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The effects of Prop 13 [California’s Proposition 13] have been felt most strongly, though, in local politics. Before the Jarvis-Gann measure, local agencies and their boards had dual duties. They decided how much to spend on public services, and they set the property tax rate needed to supply that money. . . .

Without the power to tax, local governments were less of an immediate threat to local pocketbooks. It was no longer necessary for business and taxpayer groups to watch them so carefully. And so leaders of business groups began a retreat from local service.

(Joe Mathews and Mark Paul 2010, 54–55)

The Upper Cascadia County public safety teaching case points out the challenges of obtaining revenues to fully fund this fictional county’s public safety programs. The rejection of a renewal levy by county voters at the last election sparked a chain of events with large, small, near-term, and long-term consequences. Faced with a pending reduction in revenues, the county’s finance director, Elizabeth Brown, the department analysts and directors, and the county executive implemented thoughtful but broad reductions in services and programs. County administrators have followed the expressed directions of the voters and trimmed programs and services. From the teaching case, we can infer that a few public safety services, such as the sheriff’s patrols and emergency call response, will remain as before, but many other important services concerning inmate release, reentry, and retraining; domestic abuse response; criminal prosecution; and youth and juvenile services will either close or fall to a reduced level. With the immediate program reductions in place, county administrators must now figure out the best way to reestablish and rebuild funding for the public safety function.

All local governments face the challenge of securing and blending revenue sources to support their programs, operations, and capital investments. Taxes, charges and fees, fines and penalties, intergovernmental revenues, nongovernmental grants, and borrowed funds provide the primary revenues for local governments. Based on these sources, local governments strive to develop a diversified, consistent, durable, and resilient resource base from which to fund their programs. The active design and management of a revenue system requires attention to the policy intention and regulatory structure of the system, and to its implementation and operation (Mikesell 2005, 99). Not only must local governments design a diversified, sustainable, and publicly acceptable revenue portfolio, but they must implement their revenue system in a fair and open manner. The Upper Cascadia County teaching case demonstrates that while government revenues often seem somewhat “guaranteed,” voters may exercise unexpected choices. Proactive entrepreneurial efforts are necessary to develop and maintain revenue flows for governmental programs. Administrators have a critical leadership role in educating elected officials and the public on the need for revenue

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development activities, on the value citizens receive for the revenue, and on the technical aspects of effective revenue system design and implementation.

To explain this challenge fully, this chapter opens with an overview of the sources and types of revenues used by county, city, and special district local governments. This includes a discus- sion of taxation, charges for service and fees for service, intergovernmental revenues, and other governmental resources. Intergovernmental grants and reimbursements typically do not fully cover the local government costs of meeting state and federal requirements. Based on this imbalance, the chapter touches on the challenges of unfunded and underfunded mandates. It then discusses the differences among state government revenue sources and local government sources, including how different sizes and types of local government rely on different blends and sources of gov- ernmental revenues in their attempts to develop a sturdy revenue base. The chapter explores this variability and provides a summary of the tax and revenue burden state and local governments place on citizens in the different states.

The relative importance and balance of the different revenue collections has changed over time. The 1970s brought a major reduction in the importance of local property taxes due to property tax limitation initiatives that were spawned by California’s Proposition 13. Between 1980 and 2003, however, changes in the balance of revenue sources were less dramatic (Mikesell 2005). Property tax, individual income tax, and utility and liquor sales tax receipts have declined slightly in importance. Local option sales taxes, along with charges and fees for service receipts, rose to replace some of the lost property and income tax revenues. This chapter closes by considering the continuing impacts of the financial downturn and recession of 2007–2009 on the balance of future local government revenues.

SOURCES OF LOCAL GOVERNMENT REVENUES1

State statutes and regulations provide local governments with the authority to raise and collect revenues in order to carry out their legally authorized missions. In the United States, local gov- ernments stand as a third quasi-independent government alongside the federal and state levels because of their delegated authority to independently raise revenues. Acting within the structures and constraints set by state laws, local governments access and use revenues from a variety of sources to fund their programs and activities. The blend of revenues tapped by each local gov- ernment reflects state statutes, the health of the local economy, and the local political culture and citizen attitudes toward government and taxation. As the chapter’s introductory epigraph explains, taxation motivates citizens to take an active interest in local community governance. Without ef- fective taxation authority, California’s local governments lost business leaders as active members of their local polities. Business leaders with their backgrounds in finance should provide a critical oversight to local government finance and revenue decisions. This expertise was lost in California with the passage of Proposition 13, which shifted many revenue generation decisions away from local governments to the state capitol in Sacramento.

The rationale behind the American Revolution presents a stark contrast to the loss of citizen interest in local tax and revenue issues. The British imposition of the Stamp Act and other mercantile duties on the American colonies without their representation in Parliament resulted in a loss of American confidence in government efforts to raise revenues. The failure of the British govern- ment to hear and respond to colonists’ pleas and expectations fueled the war for independence. A functioning tax and revenue system requires involvement both by citizens and by government institutions to clarify needs, set expectations, and ensure transparency in decision making.

State taxation and revenue structures vary widely from one state to another. Each state’s con- stitution, statutes, administrative regulations, manuals and handbooks, judicial precedents, and traditions combine to define the framework within which local governments in the state may raise

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revenues. The state framework in turn shapes the kind of financial and revenue relationship that local governments have with respect to their parent state. Local revenue authority illustrates and expresses the principle of federalism that is extended downward from the national government through the states and finally to local jurisdictions. In keeping with the American decentralized model of federalism, states typically do not micro-manage the financial decisions of local govern- ments, but they do exert control on local revenue generation in a variety of ways. State laws and regulations authorize local government to collect tax and fee revenues. State laws and regulations also may (1) limit tax rates, (2) cap the total potential collection or tax levy, (3) define property valuation practices, and (4) define the procedures by which a local government considers and im- poses a tax or changes rates for charges and fees. State manuals and regulations define the formats and reporting that structure revenue collection procedures for local governing jurisdictions. On a more subtle level, state reimbursements, matching funds, and grants motivate local governments to adopt preferred programs and adhere to required procedures (Henkels 2005, 205 and 221). As the Upper Cascadia County public safety services teaching case demonstrates, state laws define procedures for placing property tax proposals before the voters, and state courts determine the constitutionality of revenue generating strategies, especially property tax rate limitations.

Ideally, different sources of revenue will blend to provide a diversified, stable flow of resources to a local government. A diversified revenue base reflects a roughly equal proportional balance of different tax revenues (Carroll, Eger, and Marlowe 2003; Carroll 2009; Carroll and Johnson 2010). Diversification also applies to the balance of tax and nontax revenues and to the balance of different intergovernmental revenues sources (Carroll, Eger, and Marlowe 2003). An effective balance of revenue sources enhances the prospects for stability over time. This stability is important for sustaining organizational competence and capacity and developing program activities that ef- fectively address community needs. Under a diversified balance of revenues, a temporary increase in one source of revenue can help to offset a cyclical or temporary decline in another source. For example, during a period of economic downturn, individual and business income taxes quickly fall, reflecting a contracting economy. In contrast, property taxes fall at a slower rate because of the lag time that delays the application of lower assessments to all properties in the district. State property tax limitations also have the effect of dampening fluctuations in property values.

The complexity and variability of the impact of the economy means that local governments need to develop a revenue mixture that consistently generates the funds needed to support exist- ing services. A diverse portfolio of taxes may also increase taxpayer equity by extending several different levies to all groups of citizens and types of economic activity. For example, a retail sales tax will capture revenues from tourists and out-of-state visitors who do not own property or earn income in the state. The following sections introduce the different forms of local government rev- enues and summarize their strengths and weaknesses. The overview deals first with tax revenues that require ballot initiatives or legislative action for their adoption. In importance, these sources include taxes, charges and fees for service, and fines and penalties. The overview then turns to revenue forms that require administrative action for acquisition. These include the major category of intergovernmental revenues, as well as those generated through the financial system.

Revenue Source: Taxes

Taxes provide the primary revenue source for most governments, but as we’ve just described, levying and collecting taxes quickly raises concerns among citizens. Taxation has equity benefits that other revenue raising techniques lack. An understanding of why governments levy taxes and how they seek to generate fairness and equity in a tax system is critical to its public acceptance. To build this understanding, we turn next to a discussion of some basic tax theory and then to a discussion of tax system equity and fairness.

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Why Tax? The Economic Intent of Taxation

The purpose of a tax is to fully recover costs from all possible citizens who could benefit from a good or service. A broad-based tax with effective collection spreads the tax burden and lowers each citizen’s proportional share (Mikesell 2005). Taxation also accommodates variation in citizen demand for a service. Communities and local governments do not know exactly how much each citizen desires a particular public service, but a broadly and consistently applied tax assures pro- gram cost recovery and prevents free riders from taking advantage of the services without paying for them (Browning and Browning 1992; Irvin and Carr 2005).

Taxes are especially effective in covering the costs of public goods and nonmarket govern- mental services. Once a public good is made available to all citizens, it is difficult to limit access to the good or service: the delivered benefit is not exclusive to a particular citizen. It is also very difficult to assign a specific cost for a public good to each taxpayer. For example, when a com- munity decides that a local library is a community good, it becomes difficult to fund the library operation solely out of user fees. The library becomes a public benefit (public good) for all and a community amenity, whether a citizen chooses to use it or not. It is better to fund the library out of taxes that everyone pays. Familiar public goods provided by most local governments include clean and affordable water, sewers, a well-maintained street and transportation system, a broadly educated citizenry, a safe community, national defense, scenery, and a clean environment.

Some governmental services produce nonmarket goods and services. Such services cannot be valued, or are purposely not valued, through market transactions. To value such services in the market (1) would place a monetary value on inalienable rights of citizenship, (2) might actually jeopardize constitutional protections, or (3) could, perhaps, raise questions of ethical conflict of interest. Nonmarket governmental services include (but are not limited to) elections management, property tax assessment, criminal procedures and issues, and matters involving civil rights. Again, a broadly based, equitable tax allows the community to provide these nonmarket services to all of its citizens.

As a public finance tool, a tax recovers an increment of value from one of three economic bases: wealth, consumption, or income. As examples, property taxes capture a percentage of the value of the accumulated wealth of individuals and corporations. Retail sale taxes, use taxes, motor fuel taxes, and excise taxes all tax the value of consumption at the point of sale to the consumer. Individual income taxes capture a portion of the value of income generated by residents who live in the jurisdiction or of workers who work in the jurisdiction but live outside its boundaries.

Most states rely on some blend of tax revenue from property, income, and sales taxes. Where a state does not impose an income tax or a sales tax, it must make up the foregone revenue through some other type of tax. Not imposing a particular type of tax might be advantageous to certain types of businesses, which can lead to increased private investment and job growth. As examples, a deferral of property taxes and a favorable corporate income tax treatment of large and costly manufacturing equipment may encourage equipment-dependent businesses to settle in a particular state. Alternatively, favorable treatment of capital gains revenues on income taxes may support personal small businesses and entrepreneurs seeking to capture value in their companies. Under- standing the tax environment imposed by a state requires a comprehensive understanding of how the different taxes integrate to create a total tax burden on property owners, businesses, and citizens. We examine the relative tax burdens among the different states later in the chapter.

