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A Unique Opportunity

The recently released Composite Index of Local Ability to Pay (CI) provides a unique opportunity to reform local public finance in Virginia. It can, and certainly should, be the impetus for the General Assembly to conduct a long over-due investigation of how to calculate ‘Local Ability to Pay.’

The new CI is both like and unlike its three immediate predecessors. Like recent CI’s, it is heavily influenced by real estate values, but unlike in earlier CI’s where disadvantaged localities (losers) never exceeded 40 percent of the population of the Commonwealth, fully 60 percent of the total population are losers in the current CI.

I have prepared a memo describing, among other things, the perversity of the CI formula – summarized in a series of articles for Bacon’s Rebellion. Better than any mere memo, the current CI demonstrates the policy’s shortcomings and should grab the attention of a majority of members in the General Assembly.

Also unlike its immediate predecessors, the current CI disadvantages many of Virginia’s major cities. The city of Richmond, for example, experienced a nearly 700 point increase in its CI. Based on the original 2009 funding, this will result in a decrease of over $12 million in Commonwealth funding. Other cities experienced a smaller, but still significant increase in their CI, and consequent loss of funds. Of course, these are the very localities always disadvantaged by the failure of the CI to account for the ‘municipal overburden’ of mandatory non-education expenditures associated with high population density. (See JLARC’s Review of Elementary and Secondary School Funding and my memo)
This is the first ‘post bubble’ CI and as such winners mostly had declines or modest increases in real estate values. But the real estate bust arrived at different times in different localities. Richmond saw its ‘True Value of Property’ increase more than 26 percent per capita compared to the state average of 15.5 percent. According to the logic of the CI, since Richmond now has more real property ‘revenue capacity’ relative to other localities, it is expected to raise more revenues locally. Perversely, Richmond is ‘richer’ in large part because of declines in real estate ‘values’ elsewhere. The CI calculates that it has a greater ‘Local Ability to Pay’ and needs less state aid. If Richmond’s entire shortfall is replaced by an increase in real estate taxes, it will have to raise its tax rate over 5 cents on its already high rate of $1.20 (based on 2007 data).

I anticipate that there will be proposals to ignore the current CI altogether and continue the immediate past CI, or to ‘hold harmless’ the losers. Both ideas should be resisted.

As to the first option, any argument against the current CI (and I agree that it is perverse) applies equally, and for similar reasons, to prior iterations. While I am sympathetic to the second option, I am not sure that sufficient funds, approximately $130 million, are available in the present fiscal circumstance. If funds of this magnitude – or any significant proportion thereof – can be found, then serious consideration should be given to reform of the CI. Under my proposed reform, the total ‘cost’ is approximately 160 million dollars. In other words, 80 percent of my proposed reform can be funded by the cost of ‘holding harmless.’

Because the CI apportions a fixed appropriation, it is a ‘zero sum game.’ Any locality’s gain comes at the expense of another’s loss. Any reform of the CI will be compared by the losers to the current formula. This is a prescription for stasis. The only solution to this dilemma is to identify and enact a source of funds to pay for reform.

I have suggested a real estate transfer tax as the source of funds. Although I consider myself a fiscal conservative, this does not seem unreasonable to me. After all, recent real estate transfers are the main factor used in periodic assessments, which in turn heavily influence Commonwealth funding under the CI. Moreover, the purpose of reforming the CI is to reduce the over-dependence of local governments on the ad valorem annual real estate tax.

Estimating the amount of revenues requires predicting the future real estate market. For want of anything better (and assuming that the real estate market will recover at something approximating the market in the year 2000), I have calculated the revenues using a one percent real estate transfer tax based on the year 2000 real estate market. Under my assumptions, the revenues in that year would have been approximately 200 million dollars, more than enough to fund my proposal. By way of comparison, in 2007, the most recent year for which data is available, one percent of real estate transfers would have yielded over 400 million dollars in revenues.

Of course, the real estate transfer tax may be viewed as in conflict with the ‘no new taxes’ position of the Governor-elect and many members of the General Assembly. Again, I am in general agreement with this position. However, everything must be considered in context. Doing nothing local real estate taxes will increase in most – if not all – localities (depending on the next biennial appropriation). Doing nothing about the CI (and failing to enact the necessary source of funds), will continue the perversity of the CI as described in my memo. It just ‘kicks the can down the road.’ Rather, the General Assembly should investigate and reform the CI. It should determine whether the relative ‘revenue capacity’ of real estate is a sensible measure of ‘Local Ability to Pay’. The General Assembly should also enact the necessary legislation to fund on a continuing and permanent basis, changes to the CI.

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