CITIES ON THEIR OWN: LOCAL REVENUE WHEN FEDERALISM FAILS.

• Author: Scharff, Erin

Introduction 919 I. Fiscal Federalism in Decline 923 A. Fiscal Federalism 923 B. Responsibility Without Fiscal Authority 927 II. Making Ends Meet 930 A. Other Revenues 930 B. Other Budget Options: Borrowing and Shifting Funding Priorities 937 III. A Way Forward 944 Conclusion 947 INTRODUCTION

As I write in the winter of 2020, the health, fiscal, and, frankly, humanitarian crises confronting U.S. cities continue unabated. The COVID-19 pandemic has required local governments to spend more to retrofit public spaces, increase cleaning frequency and protocols, and expand the work of public health departments. In addition, many local communities have allocated funds to address deepening problems of poverty and hunger and have provided cash assistance to struggling local businesses. (1) Meanwhile, local revenue collections shrank significantly. While not as deep as predicted in March 2020, cities face considerable budget shortfalls. To take a few headline numbers, New York City faces a $3.8 billion shortfall; (2) in October 2020, Chicago predicted a $1.2 billion shortfall; (3) and as of December 2020, Los Angeles officials were struggling with a $675 million shortfall, (4) while San Diego faced an $86 million shortfall. (5)

The pandemic has been especially harsh on the economies of large urban areas. However, even smaller urban communities face significant shortfalls. (6) Meanwhile, a meaningful federal response was slow to materialize. In a functioning federalist system, one might expect the central state to quickly address state and local fiscal challenges that are national in scope. Not only would such funds ensure state and local governments had the money to invest in their responses to the pandemic, but they would also prevent public sector cuts that would otherwise deepen the economic recession. While Washington managed to pass one round of stimulus for U.S. workers and businesses, (7) local governments began making cuts almost immediately. (8) At least some political leaders in Washington seemed to believe that the current fiscal crisis confronting local governments is of their own making. (9) This kind of talk is obviously not grounded in reality, though budget decisions made prior to the pandemic limit local options to respond prudently. The American Rescue Plan passed in March of 2021 provides meaningful federal dollars to assist local governments with revenue shortfalls, but delays in this assistance complicated local governments' response to the pandemic. (10)

The current recession is an unlikely place to draw meaningful lessons about local fiscal health and local financial crises. The fiscal challenges currently confronting urban areas in the United States are sui generis. We are facing a global economic contraction, unprecedented since the Great Depression, driven by public health regulation and advice that discouraged consumer spending. (11) Rebuilding the economy requires an effective public health response, (12) and the speed at which urban environments will recover will depend on how quickly residents and tourists feel it is safe to resume normal life. Scientists have produced a miracle: vaccines that are 90% effective in record time. (13) But how quickly this miracle will result in meaningful public health improvements in the United States remains to be seen, as the vaccine rollout was slow and uneven in its early days. (14)

In the fall of 2020,1 flew to New York City for less than 24 hours to attend a shiva. When will I feel comfortable doing that again? When will global travelers return in large numbers to New York? When will a U.S. passport once again be a gateway to the world? These questions are beyond the scope of this Essay and this symposium, but the answers are at the heart of how long it will take for the U.S. economy (and that of its urban areas) to recover and how such recovery might look.

Though this unique crisis is the result of public health measures, and recovery depends on the success of such measures, it has also exposed the fragility of local revenue and highlighted the fissures in the U.S. body politic. The problem of local revenue sufficiency is not new, nor is the tendency of state and national leaders to blame local fiscal problems on local choices alone rather than understand them to be the result of decisions made at the local, state, and national levels. (15)

This Essay proceeds in three parts. Part I describes the brokenness of U.S. fiscal federalism, which has both devolved significant responsibility to local governments and left them without the fiscal tools commensurate with this responsibility. Part II discusses the ways that local governments have sought to secure own-source revenue in the context of declining state aid and state-imposed revenue restrictions, including the choices cities have made or are considering in their fiscal year budgets for 2021. Part III argues that if localities are really on their own, they should be given the fiscal tools necessary to respond to local problems, including significantly more taxing authority.