Tax Acceptance and Fairness

The tax transaction asks individual and corporate taxpayers to pay a cost in return for a set of benefits of roughly comparable value. For most taxpayers, the combination of direct personal benefits and

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indirect community benefits must roughly equal or exceed the taxes paid. Each citizen’s preference of the exact balance of K–12 schools, police protection, fire protection, public works, parks and recreation, libraries, or social services is never fully known. Communities and local governments don’t know exactly how much each citizen desires, or doesn’t desire, a particular public service (see the discussion of Anthony Downs’s theory of relative ignorance in chapter 1). Statistical in- dicators, user counts, demographic information, and public opinion surveys give an indication of a community’s aggregate demand for different services. State law may require counties or cities to provide a minimal volume and quality of a particular service irrespective of citizen preferences. In practice, local government programs represent a bundle of transactions that cover an array of services and an array of service delivery approaches. An individual taxpayer might prefer more or less of a particular service, or delivery of a service in a certain manner. A citizen might prefer more funding for public safety, prefer less to fund mail-in or electronic voting, and be satisfied with contracted fire protection services. Voters may find a particular program or service to be unnecessary, wasteful, and even philosophically repugnant, but they are forced to pay into the service because it is part of a larger bundle. Thus, to gain broad coverage of all beneficiaries and low per citizen costs, taxes are compulsory on members of the community to a greater or lesser degree. Economist Charles Tiebout (1956) argues that, if citizens are freed from constraints such as property ownership or employment requirements, they will move into or out of a community to match the level and blend of public services that they desire and can afford. This selective shopping behavior often becomes evident when new residents move into a metropolitan region and have a choice of residing in one of several school districts and numerous local jurisdictions. However, national technical and professional standards, state and regional codes, and citizen expectations have led to a surprisingly uniform selection and quality of local government services.

The broad, compulsory coverage of effective taxation contrasts with the somewhat volun- tary nature of charges and fees for services. In a charge or fee for services transaction, a citizen chooses to pay for the government service consumed. For some citizens, a fee is preferable to a tax because it theoretically recognizes the economic liberty of the citizen purchaser. But the charge for services transaction for government services is not a simple two-party exchange. Most governmental services generate not only the purchased benefits to the individual, but also public benefits to the community as a whole. In paying a charge, the purchaser is in effect paying for a share of the community’s public benefit generated by the service. Funding government services through taxes shifts the cost of community benefits back onto all taxpayers.

Each community must find a balance between services supported by taxes, those supported by fees, and those that are left to citizen responsibility. As examples, citizens in extremely high wealth communities find less need to fund local public libraries because, through personal wealth, they have access to all necessary books and media sources. Similarly, citizens in wealthy gated communities may not prefer a full level of police and public safety protection because the com- munity association provides its own private security services. Parents with religious preferences may prefer to homeschool their children in lieu of using secular local public schools. Parents who practice homeschooling may be reluctant to support taxes for the local school district.

Those who are suspicious of taxation often perceive no direct benefit from a particular gov- ernment service or investment. For example, a citizen may rarely, if ever, use a road or bridge on the far side of a county and thus feels no ownership or responsibility to pay for its upkeep or replacement. Similarly, citizens from the urban center of the county may feel indifferent about roads in a rural part of the county. One of the challenges faced by public service leaders is to educate the public to see and value the whole. This holistic perspective is necessary in order for a community to agree to tax itself for the betterment of all citizens. A set of uniform, broadly applied taxes both reflects and helps to generate the sense of a commonwealth across the entire community (Fischel 2000, 26). Implicit in this governance agreement is that most citizens and

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businesses will use only a portion of the full spread of government services. Each citizen will use some level of services, and other citizens may provide a subsidy to cover the costs. Broad-based taxation provides the means to share costs, to build economies of scale, and to efficiently and effectively deliver services.

As we observed in chapter 1, voters tend to have a limited or short-term perspective on tax initiatives. Anthony Downs (1960) argues that this perspective results in a limited understanding of government services and the benefits they generate. Voters evaluate the types and mixes of services proposed for enactment and then support the candidate or party that appears to provide the greatest total benefit. In reality, Downs argues, voters are often ignorant of the benefits re- ceived, the timing of when benefits are delivered, or the downstream implications of a particular bundle of services. Voters lack perfect and complete knowledge because gaining knowledge is extremely time consuming and labor intensive. Moreover, the full array of government services is extraordinarily broad and complex. Many public services deliver benefits in the distant future or in unexpected places. Applied to the real world, voters are consumers and are used to the immediate benefit of private market goods: fast food, instant downloads, and information at a click. Much government spending takes the form of investments for prevention or of incremental spending on an issue or problem. And with this kind of gradual spending over time, voters often fail to realize the full array or the delayed benefits they are receiving. Instead, they focus solely on the immediate costs in taxes and payments to government. They see these upfront payments as a lost opportunity for spending on private goods with a more immediate or recognizable near- term benefit (Downs 1960, 551). According to Downs, even the most knowledgeable citizens vote using partial or imperfect knowledge (544). The cumulative result of voter ignorance is budgets that are smaller than they otherwise would be if citizens had full knowledge of what benefits their tax dollars were producing.

Downs’s general argument about why democracy produces smaller budgets than what the benefits would justify is tempered by our highly decentralized system of local government. Land- use economist William Fischel (2000, 37 and 39) argues that unlike the large national and state governments, local governments are geographically bounded and identifiable. Fischel finds that homeowners behave more like corporate stockholders. Most homeowners work to maximize the value of their property individually and collectively as a community by purchasing services for themselves and for the community. Fischel argues that homeowners and certainly homebuyers have a strong understanding of local schools, neighborhood quality, city services, and the quality of the community. At the local level, government services are more evident and defined: a local parks district might build a pool, recreation center, and athletic fields using a 30-year bond for funding. Citizens can see the facility under construction, use the facility, and understand where their money has gone and what it supports.

The degree of remoteness and uncertainty is often less obvious in local government services. However, even at the local level, voters rarely understand the full array of services provided by a county, large city, township, or special district governments. Part of this lack of awareness is because governments, especially local governments, strive to be as unobtrusive as possible in the lives of citizens. Similarly, voters typically do not keep track of which special district or local government provides which service to the community. Voters also may not fully appreciate the complexity or remote benefits of education, social services, recreation, urban renewal, or com- munity development services. In the end, most voters are partially or preponderantly ignorant of their local governments. Accepting taxation for future or obscure benefits remains a challenging decision.

Even if voters had perfect information on both taxes and services, they would still tend to un- derfund public goods. This is because when you fill up your own shopping cart at the supermarket, you are paying for exactly what you want. But a pluralistic system guarantees that no one will be

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exactly happy with the collection of items in the public goods shopping cart; there will always be a dearth of some things and too much of others. The cartload of public goods and services is never worth to us (as individuals) what it costs.

The voter decision to accept a new tax also reflects a set of expectations related to the fairness or justice in the structure and burden of the tax. Expectations of fairness include both procedural fairness and allocative fairness (Rawls 1999, 2001; Thibaut and Walker 1975). These expecta- tions express themselves in at least four ways. First, voters expect that the procedures used to adopt a tax or fee increase will be fair. Most citizens expect to vote on any measure that changes or imposes new taxes. Citizens also want to present their concerns over a proposed tax to their elected representatives. Procedural fairness requires that citizen have an opportunity to voice their opinions, concerns, and frustrations.

Second, voters expect their allocated tax burden will be the same as that carried by their peers in similar circumstance. This notion is defined as horizontal equity in the tax structure. Voters also expect vertical equity in tax burden. Some voters feel that all payers—high or low income, high wealth or low wealth—should carry a uniform burden. This is known as a proportional tax structure or flat tax. Policy choices may ask those citizens and businesses with greater wealth or income capacity to pay proportionately more than others may. This would give the tax burden a progressive structure, with a heavier burden on those with a greater ability to pay because of greater wealth or higher income. A tax that places a relatively heavy burden on those with lower resources is termed regressive structure. Sales taxes and motor fuels taxes are considered regressive—since low-income individuals and families must purchase gasoline and food, they therefore must pay a larger proportion of their total income or wealth in order to do so.

Third, voters need assurances that peer compliance with a tax is at a high level and is consistent. Visible and effective tax enforcement reinforces the fairness of universal compliance. Fourth, vot- ers expect fairness in the administration and in the application of the tax rules to their personal circumstance. Technically competent, experienced, and unbiased assessors, and prompt, courteous, and accessible review of appeals by a county board of equalization, reinforce taxpayer perceptions of fairness in local property tax procedures. Clear instructions and well-defined procedures help citizens and businesses comply with, and have confidence in, a tax. Similarly, if the state depart- ment of revenue audits one’s tax returns, one expects fair procedures, oversight of the revenue agent, and fairness in any settlement.

Fear of being caught and enforcement deterrence may provide an effective compliance moti- vator for some taxpayers. A strong enforcement program raises the costs and the consequences of cheating (Andreoni, Erard, and Feinstein 1998, 851). Strong and consistent enforcement demonstrates that tax cheats will be caught and that the opportunity to underpay, or not to pay, is very rare. At the local government level, property taxes and sales taxes are largely imposed and enforced through well-designed systems. While performance varies across local governments, annual property tax delinquencies typically range between 2 and 5 percent (e.g., Waldhart and Reschovsky 2012; Johnson 2011), with an exceptionally low rate of 0.59 percent in Arlington County, Virginia, in 2011 (McCaffrey 2011). The property tax delinquency rate recognizes that counties will not receive the full amount of expected revenue. Where permitted by state regula- tion, counties may increase the property tax rate in order to compensate for this expected loss in revenue (Johnson 2011).

Most taxpayers, however, possess a sense of moral obligation to support the community (cf. Bellah et al. 1985). Taxation is a trust reliance relationship between taxpayer and government (Scholz 1998, 135). Accepting a tax is a risk on the part of the voter that the government is trust- worthy and will perform as promised into the future. In the reverse, a government hopes that tax- payers will be trustworthy and will make prompt and full payments. The more taxpayers perform in making payments, the less effort and expense is required to ensure compliance. Both taxpayer

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and government must see each other as trustworthy, dependable, and embracing the interest of the other party. Trustworthiness on the part of the citizen is expressed as a duty to contribute to the community. Performance of duty in turn leads to the emotions and behaviors of trust reliance that in turn leads to compliance.

The willingness of citizens to accept and to pay taxes reflects a complex personal psychology that includes deeply held political values, a sense of the community, the need for services, concerns over the fairness of the tax, pressures from the media and current events, individual finances, the limitations of the current economy, and hopes for and perceptions of the future. The taxation transaction is almost always much more complicated than a mere cold rational exchange.

To gain broad acceptance, citizens must view the combined state and local tax system as fair, equitable, and efficient (Bartle 2003; NCSL 2007b). State and local government tax policies should strive for a tax system that has stability, certainty, and sufficient yield; low administration and compliance costs; and a diversified balance of revenue sources (Carroll, Eger, and Marlowe 2003). From an economic perspective, taxes should be efficient with minimal distortion to the larger economy, and a state and local tax system must recognize and be responsive to interstate and global competition. No combination of state and local tax policy will score perfectly on all of these criteria, and poor implementation by state agencies and local governments can weaken effective tax system design and policy. Quality tax administration by local governments is criti- cal to meeting citizen expectations of fairness and equity. To understand what makes up a local revenue system, we turn next to explain the different types of taxes.

