ALAMEDA, Calif. — California Controller John Chiang said the city of Bell has been illegally taxing property owners for its retirement obligations, undercutting assumptions the city used to sell more than $9 million of pension obligation bonds in 2005.

Chiang said Friday that the city has been levying a higher-than-permitted property tax rate since 2007.

The working-class city of about 40,000 residents has been under the microscope since reports emerged last month that it was paying its city manager almost $800,000 a year.

The ensuing uproar led to the resignation of manager Robert Rizzo and three other top members of the administration with higher-than-normal pay.

The state attorney general and the local district attorney are investigating Bell. The state controller's office launched an audit at the request of the city's new interim chief administrative officer, Pedro Carrillo.

The illegal tax rates were discovered in the initial phase of that audit, Chiang said.

"While my investigation into the city of Bell continues, these unlawful taxes must stop immediately," he said in a statement.

Bell raised the property tax rate assessed to pay the city's pension obligations from 0.187554% to 0.237554% in 2007, Chiang said, noting that the levy is now 0.277554%.

The increase violates a state law that caps such pension levies at the rate charged in fiscal 1984, according to Chiang.

However, that's not the information the city shared with investors when its Bell Public Financing Authority sold $9.225 million of taxable pension obligation bonds in 2005.

"The city is obligated to levy and collect the retirement tax in an amount sufficient to meet the city's contributions to the California Public Employees' Retirement System," according to the official statement. "The retirement tax has no stated maximum rate or amount within the special purpose for which it is levied."

In its most recent comprehensive annual financial report, for the period ending June 30, 2009, Bell reiterated its intent "to gradually increase the tax levy to the full amount required to meet the city's pension costs."

Because of that commitment, both Fitch Ratings and Standard & Poor's assigned underlying ratings to the pension bonds equal to the city's general obligation bond rating.

On Aug. 10, in the wake of the turmoil surrounding the city, Standard & Poor's lowered Bell's rating to BB from A-minus and placed it on CreditWatch Negative.

Fitch assigns an A-plus rating to Bell's GO and pension bonds. Amy Doppelt, a Fitch managing director, said Monday that the rating agency is reviewing the Bell situation.

Ambac Assurance Corp. — rated Caa2 by Moody's Investors Service, and 'R' for regulatory intervention by S&P — insures the pension bonds.

Such taxes are unusual in California. According to a 2003 staff report by the Senate Local Government Committee, 25 cities and one county imposed such retirement taxes, all approved by local voters before the state's 1978 Proposition 13 property tax cap.

Bell voters approved the city's retirement tax in 1944.

The staff report was prepared for a bill that would have allowed the 26 jurisdictions to raise retirement tax rates above the 1984 limit. The bill cleared the Legislature, but Gov. Gray Davis vetoed it.

According to the official statement for the pension bonds, Bell's city attorney at the time was Edward Lee.

In the wake of the Bell salary revelations, Lee resigned from both his position as Bell's city attorney and his partnership in the law firm Best, Best & Krieger.

Nixon Peabody LLP was bond and disclosure counsel on the pension bond deal.

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