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...pressure remains Ottawa and the provinces find new ways to give cities access to a richer revenue stream.
How to relieve the pinch? Various options have been suggested, including giving cities a share of sales and income taxes, raising property taxes, or relying more on user fees or excise taxes on hotels and fuel.
It is important for Canada to ensure that municipal funding includes adequate access to resources and the right incentives for municipal politicians to respond to the needs and wishes of their voters. In our search for a better financial model to improve political accountability, we find that an additional tax field for municipalities is generally not warranted, although it is important to provide municipalities with greater flexibility in financing their expenditure responsibilities. We conclude that current tax fields are adequate, since in most provinces, more revenue could be generated from residential property taxes or user fees. Additionally, municipalities can make more use of excise taxes, such as fuel and hotel taxes, to fund transportation and tourism: several cities already share, or have the right to share, in such taxes with the provinces.
A sensible approach to municipal funding problems would be to: (i) shift most social service costs to the provinces; (ii) pursue municipal property tax reforms to reduce the scope for tax competition and exportation; (iii) raise more municipal revenue from user fees where reasonable; and (iv) reduce provincial transfers to municipalities. One effect of our fiscally neutral proposal would be improved political accountability, because taxpayers would clearly see where their money is spent and who spends it.
Ontario and Alberta may be special cases, for differing reasons, where further alternatives could be considered. While we maintain that the residential property tax should be better exploited in these provinces, giving them additional flexibility in taxing powers might be considered. One option is a novel tax field: an earned income tax on residents, to be applied to employment and self-employed earnings of municipal residents and collected through the income tax system.
Municipal leaders were relieved to hear last year that they will receive a share of the federal gas tax. Like manna falling from federal heavens, their share will total $5 billion over the next five years. Mayors who felt like exiles from Ottawa s agenda have applauded their improving fiscal fortunes in face of demands for more infrastructure spending. But while the gas tax transfer has made mayors happier politicians, it fails to achieve a "cities agenda" whereby municipal governments are given greater responsibility for raising taxes to fund their expenditure responsibilities.
In this Commentary, we look for a financial model for municipalities that would improve municipal financing and encourage greater independence and responsibility. The key is to allocate appropriate expenditure and tax powers to municipalities, which would also have greater autonomy in choosing their tax policies. It is often argued that municipalities need another taxing power beyond the property tax, which, by itself, is considered insufficient to meet their commitments (Kitchen and Slack 2003, TD Bank 2004). Ideas include an income surtax, sales tax, or excise taxes on fuel and hotels. Giving additional taxing powers to municipalities seems to be an inviting idea for those wishing to see cities with powers similar to other levels of government. Nevertheless, in our search for a better financial model to improve political accountability, we find that an additional tax field for municipalities in the provinces is generally not warranted, although it is important to provide municipalities with greater flexibility in financing their expenditure responsibilities.
To a great extent, municipal finance has not kept pace with the challenges faced by our growing cities. While urbanization contributes significantly to economic growth as people are able to undertake transactions at lower cost (Aedes and Glaeser 1995; Krugman 1991), the greater demands placed on municipal governments to provide a good quality of life have strained resources. Thus, it is important for Canada to make sure that the municipal funding model provides both adequate access to resources and the right incentives for municipal politicians to respond to the needs and wishes of their voters.
Caution is required in seizing on bold reforms, lest they create inefficiencies and distortions. Municipal financing is fraught with issues that include the following:
* The Drawbacks of Downloading: In Ontario, municipalities are partly responsible for provincial welfare programs, and must spend a large share of their expenditures on social services, including social assistance, childcare, immigration services social housing and the homeless. This arrangement was also the case in Nova Scotia until 2002. Yet economic downturns can affect some municipal areas, such as those heavily reliant on slumping industries, more than others. What's more, local jurisdictions are less able to cope with higher local welfare costs and rising deficits alone, without sharply raising taxes or issuing municipal debt that is sold at higher interest costs than provincial debt.
* Taxing Out-of-Towners: Municipal taxing powers currently provide opportunities for mayors and councils to shift taxes onto non-residents who pay for public services of primary benefit to residents. Particular concerns have been raised about high non-residential (business) property taxes in excess of the value of municipal services used by businesses (Kitchen 2004; Bish 2003; Slack 2002). Often, the owners live outside the community. This can lead to tax exportation outside the community, where non-residents pay higher prices for goods exported to them, or receive lower returns for property investments in the municipality with the heavy tax burden on business.
* Where Does the Buck Stop, or Start?: Provincial transfers to municipalities--and the new gas-tax transfer from the federal government--undermine political accountability. As Inman (2005) points out, the transfer mechanism has eroded political accountability in many countries, such as Brazil and the United States, to their detriment. Fiscal costs escalate when municipal politicians have little incentive to reduce costs and keep taxes as low as possible for their voters. Political accountability is improved if elected politicians wishing to spend money on public services must raise revenues from the voters who benefit from those services. Transfers on a limited basis are appropriate if some municipal services are of some benefit to residents in other jurisdictions (e.g., transportation networks). They also make sense if there is a need to equalize sharp differences in fiscal capacities among rich and poor municipalities so that basic public services can be provided at comparable tax rates. Otherwise, there is not much reason for provincial governments to transfer revenues to municipalities, which then fund municipal services that primarily benefit local taxpayers.
