WESTCHESTER ALLIANCEIONA COLLEGE

BY TIMOTHY O’DWYER AND JAMES MURPHY

Urban Finance:The Politics of Revenue and

Spending Policies

Introduction The Constitution does not mention cities, towns or any other kind of local

governments. States were given the right to create, regulate, and, if necessary, eliminate local

governments. States heavily regulate scope, content, and means by which a city fulfills policy

demands of their citizens. As such, local politics, which represent the local demands, are muted on terms of

taxation and spending for local governments. Local governments do have legal authority to tax their residents and to make

decisions legally binding on them. Limit on amount of revenue a local government can raise through taxation Obviously,

everyone wants to pay less in taxes Local residents preferences on taxation and spending are diverse and subject to

change. Without local government’s legal authority to make binding policy decisions,

competing interests would cause political instability.

Revenue Sources Municipal governments draw upon sources such as property and

income taxes, sales of goods and services and fees. Largest single source of revenue for all municipal governments

residential and property tax. Local governments prefer property tax over income tax because it does not fluctuate

frequently and can be easily assessed. In 1962, property tax accounted for ½ of all revenue raised by municipal governments in US.

2nd largest source for revenue fees and charges. Includes water, garbage, and sewerage services and charges for parks and public

facilities. Sales tax and other taxes (personal and corporate income tax) make up a smaller portion

of revenue. External source of funding is federal and state aid.

Federal assistance to local and city governments focused on social services that addressed issue between those living in the city and those in the suburbs.

Federal Assistance was at its highest point during the 1960s Johnson Administration, but declined afterwards.

Today, federal assistance for local governments is given to state governments, which would then be distributed to localities.

Revenue Sources State aid to localities comes from funds raised by states on own

authority to tax. States generally levy tax on sale of goods and services and collect taxes from local merchants and return a portion of sales tax receipts to localities where they were made.

Ability to incur debt is regulated by state law and cities incur debt by means of general obligation bonds. General Obligation Bond – allow municipality to borrow in commercial credit

market; amount lent and interest paid to lender are repaid by city’s authority to tax its residents – “Full faith and credit of the city”.

Problem with G.O.B. – is need for voter approval through public referendum and these referenda put limits on amount of money that can be borrowed and how it is used.

Alternative is the revenue bond, which does not require voter approval. Revenue bonds raise money for specific projects and are issued to pay for capital

projects such as construction of roads , buildings and other large projects and is repaid with the revenue produced by the facility or project.

Regressive Tax

First reason why US localities reduced reliance on property tax regressive tax.

Regressive Tax – poor and middle class pay higher percentage of personal income on property and residential tax than wealthier citizens. Result: property tax is extremely unpopular form of tax. Problematic for low-income and property poor communities.

Community’s tax base is sum of all values taxed by a locality Two communities of equal size with different tax bases show the

disparity and unequal access to basic goods and services – if the community that pays less, they might lose essential services provided by the state.

Efforts to reduce/eliminate regressiveness of property tax – provide exemptions for poor and elderly have succeeded in equalizing percentage of personal income paid in property taxes.

Property tax

Second reason property tax is inefficient form of taxation Citizens protest what they see as arbitrary and unfair tax assessments. Resulted in establishment of assessment boards to oversee process

and appeal procedures to ensure citizens are heard. Problem with boards is increased cost of levying property tax.

Bond indebtedness – amount of principal and interest that localities owe to lenders. Repaid over fixed period of time from taxes and other revenues raised

by locality. Indebtedness allows municipal borrower to obtain immediate benefits w/o immediate expenditure by taxpayers.

Bonds enable cities to pay at later time for what they can receive immediately.

Bonds are paid with future revenue and by future taxpayers and voters.

Functional Spending

Two important observation can be made about scope and content of municipal functional responsibility. 1st – cities responsible for narrow range of functions –

confinement to basic of “housekeeping” activities and essential services: Public security (police and fire), roads and utilities.

2nd – limited scope of municipal responsibility and level of spending for many social services including health programs, welfare and hospitals. Although property tax remains main source of revenue, it

has declined over past decades. Locality spending constrained to a narrow range of basic

goods and services and responsibilities for social services.

