Rethinking Local Government Revenue Systems: Why is it necessary?

• Position: RETHINKING REVENUE

The Rethinking Revenue initiative is a joint project of many organizations that have an enduring interest in creating thriving local communities and making sure that those communities are served by capable and ethical local governments. Rethinking Revenue is about providing local governments with the ability to raise enough revenues for the services their communities need--and to raise those revenues fairly and in a way that is consistent with community values.

We contend that rethinking is necessary because local government revenues have not remained aligned with modern economic realities. We will show that this contributes to distortions in the economy and unfairness in how taxpayers are treated. Let's consider the quintessential local government revenue: the property tax. The changing economy has challenged the relevance of the property tax. Most fundamentally, a large part of the value created in the modern economy does not involve property--it often involves less tangible things, like financial instruments or bits and bytes. For example, from 1989 to 2019, the top five fastest-growing categories of wealth held by families were types of financial instruments. (1) This has changed the relative importance of assets in the composition of family wealth. Financial assets increased as share of total assets, from 31% to 42%. The relative share of wealth derived from primary residences and equity in nonresidential property both decreased. (2) 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 sales tax is an important revenue for many local governments. Only recently have sales taxes been applied to online sales. (3) Though this has helped keep the sales tax more relevant than it otherwise would be, sales taxes are routinely not applied to many services. Consumers have been shifting more of their purchases to services over the years. (4) There is not an obvious reason why services should be exempted from the tax.

Other local government revenues have changed over time:

* Fuel taxes do not account for the increase in fuel efficiency and electric vehicles.

* Cable television franchises do not reflect the "cut the cord" phenomena of consumers leaving traditional cable television for online alternatives.

* Many local governments have become more reliant on fees and fines. (5) Fees and fines are appropriate in many cases because the person who benefits from the service pays for it. However, overuse of fees and fines can lead to unfair and counterproductive outcomes for citizens. An example is court fees and fines that make it harder for low-income people to disengage with the justice system. There have been documented cases where local governments spend more money enforcing delinquent court fees and fines than they collect. (6)

Finally, the American Rescue Plan Act [ARPA] has provided temporary revenue to local governments. Though this is not a long-term solution to the problems with the local government revenue system, it does provide breathing room for thoughtful, considered choices about how to reform revenue. We believe that state and local governments should take advantage of this rare opportunity.

Foremost, our outmoded revenue system can result in unfair tax and fee burdens for citizens. Often, who pays the tax does not line up with who can afford to pay or who benefits from public services. For example, people whose wealth is primarily invested in property pay more than those whose wealth is located elsewhere [such as financial instruments]. Most significantly, lower-income people often end up paying a disproportionate burden of local taxes. (7) For instance, lower-income people spend a larger portion of their income on taxable goods than higher-income people, so the sales tax often places a disproportionate burden on low-income people. (8) Also, local governments have come to rely more on fees and fines. (9) These fees and fines typically aren't scaled to the citizen's ability to pay. Even the property tax can disproportionately burden low-income people. One study found that the burden of the property tax falls disproportionately on the owners of the least valuable homes. To illustrate, property valued in the bottom 10% pays an effective rate that is double that of property in the top 10%, on average across the United States. (10)

The disparities created by the existing revenue system are not limited to taxpayers. It creates disparities between local governments, where those governments fortunate enough to have wealthy taxpayers within their jurisdiction can have higher revenues than those that don't. For example, in a state where local sales taxes are important, the city that has the regional shopping...