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The Economy Is Booming. So Why Are Cities' Revenues Still Lagging?

The structure of their tax systems doesn't align with their evolving economies.

High-rise condos in Nashville.
The nation has become giddy about the second longest bull market in history, extending now -- the turmoil of the past week notwithstanding -- some 95 months after the trough of the Great Recession. Though there may have been times over the last nine years or so when the economic future seemed to be in peril, right now most parts of the economy look reasonably strong.

But the good fortune is not shared by many city governments. Cities, which are arguably our great engines of economic growth (and the major contributor to the GDP), have been slow to see their general funds return to pre-recessionary levels. The fault lies not in their stars but in the structure of their tax systems.

Data I and my colleagues collected for the National League of Cities shows that more than a decade after the Great Recession constant-dollar general fund revenues are only now beginning to reach the levels they enjoyed prior to 2007. By contrast, states' general funds, according to data from the National Association of State Budget Officers' Fiscal Survey of the States, rebounded to pre-recessionary levels by 2013. Almost exactly the same phenomenon was experienced by the federal government.

Why haven't the cities enjoyed the same kind of revival of their general funds as have the states and federal government? It's because cities' fiscal architecture is not well aligned with the underlying economy. For example, the more progressive nature of the federal income tax and the inclusion of capital gains as a taxable item in most states has meant that record-breaking stock markets have buoyed their general funds. Not so with cities.

Approximately three-fourths of total municipal revenues are raised directly by cities. Of that amount, approximately one-third is derived from the property tax. Sales taxes account for 18 percent and user charges contribute 37 percent. The remainder, or one-fourth of total municipal revenues, consists of transfers, mostly from state and federal governments, that are largely earmarked for specific programs.

New York City is the one significant exception among the nation's large cities. While it does have a property tax, like other municipalities, it also relies on a progressive income tax and a tax on capital gains.

Property taxes do not automatically respond to a booming stock market. On the positive side, they can remain stable even when the stock market tanks. But that's a story for another economic cycle.

The growth rate in property tax collections has slowed from consistently strong levels in the 1990s and 2000s to their more-modest growth levels of the 1980s and early 1990s. Property-value growth rates do not mirror the post-recessionary growth of the GDP.

Taxable sales, which are a revenue source for more than half of America's cities, have also been slow to respond to hearty economic times. This has been particularly true as the economy has shifted from one reliant on manufacturing to one in which services have been the great growth sector. But many services are not taxed, so much of that consumption part of the economy doesn't accrue to the cities' revenue streams. And until the Supreme Court's recent ruling, many e-market transactions and online catalog sales escaped city taxation as well.

But as every local-government policymaker knows only too well, there are significant challenges to bringing in more cash. For one thing, property taxes have long been held to be the most unpopular levy, which can make increases a politically risky move. Just a few months ago, for example, the Nashville Metro Council voted by a hair's breadth to reject an increase in property taxes that would have brought an estimated $150 million in new revenue into the city. The result? Promised cost-of-living increases for city employees were put on hold. Such is the extreme and ongoing nature of this issue that in 2008 the sociologist Isaac William Martin wrote a book -- whose substance still applies -- titled The Permanent Tax Revolt.

To make matters worse, even cities that would like to structure their tax systems in a way that could avoid relying so heavily on property taxes are often prevented from doing so by state controls. Things haven't changed much from the way they were about a decade ago, when I contributed to an article for Governing. A number of states, it reported, "hold local revenue streams hostage, even though most state and local tax experts agree that giving localities greater flexibility or breathing room -- with appropriate controls by the state, of course -- is solid fiscal policy."

Cities need to more closely align their fiscal architecture with their underlying economies, potentially by expanding the sales tax to more services or adding other streams of revenue. If cities' revenues more closely reflected their economies, their fiscal conditions would be in a stronger position today than they were prior to the Great Recession.

Dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago and director of UIC's Government Finance Research Center
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