The Fairest Tax During a Recession May Be the Least Popular

What's "fair" changes along with the economy.
February 2019
By Justin Marlowe  |  Columnist
Endowed Professor of Public Finance and Civic Engagement at the Daniel J. Evans School of Public Policy & Governance at the University of Washington

All good things must end. Such is the case, economists tell us, with our roaring, post-recession economy. Goodbye bulls. Hello bears.

A slowing economy means public finance folks are once again asking how local governments can -- and should -- respond to the next downturn. Fortunately, the 10 years since the start of the Great Recession hold some useful clues that might be helpful this time around, especially about taxes.

One of the oldest questions in public finance is, “What is a fair tax?” Experts answer this question with a long wish list of criteria: A tax should minimally impact how businesses and consumers make investment decisions. It shouldn’t cost the government too much to collect. Taxpayers who owe the same amount should pay the same amount. And so forth. There’s no uniformly fair tax, but the three main local government taxes -- property, sales and income -- are fair enough for the thousands of governments that collect them.

But during a recession, “fair” can mean something different. When people are out of work, it’s fair for them to expect to pay less taxes. It’s also good economics, since consumers with more money to spend can help push the economy out of a recession. But that puts local governments in a quandary. On the one hand, they need to collect enough revenue to deliver basic services. Unlike the federal government, localities can’t borrow their way out of a budget deficit. On the other hand, if local taxes are too high, then local taxpayers suffer and the recession gets worse.

The property tax illustrates this dilemma well. Most consider it equitable, predictable and reasonably transparent. It might be unpopular, but it’s one of the fairest local revenues available. But during a recession, those paying a property tax can’t do much to reduce their bill. It’s not feasible to sell, rent or downsize when you’re out of work and property values are down. By contrast, taxpayers can reduce their local sales tax bill by holding off on purchasing that new dishwasher. Their local income tax bill will be reduced if they make less money.

The bottom line here is that the qualities that make the property tax fair in a growing economy make it just as unfair in a recession. By contrast, volatile sales and income taxes are tough to manage in boom times, but they offer taxpayers an off-ramp during recessions. In other words, the conventional wisdom tells us there’s a trade-off. No tax is fair in both boom times and recessions.

Or so we thought. A quick review of Census data shows that during the Great Recession, county governments where property taxes are the largest share of local revenues experienced some of the smallest increases in unemployment relative to other counties. Employment in those counties also recovered much faster after the Great Recession. In other words, the downturn was not nearly as bad in those counties as it was elsewhere. Meanwhile, counties that depend mostly on income taxes suffered much greater increases in unemployment and took much longer to recover.

It turns out that stable, predictable revenue sources helped, rather than hurt, local economies during the Great Recession. Why? One big reason is counties that depend mostly on property taxes also made comparatively small cuts to their local government workforces. Those stable revenues help the spending side of the ledger, and that, in turn, helps to prop up the local economy during a downturn. It’s clear that the fairness trade-off is not actually a trade-off.

All this suggests there’s no one-size-fits-all local government response to a recession. What’s fair, and what’s effective, depends in large part on a local government’s revenue structure and how that revenue structure shapes and is shaped by the local economy. Local leaders and state policymakers who want to help localities prepare for the next recession should heed this important lesson from the Great Recession.