Local Taxes

Property taxes provide the predominant source of revenues for counties, cities, and special district governments. Additionally, a small set of cities and counties collect income taxes or wage taxes (also called payroll taxes) from individuals. Most states collect an individual income tax, and most collect a retail sales tax and use taxes. In many states, a portion of the sales tax revenues collected by the state are returned to county and city governments. States also collect taxes from corporations, although nationwide this revenue source has gotten proportionately smaller over recent decades (Mikesell 2005). Whether local or state imposed, tax revenues form a primary and critical source of local government financial resources. We review each of these forms of taxation in detail below.

Property Taxes. Many local governments and some state governments impose property taxes on the wealth of their residents and corporations. State laws and regulations authorize the collection of a local property tax and define the structure, features, and requirements of the local property tax system. In many states, the actual property value assessment and revenue collection is delegated to county governments. To implement a property tax, county governments must assess the value of the property owned by each resident or corporation in the jurisdiction. For individuals, the county typically assesses the value of real property and real estate, and sometimes personal property, including automobiles, boats and trailers, and financial securities. For businesses, the assessment often covers facilities, equipment, inventory, corporate office furniture, and furnishings. Once an assessed value has been determined, a percentage tax rate is then applied to the value to determine the tax due. County governments collect taxes for themselves, for all the other local governments in the county, and sometimes for the state government.

Property taxes impose a uniform percentage burden across all levels of taxpayer wealth. Taxpay- ers with high property wealth will pay more tax because of higher property values and property attributes. The applied tax rate, however, will be uniformly the same for all property owners. Property tax burdens especially affect retirees and others who hold wealth in their property, but

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who have lost the cash income needed to pay the annual tax. State tax codes often provide an alternative assessment or delayed payment scheme for senior retirees. These adjustments inject a degree of progressivity into the uniform tax burden.

The concept of a uniform rate–based assessment on property values first appeared in the Ameri- can colonies. In Revolutionary America, taxes were often more heavily enforced on the poor than on the rich. In New York, where political concessions were needed to build support for the war of independence, tax enforcement fell heavily on the wealthy. The concept of an ad valorem, or value- based, uniform tax was proposed and debated as a means to equalize tax collections across rich and poor citizens (Fisher 1997). Congress established the first federal property tax to finance the War of 1812. This was a temporary and successful tax. Throughout the Jacksonian period, a uniform ad valorem tax was seen as an instrument of tax limitation, and uniformity clauses were included in 34 state constitutions between 1834 and 1896 (Fisher 1997). Throughout the nineteenth century, administration of property taxes became much more difficult. The property assessment included land and real estate, but also personal property and intangible business assets. Valuing mobile property and complex businesses became difficult. The adoption of the federal income tax with the passage of the Sixteenth Amendment in 1913 gave the federal government a more responsive and elastic means to capture economic growth, but the property tax remained the primary form of taxation for states and local governments until the Great Depression, when the income tax and retail sales taxes increased in importance.

Property taxes are the least popular form of tax. Part of this dislike reflects the large lump sums billed by counties rather than billing in smaller amounts on a more frequent basis. Recent research indicates that dividing large biannual tax payments into several smaller billings, or requiring routine tax payments through escrow accounts, may help to prevent tax delinquency, increase revenues to governments, and reduce home foreclosures (Waldhart and Reschovsky 2012; Anderson and Dokko 2009). Another source of dissatisfaction with the property tax reflects the difficulty of reaching an accurate, up-to-date assessment of property value. Typically, a county assessor has responsibility for implementing the property tax system and for collecting the taxes due. The assessor may be elected or appointed, depending on state law and county charter. A staff of professional assessors and analysts work under direction of the county assessor. The task of the staff is to: regularly visit every piece of property in the county; assess and estimate the value of the property; apply the appropriate tax rate to the assessed property value; respond to any protest of the assessment; produce the tax bills and notify the property owner; collect any tax due; and follow up on delinquent payments. In extreme cases, the county may seize and then sell properties with delinquent taxes. We will further discuss the mechanics of the property tax system and the effects of property tax limitations in chapter 7.

Retail Sales Use and Excise Taxes. Retail sales taxes and use taxes are percentage assessments at the point of retail sale on the value of items purchased by the consumer. The merchant or seller typically remits retail sales taxes to the state, while the purchaser pays use taxes directly to the state. Residents of a state with a retail sales tax are supposed to declare and pay tax on all pur- chases made outside the state but used within the home state. Many residents fail to pay use taxes on out-of-state purchases, often out of ignorance, and the cost of enforcement precludes states from enforcing collections on lesser value items. Because of the difficulty of enforcing use taxes, states tend to focus their enforcement activities on high value items that require licenses such as motor vehicles, boats, and trailers. For example, a state might assesses a use tax on the value of purchased motor vehicles at the time of licensing. The tax revenues are dedicated to cover the cost of the vehicle’s use of the state’s road infrastructure.

State statutes and regulations establish the authority and the structure for collecting retail and use taxes at all levels of government. All but five states—Alaska, Delaware, Montana, New

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Hampshire, and Oregon—levy a state general retail sales tax. Thirty-five states allow local gov- ernments the option of implementing a sales tax (e.g., local option sales tax) (Edwards 2006, 17; Krane, Ebdon, and Bartle 2004, 524). These states typically set a maximum authorized local tax rate and delegate the authority to local governments to adopt a tax rate up to the maximum authorized level. The local tax increment is then added to the state’s own sales tax rate to obtain a total tax rate charged to the consumer. The state department of revenue records and publishes the retail sales tax rates for all taxing jurisdictions in the state. The department of revenue also enforces the tax and collects the sales tax revenue. All businesses making taxable sales compute the prescribed percentage of the value of each sale. At the end of the month, quarter, or year, the retailer submits the collected revenues to the state department of revenue. Sales tax revenues are often submitted at the same time as any estimated corporate income tax to ease the reporting burden. The state department of revenue then returns the appropriate portion of the collections to the county or city. In four states (Alabama, Arizona, Colorado, and Louisiana), retailers submit the local portion of tax collections directly to the local governments (NCSL 2007a). The burden of collecting the sales tax falls to retailers, but with effective state auditing and electronic systems, sales tax enforcement is quite high.

The local use of the retail sales tax responded to the declining state and local property tax revenues, tax delinquencies, and widespread property foreclosures of the Great Depression. Mis- sissippi levied the first state sales tax in 1930, and New York City levied the first local level sales tax in 1934 (Edwards 2006). The retail sales tax originated when state economies were fixed in brick-and-mortar stores with a defined retail point of sale. The service sector was a relatively small portion of the total economy and was a costly sector from which to collect revenues. Doctors, at- torneys, and accountants resisted the imposition of taxes on their services. The massive growth of the service sector as a portion of the U.S. economy over the last half of the twentieth century has challenged the effectiveness of the traditional retail sales tax. Three states (Hawaii, New Mexico, and South Dakota) have comprehensively integrated services into their sales tax programs (Ed- wards 2006, 21). Other states have tried to expand taxes on services with mixed results. Finally, collecting taxes on the barter and exchange sphere of the economy—encompassing domestic help, swap meets, farmers markets, garage sales, and the like—remains difficult.

In an extension of consumption taxation throughout an economy, Canada, Australia, New Zea- land, the members of European Union, and many other countries impose a national value-added tax (VAT). This type of tax is imposed on the increased value of a product at each purchase or value point between material and component suppliers, manufacturers, distributors and wholesal- ers, retailer, and consumer in the production chain. VATs may be imposed on goods and services. Value-added taxes are not commonly imposed in the U.S., however, they have been proposed as an element of comprehensive reform of state tax codes. The imposition of a VAT results in relatively efficient collection from businesses, but the full extent of the taxation is largely obscured from the end consumer’s perspective.

There have always been sales tax evaders who travel to adjacent states without a sales tax, make purchases, and then fail to declare and pay taxes on the value of the purchases brought home. However, out-of-state telephone retail sales and, more recently, the explosion in online sales have driven deep holes into the coverage and effectiveness of state sales taxes. The U.S. Supreme Court decisions in National Bellas Hess (1967) and Quill (1992)2 denied states the authority to require the collection of sales tax revenues by other states, unless the retailer had a nexus in the state of sale. A nexus has been understood as some form of physical presence—a facility, staff, or contractor. Recently, one major online retailer has purposefully closed facilities and discontinued contracts and internet relationships with online advertising affiliates to prevent a nexus in all but a few criti- cal states. These actions have not prevented legal and legislative actions against the retailer by cash-strapped states wanting to collect internet sales taxes (Weintraub 2011; Metz 2011; Martinez

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2010, 2011). This is a developing area of case law. Researchers Bruce, Fox, and Luna (2009; Bruce and Fox 2004) project that uncollected national and locale-commerce sales tax revenues in the 46 sales tax states and the District of Columbia would reach $11.4 billion annually by 2012.

In the Quill decision, the Supreme Court specifically left room for Congress to act on the sales tax issue under the commerce clause of the Constitution. In May 2013, the U.S. Senate passed a measure that would allow states to enforce sales tax collection on online purchases. At publication, the House of Representatives had yet to act on the bill. Since the Quill decision in 1992, 24 sales tax states have passed consistent state legislation and joined the Streamlined Sales Tax system in which cooperating states collect and remit balances to the state in which the consumer resides (Streamlined Sales Tax Project 2005, 2011).

In addition to general retail sales and use taxes, states collect excise taxes on specific goods and services, or authorize the local jurisdiction to collect an excise tax. An excise is placed on a particular product on a per-unit basis rather than on the value of the sale transaction as a percent- age (ad valorem). The excise is usually on a narrow range of specific products, and the business is expected to recoup the cost of the tax when the product is sold to the consumer. Though these taxes generate a smaller amount of revenue than the property or general sales tax, they are impor- tant supplemental sources of revenue for local governments. Excise taxes on liquor and tobacco sales, and hospitality taxes on lodging, restaurants, and rental car services are examples of this type of specialized tax. Taxes on motor fuels, gasoline, and diesel fuel represent another type of sales tax dedicated to specific program purposes. Motor fuel taxes are established by the state, but revenues are commonly shared with county and other local governments for road maintenance and construction.

From the consumer’s perspective, the full impact of the general retail sales tax burden is ob- scured. A consumer’s total sales tax burden is dispersed over hundreds of purchases throughout a tax year. Where taxpayers can deduct state sales taxes from federal or other state income taxes, a taxpayer might sum up an annual sales tax figure, but for many consumers the total sales tax burden is never totaled up and made evident. Nonetheless, sales taxes have a high level of public acceptance (Edwards 2006, 17).

Retails sales, use, and excise taxes are generally perceived as regressive taxes. When assessed on all types of sales, these taxes affect low-income taxpayers most heavily. These taxpayers have the least available disposable income to cover costs beyond mandatory purchases of food, drugs, and medical care. For this reason, many states exempt the collection of sales taxes on some com- bination of food, drugs, and other selected staples. This helps to make the effects of sales taxes more flat or progressive.

