State Shared Revenue in Arizona: An Assessment

Since the 1970’s the American federal system has experienced a significant realignment of revenue raising and spending responsibilities. From the New Federalism era of the 70’s and 80’s, to the “Fend-for-yourself”[1] federalism of the late 80’s, more and more is expected of local government, with less and less assistance from the higher tiers of government. Gone is the era of General Revenue Sharing, replaced by “unfunded mandates” and categorical grants; a marked shift has occurred in the tax and spending responsibility, away from the Federal level toward the state and local level, this shift has increased pressures on the revenue-raising resources of these governments, which have been further hamstrung by tax-payer revolts and competing more aggressively for firms and residents. Today, Local governments are expected to provide an increasing number of services from: police and fire services; planning, zoning and building inspections; parks and recreation facilities; garbage collection; libraries; road maintenance; water and sewer systems; economic development and mass transit.[2]In Arizona, Local authorities rely on a number of own-source revenues to perform these tasks: property taxes, sales taxes, franchise taxes, business license taxes, bed taxes, user and permit fees, service charges, fines and issuing bonds.[3] However, there exist limits to the array of potential sources available to Arizona Local governments, as opposed to other American cities (for example, there are prohibitions against levying income, fuel and luxury taxes).

To supplement own-source revenue, and partly as a consequence of voter imposed limits on own-source revenue streams, cities and towns in Arizona must rely on State Shared Revenues. This paper aims to provide an introduction to these programs; it shall begin by looking at the political, social and philosophical underpinnings for intergovernmental transfers, followed by an articulation of economic rationales for the same. This shall be followed by an exposition of the various revenue sharing programs in Arizona, with particular attention paid to the sharing of income taxes (urban revenue sharing). The final portion shall briefly assess the impact of these transfers and particularly there importance to local government finances.

As with many other states, the State of Arizona has – for economic and political reasons – placed restrictions on the revenue raising ability of its constituent entities. To minimize individual tax burdens, eliminate inter-jurisdictional tax competition, streamline tax structures and ease tax administration[4]: the state prohibits localities from levying an income tax (ARS 43-201), luxury tax (ARS 42-3002) and limits property tax levels (AZ Constitution Article IX Sections 18(1), 19 and 24), as well as, provides for expenditure limits (AZ Constitution Article IX section 20).[5] Considering the limitations placed on revenue generating schemes, and the fact that the survival of localities is (in the final analysis) the responsibility of the state, revenue sharing has been developed as a schema to ensure the economic and political survival of these sub-state entities: “The state is ultimately accountable for the bulk of domestic services. It has the power to establish local units of government and delegate to them some of its sovereignty in particular areas. The state is obligated (a) to delegate only those functions that can be efficiently performed by the particular unit and that are predominantly local in character and (b) to provide sufficient resources to each unit so that it can fulfill its responsibilities adequately without overburdening its taxpayers in relation to taxpayers in similar circumstances in other areas of the state.”[6]Therefore, from a constitutional and political perspective, the State of Arizona (as the creator of local government) is obliged to ensure the survival and viability of its local entities.

In addition to the political rationale noted above, we can add demographic shifts, which have occasioned an expansion of urban areas in Arizona, this shift has led to more and more individuals moving into urban areas from Rural Arizona or migrating to the state from other States and nations. This expanded population has put additional strain on local resources, necessitating continued state aid.[7] It has also been argued, that since a majority of the states economic activity occurs within Urban areas: “83 percent of the state’s population lives within a city or town, more than 91 percent of the tax revenue collected by the state originates from financial activities within incorporated communities.”[8], it is only fair that Cities and town receive a portion of state revenues, accrued to the state from activities happening in the localities, this arguments forms the foundation of the “point of origin” rational for revenue sharing, monies should be returned to a jurisdiction in proportion to the contribution that locale makes to the state treasury.[9]

There also exist economic rationales for intergovernmental transfers Pattengill and Uppal[10] and Bell (1990)[11] identify the following economic rationales for supporting state shared revenue: (I) Externalities, (II) Fiscal Equalization, (III) Equity. Intergovernmental transfers can be used to correct for positive “interjurisdictional spillovers,”[12] which occur when the benefits of a locally provided public good or services accrue to non-residents. In this case, the jurisdiction shall under produce the beneficial good or service, as it does not account for the broader positive externalities. For the locality to produce the optimal amount, a subsidy may need to be provided, to subsidize the provision of said product at the optimal societal level. Fiscal Equalization maybe necessary to ensure that all jurisdictions have the necessary finances to provide a standard quantity and level of service across the state, as localities have varying resources and wealth, intergovernmental transfers may be necessary for poorer localities. Fiscal equalization also accounts for the latter Equity concerns, whereby, citizens within the state, who are at the same economic strata should largely receive similar services regardless of there residence: “On equity grounds, intergovernmental assistance may be desirable if the tax price faced by individuals of equal income in different jurisdictions providing a standard level and quantity of service differ because one jurisdiction is less wealthy than another.”[13]

