Weathering The Coming Fiscal Storm: An Emergency Proposal

by Bruce Katz, Deborah Carroll, Michael Pagano, Avanti Krovi and Frances Kern Mennone · November 16, 2023


Three years after the first wave of the pandemic, remote work is challenging the role and function of central business districts in the United States. This disruption has already pushed down transit ridership and revenues in major US cities and metropolitan areas: it is now triggering general concerns regarding the urban fiscal health of cities since central business districts and downtowns typically generate a disproportionate share of municipal tax revenues.

Our states and nation have not equipped cities with the tools to address these fiscal vulnerabilities, some of which existed even before the pandemic. And with the 2026 cessation of ARPA funding, which has been filling local budget gaps, it is imperative that we understand them. Which cities are facing a fiscal cliff, and why? What will this mean for vulnerable residents? What will this mean for our national economy? How can remaining ARPA funds help address this?

To answer these questions, we call for establishing an emergency effort akin to the Advisory Commission on Intergovernmental Relations (ACIR) that operated from 1956 to 1996. As we discussed back in 2020, the ACIR served “to strengthen the American federal system and improve the ability of federal, state, and local governments to work together cooperatively, efficiently, and effectively”.

In absence of an ACIR, cities and other organizations are taking it upon themselves to understand fiscal vulnerabilities and what actions can be taken now. For example, Cincinnati has established a commission to analyze their fiscal challenges and options for economic development. In Washington DC, the Mayor and Council have appointed a commission to rethink the tax code and create a resilient tax base.

Furthermore, the Government Finance Research Center (GFRC) at University of Illinois Chicago, which specializes in taxation and public finance research, is collaborating with the Government Finance Officers Association (GFOA) and other key organizations to better understand revenue generation that aligns with the contemporary needs of cities.

But ultimately, we need an Emergency ACIR to provide a dependable and consistent source of data that can be used to develop a fiscal “stress test”. Such a stress test will account for the variation in fiscal architecture across the country, which necessitates a more nuanced assessment of urban vulnerability to remote work trends. Furthermore, we need an Emergency ACIR that will foster more cooperation and coordination between federal, state, and local governments, so that they are equipped to respond to fiscal crises.

Below, we outline how the nuances in fiscal architecture will uniquely affect cities across the country. To follow up on these potential challenges, we then outline how an Emergency ACIR could be designed and what it could achieve.

Understanding the “Fiscal Architecture” of Cities

A city and its constituent parts are unique—some neighborhoods may serve as employment centers while others serve as bedroom communities or retail centers—influencing how a city may raise revenue there. As such, shifting commuting patterns in cities across our nation will unevenly affect where people live (property taxes), work (income/wage taxes), and buy taxable retail goods (sales taxes). Ultimately, this will disproportionately hurt or help cities depending on the composition of their taxable bases.

This heterogeneity in city’s fiscal powers is driven by state control over city taxing authority, i.e., whether states legally allow cities’ access to revenue sources that align with economic strengths of the city. Few cities, if any, have linked their taxing authority, or their fiscal architecture, to their economic strengths, and such misalignment should be considered a state-induced problem. As a starting point for states and their cities, our team categorizes local and regional ecosystems into four types of tax regimes:

Property Tax Dependent

Nearly all cities can and do levy and collect a tax on real estate. But there is significant variation in the extent to which cities depend on property taxes to fund their operations. For example, in the year leading up to the pandemic, the City of Miami generated nearly half (47%) of its own source revenue from property taxation. This compares to the cities of Dayton and San Bernadino, CA for which property taxes comprised less than 5% and 8%, respectively, of own source revenue.