Income Tax. Most people understand income taxes from their experience with the annual personal federal and state income tax returns they file on April 15. However, seven states have no state individual income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming (Braybrooks, Ruiz, and Accetta 2011). For states with an individual income tax, 15 states authorize a local option wage or individual income tax for use by local governments (Edwards 2006, 30). Local governments usually implement wage taxes on wages and salaries and compensation. Local income taxes cover wages, salaries, interest and dividend income, and other forms of income. These taxes may be implemented locally or through the state income tax system. The local wage or income tax is widely used in Indiana, Kentucky, Maryland, Michigan, Ohio, and Pennsylvania (Braybrooks, Ruiz, and Accetta 2011).

The federal government established the income tax with the Sixteenth Amendment in 1913. But with the substantial decline in property values and property tax revenues in the Great Depression, local governments also turned to the income tax as a new form of revenue (Carroll 2009; Fisher 1997). Philadelphia, Pennsylvania, began assessing a wage tax in 1938. The city continues to as-

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sess a personal wage tax on salaries, wages, and compensation earned by nonresidents working in the city, and on city residents working anywhere (City of Philadelphia 2014). Philadelphia also imposes a personal income tax on unearned income, interest, dividends, royalties, and certain rents on residents to support local schools. Cities in Ohio widely levied income taxes starting in the 1940s. By the 1960s, Michigan cities, Maryland counties and the city of Baltimore, and New York City all levied a local income tax (Edwards 2006, 30). Other governments have used an income tax on a selective basis to meet specific needs (e.g., Multnomah County, OR 2003–2005 to support public schools) (Multnomah County, OR 2014).

The federal income tax and most state taxes set graduated tax rates tied to income brackets. Tax filers with greater income typically pay at a higher rate. Numerous deductions, exemptions, and adjustments customize the tax burden for each filer and help to ensure horizontal equity across all filers of similar circumstance. In general, income taxes are understood as progressive because of the increasing tax rate for higher bracket filers. But, the Philadelphia example described above is a flat tax, with all filers assessed the same rate. The actual task of implementing an income tax falls on employers and businesses, which must withhold a portion of wages and benefits to meet tax requirements and then must submit the withholdings on a routine basis. Computerized payroll and recordkeeping has eased this burden. Self-employed residents must often submit estimated taxes on a quarterly basis over the course of a tax year.

Compared to property and sales taxes, income taxes are especially sensitive to changes and swings in the regional and national economies. A rising, growing economy brings in an increasing amount of income tax revenue, while a declining economy results in less revenue. Sales and property taxes provide complementary sources of revenue that can dampen the volatility of the income tax.

Taxes on Businesses and Corporations. Small businesses and corporations provide the economic engine that brings wealth to communities. Local governments in turn tax this wealth to provide the public goods and services that support businesses and employee satisfaction. Local governments provide the infrastructure, public safety, K–12 schools and community colleges, and quality of life amenities that sustain business operations, attract and retain talented employees, and attract new businesses. State-level tax codes, however, largely define the tax structure businesses face. Similar to personal taxes, governments typically tax the property, income, and purchases and consumption of businesses. Unless prohibited by state law, local governments may place additional taxes on businesses in their communities.

Small businesses and corporations take a wide variety of forms reflecting their purpose, multi- state or global structure, facilities and equipment needs, staffing, and capital requirements. Legally, small businesses include sole proprietorships, partnerships, and associations. Larger businesses are often chartered as corporations. Developing a fair tax structure that can respond to the wide variation in business types is especially difficult. For example, the features of a state tax code that gives favorable treatment and reduced assessment to large capital investments in equipment and facilities may not be especially helpful to creative firms developing software or advertising. The tax code in each state presents opportunities and disincentives to different types of business forms and ventures. As we will discuss further in chapter 8, business taxes are one of many factors that business owners and management take into consideration when deciding where to locate.

The state tax code in each state defines the property wealth held by businesses that may be taxed by local governments. In most states, businesses pay property taxes on some combination of real estate, equipment, and office furnishings. The local assessor makes valuation determinations and generates tax billing as would be done for individual taxpayers. In some states, assessors from the state department of revenue assess the value of large capital equipment, industrial facilities, or utilities that cross county boundaries. Such central assessment of high value properties helps to ensure knowledgeable, accurate, consistent assessment. Property taxes on commercial equipment

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and industrial facilities can generate hundreds of thousands of dollars of property tax revenues annually to counties and cities. Industrial and light manufacturing facilities are critical to the establishment of a diversified local property tax base.

The state tax code also defines any income taxes or business and occupation (B&O) receipts tax that apply to businesses. Mikesell (2005) explains that state corporate income taxes continue to decline as a revenue source. This trend is reinforced by business legal structures that pass profits from the corporate entity to its individual owners. This transfer of wealth tends to lower corporate tax liability. An array of tax breaks granted by states to businesses to encourage economic devel- opment (chapter 8) also work to lower state corporate tax revenues. Some states have imposed a minimum tax on corporate receipts irrespective of a business’s annual profit or loss. This has led to a debate over whether government spending should rise and fall with the cycles of the economy, or whether government revenues should be stabilized at a minimal level over good and bad years to provide services when they are most needed in economic downturns. A corporate minimum tax or a tax on gross receipts would support the latter viewpoint.

Many states assess a corporate income tax on corporate net earnings. Similar to the personal income tax, corporate earnings are typically adjusted for capital losses, depreciation of capital investments, spending on research and development, and for other incentives prior to computation of taxes due. Other states and jurisdictions assess business net taxable income or net profit at a prescribed rate (City of Philadelphia 2014).

In Washington State, a business and occupation (B&O) tax on business gross receipts makes a contribution similar to a corporate income tax. The state level B&O tax applies to all forms of businesses with annual gross receipts over about $12,000. Part of the B&O tax rate assessed on a business reflects a local government share of the total tax rate. West Virginia once imposed a statewide B&O tax, but now only local jurisdictions may apply this tax.

Revenue Source: Charges and Fees for Service

Charges and fees for service are a growing source of revenues for many local governments. They are imposed to cover the direct and related costs of providing a specific service. A fee approach works especially well when a local government can clearly define both the service provided and the purchasing customer group. In contrast to taxes, charges and fees for service cannot be used to fund general government services; fees are funds dedicated to support the activities and services for which they were collected. Charges and fees cover the specific costs of a wide variety of local government services including:

• monthly residential water and sewer charges; • electric and plumbing code permitting and inspection fees; • local swimming pool and golf course access fees; • utility franchise and right-of-way access fees (Henkels 2005, 222); • development planning and permitting fees; and • community college tuition and building use fees.

Utility franchise fees can provide a substantial and major source of revenues for cities and towns, though these too should be used only for the reason for which they were collected. In the past, this restriction has been liberally interpreted by local franchising governments as other revenue sources have declined or been limited. Although infrequently used, jurisdictions can also apply charges and fees to nonprofit organizations that are normally shielded by state tax codes from most local taxes (Dugan 2010). Such a loss in property taxes and business revenue has provided justification for some jurisdictions to seek ways of recovering this foregone revenue.

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Closely related to charges and fees for service, local governments grant a variety of permits and licenses. The cost of the permit or license allows the citizen or client to undertake, at the citizen’s discretion, an activity regulated by the government. Permit and license rates are typi- cally set to recover the cost of processing the application, recording and documentation, and any enforcement actions taken to ensure compliance with requirements. County governments issue familiar permits and licenses, including marriage licenses, pet ownership licenses, food handler licenses, and restaurant sanitation licenses. Many counties and cities require some form of a busi- ness license from all enterprises operating within the jurisdiction, though this is generally not as a revenue-generating action, but as a regulatory process. Permit and license revenues typically contribute a minor share of the total revenues generated by a local government.

A revenue approach that relies on charges and fees for service allows a local government to recognize a specific set of public needs and to tailor a service response. For example, homeown- ers wishing to make substantial changes to their dwelling must pay a fee to obtain a building permit, and then allow any plumbing, electrical, or structural inspection for compliance with city or county building codes. Fees for service respond to the needs of groups of citizens for specific public services by isolating the cost burden to those who consume the service. In our example, only homeowners voluntarily undertaking remodeling and construction projects are subject to the permit fee. The transparent and isolated linkage between fee and service delivery can sometimes help instill public confidence in a government’s ability to efficiently and effectively deliver the needed service in the same manner as the private sector. However, packaging many government services as simple transactions overlooks the broad public benefits generated by widespread com- pliance with regulations. In the case of construction and remodeling permits and code inspections, consistent compliance to high specifications over all construction results in reduced fire danger and reduced service costs related to fires, and lower homeowner and business insurance costs.

The transaction aspect of charges and fees stands in contrast to the public benefit aspects of tax-funded public spending. While some taxes support a narrowly defined, prescribed program or service (e.g., building a community library or a public safety levy in the teaching case example), tax revenues most often support spending on general government programs. Tax revenues can cover the cost of service delivery, but they also cover the cost of positive economies of public goods that accrue to the community through government programs. For example, K–12 schools could be run on a fee-based or voucher approach that would charge parents directly for the educa- tion of their children, much as private schools charge their students tuition and fees. In contrast, a tax-based approach to education covers the cost of educating children but also allows employers and the community to recognize that an educated population has broad economic and community benefits. A well-educated workforce allows a community to compete in the national and global environment for employers and facilities. Imposition of a tax often recognizes the public benefit from a service or investment. By contrast, imposing a fee can obviate any sense of paying for the larger public benefit. Imposing a fee tends to stratify those paying the fee as a separate group within the community. Supplementing charge and fee revenues with tax-generated funds helps to remind citizens that fee-based services generate a larger public benefit that deserves full com- munity support.

Charges and fees for service are making an increasingly important contribution to funding local government services. With tax limitations capping increases in property tax revenues, and rising uncertainty surrounding state and federal intergovernmental revenues, charges and fees present local government with a way to cover program costs; furthermore, in a market-style feedback, a steady flow of fee revenue also indicates that citizens or clients desire a program. Under the fee approach, however, citizens often feel nickeled and dimed with innumerable small charges. But because of their greater transparency and transaction focus, voters typically are more accepting of fee increases than of general tax increases. From a larger perspective, charges and fees for service

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and taxation are complementary approaches to funding government services. Each community must find the balance between these two approaches in order to fund public services adequately.

Local governments have the option of setting charges and fees at varying levels of cost recovery. Governmental agencies and social service nonprofits may establish fees on a sliding scale that allows a larger number of low-income clients to receive services, and to enhance their sense of self-worth and dignity by contributing to some portion of the service cost. This approach provides a level of subsidy to those clients most in need. However, in most cases, governments set fees to recover the full cost of providing the particular service. A break-even analysis of the costs of delivering a given quantity of services allows governments and nonprofits to set this cost recovery level. For example, county and city development planning, permitting, and construction inspection programs often use a full cost recovery approach. The downside of this approach is volatility in program staffing. In a rapidly falling construction market, fee revenues fall and government staff must be either temporarily furloughed or permanently laid off. In a rapid growth market, county and city governments must rush to hire and train examiners and inspectors.

