Problems with Exactions and Impact Fees

Exactions and impact fees have been useful tools for local government to help finance services as demand for services increases with growth.  While impact fees may be exacted for any type of impact (air pollution, park use, expanded fire protection, etc.), the most common application of impact fees is to levy them for increased road and water/sewer demand that accompanies new development.  Despite their usefulness in generating revenue, the administration of exactions and user fees contains some critical flaws that diminishes the overall utility of this tool.

The main problem with user fees is that they do not fully account for the life-cycle and replacement costs of the infrastructure that they create.  While they are often designed to give municipalities initial capital funds or at least enough financing to procure a bond (thus allowing city officials to say yes to developers and grant them the permits they are requesting), exactions and user fees don't account for the  life-cycle costs of the infrastructure that they finance, and eventually, cities must tap into their general tax revenue to pay for the expansion in infrastructure.  For areas with higher service delivery costs (i.e. far away from existing infrastructure), this can turn into an expensive proposition.

A second problem is the "nexus" legal framework that asserts that there must be a reasonable connection between infrastructure need and new growth.  In practice, this has prohibited cities from using impact fee revenue for projects that may have more benefit to their municipalities, and instead must be used for expenses related to the new growth.  Towns looking to revitalize infrastructure in other neighborhoods or fund items like expanded public transit with impact fee revenue will be unable to meet the "nexus" legal test and have these efforts stymied, as the funds must be spent on the new growth.  The "nexus" framework helps to drive the growth machine by taking away cities' ability to choose which projects get funded, and only must fund the new projects with impact fee revenue (thus, the older infrastructure in out-of-fashion neighborhoods takes longer to receive attention or gets neglected entirely, reinforcing reinforcing the logic of the vicious circle of greenfield growth and old-neighborhood abandonment).

The cost and supply of new services for growing communities is not fully accounted for by impact fees and exactions.  Cities must maximize the effects of density and find ways to more effectively incentivize infill and denser development, so that they can enjoy the efficiencies that come from agglomeration.  The "nexus" test makes generating this type of momentum more difficult, but a concerted effort by policymakers (regional government entities, such as Minnesota's Metropolitan Council, could play a critical role) towards greater density will help us rein in our infrastructure expenses and make for more efficient local governments.

Evaluating an Increase in the Minnesota Gas Tax

After evaluating the proposed increase in the Minnesota state gasoline tax, we believe that this particular tax hike has many attributes that make it a desirable type of revenue increase.  Its ease of implementation, economic efficiency, and sustainability over time make it an attractive option for the state to generate revenue.  However, we found that the tax may disproportionately impact lower-income residents, and because of restrictions on how gas tax revenue can be used, it may be difficult for lawmakers to find solutions to offset some of these consequences for poorer, auto-dependent Minnesotans.  Still, we believe that Minnesota must meet its responsibilities to maintain a high-quality transportation infrastructure for its residents, and that this increase makes sense for Minnesota at this time. 

The gas tax increase will be easy for the state to implement because it is already collecting taxes on gasoline.  An increase in this tax should not add any overhead to the state’s tax collection setup, and Minnesota taxpayers should at least be reassured somewhat by this fact.  The low cost of implementation could allow lawmakers to make a persuasive case to their constituents that no additional overhead makes this tax more affordable than other options, increasing the political feasibility of such an increase.

The tax is also economically efficient as a tool for generating revenue because demand for gasoline is inelastic.  Minnesotans are dependent on their automobiles, and cars are by far the dominant mode of transportation throughout the state.  While this may mean that many Minnesotans will be affected, it also means that the tax will be effective because of the demand inelasticity.  Driving patterns and habits are difficult for individuals to break, so the state should expect that revenue would be generated from across the population. This also indicates that the tax increase would be a sustainable revenue source, as the inelasticity will ensure that revenues will be relatively consistent over time.  In addition, current constitutional requirements that gas taxes only go to road infrastructure (and not public transit, bike infrastructure or pedestrian infrastructure) will ensure that these funds do not contribute to expanded transportation options, making auto dependence likely to continue into the future.

Our evaluation found that the most significant drawback to the gasoline tax increase is the disproportionate burden that it places on poor drivers.  Since the increase is a flat tax placed on each gallon of gas, a Minnesota gas consumer’s ability to pay the tax is not factored into the amount of the increase. This will have consequences for car-dependent households with lower incomes.  However, because revenues will be spent almost strictly on road improvements, the tax is more equitable from a benefits-received standpoint as those who drive the most will be paying an amount more closely proportional to their use of this public resource.

