by guest contributor, Peter Fugiel, Ph.D.
During the Great Depression, the sharp fall-off in property tax receipts was offset by the adoption of state sales taxes and state/local aid programs. Recovery from the current real estate recession may well also rely on increased state aid to local government units. Only this time around, the states ought to take a more balanced, multi-goal approach to their reliance on this key revenue source, an approach that benefits state finances as well.
Recent research conducted by the prestigious Rockefeller Institute at The State University of New York (SUNY) – Albany indicates that U.S. property tax revenues have fallen for the last four years, mostly following the steep decline in home values. (See “The Impact of the Great Recession on Local Property Taxes,” July 2012.) Most troubling is that as home prices continued to fall during 2012, aid to local governments was also falling in many states. In those markets and states where home values will continue to fall or do not rebound to pre-recession levels, an increase in state aid has to be considered.
A major riddle of state finance in the past twenty years is that its mainstay revenue source, the sales tax, has not kept up with the overall growth of the U.S. economy. Legislatures have tended to view the sales taxes as a “this-session’s-dollar-need” tax, in which budget shortfalls are plugged with widely different approaches taken to the each state’s sales tax policies.
Some states tax a wide variety of consumer spending on goods and services. Most states do not. Most states tax business-to-business activity, putting local businesses at a disadvantage. As the state sales tax base fails to keep up with the overall growth of consumer spending, tax rates have to be raised, giving the public the impression that the sales tax on items that are taxed, is out of control.
In addition, many legislatures have exempted food purchases, when, in fact, food purchases by the affluent represent a very large addition to the tax base. While state sales tax practices are extremely various, it is clear that only a few states like Hawaii, Washington, Nevada and Texas have learned how to use the sales tax in a more effective manner. (For a classic summary of state-by-state revenue production, see John Mikesell,”The American Retail Sales Tax,“ The National Tax Journal, March 1997, Table 1.)
Following is a summary of the major trends affecting these two major sources of state and local revenues:
1. While property tax collections, especially for schools, will continue to fall, the most likely way to replace the loss of such substantial revenues over time is for state governments to increase state aid based on a broadening of the sales tax base to include more consumer, but not business-to-business, transactions.
2. The local governments and schools that are most at risk of losing large amounts of property taxes are those in large states where the property tax is the mainstay of local revenues, sometimes equal to at least 40 percent of all school revenues. These states include Illinois, Ohio, New York, Texas, and New Jersey.
3. State sales tax bases can be expanded in many key urban states like Illinois, Michigan, New Jersey, Ohio, and Pennsylvania, where the sales tax effort is below the U.S. average.
4. Many states can use an expansion of their state sales tax bases to achieve fiscal goals beyond providing additional state aid to schools. State programs that encourage local governments to improve their own local sales tax bases would help enhance local community shopping options. State governments could allow localities that increase their local sales tax base to retain a portion of the new collections, in order to spur much-needed local redevelopment.
5. Along with the decline in sales tax receipts as a share of the U.S. economy, the decline in retail shopping in many urban areas is a major threat to a community’s appeal, and ultimately, to a community’s home values.
6. State intercept sales tax pledges for new commercial redevelopment districts, especially for retail-oriented development in new transit districts would add a level of security to local development bonds that only a pledge of state taxes could provide.
7. Communities that want to increase the appeal of their residential areas might well consider improving local shopping simultaneously with shopping-oriented transit. Inter-local agreements, especially, could spur substantial new retail and service sales revenues as local areas capture a higher share of resident shopping and purchases.
8. Correcting severe sales shortfalls for older and landlocked urban communities is a huge policy need. Missing sales tax dollars from urban areas is the most noticeable aspect of the U.S. sales tax profile. It is possible that many major U.S. cities and their suburbs are starved for new shopping alternatives, especially in those areas where reliance on the auto are less important. Every dollar a consumer can save on auto transit costs can be used for public transit-oriented shopping. That is especially true for core cities like Detroit and Newark, where retail sales are only one-third of the U.S. average.
Retail sales and local tax collections can be volatile and unpredictable. Consider the following examples:
New York City – Even though the City has maintained its overall population, and even though its per-capita income is at the U.S. average, the U.S. Census Bureau reports that New York City’s 2007 per-capita retail sales rate was only 72 percent of the U.S. average. Missing one out of every four retail dollars in a city the size of New York is a major policy challenge, not only for retail redevelopment in the City, but for New York State as well. It is not at all clear that home values won’t continue to slump in many markets in the Empire State. More state aid might be necessary.
Los Angeles – Like New York, Los Angeles has had a good population trend, and its municipal boundaries are much broader than are New York’s. Still this Sunbelt city suffers from stiff, almost unique competition from its many interlocking suburbs. As a result, the City’s retail sales per capita were a quarter below the U.S. average in 2007, the last Census reporting date.
Chicago – As with other older urban centers, Chicago has long suffered stiff competition from some of its nearby suburbs for retail customers. Even though Chicago’s per capita income is near the national average, the City’s per-capita retail sales are an amazing 54 percent of the national average. Missing half of your retail base is so startling a challenge, it is a wonder that addressing this shortfall doesn’t have to be a key component of the City’s long-range neighborhood redevelopment strategy.
Houston – Part of the recent “Texas economic miracle” that has been taking place while the national economy was in serious trouble is the state’s reliance on strong municipal governments. Key to the strength of Texas cities is a generous state policy which allows its cities to aggressively annex developing urban areas. That policy shows in Houston’s remarkable retail sales performance. Although the City’s personal income is actually somewhat lower than Chicago’s, its sales tax per capita is two and a half times larger than Chicago’s. What that means is that every sixth dollar that Houston keeps of its local share of sales tax revenues is above the national average.
Seattle – Apart from Hawaii, there is probably no other state in the country that relies on its sales tax and the tax’s broad base to support state and local governments. While Seattle’s per-capita income is quite high, at 150 percent of the U.S. average, its retail sales per capita is more than double the U.S. average. Granted, Seattle is an important tourist destination, yet it is more likely that the City’s high retail sales level is attributable to its lack of suburban retail competition. Like Houston, and even with such combined city-county centers like Indianapolis, Seattle can rely on government and locational factors to explain its remarkable retail sales performance. Perhaps ahead of the times, Washington State is well informed about its fiscal position and the role its sales tax base plays in its remarkable, ’no income tax’ state fiscal structure.
Nationwide, as property taxes continue to sag due to an extended real estate recession, state sales tax efforts have failed to keep up with state budget needs, with past growth in the U.S. economy, and certainly with the demands of urban retail and transit-oriented development. That has to change if the states are going to hold the critical role they play in U.S. fiscal federalism.
Note: U.S. Census Bureau statistics for local 2010 per capita money income and 2007 retail sales per capita numbers are available for state and local governments larger than 5,000 people in the Census Bureau’s State and County Quick Facts.
About the Author:
Peter Fugiel, Ph.D., a housing and public finance consultant in Chicago, is a frequent contributor to MuniNetGuide.com. His firm, PMN Community Services, provides research services to Chicago-area communities based on platform that combines real estate market analysis with municipal bond research.
PMN Community Services recently launched its public finance/housing research website, at USAPublicSectorMetrics.com.
Editor’s Note: The opinions expressed within this article are those of the author, and may not necessarily reflect the views of RICIC, LLC or MuniNetGuide.