To gain full cost recovery, local governments and especially special districts may charge out- of-district residents a supplemental fee above in-district rates. For instance, parks and recreation districts may charge out-of-district residents a surcharge for classes, for participation in athletic leagues, and for the use of swimming pools and gym facilities. This out-of-district surcharge rec- ognizes that in-district residents have paid taxes to cover a portion of program costs and that the services were designed specifically for the population within the local government jurisdiction.

Cost recovery–based charges and fees require that the government have a full understanding of the service costs involved. Effective cost recovery requires moving beyond rates based on the average costs of service delivery. Gaining such an understanding requires comprehensive data collection to support effective performance measurement and cost analysis. In-depth cost analysis allows a local government to identify high-cost clients and to monetize the extra costs of providing services to their more complex or extensive set of needs. Beyond cost recovery, local governments may purposefully set charges and fees to generate a profit. Some local governments provide se- lected services on a for-profit basis. For example, a city might manage its golf course, ice rink, or recreational facilities on a for-profit basis and use any net profit to subsidize other city services.

The procedure for setting the rates for charges and fees typically requires a public process and action by the county board of commissioners or judges, city councillors, or district board of directors. Public utility rates for electricity, water, sewer, storm water, and public transportation affect broad numbers of people and, as a result, may draw public scrutiny during a rate-setting procedure.

Where governments use charges and fees for service as a revenue source, accounting regula- tions may require the establishment of an enterprise fund accounting framework. This framework separates the fee revenue stream from other revenues and activities. For example, cities often establish separate enterprise funds for water, sewer, storm drainage, and electricity utility ser- vices. Enterprise fund accounting is especially useful when fee revenue is used to pay off capital construction bonds, when the law requires the use of fees rather than taxes as a revenue source, and when policy requires the use of fees (Johnson and Bean 1999). This issue will be examined more fully in our discussion of accounting funds in chapter 9.

Many local government jurisdictions impose a systems development fee or systems develop- ment charge on any new residential or business development and construction. This fee covers the cost of the utility and service system infrastructure needed to support the new development. Funded infrastructure includes water and sewer lines, drainage, roads and traffic management infrastructure, and sometimes parks and recreation and schools. The fee can be used only to sup- port the construction of new facilities, not for routine maintenance. Transportation development charges provide a similar source of revenue for road and traffic infrastructure development. As

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a comparable revenue source, some states impose a real estate excise tax (REET) on the value of real estate sales to accomplish infrastructure development outcomes. Revenues from both the systems development fees and real estate excise taxes are highly dependent on development and construction activity and on the strength of the local economy. Laws and regulations may require tracking both of these forms of revenue separately from other revenues.

The service development charge is often assessed on a per-residence or per-office basis without regard for the inherent value of the unit. For example, a county might assess a fee of about $12,000 per house. This reliance on a per-unit rather than a per-value approach subjects the jurisdiction to criticism that the fee is regressive and places a relatively heavier burden on lower income homebuyers. Extensive use of the systems development fee could also shift an unfair share of infrastructure development costs away from the general public and onto first-time homebuyers, new residents, and new businesses of the county or city (Chandler 2006). Real estate excise taxes are subject to similar criticisms of heavily loading costs onto real estate purchasers. This criticism has grown as local jurisdictions struggle to find ways of replacing water, sewer, and transportation infrastructures that are rapidly failing.

Counties and cities also impose utility access fees. These fees allow private utilities access to residences and businesses over public streets and rights of ways. Payment of these fees allows nongovernmental telephone, electricity, natural gas, and water and sewer providers the privilege of placing cables and pipes underneath city or county streets. Counties and cities set these fees not only to encourage the development of infrastructure services but also to cover the costs of maintaining and repaving roads and streets.

Counties and cities allow businesses the privilege of serving their residents under business franchise agreements. These fees often generate substantial revenues for local jurisdictions. Such agreements allow utilities access to county or city residents for a prescribed fee. Cable televi- sion and internet fiber, natural gas piping, and water and wastewater utilities may fall under the franchise fee arrangement.

In addition to the major charges and fees discussed above, counties and cities charge fees to cover the cost of numerous other activities. Public safety and corrections functions attempt to recover fees from inmates who move through the justice system. Parks and recreation departments work to recover operating costs through entry and facilities use fees. Annual business licenses, sign permits, and pet licenses bring in fee revenues as well.

Special districts make extensive use of charges and fees for service to cover their program and operating costs. The dedicated purposes of special districts reinforce their specified mission and enterprise nature. Charges and fees for services complement and reinforce this transparency. As examples, cargo handling and tonnage fees, passenger use fees, and facility rental fees imposed by a port or airport district may comprise the major source of revenue for the district. Public hospitals charge patients fees for services, medicines and supplies, and for facilities maintenance. Similarly, tuition charges and building and student fees comprise a major source of revenue for community college districts. As with city and county governments, special districts must set rates for charges and fees in such a manner as to recover costs, but not to prevent access by citizens and clients. For example, parks and recreation districts must make strong efforts to cover costs, but they must ensure that citizens of all income levels can afford and have access to district services.

Revenue Source: Fines and Forfeitures

Fines and forfeitures typically constitute a very small portion of a local jurisdiction’s revenues. These revenues represent an individual’s or business’s compensation to the community for criminal infractions, tax noncompliance, or failure to meet program requirements. These revenues include proceeds from property tax liens and forfeitures, penalties for traffic and parking violations as

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adjudicated by a court of law, penalties on late payments, and library charges for late and lost materials. Skepticism about the fairness of local law enforcement’s use of fines as revenues has long clouded public confidence in this form of revenue.

Gross failure to pay property taxes generates an unfortunate source of revenue for county governments. However, the sale of tax delinquent properties allows the transfer of the property to new owners who can pay the required taxes and who can stabilize or increase the economic value of the property—all for the public good of the community. The procedures used by county governments to recover delinquent taxes by tax foreclosure (Whatcom County 2010), forfeiture (Itasca County 2011), and property sales follow state rules and regulations. The exact procedures vary among the different states. However, the process typically requires multiple notifications to the property owner, elapsed time for an owner response, and an auction of the property to gain the highest possible value. County governments sell forfeited properties to recover the back taxes, interest, and costs on which liens have been executed. In Minnesota, the state and county reviews forfeited properties and may retain selected properties for inclusion in the state- and county-owned natural resource lands (cf. Itasca County 2011).

Revenue Source: Sale of Assets

Many local governments own clear title to land and sub-surface mineral rights within their bound- aries. Ownership of these lands (as public property) may have resulted from tax delinquencies and forfeitures, and from subsequent decisions by state and county governments to retain rather than sell the land parcels (Itasca County 2011). Governments often manage their lands and natural resources to produce revenue by routinely selling timber, forage, oil, or natural gas. Governments also generate rental income by franchising the operation of government-owned lakefronts, recre- ation areas, campgrounds, and other recreation facilities.

Revenue Source: Intergovernmental

Intergovernmental revenues reflect the principles of federalism and local autonomy that are built into the U.S. and state constitutions. Governments at any level—federal, state, or local— may independently raise revenues and may, within their authority, transfer or grant revenues to other levels of government to further the public good. From a budgeting perspective, revenues transferred from one governmental entity to another governmental entity on the same or on a different level are categorized as intergovernmental revenues. Intergovernmental revenues are roughly structured in the following forms:

• Direct grants or payments for the performance of a specific service or defined program of services under a voluntary intergovernmental agreement or a contract.

• Reimbursement payments to another level of government to offset the costs of providing statutorily delegated or mandated programs and services, allocated by formula, lump sum, or entitlement.

• Revenue sharing between one level of government and another.3

State governments are the largest source of intergovernmental revenues for local governments. These revenues range from the direct return of shared tax collections to reimbursements granted for the operation of specific programs or services. Federal transfers typically provide an important but smaller source of intergovernmental revenues for cities, towns, and special districts. Federal funds often become the final source of several complementary revenues for a project, thus making it achievable. Local governments must carefully document intergovernmental revenues both for legal and financial compliance purposes, and to enhance transparency and public trust.

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Direct Grants and Payments

Direct grants and payments for services are voluntary exchanges between governments. These types of grants and payments often exchange the performance of services for payment. For example, a small city might purchase law enforcement services from the local county sheriff’s department. The purchase would be structured under an intergovernmental agreement, similar to a contract that would specify the services provided, staffing and performance criteria, and payment amounts and schedules. The city would make regular payments, and the county sheriff’s office would register those payments as intergovernmental revenues. Programs to make intergovernmental grants may be structured on a competitive or noncompetitive basis, but the final decision to enter into agreement is voluntary. Federal grants in this category would typically include project grants, cooperative agreements, and direct federal payments for a specific use of local services (CFDA 2011, 10). For example, the U.S. Department of Justice offers grants on a competitive basis to local police depart- ments to increase officer staffing or to support the purchase of specific equipment. To receive the funds, the local government would need to perform as specified in the grant agreement, and may need to commit a contribution of local matching funds over a defined schedule.

Program Cost Reimbursements

Intergovernmental reimbursement payments provide resources to local governments in compensa- tion for the provision of program services as specified in a given statute. The transfer of revenue along with accompanying policy, program guidance, and spending controls expresses federalism in government structure. Here, federal and state governments use local governments as agents to implement their policies and programs. Statutes may mandate local government involvement, but the transfer of revenues typically becomes the largest incentive for local governments to participate in, and to comply with, the intentions of federal and state policies. Restrictions and constraints on the use and spending of transferred revenues reinforce the federal delegation of intention.

State and federal governments provide the sources of these payments. Reimbursement payments may be allocated as a grant of defined amount that covers a package of services and time span (block grant), apportioned on a per capita basis, apportioned by formula, or apportioned based on the number of entitled recipients. Statute, regulations, and program policies define how the grants are allocated as well as the standards for local performance. For example, a state department of corrections may provide a grant to a local county to establish and operate a county jail and cor- rections program based on the number of inmates participating in the program.

Similarly, states often make grants to local school districts based on the number of pupils served or under a formula that considers pupils served, labor costs, location, and other factors. This formula-based approach helps to equalize the K–12 educational resources and quality across the state and generate relative equity among school districts or counties. The larger issue of what exactly constitutes a fair share in equalization is left as a policy question for the legislature. Equal- ization of resources often results in a substantial subsidy of revenues flowing from the wealthier urban and suburban regions of a state to poorer communities.

The amount of intergovernmental revenues granted to local governments frequently fails to meet the full cost of providing the services mandated or prescribed by law. Local governments are then left with an unfunded mandate. We give greater attention to the unfunded mandate problem later in this chapter.

Revenue Sharing

Revenue sharing allows the federal or state governments to transfer or share revenues with local governments. Shared tax revenues and some federal entitlement programs fall into this category

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of revenues. Revenue sharing arrangements typically place loose or minimal restrictions on how the receiving local government can use the transferred funds. In most states, the state department of revenue acts as a fiduciary agent collecting retail sales taxes, use fees, corporate taxes, and liquor and cigarette taxes, and returning the prescribed proportion back to counties and cities. The proportion of tax returned back to the local government is an example of revenue sharing. Federal revenue sharing with counties is authorized under several programs, including the Pay- ment in Lieu of Taxes (PILT) program and other sharing programs based on federal agency sales of natural resources. We provide additional discussion on federal land and resource-related pay- ments in chapter 8.

