taxes from Rancho Cordova, but only provided $9.3 million in services. Thus, Rancho Cordova was free to incorporate as long as it paid Sacramento County $10.7 million per year in perpetuity. A deal was eventually struck and Rancho Cordova eventually incorporated; however, it is still pursuing legal action to recover some of it’s alimony payments to Sacramento County.

Ironically, one of California’s newest cities (as of July 2000), Elk Grove, is in Sacramento County. Elk Grove was able to meet revenue neutrality demands in an unusual way. Since revenue neutrality is calculated on the previous year’s data, and Elk Grove’s largest projected tax-generator, a large automall, is only now getting under way, the automall could not be counted in the calculation.

The deal that was struck between Elk Grove and the county was that the county could keep a declining percentage of property tax while the new city kept all other taxes, including its share of sales tax and the “hotel tax” (TOT). After 25 years, no more revenue neutral payments were due. The fact that the automall will be generating lots of taxes in the future but had yielded virtually none at the time of revenue neutrality calculation made the difference in Elk Grove’s successful incorporation.

By contrast, Orange County has been quite supportive of incorporation efforts in its communities. Orange County is interested in shedding municipal services wherever possible, and is philosophically supportive of self-government. Thus, the deal that it has made with local communities balances the county’s need for fiscal stability over the short term with an interest in making sure the new city gets off to a good start and becomes successful. It has not taken the same kind of punitive approach as has Sacramento County. For example, the recently incorporated city of Rancho Santa Margarita reached agreement with the county in a cooperative atmosphere. The gist of their deal is that Rancho Santa Margarita pays Orange County a total of $12 million over a ten-year period.

In exchange, Orange County covered much of the cost for providing police protection and road maintenance during the first two years following incorporation, and helped pick up the cost of building a new community center in Rancho Santa Margarita.

What Does This Mean for Nipomo?

If the financial conditions are favorable and the residents of Nipomo decide to pursue incorporation, the issue of revenue neutrality may or may not come up, depending on when Nipomo decides to pursue incorporation. Right now, Nipomo does not generate enough revenue to the county to be upside down in terms of revenue neutrality. In other words, it costs San Luis Obispo County more money to support Nipomo with county run services than Nipomo generates in revenue for the county.   We are in a much better position for incorporation than are our neighbors to the north in Cambria.  That, however, is the topic of still another post.  In short, Nipomo does not now need to be worried about revenue neutrality issues, because their proposed fiscal feasibility as a stand alone city is still in the red, rather than the black.  This is rapidly changing, and will continue to change in Nipomo’s favor as time goes by.


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