The toll of the current public health crisis continues to unfold on municipal budgets with revenue shortfalls anticipated to near $360 billion over the next three years. These shortfalls are impacting families and local economies nationwide as cities respond with tough decisions to furlough or even lay off dedicated staff and cut investments in critical infrastructure and essential services, like summer youth programming and emergency response services. This, even after the federal government provided $1.1 trillion in funding to state and local governments. Given severe restrictions on the funding, only 36 cities out of 19,000 qualify.
With increasing costs related to coronavirus response, increasing needs of residents and businesses as they navigate their own financial pressures, decreasing local revenues, and mandates that cities balance their budgets, how will cities remain fiscally sustainable?
One path that has been suggested is that cities should just rely on their own revenue raising capacities, like increasing taxes. Cities will need to be dynamic as they adjust their budgets to new economic realities. Unfortunately, their options are often hamstrung by tax and expenditure limits (TELs). TELs are state-imposed, and occasionally voter-imposed, restrictions on the ability of local governments to raise taxes or other revenues, or restrictions on how to spend those funds.
To better understand how TELs influence the ability of cities to respond to their current and projected budget shortfalls, we analyze data from the new NLC-Temple University State Preemption Tracker. This legal database focuses on state statutes and constitutions to determine whether or not a state preempts localities. Our findings indicate that nearly every state preempts cities from being able to adapt how they adjust revenues and expenditures, with cities in some states experiencing more stringent and widespread TELs than others.
(Access data appendix here)
TELs and Fiscal Realities
States dictate whether and by how much cities can raise and spend their revenues, and over the past 30 years, this local authority has become increasingly restricted. According to NLC’s long standing City Fiscal Conditions survey of municipal finance officers, since the mid-1990s, irrespective of economic conditions, the percentage of city finance officers reporting increases in property taxes, for example, in any given year has been reported at about this same level. This reflects state-imposed, and in some cases, voter-imposed restrictions, on local property tax authority. Increases in sales, income or other types of tax rates are even less common.
Typically, TELs impact property taxes by limiting the tax rate, growth in the tax rate and total revenue but overall there are six key types of TELs affecting the full range of local taxing and spending authorities:
- Full disclosure tax requirements (or “truth-in-taxation” requirements”): Laws requiring local governments to disclose and hold public hearings on even minute tax changes. These requirements can be a stumbling block as local leaders seek to meet timely fiscal needs within established rules and regulations.
- General revenue limits: A legal limit on annual increases in total revenues from all sources in a jurisdiction. For example, when the economy improves, revenues cannot increase in response, limiting the ability of cities to reap the benefits.
- General expenditure limits: A legal limit on annual increases in a jurisdiction’s total expenditures.
- Property tax rate limits: A legal limit on property tax rates so that they are either frozen or tied to an index or formula.
- Tax assessment limits: A legal limit on annual increases in assessed values that either freezes such values or ties increases to an index or formula. Some states freeze or limit a property’s assessed value until it is sold then start over with the new market value.
- Tax levy limits: A legal limit on the amount of revenue raised by the property tax or on the rate of growth in property tax revenues.
TELs grew in popularity beginning in the 1970’s as states attempted to rein in inflation and cost of government. California’s adoption of Proposition 13 and Colorado’s Taxpayer Bill of Rights (TABOR) ushered in a wave of states in the West turning to TELs as a policy option. These TELs have severely hindered the ability of local governments to respond to fiscal challenges. According to the Public Policy Institute of California, TELs associated with Proposition 13 forced cities to lose out on nearly $70 billion in revenues in 2010 alone, and fundamentally altered the ability of localities to set their own rates and budgets.
TELs Prevalent but Unevenly Applied
As of 2019, our analysis of the data on the six types of TELs in the NLC-Temple University State Preemption Tracker points to at least 48 states that have at least one TEL, with many having more than one restriction. This amounts to a total of 132 TELs in cities nationwide. The most common limits are property tax rate limits (35 states) and tax levy limits (36).
Only two states do not have limitations we examined: Vermont and Hawaii. No state has all six restrictions, but four states (Arizona, Colorado, Nebraska and New York) have different combinations of five of the six TELs. Thirty-four states have what are called potentially binding limits in place. This is either a levy limit (because it caps the bottom-line level at which the levy might increase) or some combination of rate and assessment limits together, leaving cities with few options to adjust their revenue streams.
Limited Budget Choices during a Crisis
Cities will need to adjust their revenue streams in response to COVID-19’s effects on immediate budget concerns, as well as budgets well into the future.
Yet, for most cities, it will not be as simple as relying on their own local tax sources. In fact, just the opposite may happen in Colorado, where a residential assessment rate formula could cause the rate to drop to 5.88% from 7.15%, which would translate to a roughly 18% drop in residential property tax revenues for local governments.
In California, cities will face tough political realities as revenue-proposals, including tax increases, will need to go before voters. In the March elections, California cities had several tax increase proposals rejected by voters, highlighting the challenges cities face when voters are facing their own financial concerns.
In Washington state, cities have been confronted with a 1% limit on annual increases in property taxes. In the first five years after the cap was introduced, cities lost an estimated $500 million in property tax revenue, leaving cities with fewer revenues to keep up with the rising costs of community services. Similarly, a Rice University Kinder Institute study recently reported that the 2019 local property tax cap imposed in Texas will constrain budget options and limit service levels in Dallas and San Antonio.
Excluding Vermont and Hawaii, TELs cover around 19,100 cities, towns, and villages; these municipalities collect over half a trillion in own-source revenue, according to the 2017 Census of Governments.
As a result of restrictions on tax revenues, cities can either cut services or increase the fees charged for services. Of course, increasing fees places greater financial burden on businesses and residents, particularly those who can least afford it. In fact, in response to COVID-19, cities have gone to lengths to spare communities additional hardships by instituting property tax deferments, business license fee suspensions and library charge cancellations.
In the absence of further intergovernmental support, cities are turning to their option of last resort, which is to severely cut services at a time when the community needs them most, to layoff and furlough employees, who comprise a large share of America’s middle class, and to pull back on capital projects, further impacting local employment, business contracts and overall investment in the economy and community.
About the authors
Christiana McFarland is NLC’s Research Director. She leads NLC’s efforts to transform city-level data into information that strengthens the capacity of city leaders and that raises awareness of challenges, trends and successes in cities. Follow her on Twitter @ckmcfarland.
Spencer Wagner is the Program Specialist with NLC’s Local Democracy Initiative. His research focuses on state preemption of local policy and its impacts.