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With the upcoming end of the "triple flip," a complex, decade-old mechanism affecting state and local finances in California, we have received inquiries seeking a basic understanding of what the triple flip is and how its end will work exactly. This note addresses those issues.

Background

Economic Recovery Bonds and the Triple Flip. In 2004, voters approved Proposition 57, which authorized the state to issue up to $15 billion in deficit financing bonds (also known as economic recovery bonds, or ERBs). $11.3 billion of these bonds were issued in 2004 and an addition $3.3 were issued in 2008. Proceeds from these bonds were used to address the state’s budget shortfall. To repay the ERBs, the state pledged one-quarter cent of the local Bradley-Burns sales tax. In particular, it reduced by one-quarter cent the Bradley-Burns sales tax, which cities and counties use for general and transportation purposes, and replaced it with a one-quarter cent state special fund sales tax for repayment of the bonds. To hold local governments harmless, the state initiated a complex series of revenue exchanges commonly referred to as the “triple flip,” which we describe below, to continue until the ERBs are repaid.

         Flip 1: Shifted one-quarter cent of the Bradley-Burns sales tax to the state to repay the ERBs.

         Flip 2: Replaced the diverted local sales taxes, dollar for dollar, with property taxes shifted from school and community college districts—specifically, from county Educational Revenue Augmentation Funds (ERAF).

        Flip 3: The school and community college district tax losses from the redirection of ERAF to cities and counties, in turn, are offset by increased state education aid under the Proposition 98 minimum guarantee.

Overall, the intent of this mechanism was that cities, counties, and school and community college districts would not experience any net change in revenue from the triple flip.

Allocating Sales Tax Revenue to Local Governments. Businesses remit sales tax collections to the State Board of Equalization (BOE) at the end of each month. These remittances generally correspond to sales that occurred during the prior month. The BOE allocates the portion of these revenues from the Bradley-Burns rate to cities and counties, based on the location of the taxable sales, three months after the end of each quarter. For example, on a cash accounting basis, second-quarter allocations reflect first-quarter sales tax activity. Allocations made over the course of a fiscal year, therefore, are for taxable sales between April 1st of the prior fiscal year and March 31st of that fiscal year. As a result of this accounting process, during the first year of the triple flip, cities and counties received ERAF monies equal to only three-quarters worth of taxable sales that occurred in that year. Therefore, in order to hold cities and counties harmless, ending the triple flip requires one additional quarter of ERAF transfer to cities and counties, as discussed below.

Ending the Triple Flip

Finalizing the Triple Flip. The administration currently anticipates the ERBs to be repaid during the first quarter of 2015-16. Current law regarding the end of the triple flip sets forth a two-step process to ensure cities and counties receive revenue associated with local sales taxes reduced to repay the ERBs. This process also ensures the state has sufficient resources in its ERB special fund to finalize bond repayment and close the fund.

Step One. The triple flip mechanism described above will continue for the first quarter of the 2015-16 fiscal year—July 1st through September 30th. This means property taxes from schools and community colleges will continue to shift to cities and counties to replace diverted sales taxes that correspond to taxable sales activity in the fourth quarter of 2014-15. In effect, this step ensures cities and counties receive reimbursement for taxable sales that occurred up until the end of 2014-15.

Step Two. Second, current law requires that the quarter-cent tax rate continue going to the ERB repayment special fund for an additional quarter beyond the end of the quarter in which the bonds are repaid. This means the quarter-cent sales tax revenue for taxable sales through the end of 2015 will continue to flow into the ERB special fund. Beginning January 1, 2016, the Bradley-Burns rate will revert from 0.75 percent to its original 1 percent, and the locals will receive the quarter-cent sales tax revenue as they did before the triple flip began. After the one-quarter triple flip described in step one, locals will still need to be reimbursed for their taxable sales at the reduced rate for the first two quarters of 2015-16. Therefore, current law requires the state to transfer monies from the ERB special fund to cities and counties for this amount.

2015-16 Governor’s Budget Includes Transfer to Cities and Counties. To ensure cities and counties are made whole for the entire triple flip, current law—as described in step two—requires the state to transfer to cities and counties in 2015-16 an amount equal to how much the sales tax will generate during the first two quarters if 2015-16. The 2015-16 Governor’s Budget includes $845 million for this so-called Fiscal Recovery Countywide Adjustment Settle-Up. This amount may be slightly different from the exact amount of revenue generated from two quarters of the ERB sales tax rate for two reasons. First, it is an estimate and therefore could be higher or lower than actual. Second, the transfer is an estimate of the overall difference—beginning in 2004-05 and ended December 31, 2015—between what cities and counties received via the ERAF transfer and the amount of sales taxes they would have received otherwise. In this way, it is intended as a final estimate to hold cities and counties harmless overall, first and foremost for the final two quarters of sales taxes but also for any remaining amount of settle-up required.

Current Law Includes Contingency Plan. Under current estimates, sufficient funds will be available in the ERB repayment special fund to fully backfill cities and counties for the final settle-up of the triple flip. This is because sales taxes will continue flowing to this fund after the bonds have been repaid. However, if the amount of revenue in the special fund is not sufficient to finalize the triple flip, current law requires the state to perform an additional cycle of the triple flip in order to transfer to cities and counties—via ERAF—the final settle-up amount.

Impact on Schools and State General Fund

How Does This Affect Schools and Community Colleges? For the duration of the triple flip, property taxes were transferred from schools and communities colleges to cities and counties each year. The state, in turn, backfilled education entities via state education aid under Proposition 98. As a result, school and community college district experienced no net change in available resources due to the triple flip. By the same token, school and community college districts will experience no change in available resources due to the triple flip’s end.

How Does This Affect State General Fund Spending? In recent years, the ERAF transfer has totaled about $1.6 billion annually. Under current projections, the ERAF transfer will continue for one quarter of 2015-16, meaning the state will backfill schools and community colleges for one-quarter’s worth of the transfer. We estimate this amount to be approximately $400 million. The remainder, about $1.2 billion (the difference between $400 million and $1.6 billion), will increase local property taxes going to school and community college districts and therefore reduce required state education aid by an equivalent amount. In particular, as we noted in our recent Overview of the Governor’s Budget, proposed Proposition 98 spending for 2015-16 is up only slightly, despite a large increase in the minimum guarantee. This is due largely to the additional $1.2 billion in school and community college district property taxes available because the triple flip ends in 2015-16.