Finance

The Tax Grab Game

Cities are finding ways to raise revenue from suburbanites, without actually calling the levy a commuter tax.
by | April 2007

Talk about a politically charged phrase. "Commuter tax" is such a loaded term that people who support one often try to find some other way of saying it. Alice Rivlin, who's spent much of her professional life managing or overseeing federal budgets and helping to rescue local finances, steers clear of the phrase--even though she's a firm believer in the idea of her hometown, the District of Columbia, taxing the income earned in the city by people who live in the Maryland and Virginia suburbs. "I never use the term 'commuter tax,'" she says. "That's anathema."

It's also the fastest way to doom a city's attempts to raise money from suburbanites. At the heart of the commuter-tax debate is this question: Do the millions of people who enter cities to work each weekday cost more than they contribute to the urban center? Suburbanites almost always answer "no" and they've made sure their representatives in elected office agree. For years, central cities have been learning that this is a fight they can't win as, time and again, their efforts to tax the wages of suburbanites have failed in the face of political tension and economic reality. Often, cities also face the opposition of their own business communities, which believe that such a tax could drive employers away. No city, after all, can be a center of economic activity without its commuters.

But there may be an end run around the commuter-tax dilemma. Quietly, a number of cities are figuring out ways to raise revenue--without also raising the spectre of a commuter tax--from workers who commute to the city. Cities in Ohio and Texas have found success by casting inter-jurisdictional taxation as an alternative to something suburbs and their residents fear even more: annexation.

TO TAX OR ANNEX

There is a definite link between annexation and commuter taxes. Annexation is, after all, the most common way that cities impose commuter taxes: When a city absorbs a suburb, it absorbs its tax base, too.

And annexation can be just as frightening a term as commuter tax. The same sort of urban versus suburban politics that have bogged down commuter taxes also have affected annexation. For decades, there have been growing anti-annexation pressures. In the Northeast, annexation has been relegated to the history books in such states as New York, Pennsylvania and New Jersey. Even where annexation is legal, it is never easy. Omaha enjoys some of the nation's most permissive expansion laws, but its just-completed annexation of the 8,200-person town of Elkhorn happened only after an emotional political battle and a legal dispute that went all the way to the U.S. Supreme Court.

That said, annexation remains a fact of life in much of the country. During the 1990s, many cities acted on their ability to usurp smaller neighbors, with the result that cities expanded by more than 3,000 square miles--an area larger than the state of Delaware--in that time period, according to a recent study by David Rusk, a former Albuquerque mayor and regionalism expert. Rusk also reported a close connection between annexation powers and healthy credit ratings--the additional tax revenue doubtless being a helpful factor. "Although annexation gets tougher and tougher in almost every legislature, in almost every state," Rusk says, "it is not a dying phenomenon."

Nonetheless, it remains politically unpopular with the communities that get annexed. Concerns about such absorption--and the political tumult that ensues--keep both big cities and less-developed areas wary of the action. Many suburbanites fled the cities years ago and don't want the cities coming after them.

But the threat is there. In Ohio, which permits both annexation and traditional commuter taxes, some city leaders are following the lead of Akron Mayor Don Plusquellic who came up with a solution to the tax- or-annex syndrome. In the mid-1990s, Plusquellic, sick of annexation fights, struck a deal with surrounding townships. Akron agreed to supply the townships with water and sewer services in exchange for extending its income tax to their undeveloped commercial areas. Soon after, the Ohio legislature granted permission to other localities to form these arrangements, known as Joint Economic Development Districts.

While the particulars of JEDDs differ, the trade-off is always the same: revenue for services. JEDDs require the consent of the township and city alike. "We don't want to have a situation where there's a tax grab," says state Senator J. Kirk Schuring, who, as a state representative, sponsored the JEDD legislation.

Ohio's JEDDs were designed as a direct response to annexation conflicts. That's especially obvious when considering JEDD's baby brother, CEDA. Cooperative Economic Development Agreements, approved by Ohio a few years after okaying JEDDs, are more sweeping trades of revenue for services. They're often so sweeping, in fact, that in some cases they're practically annexations--except that township land doesn't literally become part of the city. This fact is often enough to squelch the opposition typically associated with annexation. Both JEDDs and CEDAs have cut down on regional competition, too. Rather than central cities and townships fighting it out in a zero-sum game for new development, cities feel empowered to steer development to a surrounding area, knowing they will see a piece of the revenue regardless of where the business decides to locate.

This isn't to say that tensions between cities and townships don't exist. Central cities in Ohio are more powerful than in most states, and one way this is reflected is in their control of water. As a result, townships that want development don't have very much choice but to cooperate with their bigger neighbors. "Clearly, blackmail is a part of it," says Michael Cochran, executive director of the Ohio Township Association. That much was obvious last year when Plusquellic threatened not to supply water to a fire station in a surrounding township after officials there balked at a proposed business relocation.

Still, Cochran acknowledges that even if the playing field isn't level, the JEDDs have generally improved regional relations. "Annexation of our territory was and still is a major issue," he says. "This was one way not to go to that really nasty fight."

VARIATION ON A THEME

Where Ohio has its JEDDs, Texas has its MUDs. Legislation passed in 1999 allowed cities "limited-purpose annexation." The purpose of such annexations, which are codified in agreements between cities and surrounding municipal utility districts--the MUDs--is indeed quite limited: The actions do almost nothing other than win more revenue for cities and MUDs alike.

Houston has struck more than 100 limited-purpose annexations by making this deal: The city extends its sales tax, which is 1 cent higher than the tax in surrounding Harris County, to the MUD. In exchange, the MUD, which doesn't have the power to raise its own taxes, gets half the revenue from the 1-cent increase and a promise that it won't be annexed for 30 years. There generally isn't any exchange of services involved. Since 2001, the city has netted $43 million in revenue in this way.

If that seems like an unfair deal--Houston taking revenue and giving nothing in return--many MUDs don't see it that way. "As with a lot of suburban developments across the nation," says Margaret Wallace, assistant director of Houston's Planning and Development Department, "there can be a fierce independent streak in them." That means that people living in the MUDs prize their local institutions, such as volunteer fire departments, and don't care that Houston could almost certainly enhance the level of services they enjoy. "There isn't agreement out there that we add in any value," Wallace says. For that reason, the three-decade promise of no annexation is seen as a major benefit, easing tensions even as revenue flows from the suburbs to the city.

Although they differ on such major details as the provision of services, the MUDs and JEDDs have several big things in common. One is that, unlike a traditional commuter tax, none of these arrangements punish suburbanites for coming into cities to work. In this way, the fear that the taxes could end up hindering economic development is negated.

Both also differ from regional taxation approaches, such as the Minneapolis area's property-tax-sharing system. Under that system, several hundred municipalities and school districts throughout the Minneapolis metro area, including cities and suburbs alike, share and redistribute property revenue based on a complex formula. But in Texas and Ohio, it's clear which direction the revenue flows: from suburbs to cities.

What's ingenious about the arrangements in Texas and Ohio is that, by and large, they avoid the regional acrimony typically associated with both commuter taxes and annexation. This contrasts starkly with places such as New York City, where the focus on traditional commuter taxes is both a source and symptom of regional tension. Or, as Lee Koppelman, director of SUNY Stony Brook's Center for Regional Policy Studies, puts it, "Regionalism doesn't exist."

Josh Goodman
Josh Goodman  |  Former Staff Writer
mailbox@governing.com

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