Maintenance of Effort Requirements

Many reimbursements and direct grants require the local government or school district to match a federal or state contribution at a proportional rate, or to cover a specified share of costs over the life of a grant. These specifications are known as maintenance of effort requirements. For example, a federal Department of Justice grant might require an increasing local contribution to cover the cost of hiring a new police officer over the three-year life of a grant. Typically, grant agreements contain triggers and penalties for noncompliance with performance requirements or matching funding levels. Most of these provisions are financially onerous by design. Critically, to receive funds through a matching arrangement, local governments must appropriate and spend funds. In times of tight budgets and limited local resources, administrators must take a leadership role to ensure that both elected officials and the general public are educated on the need for the local government to allocate and spend money in order to receive money. Ensuring the availability of local matching funds is challenging when budgets are tight and other needs are pressing. In many grant programs, local governments and school districts must further demonstrate to the federal or state agency that they will make a commitment and will maintain appropriations of matching funds over the full life of the grant.

State Sourced Intergovernmental Revenues

State governments provide a wide variety of intergovernmental revenue streams to their counties, cities, towns, and special districts. As mentioned, state intergovernmental revenues are structured and packaged in a variety of forms, ranging from one-time grants and reimbursement for contracted services, to partial or full reimbursement for provision of state-mandated duties, to the fiduciary collection and sharing of tax revenues. Each state structures its intergovernmental revenues dif- ferently. Counties in Alaska, Massachusetts, Michigan, North Carolina, Oregon, Tennessee, and Virginia receive over one-quarter of their annual revenues from state intergovernmental aid. In contrast, counties in Delaware, Maine, New Hampshire, and Vermont receive less than 1 percent of their revenues in state intergovernmental revenues (Bartle 2003). This partially reflects the much-reduced role of county governments in the New England states (U.S. Census Bureau 2007b, see chap. 1). State governments often act in a fiduciary capacity to efficiently collect tax revenues and then return a prescribed portion of these entitlement revenues to local counties. These col- lected revenues include retail sales and use taxes, liquor excise taxes, liquor profit share, beer and wine excise tax, cigarette taxes, timber severance and natural resource use taxes, as well as motor vehicle and highway fund shares. A portion of state lottery revenues may be shared with county governments. Depending on state law, cities and towns may also receive a share of some of these entitlement tax and revenue streams. Counties may receive state grants as reimburse- ment for the provision of services to its residents. Under this type of contractual or partnership arrangement, the state is purchasing program delivery services from local governments. Mental

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health services, services to the elderly, veterans’ services, and other services may be structured under a grant for service model.

Federally Sourced Intergovernmental Revenues

A large number of federal programs and revenues provide intergovernmental revenues to local governments (NACo 2011a). In contrast to state governments, the federal government does not act in a fiduciary tax collection and distribution role. However, the federal government does pro- vide funds to help reimburse county governments for federal lands and facilities within county boundaries (chapter 8). Numerous other programs provide federal support to county governments, cities, and local communities. Community development block grants (CDBG) and the HOME Investment Partnerships Program from the U.S. Department of Housing and Urban Development provide a critical source of federal funds to counties and cities for community development and housing. U.S. Department of Justice public safety programs provide matching funds through competitive grants to counties and cities. These funds allow local governments to hire law en- forcement officers and to purchase equipment and software on a cost share basis. U.S. Department of Homeland Security grants are also available to cities and local governments for emergency management and security preparedness. Other federal departments provide grants to local govern- ments for transportation infrastructure and transportation planning, conservation, environmental infrastructure, missing children and law enforcement, and education assistance. The Catalogue of Federal Domestic Assistance (CFDA, www.cfda.gov) provides an entry point for identifying federal intergovernmental grant resources.

Unfunded Mandates

Shortfalls in intergovernmental revenues renew the long-standing debate over unfunded mandates. An unfunded mandate is a statutory or regulatory responsibility or duty from a higher level of government delegated to another government without providing sufficient funding to allow compli- ance and implementation (Osbourn 1995; NCSL 2013 Unfunded Mandates Reform Act of 1995). The National Conference of State Legislatures (NCSL) applies a broader definition that recognizes an unfunded mandate any time a federal decision requires a state or local government to spend funds (NCSL 2013). NCSL sees any spending requirement by state or local governments as a cost shift from the federal level. Unfunded mandates are evidence of the challenges and realities of federalism and the delegation of authority across levels of government. State and local governments are asked by the federal government to become instruments of program implementation, but they are frequently left with insufficient funding and regulatory burdens that make their participation difficult and costly. The NCSL estimates that U.S. Congress has shifted over $131 billion in costs from FY 2004 to 2008 to states (NCSL 2010b). Federal unfunded mandates on states and local governments take a variety of the following forms (NCSL 2013):

• direct federal orders without sufficient funding to pay for their implementation; • burdensome conditions on grant assistance; • cross sanctions and redirection penalties that imperil grant funding in order to regulate and

preempt a state’s actions in both related and unrelated programmatic areas; • amendments to the tax code that impose direct compliance costs on states and restrict state

revenues; • overly prescriptive regulatory procedures that move beyond the scope of congressional intent; • incomplete and vague definitions that cause ambiguity; and • perceived or actual intrusion on state sovereignty.

OBTAINING GOVERNMENTAL REVENUES 181

The Unfunded Mandates Reform Act of 1995 (UMRA, P.L. 104–4) gave formal recognition to the unfunded mandates problem. The act (1) requires that Congress perform a financial analysis to determine the impact of legislation on states, local governments, tribes, and the private sector; and (2) establishes congressional procedures to prevent the creation of an unfunded mandate. UMRA also establishes similar checks on the regulatory process. However, UMRA allows the federal government many loopholes for major entitlement programs, emergency assistance, national secu- rity, emergency legislation, constitutional rights of individuals, prohibition of discrimination, and accounting and auditing requirements (Osbourn 1995). For example, the Medicaid, child support, and Title 4E foster care and adoption assistance programs are open-ended entitlements without a cap on federal funding or state administrative costs or matching obligations (NCSL 2013). Given these many exemptions and a limited availability of federal funds, unfunded mandates will continue into the future. Faced with similar revenue shortages and federal performance requirements, state governments too are not immune from creating unfunded mandates for local governments.

The NCSL and the National Association of Counties (NACo) have long advocated against unfunded mandates (cf. NCSL 2014, 2013; Whitley 2010). Local governments should actively communicate and advocate with their legislators at the federal and state levels to prevent the imposition of unfunded mandates. But in situations where intergovernmental revenues are chroni- cally insufficient to accomplish needed program outcomes, local governments should also make a policy decision to develop new sources of revenue to cover shortfalls.

Intergovernmental Revenues Are Vulnerable to Reduction

In most states, intergovernmental payments have been a consistent and durable revenue source for state and local governments (Carroll, Eger, and Marlowe 2003, 1500–01). However, these payments are authorized by statute, and the legislature or governing body that created the statute can modify it as the situation demands. The economic downturn of 2007–2009 curtailed economic growth, which led to a major reduction in income and sales tax revenues to state governments. In 2009 and 2010, this reduction was somewhat blunted by the American Recovery and Reinvestment Act of 2009 (ARRA, “Recovery Act”), which included a variety of intergovernmental revenue shared with states and local governments. The Recovery Act helped many states bridge to a new reality of reduced revenues, but since its conclusion, states must balance their budgets without this major federal supplement. Facing reduced revenues and requirements to produce balanced budgets, state governments have carefully examined all expenditures, including intergovernmental entitlements and grants to local governments. These state intergovernmental payments are now in jeopardy of reduction or elimination (cf. Hannah-Jones 2011). Efforts by Congress to balance the federal budget and to eliminate deficit spending will leave federal intergovernmental transfers to state and local governments in jeopardy for years to come. Local governments should actively advocate in their state legislatures and in Congress to protect and to ensure full funding of programs that authorize and fund intergovernmental transfers (e.g., NACo; NCSL). Beyond advocacy, where intergovernmental revenues are chronically short or are permanently eliminated, local govern- ments must make a policy decision to diversify and to develop new sources of revenues to support community needs, or face the prospect of cutting services.

Revenue Source: Borrowing and Debt Instruments

State statutes grant local governments the authority to borrow money and to use that money as revenue for short- and long-term purposes. The debt instruments used by local governments include several major forms. Many local governments have established lines of credit for short-term needs. Like a line of credit on a residential home, a line of credit provides a local government with the

182 REVENUES AND BUDGETING

potential to borrow up to a specified level of funds quickly at a preset rate. Local governments may also borrow funds using short-term notes or bank loans. These are often used to cover cash flow needs, especially in paying operating expenses during the short period of time when quarterly or semi-annual tax bills from citizens and businesses have not been collected (see chapter 17 on cash flow management). These loans are called warrants because the local government guarantees the payment of the loan from the taxes it will receive. Continuously relying on short-term notes to cover routine operations and maintenance expenses indicates that a jurisdiction is living well beyond its revenue means and is in jeopardy of defaulting.

For longer-term borrowing to cover capital projects and capital purchases, local governments often sell bonds to investors. Local governments typically place a ballot measure before voters to propose a capital project, to agree to borrowing to fund the project, and to establish a special tax assessment. Governments use the dedicated tax revenues to make regular payments to pay off the borrowed principal and interest, much like a home mortgage. We take an extensive look a long-term debt instruments and capital purchases in chapter 16.

Revenue Source: Gifts and Donations

Gifts and donations make up a very small but growing source of local government revenues (Irvin and Carr 2005). The contribution of gifts to the larger revenue picture is largely a function of how aggressively government administrators work to develop philanthropic sources and to assure transparency in use of the donations. Rather than take gifts and donations directly, many local governments have established quasi-independent nonprofit organizations to accept and to coordinate public donations. Friends groups or foundations widely support community libraries, parks and recreation programs, and other local government programs (Irvin and Carr 2005, 41). Chapter 8 provides additional discussion on governmental and public foundations, including their revenue sources. Philanthropy theorists argue that government-provided services will displace and extinguish philanthropy to nonprofit organizations supplying the same service. However, Weisbrod (1977) argues that citizens will provide donations to government organizations to provide service levels above the median level of voter provision. For example, citizens with school-age children may contribute heavily to their local public school or school district education foundation to assure classroom or extracurricular resources above the level provided by a community property tax.

Revenue Source: Opening Fund Balance Forward

A public budget allocates revenues and resources to particular programs and allows the spending to accomplish program tasks. However, governments may purposely leave some money unspent in a program’s account or fund. Some resources in a fund are purposefully reserved for specific purchases or for pending program expenses. Other resources are left to cover anticipated end-of- year expenses and fiscal year close out (chapters 17 and 18). An increment of resources simply may not have been spent at the close of the fiscal year. Any unreserved resources in an account or fund at the close of the fiscal year may be available for spending in the coming fiscal year. These unspent resources often accumulate in a fund or account and are termed the opening fund balance. The level of the opening fund balance tends to increase in a growing economy when tax and fee revenue exceeds forecasts and budgeted spending. Opening fund balances may provide substantial resources to supplement tax, fee, intergovernmental, and other revenues. Budget policy in some jurisdictions may encourage keeping a large opening fund balance as a quasi-reserve fund. The unspent opening fund balance may be used as a reserve cushion against short-term cash flow problems, as a response to unexpected increases in service demand, or as resources to backfill revenue shortfalls due to economic downturns. We will provide a more detailed discussion of accounting funds and opening fund balances in chapter 9.

