Your City Uses the Sales Tax. What Now?
(Source: Unsplash/Chris Briggs.)
I’ve previously discussed the reasons a local government shouldn’t rely primarily on the sales tax. Cities reliant on the sales tax find it hard to be concerned about the long-term implications of present actions. Their operations become transactional because transactions are what keep the city flush. They chase big projects, salivating at the potential cash haul while discounting the risk and long-term expense. There is no system of local taxation that undermines the relationship between residents and city hall more than the sales tax.
I’ve also looked at the way sales-tax-funded cities handle debt, and how this magnifies the problems of the sales tax. Routine maintenance is paid out of sales tax revenues while large projects can be bonded for and paid out of a property tax assessment. Instead of spending nickels and dimes on maintenance year after year, keeping the place in good condition, things have to fail so that the repairs can be aggregated into big debt-funded projects. Again, the interests of those at city hall diverges from the interests and expectations of citizens.
While this is all true, none of it comes from ill intention. Charlie Munger, vice president of Berkshire Hathaway, famously said, “Show me the incentive, and I’ll show you the outcome.” The incentives for a city funded primarily by the sales tax are clear. The boom and bust approach, along with negative long-term outcomes, are fairly consistent across sales tax cities. The question is: Does it have to be this way?
What do cities that are stuck with the sales tax as their primary funding mechanism do to become a Strong Town?
The answer requires a commitment to a culture of restraint and accountability. The math is simple; it’s the human element that is the real challenge.
Step 1: Acknowledge the Incentives. Make This Acknowledgement Part of the Culture.
The first step of the Alcoholics Anonymous 12-step approach is a profession of powerlessness. The alcoholic lives in a world where alcohol is readily available, and where there is continuous social pressure to consume. They are called upon to acknowledge their powerlessness to control their own consumption. They do this profession in front of others, not only for personal accountability, but as a way to connect to, and receive support from, other humans who share the same condition.
This first step is really difficult, even painful, but it can’t be skipped. It’s not a show of weakness but a sign of strength. We’re all human; the truly strong wrestle with what being human means.
City leaders—elected officials, appointed officials, senior staff—should routinely acknowledge the incentives of the sales tax system. They need to profess that the sales tax system creates incentives for them to:
Chase projects that boost short-term sales tax revenue.
Overstate the benefits of new sales-tax-generating developments.
Understate the costs and the risks associated with new sales-tax-generating developments.
Discount the value of routine maintenance.
Favor large, concentrated sources of sales tax revenue over smaller, more diffuse sources.
Discount the value of residents outside their role as consumers.
They should do this together. They should do it out loud. Every time they work on the budget, evaluate a new project, or undertake an issue that impacts spending, they should take a moment to acknowledge what the incentives are.
This might seem silly, but it’s not. Acknowledging the incentives creates a culture of accountability. In group decision making, we want to be our collective best selves. By acknowledging the incentives—and how they contradict what we are trying to achieve together—we help each other move past the easy outcome to something more meaningful.
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Step 2: Go Beyond GAAP To Track What Is Really Going On.
The Generally Accepted Accounting Practices (GAAP) for cities creates, in the best of circumstances, a lack of financial transparency. Liabilities are counted as assets. Long-term promises are hidden or ignored. Internal transfers mean that Peter robbing Paul is a standard practice. Cash in the pocket means the budget is balanced, regardless of the future implications. The lack of transparency for decision makers and the public is a feature of GAAP, one that lubricates the financial system, not something nefarious added by local finance officers.
That is true in the best of circumstances. A city funded primarily by the sales tax has an even greater challenge. I’ve called the sales tax a cash cow: revenue that appears on a city’s balance sheet without any feedback loops necessary to discern its cost.
Cities need to go beyond GAAP to create these financial feedback loops. To the greatest extent possible, sales tax revenue should be split into geographic areas. Expenses, including the accumulated liability for future maintenance, should be calculated in the same geographic terms. Due to the volatility of the sales tax, this all needs to be tracked over time to expose trends and gain an understanding of how different land use patterns perform over time.
Don’t think of the city as one big budget. Think of it as multiple geographies, each with their own revenue stream and cost of service, each with their own profit and loss calculation, aggregated together to make a budget. The results of this will be illuminating, even shocking.
A geographic understanding of the sources of revenue and expense is critical to making decisions on growth, development, and public investment. (Source: Urban3.)
Step 3: Figure Out What Works. Do More of That.
Time and again, our instincts betray us. We tend to value the big box store over the downtown shop. We tend to value the new neighborhood over the old. We assume that the things we build today perform better financially than the things our ancestors built. The eye test suggests this, but the math shows otherwise.
Looking at new development proposals, finance directors and project development officials are typically asked to project out revenues and expenses. Going back to the incentives we acknowledged, we know this projection exercise results in wishful thinking, motivated reasoning that tends to overestimate benefits while discounting costs and risks.
When we go beyond GAAP and look at the city geographically, we discover what development patterns make the community wealthier and which rob us of our capacity. A more credible approach, therefore, is to rely on past examples as the best predictor of future results. There are few reasons to believe the new big box store will outperform the old big box store, regardless of what we hope will happen. Similarly, there is every reason to believe an adaptable downtown shop built in the traditional style will continue to outperform.
We can fast-track the things we know have historically worked, measuring the results and trends over time to keep our insights and assumptions grounded in reality.
Step 4: State Assumptions for Projects. Compare With Results.
Having a sales tax as the primary source of revenue does not mean that the city can’t undertake substantial development projects, including things that have not been done before. It does mean, however, that there is an extra duty necessary to perform fiscal tracking and reporting to validate assumptions.
Project development should include answers to the following questions:
What are our up-front cash expenditures?
What is the long-term financial liability we are assuming?
What are the annual maintenance costs we are expected to incur?
What is the new sales tax revenue we are expecting?
What adjustments to sales tax revenue in other parts of the city do we anticipate?
Each of these questions, and potentially more, should be answered with specific dollar amounts, along with an assessment of risk (the anticipated range of volatility for these projections). Those numbers then become the baseline.
As an act of reinforcing the city’s culture of financial accountability, the ongoing results should be reported and compared to the projections. The expectation is that this is done in a high-profile way, with the underlying data available to citizens to reference.
Where there is divergence between projection and outcome, there needs to be discernment as to the causes. We can’t learn from our successes or our mistakes, and we can’t have a real culture of accountability, if we aren’t questioning our own assumptions and holding ourselves accountable.
A city may not be able to change from a sales tax system to a different approach—it might be stuck with what the state allows—but that doesn’t make them helpless to overcome the challenges the sales tax presents.
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Charles Marohn—known as “Chuck” to friends and colleagues—is the founder and president of Strong Towns. He is a land use planner and civil engineer with decades of experience. He holds a bachelor’s degree in civil engineering and a Master of Urban and Regional Planning, both from the University of Minnesota.
Marohn is the author of Strong Towns: A Bottom-Up Revolution to Rebuild American Prosperity (Wiley, 2019) and Confessions of a Recovering Engineer: Transportation for a Strong Town (Wiley 2021). He hosts the Strong Towns Podcast and is a primary writer for Strong Towns’ web content. He has presented Strong Towns concepts in hundreds of cities and towns across North America.