As can be seen above, there exist a multitude of reasons, economic and non-economic for intergovernmental fiscal transfers and the development of a state shared revenue system in particular, to ensure that localities are providing the appropriate level and quality of services and are sustainable sub-state entities: “An essential part of keeping Arizona cities whole and operating is our system of revenue sharing. Established decades ago as a trust between Arizona residents and their state government, the revenue-sharing system is based on the belief that the state prospers only when its component parts prosper.”[14]

There are two broad categories of intergovernmental transfers in Arizona: (i) State Shared revenue and (ii) State appropriated funds. The former, are state aid to local governments from earmarked revenue sources. That is, the funds come from state revenue sources, local governments have no control over the amount of revenue collected, and the funds are distributed by formula rather than returned to the jurisdiction of origin. These funds are typically governed by statute. Examples of such programs include sharing of state income taxes, sales taxes, motor fuel taxes and motor vehicle taxes. The latter are transfers that are provided to localities via the budget appropriations. Programs in this category include school equalization assistance programs, health and hospital aid, law enforcement and justice grants, flood control aid, library grants and disaster aid.[15] Intergovernmental funds can either be categorical (that is earmarked for a specific purpose or general (for general use), and may also require matching commitments from the local government.[16]

The focus of this paper is necessarily on State-Shared revenue, of which there are a number of programs in Arizona:

I) Transaction Privilege Tax (TPT):

A portion of the State’s collected sales tax (or TPT) is designated by statute for distribution to a “distribution base.” According to the Arizona Department of Revenue, the division of the TPT between the “distribution base” and “non-shared base” varies from one category of the tax to the next: “For example retail sales is 40% distribution and 60% non-shared.”[17] Of the monies in the “distribution base” 25% goes to cities, 40.5% to counties and 34.49% to the state.[18] An estimate by the Arizona League of Cities and Towns put the 2009 TPT transfer to cities and town at $374,000,000.[19] This intergovernmental transfer is non-categorical and non-matching; the funds go directly to the general funds of the local authority to be utilized as desired.

II) Highway User Revenue Fund (HURF)

These monies come from state gasoline and use fuel taxes, motor vehicle carrier fees, motor vehicle registration fees and other miscellaneous fees.[20] Monies are first allocated to the Arizona Department of Safety and the Economic Strength Project Fund, as well as, any additional allocations as may be deemed necessary by the legislature. The balance of the monies is divided as follows: counties (19%), Cities and town (27.5%), Cities with over 300,000 residents (3%) and the State Highway Fund (50.5%). According to AZ League of Cities and Towns, this accounted for $319,944,000 in state transfers for the year 2009.[21] Article IX section 14 of the State Constitution requires that these funds only be used “solely for highway and street purposes.”[22] This is a non-matching fund.

III) Local Transportation Assistance Fund (LTAF)

Funding for this program comes from the State Lottery and Vehicle License Tax (VLT). This is a categorical, matching grant focused on the development of transit services (in cities with more than 50,000 residents) and general transportation (cities with less than 50,000 residents)[23]. It requires a 1:1 matching commitment from the former and a 1:4 commitment for the latter cities. The Arizona League of Cities and Towns estimated the 2009 transfer to have been $23,000,000[24].

IV) Urban Revenue Sharing.

This is the final and most significant Revenue Sharing program in Arizona, according to AZ League; transfers were $628,644,630 in 2009 or approximately 47% of the major state transfers to cities. The Joint Legislative Budget Committee (JLBC), but the FY 2009 transfers at $727,662,400.[25] The fund was established in 1972 via a voter initiative, it was enacted as ARS 43-206, which states in part: “There is established an Urban Revenue Fund. The Fund shall consist of an amount equal to fifteen percent of the net proceeds of the state income taxes for the fiscal year two years preceding the current fiscal year.”[26] As noted, the statute provides for the distribution of 15% (though the percentages has been varied through legislation) of the states individual and corporate tax receipts. The statute is a necessary corollary to the Constitutional provisions barring local income taxation. Monies are distributed each year based on receipts from two years prior, thus, FY 09’ transfers were based on FY 07’ revenues. This allows for better planning and revenue management on the part of the revenue department and allows localities to better-forecast revenues. However, basing transfers on two-year-old revenue figures may strain current state resources. Case in point, though state income tax revenues declined by 14% and 25% in FY 08’ and FY 09’ respectively, Urban Revenue Sharing for those two years rose by 24% and 6% respectively, tied as they were to the State’s better fiscal and economic situation in FY 06’ and 07’.[27] Conversely, transfers are likely to experience downward pressure in the next couple of years, based, as they shall be on the poor fiscal and economic situation in FY 08 ‘and FY 09’.

