Rethinking Local Government Revenue Systems": PART 2: Criteria to evaluate local government revenue.

• 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.

In the February 2022 issue of Government Finance Review, we explored the imperative to rethink how local governments fund services in "Rethinking Local Government Revenue Systems." This article defined the problems that local governments' revenue systems create for local governments and their taxpayers and ratepayers. In short, local government revenues have not remained aligned with modern economic realities. This contributes to distortions in the economy and unfairness in how taxpayers are treated. An antiquated revenue system impacts local governments' ability to provide services critical to the needs of their communities.

There are many options for how local government revenues could be changed. To help guide us toward the best options, this article is dedicated to developing a set of evaluation criteria. These criteria will help us differentiate between how local governments could raise revenue and how they should raise revenue. How local governments should raise revenue is not just or even a technical question of economics or finance. As we will see, questions of fairness and accountability of local government to the public are critical. The criteria will be used by the Rethinking Revenue initiative to evaluate suggestions we have for state and local governments as our initiative moves forward. More importantly, we hope that the criteria can encourage a reexamination of local revenue by state and local government policymakers and help guide conversations about the future of local government revenue.

Isaac Newton said: "If I have seen further, it is by standing on the shoulders of giants." In this spirit, the Rethinking Revenue initiative began this phase with the National League of Cities report, Toward a System of Public Finance for the 21st Century, which identified Guiding Principles for a Public Finance System. (1) We updated and adapted those ideas for the Rethinking Revenue initiative. We also would like to acknowledge the work of the National Conference of State Legislatures in its "Principles of a High-Quality Revenue System, 4th Edition." (2)

The purpose of the Rethinking Revenue initiative is to engage state and local government leaders in a conversation about better ways to raise revenue for local government. The criteria we describe in this article are meant to set the terms for the conversation, not to settle a debate about which sources of revenue or methods of raising revenue are "best." As you read the criteria, you might come to doubt that it is possible to find a source that satisfies all the criteria. Your doubt would be well-founded for two reasons:

First, there are inevitable conflicts between criteria. For a revenue source to do well on one criterion, it may do worse on another. To illustrate, a revenue source associated with the public service it is intended to fund might give the public a sense of accountability. A local tax might be legally restricted to use for repairing streets. However, this might limit the source's contribution to the overall adequacy of the local government's revenue-producing capacity: If street repair becomes less of a concern in the future, then revenue would be tied to this now suboptimal use. There are even potential conflicts within the criterion. As we will see, people define "fairness" differently, yet fairness is essential for the continuity of a revenue system in a democratic government.

Second, the local government revenue system is complex. This means that there are many "moving parts," and those moving parts interact with each other. For example, an individual local government may have different revenue sources. Each source will perform differently against our criteria. Additionally, when all of those sources are considered together as one revenue portfolio, the revenue portfolio might perform differently against our criteria than any single source (as in, the whole is different than the sum of its parts). Let's illustrate with our criterion of fairness to taxpayers and ratepayers. No revenue source can be fair to all people. Some people will be burdened more than others. However, if the same group of people is disadvantaged by every revenue source in the portfolio, the impact will be much different than if different groups of people bear the disadvantages of different sources. The former amplifies the disadvantage for the disfavored group, while the latter attenuates the disadvantage by distributing the disadvantages among many taxpayers and ratepayers. Of course, local governments don't exist in isolation. The behavior of other local governments adds to the complexity, but a more important consideration is the policy of state governments.

State governments play a special role in local revenue systems because, in the U.S. federal system of government, local governments receive their power and authority from their states. Therefore, local government revenue sources are created and regulated by states. * The requirement to align state policy with the revenue needs of local government complicates rethinking revenues but also provides the opportunity for experimentation with different revenue arrangements in different states.

This means that trade-offs and compromises will be necessary to create a better local government revenue system. Nevertheless, state and local government leaders can use criteria described in this article to 1) evaluate current and potential new revenue sources; 2) evaluate how those sources add up to a complete revenue system; 3) assure stakeholders that a comprehensive and transparent set of criteria guided the evaluation; and 4) reach decisions that satisfy as many conditions of an ideal revenue-raising system as is practical, while reflecting the values, preferences, and needs of the community.

Criteria to Evaluate Local Government Revenue

The rest of this article is dedicated to exploring our six criteria to evaluate local government revenues. Each criterion is concluded by a set of "questions and conversation starters" to show how to apply the criteria to real-world questions about local government revenues. These questions, though, are not meant to be comprehensive. The reader is encouraged to think about other questions these criteria might raise for starting a conversation that reflects local circumstances.

The reader should also consider how the criteria (and the questions and conversation starters) might take on a different character when used to evaluate a complete revenue system versus an individual source. A "source" is one particular means through which a government raises revenue, like the property tax. The "system" is the portfolio of all revenue sources a local government has, plus the impacts of the policies of other governments, particularly state governments. We suggest that the criteria are useful for evaluating both systems and individual sources. The fact that they might apply differently to systems versus sources can help reveal the complexities in rethinking revenue.

Finally, consider that the criteria are not necessarily "goals" for a local government revenue system. This is because the criteria invite discussion of the trade-offs that must be made. A goal...