Trends in infrastructure funding: the other Year 2000 problem.

• Author: Pagano, MIchael A.

A National League of Cities survey demonstrates that operating revenues and spending grow only incrementally compared to capital revenue and spending.

The unprecedented economic growth of the past seven years has benefited not only individuals and corporate bottom lines, but also the public treasuries of all levels of government. However, municipal governments have experienced comparatively modest increases in revenues while federal revenue growth has increased dramatically since 1992; and the growth rate in state revenues has outpaced the growth in the nation's Gross Domestic Product (GDP).

As robust as the economy has been in the past seven years, the rising tide does not lift all boats equally. The extent to which government finances have improved depends in large part on their taxing authority and principal general tax source. Yet, even as the revenue growth has been generally upward, spending for physical facilities (infrastructure) has been stronger still. The fortuitous fiscal position of cities should not be squandered, lest the cities of the 21st Century face another round of crumbling infrastructure and cities in ruin.

Revenues

Federal, state, and city governments depend to a certain extent on different revenue sources. States rely on income and sales taxes; the federal government on individual income taxes; and municipalities on a blend of property taxes, user fees, specific taxes, and, for some cities, sales and income taxes. Estimates of the revenue responsiveness of income tax systems (revenue elasticity) is 1.75 meaning that as personal incomes grow by 1 percent, general tax revenues increase by 1.75 percent. For sales tax, the elasticity is approximately 1 percent; and for the property tax 0.75 percent. Not surprisingly, federal tax revenues have grown at a greater annual rate than the GDP. States' revenue growth has kept pace with the growth in GDP, while cities' revenue growth has not. Indeed, growth in cities' revenues has fallen behind the revenue growth rate of the states and federal governments since 1993. See Exhibit 1.

When the economy is robust, revenues increase commensurately, filling federal and state coffers. Since city governments rely more heavily on the property tax, municipal revenues will increase at a slower rate than state and federal revenues during times of economic growth. However, during recessionary periods, municipal revenues can show greater resilience than state or federal revenues. Therefore, there is a trade-off present in selecting different revenue structures. A revenue system based primarily on an income tax ought to enjoy greater revenue growth during times of prosperity, but will probably decline dramatically during times of economic contraction. Property taxes provide a more stable source of revenues for governments across the boom and bust of economic cycles. Although cities currently are not enjoying the same revenue growth as the federal government, cities' fiscal situations are likely to decline less dramatically when the economy slides into recession.

Even though average municipal revenue growth has lagged behind average state and federal revenue growth, the revenue structures of all municipalities are not alike. One illustration shows this diversity across the municipal sector. General fund revenue growth between FY 1996 and FY 1997 averaged 5.29 percent for all municipalities with populations greater than 50,000. The average...