MRSC has joined with Phil Olbrechts, Attorney, Ogden Murphy Wallace, Pat Dugan, Dugan Consulting Services, Arthur Sullivan, Program Manager of ARCH (A Regional Coalition for Housing), and Anindita Mitra, founder of CREÄ Affiliates, LLC, to bring you the "Planning Advisor" article series on planning and growth management issue affecting Washington Local Governments. The "Planning Advisor" will feature a new article each month with timely information and advice you can use.*

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Addicted to Growth?
Fiscal Realities and Community Development

April 2009

By Pat Dugan
Dugan Consulting Services

Introduction and Background

The way cities develop can be influenced by fiscal realities. Some of these realities and their implications on city growth and development are apparent, such as whether there will be sufficient fiscal capacity to provide the capital facilities needed to support new development. In other cases, these realities may be less apparent. This article offers a preliminary exploration of some of the more powerful, but less apparent, fiscal realities that may be affecting the way many communities are developing.

One of the more dominant features of Washington local government finance over the last decade has been the passage of a series of voter initiatives that have constrained the fiscal capacities of local governments. These initiatives are popularly known as the “Eyman initiatives.” ¹ These initiatives and many of their implications are well understood in public finance, but planners may be less familiar with their full ramifications. More importantly, the implications that these initiatives can have on the growth and development of communities have not been well recognized or explored in either context. Collectively, these initiatives have tended to make local governments dependent on growth to such an extent that some local governments may be thought of as being “addicted” to growth. This dependence is often not only on growth, in general, but on particular types of growth. As such, these initiatives are influencing how and at what pace some of our communities are growing.

This discussion may also be useful as “primer” for planners on some of the basic features of local government finance in Washington State, since in order to understand the implications of these initiatives on growth and development, one first needs to understand the complexities associated with the Washington State system of local finance.

Significant Voter Initiatives on Local Government Finance

A series of public initiatives since 1999 have substantially altered local governmental finance.

The passage of Initiative 695 in 1999 (later supplemented by legislation to cure constitutional issues associated with it and another Initiative (776) that passed in 2002) dramatically reduced the revenue available to the state from the Motor Vehicle Excise Tax (MVET). As a result of this reduction, the State eliminated its program of sharing a portion of this revenue with local governments and using the tax proceeds to fund the state sales tax equalization program.² This initiative then had the “double whammy” of not only eliminating a significant source of revenue for all cities, but also, for all practical purposes, doing away with sales tax equalization that many residential communities relied heavily on.

In the long run, the most potent Initiative to constrain revenue is probably Initiative 747, which passed in 2001 (again followed by legislation to cure constitutional issues associated with it). The power of this legislation is complex and closely related to the unique way property tax levies work in Washington State.

Washington State Property Tax System

Complex laws³ govern the power of a local government to tax property values. These laws begin with limits set in the State constitution, and are implemented and further restricted by legislative enactments. Voter initiatives have further restricted the power of local governments.

Currently, there are two significant limits. The State constitution sets the first limit. The constitution limits the “regular” levies of local governments to $10 dollars per thousand dollars of assessed value (or one percent of the value).⁴ This $10 per thousand limit is then allocated among various local governments (including a state levy to support schools) by the legislature and each type of local government cannot exceed its share of the constitutional $10 limit.⁵ This limit varies among cities, but generally ranges from $1.80 per thousand assessed value in a new city⁶ to $3.60⁷ per thousand for most long established cities.

Another limit is the 101% “limit factor.”⁸ This limit factor usually determines the actual tax levy for most cities in the state, since most cities are well below their share of the constitutional limit described above. Prior to Initiative 747, State statute limited (irrespective of the constitutional limit) any increase in taxes to less than 106% of the jurisdiction’s highest levy in the last three years (usually the previous year’s levy). For example, if a jurisdiction levied $1,000,000 in taxes last year (and this was its highest levy) it could levy $1,060,000 (6% more). Added to this amount, is the amount of taxes that come from any new construction that occurred during the previous year (at the tax rate of the previous year). If, as the example, $40,000,000 in new construction occurred during the last year and the previous year’s tax rate was $2 per thousand, an additional $80,000 would be added ([40,000,000 / 1000] x 2) to the $1,060,000 for a total of $1,140,000. Initiative 747 reduced the limit factor to 1% rather than 6%, changing the math above to a 1% increase in the $1,000,000 levy to $1,010,000 to which $80,000 would be added from new construction, for a limit under I-747 of $1,090,000.

As can be seen from this math, the 101% limit prevents the property tax from keeping pace with inflation and growth at the same time. Without any growth, the amount of property tax a city can raise can increase only by 1% per year. This is in spite of whatever the inflation rate might be, but is usually significantly more than 1%. If the property tax revenue generated by new construction is used to compensate for inflation (as it often does in most jurisdictions), little if any revenue will be available to support services to the new development. Since new growth eventually will result in an increased demand for services, the limit factor constrains the ability of a local government to respond to such increased demand, in addition to keeping up with inflation. The demand for new services to support growth is usually manifested slowly over time, and the impact of this limit may not be apparent for many years. Nonetheless, over time, this limit will become a very significant constraint on the fiscal capacity of a community to support important services.

