PART 1 - RETHINKING LOCAL GOVERNMENT REVENUE SYSTEMS: Why is it necessary?The Rethinking Revenue initiative is a joint project of many organizations that have an enduring interest in creating thriving local communities and making sure that those communities are served by capable and ethical local governments. Rethinking Revenue is about providing local governments with the ability to raise enough revenues for the services their communities need—and to raise those revenues fairly and in a way that is consistent with community values. This first report from Rethinking Revenue is about defining the problem that local government revenue systems face. As the famed inventor Charles Kettering said, “a problem well stated is a problem half-solved.” The Rethinking Revenue initiative will follow this report with suggestions grounded in proven approaches to reform local government revenue systems.Why is rethinking necessary? We contend that rethinking is necessary because local government revenues have not remained aligned with modern economic realities. We will show that this contributes to distortions in the economy and unfairness in how taxpayers are treated. Let’s consider the quintessential local government revenue: the property tax. The changing economy has challenged the relevance of the property tax. Most fundamentally, a large part of the value created in the modern economy does not involve property—it often involves less tangible things, like financial instruments or bits and bytes. For example, from 1989 to 2019, the top five fastest-growing categories of wealth held by families were types of financial instruments. This has changed the relative importance of assets in the composition of family wealth. Financial assets increased as share of total assets, from 31% to 42%. The relative share of wealth derived from primary residences and equity in nonresidential property both decreased. In short, wealth has become less connected with real property ownership and therefore does not represent the taxpayer’s ability to pay in the same way it used to.Rethinking Revenue ProjectRRP_97556dea-3f2e-11ec-8aac-edec1b83ea00ABOUT THE RETHINKING REVENUE PROJECT ~ Local government revenues must adequately fund the public services that a community desires without creating excessive inefficiencies on unfairness in the revenue raising system. However, local government revenue structures are largely based on assumptions that no longer hold today due to digitization, globalization, demography, political changes, and other trends. Furthermore, fairness is becoming an increasingly important concern for public finance. It follows that this concern should include how revenues are raised. For these reasons, the Rethinking Revenue project is taking a fresh look at how revenues are raised. The project will raise new and interesting ideas like those featured in this paper and will produce guidance for state and local policy makers on how to local government revenue systems can be modernized. We hope the ideas presented in this paper will spur conversation about the possibilities for rethinking revenue.Local GovernmentsState PolicymakersLocal PolicymakersRethinking Revenue PartnersThe Rethinking Revenue initiative is a collaborative effort involving:American Planning Association (APA)Government Finance Officers Association (GFOA)International City/County Management Association (ICMA)Center for Intergovernmental PartnershipsNational Academy of Public Administration (NAPA)National League of Cities (NLC)Center of Municipal Financeat the University of Chicago’s Harris School of Public PolicyGovernment Finance Research Centerat the University of Illinois at Chicago’s College of Urban Planning and Public AffairsContributorsACKNOWLEDGMENTS:William BarnesNational League of Cities (Retired) *Fellow of the National Academy of Public AdministrationDon BorutNational League of Cities Retired Executive Director *Fellow of the National Academy of Public AdministrationJenna DeAngeloAssociate Director of Local and Regional Fiscal Health, Lincoln Institute of Land PolicyLee FeldmanCity Manager of Gainesville, Florida, former President of ICMA *Fellow of the National Academy of Public AdministrationTeresa W. GertonPresident and CEO, National Academy of Public Administration *Fellow of the National Academy of Public AdministrationJason JordanPublic Affairs Director, American Planning AssociationShayne KavanaghSenior Manager of Research, GFOARick MattoonVice President and Regional Executive, Federal Reserve Bank of Chicago—Detroit BranchChristiana K. McFarland, PhDResearch Director, National League of CitiesTad McGalliardDirector, Research and Development, ICMAChris MorrillExecutive Director / CEO, GFOA *Fellow of the National Academy of Public AdministrationMarc OttExecutive Director / CEO, ICMA *Fellow of the National Academy of Public AdministrationMichael A. PaganoDirector of the Government Finance Research Center, University of Illinois at Chicago (Retired) *Fellow of the National Academy of Public AdministrationKurt