Finance

Breathing Room

On January 29, Florida's voters will decide whether to approve a constitutional amendment -- sent to them by the state legislature -- that would set sharp...
by | December 31, 2007
 

On January 29, Florida's voters will decide whether to approve a constitutional amendment -- sent to them by the state legislature -- that would set sharp limits on what the state's localities can collect in property taxes. While end-of-year polling data suggest that the amendment is not likely to pass, the specter of losing $2 billion for schools and yet more dollars for infrastructure, technology updates, public amenities and all the things that attract business, has been a constant worry for cities, counties and school districts.

Tax decisions are always a tradeoff. While the state's beleaguered homeowners would rejoice over any constraints on the much-loathed property tax, there's a downside to removing taxing power from localities: They come up short of money to invest in things that make an economy tick.

"Local governments are a key local economic actor -- not just an extension of state government," says Michael Pagano, a dean at the University of Illinois at Chicago. "They need to be nimble in the face of economic circumstances -- just like a company does."

Without flexibility, a locality is at the mercy of economic ups and downs and decisions made elsewhere. The locality can't even work with its local business community and taxpayers to craft a system that might best meet all their needs.

Flexibility also is key to global competitiveness, working to attract companies from all over the world and to keep a highly mobile labor force in place. "Any restriction on their ability to raise the money to invest," says Barry Bluestone, director of the Center for Urban and Regional Policy at Northeastern University, "can harm them" -- and, by extension, the home state as well.

Yet a number of states hold local revenue streams hostage, even though most state andlocal tax experts agree that giving localities greater flexibility or breathing room -- with appropriate controls by the state, of course -- is solid fiscal policy. They also agree that it can lead, as Bluestone suggests, to more vibrant support for economic development.

CONTROL ROOM

When a locality has authority over its taxes, it can match its revenue-raising tools to the underlying economy. "If a state imposes a uniform revenue and tax structure on its localities," says Chris Hoene, head of research for the National League of Cities, "it ignores the variation of its localities' economic bases and their diverse spending needs." It is, course, up to each locality to figure out whether a particular revenue-raising tool is worth levying on its constituents -- whether the administrative or transaction costs outweigh the amount of revenue the tax would raise.

At the same time, localities with a great deal of flexibility need to be cognizant of how their taxes and rates fit in with those the state is already levying -- and make sure that the sum total doesn't create an unsupportable tax burden. Or that different local variations on a single tax don't impose unfair strains on businesses in a state.

That said, flexibility is still key and one way states give cities or counties leeway is through a local option to control the tax rate and to use the revenues they raise as they see fit -- that is, without state earmarks. Localities also can breathe better if they have a range of taxes to use. For a locality to weather economic ups and downs, it can't be overly reliant on any one source of revenue.

Most states limit localities to the property and sales tax as a sources of revenue. A few keep their localities really short of breath, limiting them to one tax source. Cities, towns and counties in many New England states, for instance, have access only to a local property tax. "On its own, reliance on the property tax produces powerful inequities in development," Bluestone says. "Rich communities get rich because they can provide better schools and police protection than communities with stagnant and falling property values."

The intersection between local authority and revenue independence is what's known as "own-source capacity." That is, the extent to which fiscal policy decisions made by local government officials actually determine the fiscal direction of the locality. In addition to the tax revenue, there are fees and charges that localities set and that flow into the general revenue coffers. These add to the own-source capacity and enhance a locality's ability to pay for services it wants to provide. This is particularly important in localities that have the primary responsibility for their school funding.

There's another part of the equation, of course. Some states that allow for minimal own-source capacity help to make up for the shortfalls with state aid. While too much state aid can make localities too dependent on the state -- and create state budget problems -- generally speaking, state aid increases the overall capacity of a local government. In many instances, it provides a level of equalization and base support for localities that may lack other resources. State aid to school districts, for example, often relies on an equalization formula to ensure that the state meets its constitutional responsibility of providing adequate support to schoolchildren.

In Massachusetts, which keeps its localities dependent on one tax, state aid has been used to keep the local communities from diverging dramatically, making up in large measure for whatever inequities are produced by reliance on the property tax.

TEL TALK

Another way that local tax systems are constrained significantly is through tax and expenditure limitations -- TELs. There are two main types of TELs: those that put restrictions on revenue raising and those that set limits for overall spending. Spending limits on localities are a good deal less common than tax limits.

Sometimes, TELs are imposed by voters. But state legislatures also do it or, as in Florida, ask voters to approve it. It can, however, be short-sighted. "There's an assumption at the state level," says Kevin O'Brien, former director of the Center for Public Management at Cleveland State University, "that every day is a sunny day and there are no extraordinary circumstances -- that you won't need firefighters on the ridge."

For localities, the most common TELs have to do with property taxes. California's Proposition 13 and Massachusetts' Proposition 2.5 are the uber-TELs. They were imposed by voters, and they have made their mark. "Prop 13 turned California from a state that was among the best in primary and secondary education to a ranking in spending that was near the bottom," says O'Brien, who is currently executive director of the Great Lakes Environmental Finance Center. "That is the legacy of their TEL."

The Massachusetts TEL limits towns and cities from increasing the total property tax levy to no more than 2.5 percent of the community's total assessed value (the levy limit) and from increasing the tax levy to no more than 2.5 percent of the prior year's levy limit. "Homeowners felt they were paying enormously high property taxes," says Bluestone. "And that was because the property tax was essentially the only real source of local revenue."

The bottom line, though, is that the TEL makes it much more difficult for cities and towns to raise the revenue they need. "That you can't raise revenue by more than 2.5 percent on existing property is a powerful constraint," Bluestone says. Towns and cities in Massachusetts often ask voters for an override but these are increasingly unsuccessful, leading to cutbacks in schools and social services -- "just when," Bluestone says, "these communities are competing like never before for jobs and investment."

For state policy makers, there are obvious policy levers to pull to improve the fiscal and economic vitality of local governments. More local tax authority is perhaps most obvious. Maintaining or increasing state aid levels, particularly where state aid reduces inequities, is another -- but one that is often pulled in the opposite direction, particularly in response to economic downturns. Doing so, however, can harm the ability of the state and its localities to recover from the downturn.

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