The Impact of Voter Initiative Fiscal Constraints on Community Development in Residential Communities

Cities that are primarily composed of residential communities have been the most affected by these initiatives. These communities are generally very reliant on the property tax since they often have a small amount of commercial uses to generate any significant sales tax revenue. These communities were fully impacted by the “double whammy” of Initiative 695 described above—they lost not only the direct revenue produced by the MVET, but also most of them lost a significant amount of revenue from sales tax equalization.

In some of these residential communities, the immediate impact of the Eyman Initiatives was mitigated or shielded by high growth rates. The growth in new residential development brings in new tax revenue from the new construction.⁹ With the help of this new construction revenue some of these cities were able to recover from the immediate loss of revenue, usually with a series of aggressive budget measures that reduced services and sometimes with a restructuring of city operations.

Nonetheless, most of these cities face a long-range problem. They tend to be heavily dependent on the property tax¹⁰ and this source of revenue is constrained by the 101% limit factor imposed by Initiative 747. The limit factor forces them to rely (unless they can attract a significant commercial development) on the revenue from new construction just to keep pace with inflation. This shift leaves little revenue to support increased services to serve new development. Although eventually they will not be able to afford to serve the new growth without budget cuts elsewhere, they nevertheless need it just to maintain their existing services. It is easy to think of these cities as being literally “addicted” to growth; they cannot maintain their existing services without continued growth, but more growth only increases their dependence on continued growth for revenue.

The only hope many of these communities have to get out of this bind is to attract commercial development to help diversify local revenue. Consequently, these fiscal pressures tend to drive planning decisions associated with both the growth of the community and the character of that growth.

Effect of the Initiatives on Economically Diversified Cities

While residential communities are most impacted by these initiatives, larger, more economically diversified communities have also been significantly affected, although in much more subtle ways.

Although these diversified cities were not affected by the loss of sales tax equalization in the early initiatives, the initiatives did eliminate the directly shared revenue from the Motor Vehicle Excise Tax (MVET). The elimination of state shared MVET taxes represented a significant loss of revenue that had to be made up in some way, even though the more diversified character of these cities made it easier for them to adjust to the loss than the residentially oriented communities.

Passage of Initiative 747 has had a more significant impact on these cities, but again, these impacts have been less dramatic than in the case of more residentially oriented communities. While in the short-term, the more diversified character of these cities gives them a more diversified revenue base to buffer the immediate impacts of the reduced 101% limit factor, this limit factor constitutes a significant impediment for every city to keep pace with inflation to adequately fund services, as described above. As time goes on, the inability of the property tax, a major revenue source in any city, to keep up with inflation will gradually tighten the local government’s finance and make budgets more difficult to balance each year in the face of increasing inflation and growth.

Since these fiscal pressures are generally well understood by local finance directors and city managers, prudent fiscal management encourages consideration of proactive measures to help keep up with inflation. Gradually, the direct loss of revenue from the various initiatives, coupled with the enactment of the 101% limit factor by Initiative 747, has made these cities search for, and aggressively pursue, other sources of revenue. This has often meant a much greater interest by city council and city management in pursuing new developments that would generate sales tax revenue.

Although economic development has always been an important objective for most cities and counties, the Eyman initiatives have fueled even greater emphasis on this activity. Virtually every mid- to large-sized city now has a dedicated economic development staff, often reporting directly to the mayor or city manager. Many such economic development programs have become particularly focused on attracting and promoting sales tax generating development.

In many cities, there may be other alternatives available. Some cities may not have exercised their full authority to increase utility taxes,¹¹ and most cities have not exercised their capacity to impose a business and occupation (B&O) tax. However, increasing or imposing these taxes is very controversial any many — if not most — cities prefer to pursue economic development instead.¹² To paraphrase what I once heard one city councilman say in considering expansion of a city’s economic development program to attract new sales tax generators to the city, these generators were “the geese that would lay the golden eggs” the city needed to maintain services. To this councilman at least, such economic development programs were preferable to the city increasing utility taxes (which it had considerable capacity to do) or imposing the business and occupation tax. Cities eagerly pursuing sales tax revenues frequently seek to find ways to stimulate new retail development by being willing to help finance facilities that private development previously may have been expected to finance themselves.

These pressures to acquire more sales taxes in response to the constraining of property tax have created a bias toward retail development that can generate sales taxes. This bias can be so severe in some communities as to lead to discouraging development that does not generate sales tax revenue, reflected in the often heard phrase that “single family homes do not support themselves.”

The Insecurity of Increasing a Reliance on Sales Taxes

Although attracting new sales tax generators provides fiscal relief in the short term, too heavy a reliance on the sales tax unfortunately carries with it some adverse implications.

The most significant implication is that the sales tax tends to be an unstable source of revenue and is very sensitive to economic cycles. This is abundantly illustrated by the current economic recession, when almost every local government is wrestling with significant budget cuts necessitated by a rather sudden and often dramatic drop in anticipated sales tax revenue.