OBTAINING GOVERNMENTAL REVENUES 183

REVENUE BLENDS TO SUPPORT LOCAL GOVERNMENTS

The regional economic activity and the accumulated wealth in the community form a base from which to generate the continuing revenue to fund government operations and capital projects. Property taxes, sales taxes, charges and fees for service, and intergovernmental revenues provide a solid, continuing financial base for most local governments (Edwards 2006). Continuing rev- enues provide the base on which to size a government’s organization and procurement. Exhibit 6.1 displays an estimate of the relative share of the major sources of local governmental revenues for all U.S. local governments in 2009. The exact balance of the different continuing revenue sources used by a local government will vary with the fiscal year. Economic cycles of growth and recession will cause an ebb and flow in sales, income, and business tax revenues.

The wide variation in size, state tax regulations, and purpose causes an individual local govern- ment to deviate from the national averages in Exhibit 6.1. State property tax limitations may lessen the contribution of property taxes as a revenue source. State law may or may not authorize a juris- diction to impose a retail sales tax or an individual income tax. Enterprise revenues from water and electricity utility sales, recreation facilities, or transit district fares may contribute an identifiable and substantial share of a government’s total revenues. The size and stability of enterprise revenues, as well as policy decisions on how to use enterprise profits to subsidize other governmental functions, determines the continuing revenue base on which to size an organization and its procurement.

Revenues related to one-time activities and to one-time short duration revenues serve to supple- ment and complement a local jurisdiction’s continuing sources of funding. The flow of borrowed revenues from bonds and financial notes often will follow the start-up, construction, completion,

Exhibit 6.1

Local Governmental Revenues by Source, 2009, for All U.S. Local Governments

Source: U.S. Census Bureau, 2009. Table 1: State and Local Government Finances by Level of Govern- ment by State.

Intergovernmental federal government, 4%

Intergovernmental state government, 31%

Property taxes, 27%

General sales tax, 4%

Selective sales and other taxes, 2%

Individual income taxes, 2%

Corporate income taxes, 1%

Current charges and fees for services, 15%

Interest, sale of property, and misc., 6%

Utility revenue, 8%

184 REVENUES AND BUDGETING

and lifespan of capital construction projects. Grant revenues from the federal and state governments will increase intergovernmental revenues over the lifecycle of the grant. Some grants provide local governments with continuing revenues on a permanent basis, while other short-term grants last for only one to several years. Administrators and elected officials should recognize that short- term, one-time grants from public and private sources provide only a supplement to continuous revenues or recurring revenues. The revenue balance that supports a jurisdiction adjusts over time, but increasing the diversity of both recurring and one-time sources of revenue should stand as a strategic goal (NCSL 2007b; Krane, Ebdon, and Bartle 2004).

Examples of Local Revenue Sources

The following set of exhibits (6.2 to 6.6) presents representative examples of the balance of revenues used by local governments of different sizes and types. These exhibits demonstrate the ongoing importance of property taxes and charges and fees for most local governments. Charges and fees are especially important for special district governments.

Large- and mega-sized urban/suburban counties are some of the largest full service governments in the country. Exhibit 6.2 demonstrates revenues for one such county government. This county contains 1.9 million residents, including one city of 600,000 residents and two cities of about 100,000. For 2010, the total budget from all funds was about $4 billion. Even with its mega size, the county government is heavily reliant on property and sales taxes, and on charges and fees for services. Local intergovernmental revenues add to the total county revenues. For example, small

Exhibit 6.2

Large- and Mega-Sized Urban/Suburban County Revenues by Source, 2009: All Funds

Source: King County, WA 2009, B-11. For clarity, all federal grants and revenues, including Recovery Act funds, were combined into a single federal category. All state funds were combined into a single category, and all local intergovernmental revenues and grants were combined. King County operates a very large transit system that accounts for a large portion of the “transit revenues and other” wedge.

Taxes, 28%

Licenses and permits, 1%

Federal grants and shared revenues, 3%

State grants and shared revenues, 2%

Local intergovernmental payments, 10%

Charges for service, 27%

Fines and forfeitures, 0%

Transit revenues and other, 29%

Total revenues, $4.07 billion; Total population, 1.91 million

OBTAINING GOVERNMENTAL REVENUES 185

cities in counties often contract with the county sheriff under an interlocal, intergovernmental agreement for law enforcement patrol and investigative services. Large counties may also oper- ate an extensive transit system and wastewater and sewer facilities on an enterprise basis. These enterprise functions result in substantial utility and transit revenues, all segregated to support the operations of the particular service.

In contrast to a mega urban/suburban county, Exhibit 6.3 represents a western state rural county with a small population and an extensive acreage of nonassessed federal public lands. While the geographic size of the county is quite large, the county government is very small, serving a population of about 73,000 citizens with a limited economic base. Again, property taxes provide the primary source of revenue for this county government, while charges and fees for services provide a smaller portion of the total. Interestingly, the direct federal PILT reimbursement pay- ments provide about the same proportion of federal intergovernmental revenues as in the much larger mega county just described above.

Exhibit 6.4 demonstrates the revenue balance for a representative small city with a population of about 16,500. Property taxes generate about one-third of the total revenues, and charges for service generate about 40 percent—a little bit more than in the mega-county example. Retail sales and use taxes generate a small but important source of revenue for this city. The state actually collects this tax from local merchants and then reimburses the city and the local county according to authorized percentages. Licenses and permits, as well as fines and forfeitures, each contribute a small portion of the total revenues.

Townships in the mid-Atlantic and central states provide local services to suburban and rural residents. Larger townships (first class in Pennsylvania) typically surround large cities and serve suburban areas. Smaller townships (second class) are smaller in capacity but provide similar lo-

Exhibit 6.3

Rural County Revenues by Source, 2010: Counties with Extensive Federal Lands

Source: Umatilla County, OR 2010, General Fund 101, pp. 16–17. Umatilla County has elected to take federal Payment in Lieu of Taxes (PILT) payments to compensate for lost property tax revenues on federal lands in the county.

186 REVENUES AND BUDGETING

cal government services to suburban and rural residents. Exhibit 6.5 demonstrates revenues for a representative small township that serves about 3,800 residents. The exhibit covers general fund revenues and six other dedicated special fund revenues. The exhibit indicates that the township relies on real estate property taxes, but it also depends heavily on wage- and services-based income taxes. The township collects no sales tax revenues. The township receives intergovernmental revenues from the state and other local governments, but none from the federal government.

The township example in Exhibit 6.5 and the small city example in Exhibit 6.4 demonstrate useful comparisons. Taxes provide a major source of revenue for both jurisdictions (40 percent in the city and 66 percent in the township). The township, however, collects very few charges and fees for services; instead, taxes and permit revenues cover most service costs. The small city uses the nomenclature of charges and fees (about 40 percent) to include revenues from its enterprise funds and services to individual users. Interestingly, the combination of taxes, license and permit revenues, and fee revenues in both jurisdictions totals about 80 percent of all revenues collected. Intergovernmental revenues provide about the same percentage of revenues to both jurisdictions (about 15 percent) with little federal contribution.

In contrast to the general-purpose county and city governments, Exhibit 6.6 demonstrates a medium port district with a marine shipping program. The district operates enterprise functions loading and unloading a variety of bulk commodities, containers, large manufactured equipment, and passengers, and renting land and property to businesses. The enterprise functions bring in the majority of the district’s revenues. Marine terminal fees are an especially important source of rev- enue. The district also receives property tax income that funds a set of nonenterprise governmental

Exhibit 6.4

Small City and Town Revenues by Source, 2010: All Funds

Source: Revenue proportions for this example small city are drawn from the City of Camas, Washington, Budget 2010. Camas operates proprietary storm drainage, city sanitary and water-sewer programs that gener- ate extensive charges for service revenue. City of Camas 2009.

OBTAINING GOVERNMENTAL REVENUES 187

functions. These governmental functions provide general government services, facilities planning and environmental services, and economic development services similar to a county government. This district is located in a state with general and local retail sales and use taxes, but the district receives no sales tax revenue. Any federal revenues would come from specific grants.

Our focus here is local government revenue sources. There are important differences between local and state revenues, as explained in Exhibit 6.7 on page 189.

Relative Revenue Burdens

The collective structure of law, regulations, and tax program implementation combine to create the revenue burden carried by the residents and businesses of each state. Exhibit 6.8 provides the relative ranking of the per capita revenue burden by state based on state and local revenue collec- tions. Revenue sources include property taxes, general sales taxes, motor fuels taxes, alcoholic beverage taxes, tobacco taxes, individual income taxes, corporate income taxes, and charges and fees collected. A ranking based on a total of all revenues is included on the right side of the table. The exhibit computes its rankings on a per capita basis that standardizes the revenues for com- parison across states. However, several states with apparent high burdens (like Alaska, Wyoming, and North Dakota) receive their high rankings because of severance taxes on petroleum, natural gas, and coal extraction. To imply that each citizen of these states bears a full revenue burden is

Exhibit 6.5

Small Township Revenues by Source, 2012: All Funds

Source: Lower Milford Township (Pennsylvania) provides an example of a smaller (class 2), often-rural township government. Lower Milford Township 2011.

188 REVENUES AND BUDGETING

incorrect (Braybrooks, Ruiz, and Accetta 2011). Operating a state government requires a basic fixed cost of program and funds, thus small population (fewer than a million residents) states may generate high per capita burdens relative to most states. Alaska, Wyoming, Vermont, Delaware, North and South Dakota, Montana, and even the District of Columbia have high burdens, in part because of their comparatively small populations.

Exhibit 6.8 demonstrates the relative revenue burden between states, and also how states bal- ance individual tax, corporate tax, and charges and fee revenues into a total package. The exhibit demonstrates a set of high revenue states with relatively heavy burdens: the District of Columbia, New Jersey, New York, Connecticut, and Hawaii. Another group demonstrates relatively low total revenues collected per capita: South Dakota, Tennessee, and Arizona. Other states demonstrate a balancing of revenue sources with heavy reliance on one or two preferred revenue sources. Wyoming relies heavy on property taxes and general sales taxes, along with charges and fees, but has no personal or corporate income tax. Washington State has high general sales and business gross receipts taxes, and high charges and fees for service, but no individual income tax. Hawaii has a high general sales tax that captures tourist spending, but a very low corporate income tax. In contrast, Maryland and Oregon rely heavily on individual income taxes. Oregon has no gen- eral sales tax, and Maryland has a relatively low general sales tax and low charges and fees. In general, the New England states rely heavily on property taxes. Massachusetts, New Hampshire, and Vermont have very high property taxes, as well as strong corporate income taxes, but low or no general sales tax. The District of Columbia, Connecticut, and Rhode Island assess very high property taxes, but collect very low fee revenues. South Carolina and Iowa assess relatively light property, general sales, and income taxes, but rely heavily on charges and fees. As these configura- tions illustrate, states may collect little or no revenue from a particular source, but then diversify their revenues from all other available sources.

