The City of St. Louis’ 1% earnings tax is at risk, but alternatives exist

This article first appeared in the Solutions newsletter. Click here to learn more about the newsletter and sign up.

I’ve written before in Solutions how a progressive municipal government can talk big all day, but without revenue, it can’t do big things. The city of St. Louis does find itself in a historic moment revenue-wise, having reaped windfalls from the federal pandemic stimulus and the Rams litigation payout. Yet those piles of cash won’t last forever. 

In ordinary times, the city’s largest source of funds is the annual tax of 1 percent on individual and business earnings—a.k.a. the earnings tax. This levy accounts for about a third of general revenue, which is the bucket of money used to pay for essential services such as police, firefighters, streets, parks, and judicial offices. Right now, the earnings tax is being scrutinized by Missouri’s courts and a hostile state legislature. And the question in both venues is not whether the city needs the revenue or the services that it provides; it’s how the city is gathering that revenue—i.e., by taxing earnings. Which raises a broader question: Is there a better way to get the revenue?

The Growth Disagreement

You can make the argument (and several high-level officials in City Hall have made it) that a tax on the earnings of those who live or work in the city is not a problem. A number of vibrant metros, from New York and Philadelphia to Pittsburgh and Cincinnati, do something similar. Just look at Columbus, Ohio: It taxes resident income and boasts not only the fastest-growing population in the Midwest but also an economy that has outperformed the national average by 10 points. So we know the tax isn’t preclusive of growth.   

But St. Louis has an unusual city-county division, which means that businesses and workers in the city can, with relative ease, avoid the tax by moving into nearby counties. How many have done so? I haven’t found direct empirical research on that, although in July, Howard Wall, a Lindenwood University economics professor, published a paper for the Show-Me Institute—a pro-free-market think tank founded by Rex Sinquefeld, the wealthy political donor who has long waged war on income taxes. Using data from more than 500 U.S. cities and controlling for certain variables, Prof. Wall found that “cities with earnings taxes tended to have lower growth than otherwise similar cities.” He also estimated that in St. Louis from 2010–2019, the earnings tax reduced population growth in the city by 10,800 and in the region by 58,500. (This jibes, by the way, with the conclusion of Edward Glaeser, who chairs Harvard University’s economics department and observed in his 2012 book, The Triumph of the City, that “the indirect effect of a local income tax is to encourage richer citizens and businesses to leave.”)

Still, even if you dismiss the notion that the earnings tax stifles the city’s economy, there’s another reason to start thinking about alternatives: The Missouri Supreme Court or the state legislature could knock a big hole into it by siding with remote-worker plaintiffs who are suing for refunds. 

Threats on Multiple Fronts

Remote workers barely existed in the postwar period, when the tax was born. Back then, residents were flocking to live in the county suburbs but still commuting back into the city for 40 hours a week. Thus, they were enjoying plenty of city services; the tax ensured at least some payment for services rendered. The city did make exceptions, though. Up until the COVID-19 pandemic, a Chesterfieldian who worked at a downtown bank, for example, could, in a given year, drive into the office most days; work from home for three days; take a business trip to Chicago for three days; then request an earnings-tax refund for those six days of work performed outside the city—and the city would grant it. Yet once the pandemic shut down offices and launched the work-from-home era, the city announced—without any formal rule-making procedure—that it would issue refunds only for business travel. So a group of work-from-homers who live in the region but outside the city sued for refunds, and in January, a circuit judge agreed that they were entitled to them. The ruling is being appealed. (AT&T has filed a similar suit, but it hasn’t moved much.) If this decision stands, the city may have to refund up to $50 million per year, a city official recently said. That’s about a quarter of the revenue generated by the tax. 

This court decision is only one threat; there are others. In 2010, Missouri voters approved Proposition A, a ballot measure backed by Sinquefield. The resulting law mandates that every five years, voters in the city of St. Louis decide whether to retain their earnings tax. So far, they’ve done so by big margins (87.5 percent in 2011, 73.3 percent in 2016, and 79.4 percent in 2021). But there’s no guarantee that such support will continue; at least that’s what Mayor Tishaura Jones warned in 2021, when she was still treasurer. She told the St. Louis Business Journal that the earnings tax’s share of the revenue pie was “just unsustainable” and that “we need to see how we can diversify our sources of funds to make us not so dependent on the earnings tax should the voters ever decide that they don’t want to pay it anymore.”

These days, Jones is striking a different note—though not necessarily an inconsistent one—in response to the Missouri House of Representatives’ special interim committee on the earnings tax, which has begun to hold hearings, no doubt to give momentum to the ongoing legislative effort to force refunds for remote workers. Jones told Spectrum News a couple of weeks ago that if legislators eliminated the tax, they’d be “responsible for cutting basic services such as first responders from the citizens of St. Louis and Kansas City.” 

But cutting services would only need to happen if the tax were eliminated with no viable alternative in place. When asked about alternatives, Jones declined to comment. So she may still believe privately that they’re worth pondering. 

A Better Way?

In general, I’ve detected a widespread distrust at City Hall toward this committee—a suspicion that Republicans in the state capital loathe taxes so much that they’re willing to axe them without regard for the consequences. But at the first hearing, on September 12, in Jefferson City, Rep. Jim Murphy, the Republican chairman whose district contains parts of southwest St. Louis County, insisted that he’s genuinely interested in alternatives. “There are people out here that are saying that the only way we’re going to fix St. Louis city is to let it hit the bottom,” Murphy said. “[That] once it hits the bottom, we can rebuild it. I will tell you: If St. Louis city hits bottom, it’ll never rebuild. We cannot allow that to happen…. We’re here to look for a better way, not to destroy this city.”  

So I asked Murphy last week: What would a better way look like? He says he’s interested in the notion of “enterprise zones,” where businesses would be exempt from the earnings tax; the idea is to foster so much economic growth that a tax on earnings becomes unnecessary. That idea and others could be fleshed out in the committee’s final report, which Murphy says will be filed before the next legislative session starts in January. 

Other ideas for replacing earnings-tax revenue have been floating around City Hall itself for years. One is to hike up the city’s relatively low property tax rate. Nationwide, the levy on property is the largest source of funds for local governments, according to the Lincoln Institute of Land Policy. (Data from the U.S. Census Bureau show that local governments take in roughly $15 in property taxes for every $1 in income taxes; in St. Louis, that ratio is lopsided the other way at about $1 to $3.) But state law gives the city very little wiggle room on this rate; more on that later. Another idea is to arrange for payments in lieu of taxes from universities, which, as 501(c)(3) charitable nonprofit organizations, are tax-exempt. At least seven ivy league universities have now begun to make payments of this type. In future editions of this newsletter, I’ll explore alternatives such as these. 

In the meantime, I’ll leave you with the argument that Paul Payne, the city’s budget director, made for me last week: that the focus on the earnings tax is misplaced. Yes, Payne acknowledges, it can act as a disincentive to growth, as any tax will do. But he argues that it’s merely a downstream effect of the true difficulty: that we live in a metro where residents move daily across a weirdly fragmented governance landscape. “If you were an outsider and you looked at our tax structure,” Payne said, “the earnings tax would not jump out at you as the source of the city’s ills. What would jump out at you is: What is a city not within a county?” 

An oddity indeed—and yet another issue to be explored down the line in Solutions.