ThurmaierDistinguished Engagement Professor and Chair, Department of Public Administration, Northern Illinois University *Fellow of the National Academy of Public Administration Barry L. Van LareFormer Director, Office of Management Consulting and Training, National Governors Association *Fellow of the National Academy of Public AdministrationChris BerryProfessor, The University of Chicago, Harris School of Public Policy Director, Center for Municipal FinanceThriving communities served by capable and ethical local governments_97556fc0-3f2e-11ec-8aac-edec1b83ea00To provide local governments with the ability to raise enough revenues for the services their communities need_97557114-3f2e-11ec-8aac-edec1b83ea00CommunityGovernanceCapabilityCost EffectivenessFairnessEthicsUnderstandingUnderstand the current state of local government revenues_975572b8-3f2e-11ec-8aac-edec1b83ea00Step 1What issues will we address in this report and the Rethinking Revenue initiative? This report is Step 1 of the Rethinking Revenue initiative. Step 1 is about understanding the current state of local government revenues because, as it has been said, “a problem well stated is a problem half-solved.” We will examine the following questions in the rest of this report. * What is the scale of the problem? * Can’t local governments just spend less? * Where does local government revenue come from now? * Where does the Rethinking Revenue initiative go from here?RevenueProvide revenue options responsive to local economies that keep up with the cost of public services_975573e4-3f2e-11ec-8aac-edec1b83ea001.1WHAT IS THE SCALE OF THE PROBLEM? Local governments are a diverse set of jurisdictions, so the scale of the problem varies. When we look at revenue data aggregated across all local governments, we find that total local government revenue has gone up after adjusting for inflation and population growth, as Exhibit 1 demonstrates. However, when we look beyond the aggregated data, there are some important nuances. First, as we will discuss more later in this report, user fees make up an increasing portion of many local government budgets. User fees are the most regressive form of local revenue. Second, the extent to which a local government’s population increases and the wealth of its citizens’ increases will impact the extent to which revenues stay at least even with expenditures. For example, one study of larger cities found that from 2003 to 2018, larger and wealthier cities enjoyed revenue growth in excess of expenditures, while smaller and poorer cities had higher growth in expenditures than revenues. A rethought revenue system should provide all communities with revenue options responsive to local economies and that keep up with the cost of public services.Flexibility & AccountabilityProvide flexibility for local government while maintaining accountability_97557506-3f2e-11ec-8aac-edec1b83ea001.2Another important nuance is the room that local governments have to make choices about their revenue portfolio. Their autonomy is limited by the laws of state governments, and their ability to adjust to shifts in the underlying economy or external shocks is limited by states’ actions. For example, nearly nine in ten cities in the U.S. do not have the legal authority to levy an income or wage tax, and around 45% do not have authority to levy a sales tax. Some states also have tax caps and other limits on the revenues that local governments are allowed. Moreover, a local government’s ability to propose and implement revenue changes is affected by: a) residents’ and taxpayers’ demands for services at an acceptable price; and b) the link between the local government’s legal ability to implement different types of taxes and fees and whether the underlying economy would support a given tax or fee.21 Hence, a local government’s “Fiscal Policy Space” (i.e., room to make choices) is bound by state law, what the underlying economy will support, and public demand for government services and willingness to pay for them. Each government’s Fiscal Policy Space is unique, which means that we must be careful about drawing conclusions about the fiscal health of cities from aggregate data. Also, though there is not a universal trend across all local governments as to whether Fiscal Policy Space has expanded or contracted over recent decades, changes in the Fiscal Policy Space can limit local government choices about how to best solve local problems. Rethinking local government revenue systems can provide the needed flexibility for local government, while maintaining accountability for how much revenue is raised and how it is used. Cost EffectivenessMake local governments more cost-effective_97557628-3f2e-11ec-8aac-edec1b83ea001.3CAN’T LOCAL GOVERNMENT JUST SPEND LESS? There are opportunities for local government to be more cost-effective. We advocate that revenue reforms happen side by side with reforms to make local government more cost-effective. Examples of opportunities to improve cost-effectiveness include but are not limited to [the