Government Policy Explains Why California Leaves Money on the Table

California’s political leaders are in the midst of celebrating their temporary “solving” of the state’s Brobdingnagian budget mess by combining spending cuts and tax increases with heavy doses of accounting legerdemain. Once again, however, Sacramento has failed to take advantage of a golden opportunity to stanch the red ink without imposing a much heavier burden on the private sector: selling state-owned properties.

To be sure, and at the urging of Governor Arnold Schwarzenegger, the Department of General Services – the state’s landlord – recently has begun exploring opportunities for marketing some of California’s most valuable assets, including the Los Angeles Coliseum, San Francisco’s Cow Palace, San Quentin State Prison and fairgrounds in Del Mar, Orange and Ventura counties.

That renewed effort represents a major policy change since 2000, when California’s state auditor sharply criticized the DGS for failing to dispose of so-called surplus state property expeditiously, thus bypassing billions of dollars in potential revenue. Sequestering no longer publicly needed buildings and grounds in lockboxes, as did Caltrans, which finally sold a piece of property in the mid 1990s it had designated as surplus 38 years earlier, leaves tons of money on the table. The ultimate dispositions of LA’s unused Reception and Civic Centers have been pending for decades.

As far as can be told, the last surplus property transaction of any significance took place in fiscal year 2002, when the state sold 152 acres in Santa Clara County for $149 million. That parcel was part of a 292-acre property that had been declared surplus in 1996.

According to the statewide property inventory maintained by the Real Estate Services Division of the Department of General Services, as of January 2, 2008, the taxpayers of California owned 22,727 buildings and more than 6.7 million acres of land at 2,313 sites around the Golden State.

It turns out that state government policy erects barriers to exploiting that potential source of ready cash.

Other than ordinary bureaucratic inertia, delays created by filing environmental impact statements and complying with master facilities plans, the chief reason for foot-dragging is that state agencies have little incentive to identify and sell the properties they no longer need. If and when surplus property actually is disposed of, the DGS applies the proceeds (net of its own costs) to pay interest and principal on state bonds. Agencies incur the cost of identifying surplus property, but do not share in the gains from doing so.

Moreover, “surplus” properties can be disposed of only if the state legislature approves such actions. And political considerations mean that roughly ten to fifteen percent of the properties identified as no longer serving public purposes ever are offered to the market in the first place. Properties that eventually pass legislative muster may remain in limbo for up to 14 months until it reviews and approves their sale.

Moreover, other public agencies have the right of first refusal. If one governmental entity expresses an interest in acquiring another’s “surplus property” within 90 days, the property is transferred internally at something less than full market value, perhaps original cost, again providing no material benefit to the “selling” agency. It seems to be the case that, given its mandate to serve “the best interests of the State of California”, the DGS has full discretion over the “prices” at which such internal transfers take place.

A fiscal puzzle illustrates the dysfunctional incentives of the surplus property disposal regime now in place in California: Caltrans routinely overestimates the revenue it expects to generate from property sales. That makes no budgetary sense. Either Caltrans is not penalized for pie-in-the-sky projections or it (and Sacramento) can base spending plans for the coming fiscal year on overly rosy revenue scenarios. If so, that is a recipe for chronic budget deficit.

Two simple policy changes would transform the incentives now impeding the disposal of surplus state-owned properties: First, eliminate the right of first refusal, thereby forcing public agencies to compete with the private sector for the right to acquire “surplus” buildings and grounds, ensuring that property ownership is transferred at fair-market value to its highest and best user. Second, allow the selling agency to retain a predetermined percentage of that value, thus motivating it to identify and dispose of no longer needed property in a timely manner.

It is of course true that property now considered “surplus” is only the tip of the fiscal iceberg. If California’s taxpayers demanded that state government return to its core functions of protecting private property rights and safeguarding the rule of law, many more state-owned assets would fall under the auctioneer’s hammer.