Can Cities Beat the Fiscal Odds?
As the economy continues to show hopeful yet nascent signs of recovery, cities remain cautious about their fiscal condition. They continue to face rising costs of services, stark infrastructure needs, employee obligations, and omnipresent state and federal funding cuts and uncertainties. Still, cities have proven remarkably resilient. Despite a couple of high-profile cases, the vast majority of cities are balancing their budgets and making good on their debt.
But this hasn’t come easy or without consequences. The harsh reality is that municipal governments are operating at 90 percent of their pre-recession revenues, with little growth in sight and limited prospects for tapping into growth sectors within their local economies. Balancing local budgets in this environment is an ongoing process of revenue and expenditure choices that affect the types, levels and costs of services provided in a community. These choices often involve tradeoffs, even among investments critical to growth and innovation, such as infrastructure and workforce.
Take the city of Charlotte, for example. The city is currently looking to close a $21.7 million budget gap left by the state repeal of a business license tax and a surprise drop in property tax values. The city is reviewing its options, which include: pay freezes and eliminating positions; transferring some maintenance expenses from the general fund to a tourism fund (thereby decreasing funds for tourism activities); cutting funding to an arts and science program; and increasing development fees.
After all of this, the city will still be $10-15 million in the hole. Increasing property taxes may be politically infeasible, which likely means deeper and more widespread service cuts, higher fees, and less funding for programs and investments. No doubt, though, the city of Charlotte will find a way to close the gap, but at what cost to their future economic and fiscal health?
Even under these circumstances, our cities are leading change, progress and solutions to the most difficult issues of our time. Chattanooga is bridging the digital divide; Louisville and Buffalo are closing the skills gap; Seattle and San Francisco are raising the minimum wage. If we want grassroots innovations that are even more widespread and sustainable and that drive national economic growth, then cities need more than the fiscal cards they’ve been dealt. They need more than creative workarounds – but instead a consistent toolbox of resources to create the conditions that will accelerate their local and regional economies.
Their Hand: City-State Fiscal Structure
Cities, of course, are creatures of their states. The choices local governments can make are constrained by legal limits on their revenue raising authority.
In a new National League of Cities report, we examine the Cities and State Fiscal Structure across the 50 states and determine that a city’s “hand” is unique within each state and is a mix of:
- Municipal fiscal authority: access to sales, income and property taxes. A mix of revenue sources is needed to provide cities with stability to buffer against economic downturns, and to allow them to capture revenue growth during periods of economic growth. No state uniformly authorizes its municipalities to utilize all three tax sources.
- Municipal revenue reliance and capacity: the amount of revenue (taxes and fees) a city generates that can be used to fund services and their share of resident needs. On average, U.S. municipalities derive approximately 71 percent of their general fund revenues from own-source revenues, including 24 percent from property taxes, 13 percent from sales taxes, 3 percent from income taxes and 32 percent from fees and charges.
- State aid: the amount of state support for a municipality as a proportion of its total revenues. While it could be argued that too much state aid makes municipalities beholden to the state, in general, well-structured state aid can increase the capacity of all cities by equalizing the base support for cities that may lack sufficient resources. State aid has been decreasing despite increases in state mandates and cuts to state services that in turn force cities to pick up the slack (i.e., cuts to higher education or mental health services).
- Tax and Expenditure Limits (TELs): constraints on local fiscal autonomy through voter imposed or state-imposed taxing or spending limitations, most frequently limits on property tax rates, growth in property value assessments, or caps on the total revenue allowed from these taxes. Forty-one states currently have some form of a TEL.
Incredibly, no state has afforded its cities an expansion of municipal fiscal authority since the start of the recession. Local fiscal health remains below pre-recession levels despite burgeoning broader economic recovery in part because authorization of more local revenue authority and other enhanced capacity measures are so rare.
States are balancing budgets too, and in some cases fulfilling tax reform promises on the backs of local governments. Cities in Texas, for example, have traditionally traded lower levels of state aid for more local control but are seeing revenue threats as the state pursues caps on the local property tax. Last week, the state Senate Committee on Finance heard a bill, S.B. 182, which would lower the cap from 8 to 4 percent. This reduction would only provide a typical homeowner in McKinney, Texas a savings of $29.65 annually, but the city would have a revenue loss of $1.4 million. Similar threats are being considered in statehouses across the country.
Hold or Fold
Within these constraints, cities are using the tools available to them, and in some instances, implementing creative financing strategies. In the best case scenarios, strategies like social impact bonds, crowdsourcing, participatory budgeting and even ballot measures can help meet specific needs or increase engagement with the community. But they do not offer long-term, broad-based, reliable, general revenue streams.
Fees and charges have become an increasing proportion of local revenue due to a lack of access to other sources and the political difficulty of raising taxes. Fees and charges include development fees, waste disposal fees, court fees and service fees such as libraries and parks. They can be regressive, making it difficult for lower-income residents to access services, or impose charges on development that can negatively impact economic growth.
Beating the fiscal odds means cities are able to not only balance budgets, but continue to pioneer innovative solutions to the country’s most intractable challenges and lay the foundations for fiscal and economic growth. This requires more local tax authority, access to a mix of revenue sources, state aid that enhances the fiscal base of less-wealthy cities, and a revision of existing tax and expenditure limitations to make them less binding, or better yet, nonexistent.
We are gambling with the economic future of our country if we do not offer our cities more flexible fiscal structures that align with new economic realities and the responsibilities that we lay on their doorsteps.
Read the full 2015 Cities and State Fiscal Structure report here.
About the Author: Christiana K. McFarland is NLC’s Research Director. Follow Christy on Twitter at @ckmcfarland.