following objectives] ... That said, given the compelling reasons for rethinking revenues that we have described, we don’t think cost-cutting alone is an adequate solution. As we stated, there may be challenges that require more spending at the local level, such as infrastructure and education.FragmentationReduce the number of local governments_9755775e-3f2e-11ec-8aac-edec1b83ea001.3.1Local government fragmentation. There are tens of thousands of local governments in the U.S. It is reasonable to consider if there is too much fragmentation in local government and if public funds could be better used if there were less fragmentation.PensionsReform pension plans to ensure they are affordable and financially sustainable_9755789e-3f2e-11ec-8aac-edec1b83ea001.3.2Pension reform. Local governments should continue to pursue reforms to public pension plans to ensure they are affordable and financially sustainable.BudgetingInstitute non-incremental budgeting_975579e8-3f2e-11ec-8aac-edec1b83ea001.3.3Better budgeting. Conventional local government budgeting is incremental, where last year’s budget becomes the starting point for the next year. This means new costs tend to get layered on top of the old. We encourage alternative ways of budgeting that help governments make better decisions about how to spend limited resources.DifferencesUnderstand how revenues vary between different types of governments_97557b32-3f2e-11ec-8aac-edec1b83ea001.4CitiesCountiesSchoolsWHERE DOES LOCAL GOVERNMENT REVENUE COME FROM NOW? For readers interested in details about how revenues vary between different types of governments (cities, counties, schools) and different states, you may consult our online appendix. For everyone else, we will summarize here the two major conclusions we can draw that relate to the premise of this Rethinking Revenue initiative.LimitationsAddress limitations in current forms of taxation_97557c68-3f2e-11ec-8aac-edec1b83ea001.4.1First, though there is some variation between states, property taxes are a major source of revenue, on average, for local governments. Sales taxes are also important for many cities and counties. Local income taxes are important in a few states, but in the large majority, they are not a tax levied by the local government. The income tax may still be important to the state government, though. This shows that many local governments are still as reliant as ever on taxes that have important limitations in the 21st century.Service ChargesConsider intergovernmental revenues as substitutes for service charges_97557e52-3f2e-11ec-8aac-edec1b83ea001.4.2Second, there has been more reliance on charges for services and a decrease in intergovernmental revenue for cities and counties. For example, an in-depth study of the 39 largest cities in the U.S. showed that from 2003 to 2018, charges grew so much as to equal tax revenue for half the cities. Charges for services are among the most regressive of local government revenue sources, while intergovernmental revenues may often be more progressive. This means that local government revenue systems have likely become less fair in the last decade.PrinciplesDefine the principles should guide local government revenue reform_97557f9c-3f2e-11ec-8aac-edec1b83ea00Step 2What principles should guide local government revenue reform? Any major changes to the revenue system should be guided by a set of principles. Ideas for change can be compared to these principles. Step 2 will be about defining these principles._975580fa-3f2e-11ec-8aac-edec1b83ea00ReformsIdentify reforms to realize the principles of a modern public revenue system_9755826c-3f2e-11ec-8aac-edec1b83ea00Step 3What reforms to revenues would better achieve the principles of a modern system? We will examine how existing sources could be reformed and new sources created.ConsiderationsConsider alignment with the modern economy, fairness, and other critical considerations_975583c0-3f2e-11ec-8aac-edec1b83ea003.1We will consider alignment with the modern economy, fairness, and other critical considerations.Concerns & PrioritiesLearn about stakeholder concerns and priorities_9755850a-3f2e-11ec-8aac-edec1b83ea003.2The PublicPrivate EnterpriseState OfficialsLocal OfficialsTaxpayersPublic Service UsersStep 3 also involves learning more about what the public, private enterprise, and state and local officials think about local government revenues: What concerns do they have? What is important to them?ImplementationPut the Step 3 proposals into practice_97558654-3f2e-11ec-8aac-edec1b83ea00Step 4STEP 4. How can rethought local revenue be made a reality? We will work with stakeholders in state and local government to put the proposals generated in Step 3 into practice.CollaborationWork with stakeholders in state and local government_975587bc-3f2e-11ec-8aac-edec1b83ea004.1State Government StakeholdersLocal Government Stakeholders2021-11-06https://gfoaorg.cdn.prismic.io/gfoaorg/4d14c151-6185-4157-a954-3dee06f3530e_Rethinking+Local+Government+Revenue+Systems_R2.pdfOwenAmburOwen.Ambur@verizon.net