Why city revenue systems are becoming obsolete
What we buy, how we communicate, the way we get around and even where most of us live looks very little like it did a century ago. And yet local government revenue systems have—at their core—changed very little. The result is that local government revenues have become increasingly inequitable, meaning that they place a greater burden on lower-income folks than anyone else.
This week’s newsletter focuses on a research project based on the idea that this is fixable. Produced by the Government Finance Officers Association and a handful of partners, the “Rethinking Revenue” project shows how local taxes and fees can be inequitable and what we can do to change that.
Today’s edition of LSS will be the first of a two-part series based on this work and my recent conversation with the GFOA’s senior manager of research, Shayne Kavanagh. There’s no paywall this week because I want everyone to have access to what I think are some of the big takeaways from the project thus far. Next week, I’ll switch back to my regular format and explain how some of these takeaways fit in with technology and available federal funding.
What—and who—we tax hasn’t kept up with the times
When was the first time you bought something online? For me, it was sometime around 2000 (back when Amazon.com primarily sold used books to college students). It took another 18 years and a landmark Supreme Court ruling for governments to be allowed to collect sales taxes for online purchases. It opened up the possibility for billions of dollars in additional revenue and just in time for the pandemic when our online shopping habits spiked.
Meanwhile most services still aren’t taxed even as we have shifted to a service-based economy. The report says there “is not an obvious reason why services should be expected from the tax,” but the authors are being polite. The answer is that powerful business interests are good at getting what they want:
Massachusetts' "tech tax" didn't last two months before it was repealed.
Florida passed a tax on all services in 1987. It survived just six months.
Maryland’s 2007 computer services tax in 2007 was repealed before it was implemented.
Admittedly, sales taxes are now being expanded to many digital goods without all that dramatic debate but here’s the point: the consumer economy changes much faster than the sales tax can keep up with.
The same is true for wealth: we’ve gone from oil barons to crypto kings. The report points out that over the past 20 years, financial assets as share of total assets increased from 31% to 42% while the relative share of wealth derived from primary residences and equity in nonresidential property decreased. “In short, wealth has become less connected with real property ownership and therefore does not represent the taxpayer’s ability to pay in the same way it used to,” the authors wrote.
Bottom line: Since local governments (once) relied primarily on sales and property taxes, the modern economy is shifting the tax burden toward those who can least afford it. And because it’s so politically difficult to change these systems to match the modern economy, governments have increasingly relied on fines and fees. This reliance only reinforces the system’s inequities because fines and fees tend to be ineffective and most harmful to those who can least afford it. (For example, court fees and fines that make it harder for low-income people to disengage with the justice system.)
The problem with property taxes
Cities, counties, school districts and special districts raise roughly $500 billion per year in property taxes—roughly 70% of all locally-raised taxes. And on face value, they seem pretty fair because owners of expensive properties pay higher tax bills than those who own low-value properties.
“You’d think it would be progressive because of that,” Kavanagh says. “But because of the way assessments are conducted it tends to be regressive.”
Researchers at the University of Chicago’s Center for Municipal Finance (one of the Rethinking Revenue project partners) found that the burden of the property tax falls disproportionately on the owners of the least valuable homes. That’s because of assessments: More expensive properties are undervalued, while less expensive properties tend to be overvalued. The result is that owners of property valued in the bottom 10% pay an effective rate that is double that of property in the top 10%.
The findings led the New York Times editorial board to declare that “local governments are failing at the basic task of accurately assessing property values,” and that in doing so, “government is worsening the large and growing inequalities in the distribution of wealth and income.”
Related reading
Gaming the assessments system: Big-Box Stores Battle Local Governments Over Property Taxes
Minority homeowners face higher tax assessment rates than Whites, but there’s an easy fix
Diversification isn’t what you think it is
Kavanagh told me tax diversification isn’t a well-understood concept. “It tends to be viewed as ‘taxing different things’ but that doesn’t take into account the correlation between revenue streams,” he said.
For example, hotel taxes and sales taxes tend to go up and down together because they’re taxing the same part of the economy: consumption.
“It’s like saying, ‘I have a diversified portfolio—I’ve invested in ALL the oil companies,’” Kavanagh explained.
This also relates to tax fairness and the inequities that were highlighted by the pandemic. The social distancing measures put in place to slow the spread of the coronavirus disproportionately impacted service workers either financially or through their health and well-being by placing them on the front lines. The majority of these workers are lower-income and people of color—the same folks that the revenue project shows pay a higher tax burden.
“If the same group of people is disadvantaged by every revenue source in the portfolio,” Part 2 of the report says, “the impact will be much different than if different groups of people bear the disadvantages of different sources.”
In other words the K-shaped recovery from the pandemic recession is a result of both the economic prospects for disadvantaged populations and the financial burden placed on them by the structure of government revenue systems.
Related reading
Legal financing: using lawsuits to vindicate the public’s interest and receive compensation to help address community problems
That’s it for this week! Next week, I’ll talk about some of the pilot programs GFOA is launching as a result of this research, as well as the potential opportunities to leverage federal funding and technology.
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