Cities Need More Flexibility in How They Tax
Cities are the economic engines of our society. A strong state requires strong cities. Yet under our federal system in the U.S., cities are at the legal mercy of their encompassing states in nearly every way. Although provisions for local autonomy ("home rule") vary from state to state, cities are fundamentally legal creations of the states whose laws can be preempted by state law, and whose powers can be limited by state law. One of the areas where states most often exercise their power over cities, as spotlighted in a new report, is taxation.
Click to enlarge. (Image via Pew Charitable Trusts)
“Local Tax Limitations Can Hamper Fiscal Stability of Cities and Counties“ is both the title and the conclusion of a policy brief by The Pew Charitable Trusts. The authors examine how cities are often profoundly restricted in their powers of taxation, in multiple respects. States may prohibit cities from levying certain types of tax entirely, restrict the tax rate or any potential increase in taxes collected, or require revenue raised from a certain tax to be used for specific purposes.
The result is that, during economic downturns or emergency circumstances such as the pandemic, cities are often hit hardest, and with least ability to make the necessary budgetary adjustments to keep providing expected services. The reasons are many. Among a couple of the most significant ones:
Cities are often highly dependent on a single source of revenue and legally prohibited from using many others. According to the Pew report, most local governments are only allowed to collect one or maybe two of the "big three" taxes (property, sales, and income), and the use of other sources such as excise taxes may be sharply curtailed. (We wrote in 2020 about the particular difficulties faced by sales-tax dependent cities in the pandemic.)
Property taxes in many states are subject to caps on the annual rate of growth in a property owner's tax bill. While these caps (the most infamous of which is California's Prop 13) are generally enacted with the good intention of preventing taxes from pricing out a homeowner or small business owner as property values rise, they can create a nasty "ratchet effect" during economic downturns, as tax collections plummet but then are not allowed to return to normal levels when the economy recovers.
The authors recommend that cities be granted more flexibility to adjust their tax policies in response to local conditions and to meet local needs. Importantly, this does not mean that the overall level of taxation should be higher (or lower). Rather, it is a question of decentralizing decision-making authority and adaptability so that, in times of hardship, cities do not become dependent "wards of the state,” as is so often the case, unable to make the decisions that would best serve their own citizens. (We’ve written about this problem and its consequences in Minnesota and Wyoming, among other places.)
The Pew report makes three recommendations for states to this effect. In their words:
Temporarily lift limitations to give local officials more options for responding to extraordinary fiscal challenges, including recessions and natural disasters. For example, states could allow localities to pass temporary tax changes or use revenue that is normally restricted to specific functions for other purposes.
Adjust limitations that may prevent local government revenue from fully recovering after a downturn. In other words, states can allow tax revenue to grow as the economy recovers.
Increase local budget flexibility in the long term. For example, states can provide financial aid to local governments to mitigate the impact of tax limitations or offer relief from state mandates that increase costs for localities.
You can read the full report here for more case studies and details.
Cover image via Unsplash.
Daniel Herriges has been a regular contributor to Strong Towns since 2015 and is also a founding member of the organization. His work at Strong Towns focuses on housing issues, small-scale and incremental development, urban design, and lowering the barriers to entry for people to participate in creating resilient and prosperous neighborhoods. Daniel has a Masters in Urban and Regional Planning from the University of Minnesota, with a concentration in Housing and Community Development.
Daniel’s work with Strong Towns reflects a lifelong fascination with cities and how they work. When he’s not perusing maps (for work or pleasure), he can be found exploring out-of-the-way neighborhoods on foot or bicycle. Daniel has lived in Northern California and Southwest Florida, and he now resides back in his hometown of St. Paul, Minnesota, along with his wife and two children.