Theories of Municipal Fiscal Policies

Elitist Theory

Pluralist Theory

Market Theory

Institutional Determinants

Elitist Theory Helen and Robert Lynd (1929) – local decision making emphasized

the importance of elites whose powerful positions in community enable them to influence or determine policy decisions. Focused on economic elites, because control over capital and labor is

important to the public sector. Mills (1956) – the elite consist of those that are above ordinary

men and women and whose decisions have larger consequences; power elite “creates” demands and causes others to meet them.

Elite theory provided explanation for disparity in distribution of wealth and public services. Elite-influenced taxing and spending decisions are expected to produce policies

favoring wealthy and their interests and Elitists have found strong bias against spending for redistributive social services that help poor.

Problem: The existence of the powerful elite does not mean that the elites have power over government ‘s taxing and spending decisions. Increased citizen participation in local government, was hard to sustain and did not always

accomplish its objectives and greater citizen participation did not always result in policies congruent with newly empowered groups nor sustain political power.

Pluralist Theory Belief that decision making in communities reside in larger, diverse

section of the community. Dahl – contested positive relationship between distribution of political

resources and that of community influence. Decision-making is distributed to a wide range of groups across different policy areas. Argued that numerous types of political resources are not evenly distributed

among residents of a community – with industrialization and increased immigration to the US, the number of new voters and more diverse social and economic interests displaced the power of preindustrial elites.

Pluralists do not discredit the idea that elites influence public policy, but not to exclude other groups and interests.

Pluralists assume that the preferences of those that have power would mirror policy preferences of the public.

Problem: Unable to answer the question of the link between urban policy and the preferences of urban residents and facilitates the relationship. Fall short of explaining why greater representation of these constituencies has not produced

taxing and spending policies that approximate the preferences of newly empowered groups.

Market Theory Question: what do governments do and why? Market theorists expand explanation of municipal taxation and

spending decisions within and outside the community. National level – gov’t role is limited to activities and responsibilities that the

private market cannot handle. Scope of government’s functional responsibilities identified by goods and services that private-sector are unable to produce. Due to inefficiencies or external factors. Ex: Inability to exclude individuals from obtaining certain goods and services limits

role of private markets in providing goods and services and so national government assumes a large responsibility in supplying them.

Tiebout’s model (1956) – maintains that individuals select communities with preferences for publicly provided goods and services – “vote with their feet”. Content and level of municipal service packages defined by preferences of average voter. Efficient market mechanism for production of goods and services exists because: 1. Number and diversity of states and communities 2. mobility of voters to choose among the communities the one that best approximates their

preferences for goods and services.

Market Theory Dowding, John, and Biggs (1994) propositions on Tiebout’s

hypothesis: Larger the number of competing jurisdictions, greater the satisfaction

level of consumer voters. Larger the number of jurisdictions in same metropolitan area, greater the

competition between them for consumer voters. Large the number of competing jurisdictions, more homogenous each

jurisdiction will be. Taxes and services influence residential mobility. Higher the quality of services (tax levels), higher (or lower) the property

values in jurisdiction.Tiebout does not identify a set of services such as public

safety, utilities and roads as being essential to operation of municipal government. Tiebout states that the market is the engine for assisting service

responsibilities and thereby relating this engine to decisions on taxation and spending.

Market Theory Buchanan (1971), Peterson (1981), and Miller (1981) added the

point that mobility of residents in metropolitan area produces significant bias for retention of wealthier residents. Buchanan – municipal governance under majority rule will advantage

low-income citizens at expense of high-income residents. Result is income redistribution – cost for middle and high income persons.

Peterson – “local politics is not like national politics”, “there are crucial kinds of public policies that local governments simply cannot execute” – some policies only the national government can efficiently perform. Scope and level of community’s functional responsibilities are constrained

by inability of cities to control mobility of capital and labor across their respective borders. States and cities are less effective at preventing citizens, businesses and capital base from migrating to other locales where tax to benefit ratios are superior.

