Mello-Roos

The Mello-Roos Act provides local governments with a powerful financing tool which allows public facilities to be installed concurrently with development, while isolating the costs of doing so to the developing area. Mello-Roos financing allows public facilities in developing areas to be installed quickly and limits the financial liability for the bonds to landowners. Mello-Roos bonds have financed the construction of needed public improvements such as schools, roads, freeway interchanges, sewage treatment plants, and a host of other public facilities.

Local governments need to exercise caution in their use of Mello-Roos financing as land-backed securities are inherently risky and may pose an excessive burden on taxpayers when coupled with other taxes and assessments.The Act has been used much less extensively in developed areas due to the difficulty of obtaining two-thirds voter approval.

History of the Act

In order to appreciate the role that Mello-Roos Act plays in financing growth, it is important to understand the relationship between growth and capital financing in California and how that relationship has evolved over time. For many years during California's post-World War II population boom, the federal and state governments heavily subsidized the construction of public facilities, particularly those which produced statewide or regional benefits. At the local level, the increased service demands caused by growth often overwhelmed existing governmental structures, leading to the establishment of new governmental entities. From a fiscal perspective, the demands for service translated into higher local property tax rates.

The constitutional restrictions on taxation imposed by Proposition 13, coupled with declining levels of federal assistance, required local governments to devise new strategies for financing capital projects. Cities and counties began to rely more on their legal authority to require developers to pay for infrastructure as a condition of development approval. Developer fees emerged as an important source of revenue for school facility needs, as well. Local governments also rediscovered the special assessment acts, which had been used sparingly since the Great Depression.

But these funding sources could only be used under restrictive conditions. Special assessments could finance improvements which confer a special benefit to identifiable properties; but they could not be used to finance facilities which confer communitywide benefits, such as schools and police stations. Developer fees were constrained by the inherent limitations of a "pay-as-you-go" revenue source. The need for a more flexible local revenue source led to the enactment of the Mello-Roos Community Facilities Act of 1982.

Review of the Mello-Roos Act

The special tax authorized by the Mello-Roos Act may be used to finance the construction, expansion, rehabilitation, or acquisition of any real or other tangible property with an estimated useful life of five years or more. The legislative body creating the CFD is permitted to finance any facility it is authorized by law to construct, own, or operate. The special tax may also finance a limited number of services such as police and fire protection services, as long as the special tax is not used to supplant services already provided.

Public Policy

The special tax authorized by the Mello-Roos Act may be used to finance the construction, expansion, rehabilitation, or acquisition of any real or other tangible property with an estimated useful life of five years or more. The legislative body creating the CFD is permitted to finance any facility it is authorized by law to construct, own, or operate. The special tax may also finance a limited number of services such as police and fire protection services, as long as the special tax is not used to supplant services already provided.

While there are many public policy issues, they can be broken down into a few general categories: expenditure issues, taxation issues, housing affordability issues, and school finance issues.

Expenditure Issues. There are three key expenditure issues related to the use of landowner-approved Mello-Roos financing:

• Growth and Congestion. The prevalence of congested public facilities in California suggests that traditional political processes have not been successful in developing policies to address the impacts of growth on public service levels. The landowner vote permits local officials to make decisions, early in the development process, about the mix of taxes and service levels to be provided to developing areas of their communities.


• Level of Service Standards. In order to effectively mitigate the impacts of growth on public service levels, some objective system is needed for measuring the likely impacts of individual development projects. The establishment of level of service (LOS) standards for individual program areas permits local officials to generate cost information that can be used for negotiating developer exactions and/or sizing Mello-Roos bond issuances.


• Concurrency. Landowner-approved Mello-Roos financing can help localities implement a policy of concurrency, which describes the requirement that sufficient capacity be added to the public capital stock, at the time development occurs, to accommodate the additional demands of growth. In essence, landowner-approved Mello-Roos financing permits landowners to borrow against the value and tax capacity of their land through the tax-exempt market to pay for the infrastructure needed to serve development. It is the only feasible method of raising a large sum of capital early in the development process to finance the construction of virtually any public facility, while isolating the cost of doing so on the developing area.

Taxation Issues. The Mello-Roos Act provides little guidance regarding the apportionment of the special tax to individual properties, other than to establish the general principle that all properties in the CFD must benefit from the proposed improvements. The Act leaves the rate and method of apportionment of the special tax to the discretion of the local agency approving the levy. The only constraint is that the special tax cannot be an ad valorem property tax as prohibited by Article XIII A of the State Constitution (Proposition 13). A tension exists between the objectives of designing an equitable or fair tax structure and designing a stable tax structure. Local officials must balance these competing objectives in the design of special tax formulas.

• Tax Equity. The objective of tax equity is best served when individual taxpayers pay only for the benefit that they receive from expenditures financed by the CFD. Applying the benefit principle to the design of CFD boundaries requires the identification of the geographic region that will benefit from the proposed improvements. For CFDs formed on undeveloped land, that area typically encompasses the properties slated for residential, commercial and industrial development. Applying the benefit principle to the design of special tax formulas requires that similar properties be treated as equally as possible.


• Tax Base Stability. The objective of tax base stability is best served by a tax structure that generates a predictable and sufficient stream of revenues. A tax base formed on undeveloped land docs not afford the stability of a tax base formed on developed land. The Mello-Roos Act provides several features to improve the security of the tax structure: the ability to capitalize up to two year's interest payments into the bond issuance; the ability to tax developed and undeveloped land at different rates; and the ability to generate debt service coverage of greater than 1.0. These features tend to shift the responsibility for tax payments to those who are most likely to pay: the homebuyer, for residential properties; or the businessperson, for commercial and industrial properties.

Housing Affordability Issues. The housing affordability advantages of Mello-Roos financing are difficult to surmise on a case-by-case basis. Under certain assumptions, Mello-Roos financing may result in lower housing prices, translating into a lower downpayment requirement for buyers. The annual savings will be influenced by the tax-exempt interest rate on the special tax bonds and the transaction costs associated with the bond sale. The strength of the housing market at the time properties are sold will determine the distribution of the special tax burden between the developer and the buyer.

School Finance Issues. Landowner-approved Mello-Roos financing provides a pragmatic tool for school districts to meet the service demands generated by large-scale development projects. However, the isolation of school construction costs over an area the size of a typical CFD raises equity concerns. A broader participation in school facility finance may be justified by the benefits that accrue to society from an educated populace. Moreover, the disparate distribution of CFDs throughout the state might result in inequitable tax burdens and uneven levels of school construction activity. The two-thirds voter approval requirement is a barrier to the widespread use of Mello-Roos financing for school districts in developed areas of the state.