Exhibit 6.6

Special District Revenues by Source, 2010: Medium-Capacity Marine Port District

Source: Port of Longview (Washington) provides the data for this representative port special district. Port of Longview 2010, 4.

OBTAINING GOVERNMENTAL REVENUES 189

Exhibit 6.7

State Governments Revenue Sources Are Different

In contrast to local governments, state governments rely on a slightly different set of revenue sources (Braybrooks, Ruiz, and Accetta 2011). Although in limited use by local governments, 43 states and the District of Columbia impose an individual income tax that generates substantial revenues to state and district coffers. All but four states impose a corporate income tax that provides a smaller, but nevertheless important, source of revenue. Retail sales, gross receipts, use taxes, and excise taxes are another major category of revenues. Tobacco and liquor taxes, along with liquor sales profits, provide important sources of excise tax revenue. Thirty-six states have authorized a state property tax. Michigan, Vermont, and Washington impose a state property tax to fund K–12 education statewide (Braybrooks, Ruiz, and Accetta 2011, 5). A state level property tax for K–12 provides one means of equalizing school funding across a state. Inheritance and estate taxes provide a typically minor but politically sensitive source of revenue. Severance taxes on the extraction of petroleum, natural gas, and hard rock minerals, or on the harvest of timber, provide a substantial source of revenue for several states. State-owned lands and utility rights of way generate rental revenue. Unique to the state level, many state governments operate a lottery. Lottery profits provide a steady source of unencumbered nontax general revenue. Lottery dollars may be earmarked for a particular program or purpose, or used as annual revenues to pay off bonds. Local governments may receive a pass-through of lottery funds, but most lottery revenues remain at the state level. In contrast to the relatively limited contribution of federal intergovernmental funds at the local government level, federal transfers provide a major source of revenues at the state level for a broad array of programs. A listing of some of the major federal intergovernmental programs follows (Federal Funds Information for States [FFIS] 2011). Federal transfers for nutrition, social service, and child care programs are substantial. These transfer funds include: Women, Infants, and Children (WIC) and Supplemental Nutrition Assistance (SNAP); Temporary Assistance to Needy Families (TANF) annual block grant; Child Care and Development block grants; Child Welfare funds; Social Services Block Grants; Head Start early childhood learning funds; and Low-Income Home Energy Assistance funds. Federal funds support major health programs as well: Medicaid administration and Medicaid provider reimbursement for qualifying low-income citizens; Children’s Health Insurance Program; Mental Health Services block grant; and the Substance Abuse block grant. Many of these programs require a state percentage match for each federal dollar, or the maintenance of state spending effort. The unemployment insurance program in each state is jointly funded by federal and state payroll taxes but administered as a federal trust fund with payments to states. Federal dollars support programs for adult and youth worker training and for dislocated worker assistance. Federal funding provides critical support to state and local housing programs. The HOME investment partnership program, the Section 8 Rent Subsidy programs, the Community Development Block Grants (CDBG), the Community Services Block Grant, and housing for the elderly draw on federal funds. Federal Homeland Security funds support grants to states and to local governments for security, emergency response, and emergency preparedness. Department of Justice programs fund the Community Oriented Policing Services (COPS) and policing grants to local sheriff and police departments, the Violence Against Women program, and the Juvenile Accountability block grant. Federal transportation dollars provide substantial resources for airport, highway, and mass transit facility construction. Federal environmental funds support energy weatherization and clean drinking water programs. The National Conference of State Legislatures (NCSL) provides extensive coverage of state fiscal situations and the status of federal revenue programs (access NCSL at http:// www.ncsl.org). Efforts to reduce the federal spending deficit will very likely reduce federal transfers to the states in the coming years.

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192 REVENUES AND BUDGETING

Changing Balance and Relative Importance of Local Revenue Sources

The relative importance of the various revenue sources used by local government has evolved over the decades. The effects of the 2007–2009 economic downturn will have a continuing impact on this evolution. Property taxes once provided nearly all local government revenues. Property taxes remain especially important as a source of revenue in the New England states, but they have become less important in the southern and southwestern states. At the beginning of the twentieth century, property taxes supplied 82 percent of all local government revenues (Bartle 2003). Property tax revolts in California and in other states in the 1970s caused a pre- cipitous decline in this share (Mikesell 2005, 112); tax and expenditure limitations are now in place in 43 states (Edwards 2006, 3). In the 1990s, the decline in property tax revenue moder- ated, but by 1999 the property tax share of revenue had fallen to about 37 percent. Exhibit 6.1 confirms that this share continued to fall to about 27 percent by 2009. In an unintended political consequence, tax and expenditure limitations have often centralized local control over property taxes and revenues to the state level. In 30 states, state payments to local school districts for K–12 education have replaced some of the lost property tax revenues (Bartle 2003, 28). Some of the increase in centralized state school funding may be attributable to efforts to equalize education funding across rich and poor school districts (Edwards 2006, 4; Krane, Ebdon, and Bartle 2004, 524).

The relative contribution of federal intergovernmental payments to local governments has also evolved over the recent decades (Krane, Ebdon, and Bartle 2004, 515; Edwards 2006, 2). Federal payments to local governments reached a high in the 1960s and 1970s with the Johnson adminis- tration’s Great Society programs and the Nixon administration’s revenue sharing block grant and environmental infrastructure programs. The Housing and Community Development Act of 1974 began the Community Development Block Grant (CDBG) program during this period. This era of generous federal resources also brought spending flexibility and program responsibility to local governments. But by the late 1970s, Congress began to increase regulatory mandates on states and local governments and the supporting federal funding began to decline. This set up a wave of unfunded program requirements and mandates, many of which continue to today. By the early 1980s, the Reagan administration aggressively reduced the federal revenue programs to state and local governments. Exhibit 6.1 demonstrates that in recent years federal intergovernmental grants have become an increasingly smaller source of revenue for most local governments. Perhaps the major exception to this trend was an increase in federal funds to local governments for homeland security after the 9/11 attacks in 2001.

The recent extensive federal spending on economic recovery, dysfunctional federal budgeting and appropriations (Meyers and Joyce 2005; Joyce 2005), and a substantial federal deficit and debt have increased calls for a balanced federal budget and stronger federal spending controls (National Commission on Fiscal Responsibility and Reform [NCFR&R] 2010; Ryan 2011; Obama 2011). Recent political action has pointed toward continued pressure to constrain federal spending. Over the longer term, state and local governments will likely need to adjust to a reduced level of federal support.

State aid to local governments increased into the 1980s, but then shifted to a decline. At the same time, states devolved substantial additional functions, responsibilities, and administrative capacities to local governments, including land-use planning, regional planning, and economic development. These new administrative capacities and procedures exceeded the basic authorities granted under home rule charters (Krane, Ebdon, and Bartle 2004, 527). State intergovernmental transfers continue to provide extremely important entitlement and shared tax revenues to county and city governments, even though these transfers often do not meet the levels needed to cover local program costs.

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The decreasing contribution of property tax revenues, and of state and federal intergovernmental revenues, set the backdrop for the wild events of the economic downturn of 2007–2009. At the completion of this text in 2014, the effects of the downturn lingered, affecting local government revenues and borrowing in many communities. Unemployment rates remain high in many com- munities, even as housing values have stabilized and housing construction has begun to recover. In the face of constrained property tax revenues and limited federal and state intergovernmental transfers, local governments will need to identify sustainable levels of revenue and size spending accordingly; seek out and develop new sources of continuing and one-time revenues, explore jurisdictional consolidations and sharing of service delivery responsibilities, and possibly shed services to other organizations better situated to obtain and concentrate the necessary revenues. This situation reinforces the need for local governments and government administrators to take an energetic, entrepreneurial approach to diversifying revenue sources. It also illustrates that is- sues of revenue are tied together with larger issues of governance, including building community capacity and resiliency in the provision of services by community partners.

CONCLUSION: LEADERShIP ChALLENGE TO RAISE AND STABILIZE REVENUES

The hypothetical Upper Cascadia County teaching case with which we began this chapter presents a scenario of voter disapproval and subsequent efforts by the finance director, Elizabeth Brown, and other officials to rebuild a revenue base for public safety programs. Upper Cascadia County and all other local governments strive for a tax and revenue system that can efficiently generate a reliable and stable flow of revenues in the face of changing economic conditions. Elected and appointed county treasurers, assessors, and clerks are the key to fair and cost-effective implementation of property tax and revenue systems. A diversified balance of tax, fee, intergovernmental, and other revenues is critical to such revenue stability and reliability. From the viewpoint of citizens and businesses, a tax system must be fair and equitable in design and implementation. Local govern- ment officials have limited control over the elements and equity in their parent state’s tax structure and policy, but these officials make a major difference in how the state structure is interpreted and applied to local taxpayers. Local government officials have choices as to when and how to exercise the taxing authority delegated from the state. They can also set local property tax rates and choose when to exercise local options for sales and income taxes. Each of these choices calls for effective political and administrative leadership.

Against the challenges of public frustrations and suspicions, community traditions, staff rela- tions, economic backdrop, and the state revenue structure, the task of administrators and elected leaders is (1) to lead the community to recognize its needs, and (2) to gain the agreement to accept taxation and other revenues. Administrators are in a unique position to take the leadership role to explain needs, nurture and clarify a vision of the future, answer concerns, admit to the costs, demonstrate benefits, and deliver the services as expected.

STUDy qUESTIONS

1. Consider the county, township, or city in which you live or work. Compare its sources and balance of revenues to the graphs in the chapter. Which revenue sources are, or are not, present? What community preference and policy choices explain or drive the balance of revenue sources?

2. In your jurisdiction, how have local government revenues changed since the economic downturn that began in 2007? Is your community faced with extensive residential property foreclosures? How have local property values affected property tax revenues?

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3. In your jurisdiction, what analysis and public process are used to set the fee rates for services (e.g., permitting, construction inspections, health inspections, utility franchise, and utility service, including water, sewer, or electricity)? Are these fees set for partial or total cost recovery? Is it just to set a fee for partial cost recovery? Can you identify a fee that is set to generate a profit?

4. If you work for a governmental or nonprofit organization, how do you set the fee rates for the services that you provide? What analysis and policy process do you use to set fee rates? Are your customers, board, and donors supportive of your fee structure?

5. The chapter describes the wide variety of intergovernmental revenues shared between state and local governments. Obtain a schedule of state revenues shared with local governments in your state. Which are the most important intergovernmental revenues? If your state has a lottery, is a portion of the lottery profits returned to counties or local governments?

6. Can you identify a partial or major unfunded mandate imposed on your local government by a state or federal program? Examine the mandate from all perspectives. Is it fair for the state or federal government to impose a requirement on a local need or condition with insufficient resources?

NOTES

1. We draw on the material in chapter 10 of Morgan, Green, Shinn, and Robinson, Foundations of Public Service, 2d ed. (Armonk, NY: M.E. Sharpe, 2013) for the preparation of this chapter.

2. See Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753 (1976).

3. King County, Washington, follows a similar breakout: entitlements, shared revenues, and grants for services. See King County, 2009, 2010 Executive Proposed Budget Book, Economic and Revenue Forecast, B-11.