State law now requires that when a new city incorporates, it must come to a mutually acceptable tax distribution agreement with its county before a LAFCo can approve the incorporation proposal. As counties and cities have become increasingly fiscally stressed, these negotiations are often protracted. Some negotiations have resulted in significant concessions by the new cities, whereby a large share of sales taxes in the new city are passed on to the county. Likewise, when a city wishes to annex land, the city and county must work out a tax-sharing arrangement. Since county finances can be quite vulnerable to annexation, these negotiations have become very contentious.
Conflict often revolves around the inclusion of retail properties in the annexation area.
In our survey, we asked city managers to rate the importance of 11 factors affecting their decisions about annexation. To address these issues, several groups have proposed changing the distribution of the sales tax. We would caution, however, that tinkering with the sales tax without increasing access to property tax revenue in local communities does not fully address the lack of incentives for balanced development. Allowing cities to swap a portion of the local sales taxes for an increased share of the property tax would place all types of development on a more even footing. It is important to remember, however, that local governments that host major retail sectors do have public service needs arising from those stores and the shoppers and workers who flock there.