Paul L. Caron

Friday, May 28, 2021

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Scharff's Local Revenue When Federalism Fails

This week, Mirit Eyal-Cohen (Alabama; Google Scholar) reviews Erin Scharff (Arizona State), Cities on Their Own: Local Revenue When Federalism Fails, 48 Fordham Urb. L.J. 919 (2021):

Mirit-Cohen (2018)

The COVID-19 pandemic has required states and local governments to spend more funds to apply frequent cleaning, retrofit public spaces, support local businesses, and address pandemic-related increased poverty rates, all the while local revenue collections meaningfully shrank. Though some assistance to local governments with substantial deficits was provided through the American Rescue Plan passed in March of 2021, it is more a bandage than a panacea to their fiscal health issues. The scope and magnitude of the Covid-19 global economic contraction has only one parallel in U.S. History—the Great Depression. Scharf does a great job here comparing the effects of the current pandemic recession to the Great Recession on localities, and how state and local governments then and today handled growing spending and contractions in their revenues. She demonstrates that during the Great Depression most local governments focused their spending reductions on education, health, and social services. Yet, Scharff argues that long-term and meaningful economic renewal in the current economic recession necessitates effective reform of local fiscal policy and taxing authority. She does a great job laying the ground to some of the means to achieve such goal.


Scharff points out that in many ways, the U.S. “Fiscal federalism” (the way federal, sub-federal, and local raise and spend revenue) is flawed. Local governments’ tax authority lays its foundation on the premise of efficient fiscal federalism, i.e. revenue collection that adequately pays for local public goods and services such as trash collection, local parks, and public safety. Yet, while the responsibility of local governments to supply such goods and services remains, their authority and ability to utilize fiscal tools to raise revenue to fund these endeavors have been severely lacking, even pre-Covid. State laws do not authorize increases to property taxes, general sales taxes, and income taxes—the principal tax bases of local finance. The share of these taxes has decreased, or at best remained constant throughout the years. For low-income homeowners, as Andrew Hayashi and Ariel Jurow Kleiman noted here, property taxes force them to sell their property or otherwise make difficult consumption choices.  Accordingly, sales and income tax bases suffer from design issues and localities often lack authority to change or levy such taxes and remain resource constrained.

Some of the strategies local governments have implemented to keep their budgets balanced relied on increasing “miscellaneous” sources of revenue, increased borrowing, and cutting spending. Miscellaneous and other sources of revenue can include parking fees, business and event permits, traffic and other safety enforcement fines, and tourism taxes and fees such as air transportation charges, hotel, and rental car taxes. The latter have been greatly affected by the Covid-related shutdowns and lack of tourism in many states and localities. Generally speaking, local fiscal policy with diverse revenue streams have allowed more flexibility with revenue sources thus can alternate between, and respond to shrinking of, the different tax bases (income, property, sales) more timely and adequately. This, if designed properly according to Scharff, is where transformation of local fiscal health can occur.

Local governments can also increase their borrowing. However, borrowing to cover operating expenses is generally viewed as a last resort because it only postpones a reckoning between fiscal capacity and service provision. Borrowing for operating expenses, although quite common, is also problematic. For example, underfunding municipal pensions by paying less into pension funds than a reasonable discount rate relies on uncertain assumptions of future revenues and rates.  

Cutting spending on local services is another way to balance local budgets. But if there is anything this pandemic has created is an increased need for more public services and added local spending. In that regard, though, Scharff supports efforts to shift funding away from the criminal justice system and toward human services expenditures. She advocates that such a shift would both advance racial justice and local fiscal health. However, she admits that these efforts are unlikely to provide a panacea for local revenue problems as recent evidence demonstrates police budgets have grown during the last few years following path dependence and political economy around public safety. 

Scharff’s suggestion focuses on the following logic: if fiscal federalism dictates that localities are really on their own, they should be given more taxing authority to recoup their budgets and maintain fiscal stability, now more than ever. Accordingly, local governments need access to better designed, broad-based taxes. She argues that instead of relying on miscellaneous revenue sources, state laws that govern changes in the property tax base should grant local governments more control. But more generally, Scharff calls for expansion of local legal authority to impose income and sales taxes together with granted authority to change design choices regarding assessment growth, rate changes, and revenue growth.

For jurisdictions with high poverty rates Scharff suggests increasing state and federal aid. Such combination of federal investment via intragovernmental aid as well as expanded federal funding of anti-poverty programs will help address increased human services needs in these communities and improving local fiscal health. Providing local governments fiscal equity provisions to state guarantees for a minimal level of local services is a necessary step. Scharff concludes that reforming local revenue authority and reinvigorating a system of fiscal federalism will help many urban communities thrive. That said, some localities will still urgently need investments from state and federal governments. While the paper is not the first to state this truism, it does a good job explaining how it is even more pronounced during the Covid-19 pandemic recession.

Here's the rest of this week's SSRN Tax Roundup:

Scholarship, Tax, Tax Scholarship, Weekly SSRN Roundup, Weekly Tax Roundup | Permalink