A new report by the National League of Cities argues that states that have given their municipalities broader local taxing authority and refrained from enacting tax and expenditure limitations, such as Alabama and Missouri, have better equipped those localities to weather the current economic downturn.
Chris Hoene, director of policy and research for the NLC and co-author of the 25-page report released last week, said that for local governments to maintain bond ratings, invest in infrastructure, and be financially solvent, states need to provide sufficient fiscal autonomy for localities to fund their share of residents' needs because those localities are better suited to determine how to use tax revenues.
"The argument that we're making is to allow for more flexibility, more local tax authority, a more diversified revenue portfolio, which allows you to buffer yourself from these economic cycles and it gives you a few more tools with which to balance the budget from year to year," Hoene said in an interview. "The more and more you reduce the flexibility and authority of local governments, the less likely they are to be able to maintain fiscally viable governments."
With many state and local governments facing budget cuts and/or shortfalls starting July 1, typically the start of their fiscal years, the report recommended that states consider authorizing additional local taxing authority, maintaining state aid levels, and resisting pressures to pass permanent tax and spending limits in response to short-term changes in conditions.
But Hoene said that the usual state response tends to be to restrict municipalities when economic times are tough.
"We're trying to make the argument that what's really needed in these times, is that states should be looking at providing local governments with more local authority," he said. "It's a way to prop up local economies, in the sense that you're giving the local governments a chance to fill the [budget] gaps, giving the locals the chance to figure out how to meet their own economic development needs."
The NLC examined the three major sources of state and local tax revenue - property, sales, and income taxes - and rated the municipalities as having "authority" if they have a local option to control the tax rate.
"The most fiscally autonomous municipalities would, therefore, be allowed a local option for all three tax sources and the revenues from those sources would all be for general use," the report said. The report reached this position based on the assumption that local governments are "in the best position to ascertain both the benefits of a diverse revenue-raising toolkit and the costs of implementing such tax policies."
The NLC report also ranked states as "ahead of the pack" or "with the pack" or "behind the pack," according to their municipalities' reliance on the three major tax revenues, the localities' ability to control the majority of their revenues, the amount of state aid as a proportion of their total revenues, and the existence of tax and spending limits.
States that are "ahead of the pack" have access to at least two tax revenue sources and a third source for some jurisdictions and include Alabama, Missouri, New York, and Pennsylvania, the NLC said.
Municipalities in Alabama, for example, have access to a local option property tax and sales tax, and a local option occupation tax or income tax, paid by those working in municipalities that opt to use the tax, the report said.
Even though Kentucky, Ohio, and Washington only have two revenue sources, the NLC placed them in the top tier because they have a broad base of non-property tax revenues.
States that limit municipalities' taxing authority were rated "behind the pack" because the municipalities have access to only one or no local tax source. Idaho, Maine, Massachusetts, New Jersey, and Rhode Island, were part of the group the NLC considered to be lagging behind.
Hoene also said that often when states feel pressure from economic downturns, policymakers or lawmakers will often impose tax and expenditure limits, which hurt local governments most. At the local level, the most common tax and expenditure limitation is over property taxes, such as a property tax rate cap.
The report warned state and local policymakers that it would be "wise to resist the easy temptation of providing tax relief by undermining the local fiscal capacity."
"Tax and expenditure limits tend to have long-term implications that really restrict the capacity of state and local governments over time," Hoene said. "Those policies are made in response to short-term economic cycles, and it's not a very good fix. As much as some policymakers might be inclined to look at these tax and expenditures limits as a response, they tend to play out in such negative ways over the long term because they really tie people's hands in the sense that they're really hard to undo down the road."