Overall, we believe that the increased gas tax is a good revenue increase.  Tax increases are never popular, but an increase in the gas tax has advantages that other tax increases do not have.  Lawmakers should attempt to mitigate the effects on lower income families, possibly through credits or other instruments whereby a Minnesota taxpayer’s ability to pay is considered.  Based on our evaluation of this tax, we expect it to be an effective instrument to generate revenue in Minnesota if it is implemented.

-- Group 4, PA 5113 - State and Local Public Finance, Spring 2013

State Budget Deficits

State governments, unlike the federal government, have to balance their budgets according to law. A tough task in normal times, but after the Great Recession it became much more difficult for many states as economies around the nation suffered. Here is a list of the state’s entire projected deficit for the fiscal year of 2012.It also orders the states in terms of the projected deficit as a percent of 2011 total spending. For 2012, there are only six states that are not projected to have a budget shortfall: Alaska, Arkansas, Montana, North Dakota, West Virginia and Wyoming. 

The state budget crisis got to such critical levels that a task force was created to examine the problem of fiscal sustainability more closely in six states: California, Illinois, New Jersey, New York, Texas and Virginia. The report found there are six major threats hindering the states abilities to balance their budgets, and fiscal stability. 

(1) Medicaid spending growth- Escalating health care costs and increasing enrollments will cause state Medicaid spending growth (at recent rates) to surpass revenue growth by a considerable margin, at least $22 billion annually within five years.

(2) Federal deficit reductions- As the Federal government tries to remedy its own budget crisis, fewer government dollars in terms of grants or other federal spending might decrease, putting states in a fiscally unstable situation. Federal grants accounted for 32 percent of state’s revenues in 2009. 

(3) Underfunded retirement promises- Pension funds for state and local government workers are underfunded by $1 trillion dollars (or up to $3 trillion if more conservative investment assumptions are used. Health care liabilities are also underfunded by over $1 trillion dollars across the nation. 

(4) Decreasing tax bases and Volatile tax revenues- Income taxes have become increasingly volatile, especially since the economic crisis. Sales tax bases are eroding due to untaxed transactions; gasoline taxes are also eroding causing less money for transportation infrastructure.

(5) Local Government fiscal stress- The weak economy and reductions in intergovernmental transfers have put a lot of pressure on local governments. As a result spending on education, law enforcement and welfare programs have decreased. This threatens the overall economic and social status of the states. 

(6) State budget laws and practices- Lack of transparency and reporting have made it difficult for the public to gauge the critical nature of the budget situation. Using borrowed funds or other temporary ‘one-shot’ measures to balance the budget are not uncommon. These practices make fiscal stability extremely difficult. 

A summary of the main report may be found here. Links to the individual state reports and the full main report may be found in the previous link.

State budget crises have led to some serious consequences for the states’ residents. At least 46 states have decreased services provided, including some to the most vulnerable families, while more than 30 states have raised taxes to some degree and some quite significantly. During the recent economic downturn, when residents expected and needed services and benefits from states, they were unable to sufficiently provide them. Raising taxes to help balance the budget also puts the economic recovery at risk. 

Many states have to make some difficult decisions when trying to balance the annual budgets. In Texas, the state government cut $5.4 billion dollars in spending on education statewide. Part of the cuts involve having to lay off 25,000 public education workers, including 11,000 teachers. These cuts are occurring while student enrollment is increasing, by more than 80,000 per year. Texas is facing a two-year budget shortfall of $27 billion.

California last election passed new regulations raising the income tax rates for the wealthy, 10.3% for those earning over $250,000 and 13.3% for those earning over $1 million. The increases are expected to lower the budget shortfall, a projected $16 billion in 2012, down to $1.9 billion by the end of summer in 2013. But the tax hikes might cause an exodus of the wealthy from the state, who do not wish to pay the higher tax. The wealthy already feel they carry enough of the burden. The top 2 percent of earners, those over $450,000, pay 46 percent of the state’s taxes. Those earning over $1 million account for 25 percent of the entire state’s taxes.

This link shows all 50 states, estimated budget shortfalls, tax change percentages, and cuts to various programs. Minnesota from Jan 2010-March 2011: personal income tax increased 17%, corporate income tax increased 30.6%, and sales taxes increased 3.6%. 

The states unlike the Federal government cannot borrow large sums of money to balance their budget. This creates a difficult situation, especially after an economic downturn, where states scramble to find revenues or cut spending in order to avoid a shortfall. Citizens want states to have balanced budgets, but they might not always agree with the path taken to get to a balanced budget especially if services are cut or taxes are raised. Today many states are put in the seemingly impossible position of determining how to reduce deficits and without cutting too many services to residents or raising taxes too high.