Depending on property value fluctuations, cities with uniform tax laws that require all property be treated the same regardless of classification, could experience less financial disruption than cities with differential property tax laws that typically impose a higher tax rate on commercial property than residential property. In the latter case, those cities may experience a conversion of some existing properties from commercial to residential use, thereby reducing property tax collections (assuming rates are not adjusted).  Chicago presents an example of a city with a split property tax whereby commercial and industrial real estate is assessed at 2.5 times residential assessment rates. Hence, as developers propose a $1.2 billion repurpose of commercial/office property in the LaSalle Street corridor (the iconic commercial/office canyon in Chicago) to include more residential properties, the likely reduction in property tax collections—even if the market value of the properties remains constant—is expected to be severe.[1]

Income Tax Dependent

Only one in 10 cities across the US can impose an income or wage tax.  Dayton is one of these cities, generating the same proportion in income tax in 2019 that Miami did from property taxes, around 47%. Conversely, they generated less than 5% from property taxes and zero from sales taxes. Dayton assesses income tax at the place of work and the place of home. Nearly 4 of 5 employees who work in the city live outside the city limits, meaning that as telework takes hold as a permanent feature of the new workforce commuting patterns, the city expects to lose up to $20 million per year or 10% of total general fund revenues.

Sales Tax Dependent

Slightly more than half of US cities can collect a sales tax. San Bernardino, CA, for example, generates upwards of 40% of own source revenue from sales taxation but does not levy a local income tax.  More broadly, sales tax receipts for Oklahoma City account for nearly three-fourths of general fund revenues, which actually increased during the pandemic and are projected to continue to grow, irrespective of any change to commuting patterns. A similar variable impact is expected for cities that experience a decline in the service or hospitality sector if office workers do not return to their former employment, thereby reducing demand for nearby restaurants, bars, and post-work social activities. Although demand for such services may not decline in the aggregate, changes in their spatial distribution will most likely reap increased sales (and other) tax collections at the site of employees’ residences rather than at the site of their (nominal) employment.  And the prospect of shifting consumption of services from the metro center’s CBD to suburban or neighborhood locations may drain the cities’ coffers of much needed resources.

Diversified Structures

Our fourth category encompasses cities that had relatively diversified revenue structures in 2019 with at least 10% of own source revenue levied from all three major tax bases. Examples include Birmingham, Philadelphia, and St. Louis. In the past, the United States Advisory Commission on Intergovernmental Relations (ACIR) advocated diversity among property, income, and sales taxes for local governments due to the belief that local diversification allowed for greater local autonomy and reduced pressure on state policymakers to impose new taxes to support local governments. Tax revenue diversification may be used to accentuate the goals of equity, efficiency, administrative and compliance simplicity, revenue adequacy, and public acceptability. In fact, research has shown that revenue diversification increases flexibility and stability in local government revenue structures, which often leads to better management of environmental and fiscal stress, leading to improved financial position. On the other hand, while balanced revenue structures may be less distortionary and more equitable, diversification does not necessarily promote revenue adequacy or competitiveness of the tax structure relative to surrounding jurisdictions. In addition, diversification can lead to greater complexity in local government revenue structures, thereby making it more difficult for taxpayers to develop accurate perceptions of the price of public outputs. The resulting fiscal illusion often leads to local government overspending and greater tax effort.

Bottom Line

Whatever solution set is proffered to address the withdrawal of federal aid and the new workplace environment, policy options adopted by cities will influence the spatial distribution of commercial and residential structures. Public policies to promote downtown growth, for example, must understand not only the incentives to developers to locate and expand at the city’s center, but also the fiscal implications of such offerings. States also need to consider their impact on cities’ fiscal positions. Forty-one states impose spending growth restrictions, property tax limitations, or other tax and expenditure limitations (TELs) on cities, limiting their capacity to adjust and respond to shocks to their fiscal systems. These TELs, then, have the effect of forcing certain behaviors, such as increasing fees and charges, that might be deleterious to the financial well-being of city residents.