Cities, states, and other subnational units of gov’t pursue developmental policies that generate economic resources that can in turn be used for community’s collective welfare.

Market Theory Buchanan, Miller and Peterson created hypotheses derived from

Tiebout’s work: Expenditure’s on redistributive services are function of fiscal capacity

(wealth), not demand and public preferences in community. Expenditures on developmental services are function of demand

(population size). Tax rates and burden (local taxes as percentage of personal income) will

tend toward uniformity among communities competing in same market (for consumer voters (that is, metropolitan area).

Implications of these hypotheses: 1st. Politics (subnational level) is marginalized due to demand and public

preferences do not drive spending policies for redistributive social services.

2nd. Redistributive policy spending at subnational level largely a function of wealth.

3rd. Subnational units of government are more efficacious when engage in developmental policies and less efficacious when pursuing redistributive social policies.

Market TheoryPeterson: Municipalities spend more on

developmental and allocation functions (roads, water, infrastructure) than on redistributive services and goods (health welfare). Peterson (1981) reported that municipal spending for

array of social services, including: housing, public hospitals and health services are unrelated to indicators of poverty, minorities and other directories of need and demand.

Stein (1990) – considerable variation in range of municipal spending on redistributive social services.

Institutional Determinants Rules of governing how to make decisions, process of representation

and nature of executive office have direct connection of the influence on the content of urban public policies.

Banfield and Wilson (1963) – 1st to argue certain institutional arrangements promote interests and preferences of different groups and translate preferences into policy outputs. Public-regarding policies focus on needs and interests of entire

community; narrower private-regarding policy outputs distribute benefits to specific geographic areas and ethnic and partisan interests, independent of need for policies.

Lineberry and Fowler (1967) – confirmed Banfield and Wilson’s hypothesis showing that there are differences in taxing and spending decisions of local gov’ts with reformed & unreformed institutional arrangements. Conclusion: “In the long run, government structure may matter very little-at least when it

comes to city taking and spending policies” Conclusion may overlook important rules and procedures governing urban policymaking process.

Institutional Determinants Stein (1990) – “the way in which gov’ts organize themselves to

perform policy functions has a significant effect on the scope and content of municipal policy performance.” Conventional view of municipal public policy is urban gov’ts are

solely responsible for all phases of service provisions, including: choice of services, funding means and producing/delivering goods and services – this idea is “naïve and wrong”.

The dilemma of localities and cities providing redistributive social services provides partly answered by the use of alternative institutional arrangements. Stein and others demonstrated that these alternative arrangements produced

significant savings to cities that mitigate potentially harmful consequences associated w/ municipal provision of social services.

Paradox in the Taxing and Spending of Municipalities

Cities pursue service responsibilities that run counter to their interests

These spending policies affect: Social Economic Political

Option 1 Option 2

• Produce the service with their own resources, public employees, and equipment

Purchase services from adjacent governments

Purchase Services from a private company

Options in Providing Services

Option 1

Available to larger communities Example:

Houston, TX sells water and sewage treatment services to surrounding suburbs

Westchester Example: City of Yonkers has its own Sewer Department that

controls the sewage system

Option 2

Ideal for smaller municipalitiesWestchester Example:

Empress Ambulance is a privately owned ambulatory service that works with the City of Yonkers emergency services departments

Costs of Public Services

Cost of labor is the most expensive part of providing these services

Other costs include Facilities Equipment

Why Contract Public Services to Private Firms

Cities save significantly more and employees of these firms are better compensated

Cities that outsource these services use the savings to meet the demands of needier constituents: The elderly The poor The infirm

Conclusion

Cities are institutionally and physically weakOpen borders make it relatively easy for

productive capital and labor to move from city to city

State home-rules laws restrict municipal taxation and urban finance policies

Despite limits, cities succeed at providing redistributive social services

Work Cited

Cities, Politics, & Policy: A Comparative Analysis.

John P. Pelissero, ed., CQ Press, 2003 Chapter 9: The Politics of Revenue and Spending

Policies by Robert M. Stein. pp. 217-236