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To Fix Municipal Finances, States Need to Back Off

To Fix Municipal Finances, States Need to Back Off
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Elizabeth Fretwell was sworn in as city manager of Las Vegas in January 2009. In what can only be described as a bout of very bad timing, at that moment, Las Vegas was on the front edge of a precipitous fall-off in city revenues.

As consumer spending dropped in response to the onset of the crisis, first to drop were revenues from a state-administered tax that includes levies on sales of liquor, cigarettes and other goods, as well as real estate transfers. Before long, city revenues from the property tax followed suit as real estate values in the city began to plummet. In the downtown area alone, the assessed value of land and buildings dropped by $1 billion from its peak between 2008 and 2010. 

In all, the City of Las Vegas saw a 20 percent decline in revenues in just two years.

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In Washington, D.C., and in state capitals across the country, policymakers would respond to a similar declines with a mix of budget cuts and revenue fixes to try and draw in money from other sources. But in Las Vegas, budget cuts were the only available answer.

That's because when it comes to raising revenues, the city’s hands are tied. Local governments in Nevada control just 13 percent of their revenues; the remaining 87 percent are determined by state formulas. As a result, Fretwell had no alternative: she cut 615 positions in city government, amounting to one in five workers. Local government also moved to a cheaper City Hall building, while slashing funds for everything from education and health care and parks.   

Las Vegas is hardly alone in its inability to develop reliable revenue streams that can support local priorities through good times and bad. Indeed, most cities are highly constrained in what they can do by state laws that place limits on local government taxing and spending authority.

Municipal tax and revenue authority varies greatly across the country, depending on state law. Here are just a few examples of how states restrict city revenues:

  • Some states authorize cities to levy only local property taxes (i.e., no sales or income taxes), a common scenario in many Northeastern states.
  • Some cities in Arizona can impose a municipal property tax only after an affirmative vote of the electorate. (It’s because of this that Mesa, with some 400,000 residents, was by far the largest U.S. city without a property tax until 2009.)
  • Sales taxes are allowed in counties, not cities, in Florida and Ohio.
  • Most cities are precluded by state law from collecting local income taxes, although some states make exceptions for individual cities (such as New York City, St. Louis and Kansas City, Missouri).

Of the approximately 600 U.S. cities with populations greater than 50,000, roughly 34 percent have access to the property tax only, 8 percent have access to the income tax (in addition to having access to the property tax), and nearly 58 percent have some retail sales taxing authority.

In addition to authorizing which types of taxes cities can collect, many states place restrictions on tax rates and on other aspects of local tax policy. Tax and expenditure limits placed on local governments by state legislatures and state ballot measures have become so commonplace that they have their own acronym: TELs.

Pressures to pass tax and spending limits in state legislatures and via state ballot measures seem to be a now-permanent part of the political landscape of state and local government, whether it is the progeny of California’s Proposition 13 or Colorado’s Taxpayer Bill of Rights of 1992, or more recent efforts to rein in government in states like Wisconsin.

Diversity Means Reliability of Revenues

Considering that municipalities are the level of government closest to the people, it seems oddly undemocratic that states would so aggressively step in and try to regulate local government authority and decision-making without the explicit consent of the citizens of those cities. What’s more, state laws that hamstring the ability of cities to decide for themselves how to collect the revenues they need can result in cities becoming over-reliant on individual revenue sources — and, consequently, more vulnerable to revenue crises when a particular sector is not performing well.

In the same way that investors can protect their portfolios by diversifying their investments, cities can protect their finances and better weather economic downturns by diversifying their revenue streams. Sales and income tax receipts, for example, tend to reflect immediate shifts in the underlying economic base. If people have less money, they start spending less and sales tax receipts decline. Similarly, as more people become unemployed, income tax receipts take a fairly quick hit. By contrast, property tax receipts tend not to react as swiftly to shifts in economic conditions because of the time it takes for assessments to reflect changes in home values. As a result, property taxes are considered a more stable, less volatile revenue source than other forms of taxes.

Data showing the Great Recession’s impact on city resources demonstrate that not all revenue sources are affected immediately by an economic downturn. Sales tax receipts for cities’ general funds dropped 6.6 percent in 2009 and another 8.4 percent in 2010, while property tax receipts increased 4.2 percent in 2009 before dropping by 2 percent in 2010.

The bottom line is that cities should be able to diversify their revenue sources in ways that they think are best, and that makes the most sense given the nature of their local economies. State lawmakers may feel that cities will do dumb things if they have too much leeway to tax and spend as they want, and some cities surely will make unwise decisions. Of course, those arguments ignore the fact that the electorate can always "throw the bums out."

But to the extent that states continue to micromanage what municipalities can do, they aren’t just constraining city choices; they are limiting the ability of cities to do what’s needed to grow their economies, provide important services, and protect and improve the quality of life for local residents.

"It’s really about needing to be able to have a conversation and do what’s right for the good of the community," Fretwell says. "And right now that’s not in our sphere of control."

Top image: Creativa /Shutterstock

Keywords: Las Vegas, Taxes, Budget, Revenue

Michael A. Pagano is dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago and co-editor of Urban Affairs Review. All posts »

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