1. FISCAL FEDERALISM IN DECLINE

   1. Fiscal Federalism

      Fiscal federalism is an account of how different levels of government (federal, sub-federal, and local) raise and spend revenue. (16) It cautions against redistribution at the local level for fear that such policies will drive exit, which is relatively easy at the local level. (17) (It is manifestly harder to expatriate than to move to suburbia). As a result, conventional wisdom suggests that the national government should pay for redistribution. (18)

      In the United States, the federal government can also more easily spend counter-cyclically. While other countries allow sub-federal governments to borrow, (19) in the United States, balanced-budget requirements restrict state governments' ability to engage in countercyclical spending. (20) Thus, conventional fiscal federalism assumes that a central state would lead the response both to a global public health crisis caused by an easily communicable disease and to its resulting economic crisis. A federal government can more easily coordinate the response by, for example, centralizing the purchase and distribution of personal protective equipment and testing equipment. (21) And governments with independent currencies can more easily borrow to pay the costs of such a response.

      The legal authority granted to local governments by state law assumes functioning fiscal federalism. Such authority seems to contemplate that local governments are chiefly responsible for supplying local public goods and coordinating local services, including trash collection, local parks, and public safety. The local property tax imposes something akin to a benefits tax in that property values reflect the value of such services to taxpayers, implicitly limiting redistribution. But, of course, this is a vast oversimplification. In the 1950s and 1960s, policymakers called for local commuter taxes, recognizing that commuters benefit from the services a city provides. (22) The campaign for equity in education funding, including both litigation and advocacy, has shifted thinking around education. As a result, states now take on a much more significant role in funding what was once commonly understood to be local public goods. (23)

      Over the past several decades, political trends have further undermined assumptions in the fiscal literature about the roles of federal and sub-federal entities in funding government services. (24) While the Affordable Care Act continues to be a significant, relatively new source of distributive federal spending, (25) Republican control of the Senate and the filibuster had, until 2021, otherwise limited the growth of federal anti-poverty efforts, even as the deficit grew, both during recessionary and expansionary periods. (26) Under President Obama, Republicans in the Senate stood united in opposition to giving the President any legislative victories, even for ones that involved significant compromise on their part. (27) The crowning achievement of unified Republican control in Washington was what has come to be known as the Tax Cut and Jobs Act, (28) a policy that ballooned the deficit while providing minimal benefits to low- and moderate-income Americans. (29) But how quickly things change. With the passage of the American Recovery Plan, the 117th Congress committed itself to broad-scale, anti-poverty measures, including tax provisions estimated to reduce child poverty by more than 40%. (30)

      In many states, however, legislative majorities skeptical of social welfare spending remain ascendant. Republicans have a governing trifecta (control of both the governorship and the state legislature) in 23 states as of the 2020 election, while Democrats have similar control of only 15. (31) Many of these Republican trifectas began in the early 2000s or even earlier. (32) At the same time, political polarization has led to a Republican party leadership almost uniformly hostile to tax increases. (33) Of course, Kansas's bipartisan decision to roll back the deep tax cuts imposed earlier this decade suggests that there are limits to this tax-cut orthodoxy even among elected officials. (34) Republican voters are actually more divided on this issue. Polling suggests that a small majority of Republican registered voters support increasing taxes on the super wealthy. (35)

      Meanwhile, urban areas have grown more progressive, in part as a result of a broader trend of spatialized political polarization and demographic differences between rural and urban Americans. (36) This widening gap between urban political preferences and those of the state and (and at times) national governments has meant that redistributive policies supported by potentially large national majorities and smaller state-level majorities lack support among congressional and state-level legislative leadership. As a result of these trends, it is not surprising that local leaders...