Urban Revenue Sharing funds are distributed to the localities on a monthly basis, based on their individual share of the “incorporated population” in Arizona.[28] A complicating factor in these methodology, is that the “incorporated population” is based off the decennial census or special census certified by the Census Bureau. Therefore, Cities have an added impetus to continually outdo each other in “population counts.” A situation that is likely to favor rapidly expanding jurisdictions at the expense of smaller ones.

CONCLUSION:

Assessing the effectiveness of Revenue Sharing in mitigating fiscal disparities, or ensuring equitable provision of services and its impact on externalities was beyond the scope of this paper. However, it is possible to gauge the importance of State Shared Revenue as compared to own-source revenue. According to the Census Bureau’s report on Government Finance[29] Arizona cities received approximately $2.1 billion dollars in State Transfers in 2007 (latest data), this is against $6.1 billion in own-source revenue. The census data, however, includes $2.5 billion in sales taxes as own-source tax revenue; it is not clear whether or not this includes TPT transfers. Regardless, it is clear that state transfers do form an important and significant portion of local government financing in Arizona, anecdotal evidence of this can be found in the reaction of cities to any attempts at the legislature to reconfigure state shared revenue.[30]

There are also some larger concerns to be raised about the Intergovernmental transfers in general and Revenue Sharing in particular, these concerns revolve around the effect that such transfers have on the accountability of those who spend the money (being as it is that there is a separation between the revenue-raisers and spenders), as well as, potential unintended spending consequences at the local level, again due to the fact that the spenders do not have to raise the money, and expect it no matter what. A final concern relates to the tying of revenue sharing to the economic conditions of the state (by pegging them to income taxes), this ties the local authorities to the whims of the state economy and may lead to a dependency on the part of localities to State Shared Revenues.

State-shared revenue programs’ are an important tool to the State government, providing it with an opportunity to ensure that services are provided in an effective, efficient and equitable manner throughout the state. As well as ensuring the viability of these sub-state entities.

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[1] Morgan, David, England, Robert and Pelissero, John: Managing Urban America 6^th Edition. CQ Press 2007. Pp. 34-37

[2] Joint Select Committee on State Revenue and Expenditure: “A Fiscal Overview of Local Government in Arizona.” 1989. This document shall henceforth be referred to as (JSCSRE, Fiscal).

[3] Ibid, 4

[4] Poelker, John H: “Local Sources of Revenue” in “Sources of Municipal Revenue” Wright Edward T. ed, Charles C. Thomas Publishing 1971. Pp. 61

[5] All information regarding Arizona Constitution and Statutes retrieved from: http://www.azleg.gov/Constitution.asp and http://www.azleg.gov/ArizonaRevisedStatutes.asp

[6] Quindry, Kenneth: “State Sources of Local Revenue” in Wright ed. “Sources of Municipal revenue” fn. 4. Pp. 54

[7] For a brief on the impact of “urbanization” see Baker Benjamin “Economics of Taxation” in Wright ed: “Sources of Municipal revenue” fn. 4. Pp. 3 and Pattengill, Robert and Uppal, Jogindar: “Can Cities Survive? The Fiscal Plight of American Cities” St Martin Press, 1974. Pp. 115.

[8] Strobeck, Ken: “Changes to revenue-sharing system would devastate cities” Arizona Capitol Times, February 8^th 2010

[9] Arizona State Senate Issue Brief: “State Shared Revenues” October 2006. Pp. 1

[10] Fn 7, Pp. 115

[11] Bell, Michael: “Unrestricted State Aid to Cities and Counties.” in McGuire Therese and Naimark Wolfe ed. “State and Local Finance For the 1990’s: A Case Study of Arizona.” School of Public Affairs, Arizona State University, 1991. Pp. 394

[12] Ibid

[13] Bell, fn. 11. Pp. 394. See also Pattengill and Uppal, fn 7. Pp. 115-117 and Arizona Joint Select Committee on State Revenues and Expenditures: “State Assistance to Local Governments in Arizona.” 1989. Pp. 30. This latter document shall henceforth be referred to as (JSCSRE, Assistance)

[14] Fn 8.

[15] Bell, Pp. 395. Fn 11

[16] JSCRE, Assistance. Pp. 15

[17] Arizona Department of revenue “Arizona Tax Facts” February 2010. Pp. 5

[18] Arizona State Senate fn, 9. Pp. 2

[19] League of Arizona Cities and Town: “Shared Revenue” March 2009. Pp. 4

[20] Fn 9 Pp. 3

[21] Fn 19.

[22] Fn 5.

[23] Fn 9.

[24] Fn 19.

[25] Joint Legislative Budget Committee: “Historical General Fund Revenue Collection”, 11/18/2009. Pp. 1

[26] Fn 5.

[27] Fn 25.

[28] Bell, Fn 11. Pp. 397.

[29] Data Retrieved from: http://www.census.gov/govs/estimate/

[30] Witness Fn. 8