What is remarkable is that the expenditure and taxing powers assigned to municipalities vary considerably across provinces, so no single solution for improving municipal financing is necessarily appropriate for Canada as a whole. While Ontario has downloaded a share of social services expenditures to municipalities, in most other provinces this expenditure responsibility rests almost entirely with the province. Alberta makes extensive use of user fees to fund municipal services. Further, some Canadian municipal governments already have access to the excise tax field, such as fuel or hotel taxes. Nevertheless, there is a common set of principles for local financing that applies to all of these different jurisdictions.
A sensible approach to municipal funding problems would be to (i) shift most social service expenditures to the provincial level to be funded by the provinces, (ii) carry out municipal property tax reforms to reduce the scope for tax competition and tax exportation, (iii) raise more municipal revenue from user fees where it is reasonable to do so, and (iv) reduce provincial transfers to municipalities. A net effect would be improved political accountability, since taxpayers would see where their money is spent and who spends it. Our proposal would be fiscally neutral for the provinces, although one could consider a longer-run reform in which the provinces reduce revenues to create tax room for municipalities. We devise a method to determine whether municipalities require an additional tax field based on the above adjustments and taking into account the new federal gas-tax transfer to the municipalities. (1)
Our conclusion is that a new municipal tax field is unnecessary in most provinces, since greater revenues could be obtained from residential property taxes or user fees. Compared to others, these are better tax fields for municipalities with expenditure responsibilities that are not sensitive to upturns and downturns in the economy, such as fire, police or park services. Additionally, some municipalities could make further use of excise taxation for funding transportation and tourism (fuel and hotel taxes). Several dries already share, or have the right to share, in such taxes with the provinces. However, as we shall see, Ontario and Alberta are special cases. While we maintain that the residential property tax should be exploited further to fund municipal services in these provinces, additional flexibility in taxing powers might be given some consideration. This could be achieved through a novel tax field: an earned income tax on residents. It would be applied to employment and self-employed earnings of municipal residents, and be collected by the province through the regular income tax system. Other forms of taxation--such as the broader income tax or general sales taxes--are too harmful to economic growth or are difficult to implement properly.
Cities are rising to new thresholds of global importance, as centres of commerce, population and economic growth. This rising salience in itself, however, says nothing in favor of providing more external funding, or implementing massive new local public expenditures. The realization of a global role for cities will depend on local government's ability to facilitate the contributions of all sectors of the community, not on its ability to monopolize a region's growth.
In the balance of this Commentary we elaborate on these arguments, focusing only on municipalities rather than other local government bodies that deal with education or health. In the next section, we review key principles for the financing of municipalities. We then evaluate the current municipal financial structure in terms of the principles we describe. Finally, we provide our recommendations for a better municipal financing model, followed by our conclusions.
Existing Municipal Revenue Sources:
At present, the primary source of revenue for municipalities by province is the property tax, as seen in Figure 1. User fees are next in prominence. Other municipal tax sources are rarely used. British Columbia remits a share of its fuel tax to the Greater Vancouver Regional District. Edmonton, Calgary and Montreal are also given a share of provincial fuel taxes. Vancouver and Montreal impose hotel occupancy taxes, while Winnipeg and Toronto have the right to do so.
[FIGURE 1 OMITTED]
Historically, municipal governments had both income and sales taxes (Kitchen 2003). Municipal income taxes actually pre-dated the 1917 federal income tax and operated until 1941, when the provinces rented their income and estate taxes to the federal government for transfers. After the Second World War, the provinces resumed income taxes but did not permit municipalities to occupy the tax field. Quebec was the only province that allowed municipalities to levy sales taxes. Until 1964, Montreal levied its own municipal sales tax.
Financing Principles For Municipalities
The appropriate allocation of financing powers to municipalities should be based on four principles: (i) efficiency; (ii) minimal administrative and compliance costs; (iii) flexibility and autonomy in financing public services; and (iv) political accountability. These principles form the basis of governance for any type of municipality, from small towns to metropolitan cities.
Principle One: Levying Efficient Taxes
Taxes discourage work effort, savings, investment and risk-taking. The tax system that harms the economy the least is one that does not interfere with the allocation of resources, which is best achieved by households and businesses responding to market prices. Thus, a tax system is most efficient when it is neutral, imposing similar relative burdens on all products and business activities. Only in some limited situations, when market prices do not reflect household and business decisions that affect others (such as pollution), could some differential taxes be appropriate. However, even in these cases, other policy interventions at the provincial or federal level might be more effective than tax policies.
With respect to efficiency and the allocation of taxing powers to municipalities, two sub-principles should be borne in mind.
The first is that tax policies should not inhibit the free flow of goods, services, capital and labour across jurisdictional boundaries. Therefore, the best taxes to allocate to municipalities are those paid by the resident households and businesses that benefit from municipal services. Seen in this light, user-pay related fees or taxes (such as transit and toll charges or gasoline taxes) that cover the costs incurred to provide municipal services...
NOTE: All illustrations and photos
have been removed from this article.
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