While increasing sales taxes does help to mitigate for constricting real property tax revenue, the potential benefit is often over-estimated. Too often …

• Evaluations of new commercial development tend to overestimate potential revenues. The new stores are assumed to bring in completely new revenues when such development may actually be drawing sales for other businesses in the community. For example, it is unlikely that the new Kohl’s in Lynnwood added more sales activity in the community than otherwise would be available, but rather the Kohl’s made up for a loss of activity from a recently closed Mervyn’s, and probably drew sales from the nearby Nordstrom, Macys, etc.
• Potential costs of serving new development are overlooked or underestimated. Any new commercial activity that generates new revenue can only do so by attracting people to the new development. With people come costs, sooner or later, especially police and emergency medical services. Most importantly, increased new sales generating activity will generate traffic. If the potential traffic impacts are not mitigated, the costs associated with accommodating traffic can become quite high, especially when it is added cumulatively to other development.

Too often cities have found, or will find, that their past efforts to increase their reliance on sales tax has not provided a reliable source of revenue to keep pace with growth and inflation. Unfortunately, the response to these fiscal difficulties may be to increase efforts to attract even more sales tax generators to provide more revenue. If this is the response, these cities may be as “addicted” as the residentially oriented communities in continuing to need growth to “keep up,” while nonetheless being unable to support the increased demand for new services being generated by that growth.

Conclusion

Clearly one cannot read a newspaper or listen to a local news broadcast today without noting that most local governments are facing severe fiscal problems. If we are to maintain healthy communities with adequate local governmental services, it is important that we try to understand the basic causes of these pressures.

The discussion presented above has intentionally posed a provocative argument that the current Washington State local government fiscal structure tends to make local governments addicted to growth and that these fiscal realities will impact the ways our communities may grow in the future. This undoubtedly can be debated and it is my hope that this discussion stimulates such thought and debate (some may even assert that this “addiction” is desirable since it promotes economic development). While my characterization of this picture may be oversimplified, or in some regards misplaced, it is important that more attention be given to whether there are cities becoming addicted to growth and, if so, what public policy responses should be considered.

The lasting effects of the voter initiatives constraining local governmental fiscal capacities seem apparent in the continuing struggle by all local governments to maintain basic services. Gradually, each year, more parks are being closed, funding for swimming pools becomes more difficult, counties struggle to provide basic health services¹³ , etc. While all local governments have been affected, those that are most dependent on the property tax (and therefore most impacted by I-747) probably have had to struggle the most. The current recession has further accelerated and exacerbated these fiscal pressures by suddenly and dramatically reducing revenues from sales taxes which many local governments began to rely more on to compensate for constrained property taxes. It would probably be simplistic to assume that these budget struggles do not in some way spill over into questions about how communities should grow and at what pace.

While the “addiction” to growth described above will gradually make it more and more difficult for cities to sustain appropriate levels of service, the most significant implication of this growth addiction is what happens when that growth ceases to come. The types of measures that are being taken by local governments to cope through the current recession would become permanent and not just temporary measures.

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Pat Dugan has a unique combination of experience in both planning and public finance, spanning 35 years. As a planner, he has been a planning director in two cities (Auburn and Burien), and two regional planning agencies in Oregon and Washington; and was a planning manager in Goleta, California. In public finance, Pat has served as the chief financial officer in four public agencies including the Cities of Auburn and Lynnwood, and the Snohomish County Public Works Department. He has written extensively on financing capital facility programs and on public finance for planners. Pat now offers planning and public finance consulting services and in his own firm, Dugan Consulting Services in Everett and can be reached at consult.dugan@verizon.net.

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Anindita Mitra, AICP is the Founder of CREÄ Affiliates, LLC a planning and urban design consultancy that focuses on creating awareness of unsustainable practices, and offers a platform for affected parties to openly communicate and collaborate to arrive at creative sustainable solutions. She is also one of the Co-Chairs of the Climate and Sustainability Initiative of the Washington Chapter of the American Planning Association. Anindita's current interests include the development of sustainable master plans and streetscape designs; establishing sustainable community indicators and their integration into comprehensive plans and governance; identifying creative solutions directing communities towards energy-independence; preparing communities for the challenges potentially brought upon by the Climate Change phenomenon; and advancing the integration of transit and non-motorized travel solutions into community land use planning. She has worked throughout the United States for both the public and private sectors.

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Phil Olbrechts is a member (similar to partner) and elected member of the board of directors of Ogden, Murphy, Wallace, LLC. Phil focuses his practice on land use law and currently represents seven municipalities as either City Attorney or Hearing Examiner. He has taught over a dozen credits of land use law at the University of Washington, has taught numerous land use continuing legal education courses and has made over 200 land use presentations to elected and appointed officials throughout Washington State. Phil has served on the Seattle Planning Commission and in the past served as the Planning Director for two municipalities.

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*The Articles appearing in the "Planning Advisor" column represent the opinions of the authors and do not necessarily reflect those of the Municipal Research & Services Center.

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