These and other differences in the tax and resource-extraction authority of cities create a situation in which a one-size-fits all set of proposals might be counterproductive to a city’s fiscal health. Instead, the variation in fiscal architectures creates variation in fiscal strength. The bottom line is that cities’ dynamic fiscal positions and the developability of downtowns post-ARPA in response to new commuting patterns are creating multiple bottom lines. Spatial development and incentives to boost downtowns will differ across the city landscape in response to the alignment between a city’s underlying economy and its fiscal architecture as well as state-induced restrictions placed on a city’s fiscal decision-making authority. As cities and their states come to understand that any desired outcome (e.g., downtown growth) is constrained by the behavior of the states, the alignment of their economy, and the competitiveness of their fiscal policies to both extract resources and provide services, the prospects for enhancing the fiscal authority of cities to determine their own futures should become apparent to both parties.

Recommendation: An Emergency ACIR

As we illustrate, the fiscal trajectory of a city is complex and nuanced due to the heterogeneity of cities’ economic strengths and taxing powers. There is no one-size-fits all solution—in fact a policy proposal for one city (e.g., office-to-residential conversions) may actually induce a decrease in total revenue for another city. Local leaders have largely absorbed the responsibility of curating creative financial tools around these nuances, as they try to diversify downtown uses—but they are often flying blind and without adequate support from their states.

Both cities and states need the staffing and resources for high-quality data collection to better understand how proposed solutions will impact the spatial distribution of commercial and residential activities within and across metropolitan regions. As if these tasks weren’t already daunting enough, the end of ARPA heightens the urgency of this crisis, creating too short of a timeline for cities to solve this by themselves. Harkening back to our piece on fiscal federalism in 2020we recommend  an emergency version of the Advisory Commission on Intergovernmental Relations (ACIR) to help assess the newfound vulnerabilities of cities’ fiscal positions and convene federal, state, and local policymakers in the implementation of research-driven solutions.

The Emergency ACIR that we recommend would similarly function to address this modern set of fiscal challenges. As an independent research commission comprised of action-oriented experts, the Emergency ACIR would employ data collection methods to develop a “fiscal stress test” that assesses the financial conditions of cities and their vulnerabilities within their respective fiscal architectures. Furthermore, the Emergency ACIR needs to use these stress tests to analyze what is at stake if cities cannot meet revenue goals and critical civic services are cut. This would have a profound effect on the protection of vulnerable populations relying on these services, especially as federal support for low-income populations dwindles. Following this analysis, the Emergency ACIR would develop a set of policy solutions and offer technical assistance to state and local governments. Examples of such assistance might include how local governments can allocate remaining ARPA funds or how states can work with their respective localities to review their political authority on municipal tax activities.

To conduct this intensive research and adequately marshal resources as needed for policy implementation, an Emergency ACIR will need funding, most likely drawn (given the state of the Congressional appropriations process) from major philanthropic organizations and/or a collection of local and state governments.  As a comparison, the Congressional Budget Office scored a legislative effort to revive the ACIR (via H.R. 3883 in 2019) at $12 million. (The bill was introduced again in May 2023).

On our current trajectory, and without any intervention, many cities will not be prepared for the looming fiscal storm. We need an organizing task force like an Emergency ACIR to delineate responsibilities for our levels of government, drive relevant data and research, and create effective policy solutions. Otherwise, as we wrote back in February, cities may find themselves in a Wile E. Coyote moment, staring down into the fiscal cliff, with nowhere to turn.

Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Deborah A. Carroll is the Director of the Government Finance Research Center (GFRC) at University of Illinois Chicago (UIC). Michael A. Pagano is the Dean Emeritus of UIC’s College of Urban Planning and Public Affairs and Founding Director of the GFRC. Avanti Krovi is a Research Officer at the Nowak Lab. Frances Kern Mennone is the Managing Director of FBT Project Finance Advisors.

[1] A ULI report contends that the market value after conversion increased so much that property tax collections, even at a lower assessment rate, were higher post-conversion until the pandemic. (Urban Land Institute Chicago, LaSalle Street: Building a Thriving Future, February 2022)

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