Long-Term Remedies for Slumping Sales Tax Revenues

Short-term gimmicks to boost local sales tax revenue aren't working anymore.
July 2010
William Fulton
By William Fulton  |  Columnist
Director of the Kinder Institute for Urban Research at Rice University and former mayor of Ventura, Calif.

Everybody should buy local. It's good for local businesses, it increases local tax revenue, and it makes people feel good about their community.

But do "buy local" campaigns work? They've certainly been in vogue during the recession, especially as sales of big-ticket, big-tax items such as automobiles have been on the decline. Some cities have simply tried to raise awareness. If you shop in the next town, you're paying the salaries of their police officers, not ours. Others have taken more aggressive steps, giving gift cards or rebates for local car purchases. Yet there's one common theme: As retail sales has gone into steep decline in the last few years, jurisdictions nationwide have realized that they can't take sales tax for granted.

It's not surprising that the locals have gotten desperate about sales tax. Over the past few decades, cities and states have become more dependent on the consumer economy to survive. Beginning with California's passage of Proposition 13 more than 30 years ago, property tax--always an extremely stable source of revenue--fell into disfavor. Meanwhile, sales tax--a regressive tax but more painless to pay and hence less unpopular--has become the preferred substitute. It's surely no coincidence that as reliance on property tax has dropped in California, the sales tax rate has risen. Up from 6 percent in 1990, it's now 8.25 percent statewide, with local add-ons that can push it above 10 percent.

Yet consumer spending is volatile, and that means sales tax revenue fluctuates a lot. In the early part of the 2000s, that was good for government, because spending was through the roof-fueled in part by easy access to credit cards and credit lines. Now it's bad for government because spending has fallen through the floor. It appears to be leveling off now, but at a far lower level than was observed at the peak.

Some cities, of course, always have been sensitive to the sales tax issue. Over the past 20 years, I've read maybe a hundred "retail leakage" studies prepared by various consultants for different communities. All of them said there's a "leakage" problem--that their local residents were spending their dollars elsewhere and the community should try to recapture that money. Not one of them ever said that the community was importing sales tax dollars from elsewhere.

Almost without exception, the solution cities adopted was to attract more retailers--often with deep subsidies. In some cases, property tax increment financing was used to subsidize auto dealerships and shopping malls, with the hope of generating a sales-tax payoff. In other cases, cities simply split the sales tax increases with the retailers.

The recent recession has rendered these models outdated, at least for the moment. No increment in property taxes has occurred because property values have been falling, and there has been no increase in sales tax to share.

Nevertheless, some localities continue to subsidize their big retailers to keep them afloat. In May, the Long Beach, Calif., City Council approved a loan to legendary Ford dealer Cal Worthington of $600,000 to keep him going--and stay in town. Other cities may face similarly difficult choices as the auto manufacturing industry contracts.

Other localities have taken a different but equally aggressive approach. Some cities have simply set aside a slug of money to give rebates to people who buy-in their town-big-ticket items like cars. Others have worked with their retailers to offer gift cards: Buy a car, get a gift card worth several hundred dollars for other retailers in town.

In general, these buy local campaigns--or as one wag has called them, "bribe local" campaigns--have had the same effect as the Obama administration's Cash For Clunkers program: A brief boom in sales, followed by a crash back to previous levels when the program ended.

In the end, a buy local campaign that's truly effective is a sustained effort, not one based on gimmicks. This is hard to calibrate with retail thinking, since retailers are always focused, understandably, on the short term and often use gimmicks to boost sales. But all the evidence points to the idea that people will stop leaving town to buy things when two things happen: first, when the stuff they want to buy is available in their town; and second, when they realize that there's a relationship between where they buy stuff and how many police officers and firefighters their city can afford.

With the current retail market in flux, it's a little hard to know just exactly what stuff people are going to want to buy in the future (will they be buying cars or not). Therefore it is hard to know which retailers to go after. But the other half of it is easy: Rather than using short-term gimmicks, cities should use long-term public education efforts to ensure that their residents know where their sales tax dollars go--even when it means pointing to another city.