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The good news first: The City of St. Louis’ finances look solid in several ways. The pension systems are relatively well-funded. There’s a diverse mix of revenue streams. The city has squirreled away more in rainy-day reserves than the minimum recommended. And who doesn’t love free money from the pandemic stimulus and Rams litigation payout?
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But as I pointed out in the last edition, a danger looms: Folks who don’t live in the city but work remotely for companies located there are seeking refunds on the 1 percent they paid in earnings taxes. If these nonresidents end up getting their refunds—be it from a favorable court ruling or friendly Republican-sponsored legislation—then the city could lose as much as $50 million per year, according to a rough estimate by the Collector of Revenue’s office. Such a fiscal hole would be roughly equal to the combined budgets of the Circuit Attorney’s Office, the Division of Parks, and the Refuse Division. So it’s not nothing.
The city is vulnerable here because it relies on the earnings tax for 38 percent of general revenue. Certainly, St. Louis isn’t alone in taxing income: About 5,000 jurisdictions (or one in five nationally) do it, says Andrew Boardman, a policy analyst at the left-leaning Institute on Taxation and Economic Policy. The club of income-taxers includes New York, Philadelphia, Pittsburgh, Cincinnati, and the booming metro of Columbus, Ohio.
But having such a tax is one thing; making it a financial pillar is another. When you zoom out to the country as a whole, you notice how weird St. Louis is in at least the following respect: According to an ITEP analysis, the overwhelming majority of U.S. localities—94 percent of them—rely on property taxes as their dominant funding source. Our city doesn’t do that. Here, the earnings tax is dominant and property taxes make up only a 13 percent slice of the general-revenue pie.
The local property tax dominates in the U.S. for several reasons, says Richard Auxier, a senior policy associate at the Urban-Brookings Tax Policy Center. The concept has been around for millenia and has taken root in American culture, for one thing; for another, it’s an approximation of the benefit principle, which holds that the taxes you pay should correspond to the benefits that you receive. “Economists love the property tax,” says Auxier.
But St. Louis can’t emulate all those other cities by replacing its earnings tax with a higher property tax rate—at least, not right now. That’s because fiscally conservative state laws leave it little wiggle room. The Hancock Amendment in Missouri’s constitution requires voters to approve tax hikes, but even with gushing voter approval, St. Louis’ rate would quickly smack its head against a statutory ceiling. Paul Payne, the city’s budget director, shared with me a recent presentation slide in which he calculated that the city’s general-purpose portion of the property tax rate (that is, $1.4712 of the total $8.2661 per $100 assessed value) would need to climb by a factor of about three (that is, by $4.454) to compensate for a defunct earnings tax. But such an increase, Payne concluded, would blow right through the cap set by law ($1.49, derived here and here). Tammy Queen, the finance department director in Kansas City, told me last week that her municipality, which also has an earnings tax, would face a similar situation.
So, absent some vigorous legislative action, a wholesale switch to the property tax remains a thought experiment for now. I, for one, struggle to imagine the Republican-controlled state legislature prioritizing a bill to let Missouri’s biggest cities raise taxes. That said, the members of the special interim committee in the House of Representatives did say they’re serious about looking for alternatives to the earnings tax. I guess we’ll know more at their next hearing, which is scheduled for October 30 in St. Louis.
But to stick with the thought experiment: Suppose the city could replace its earnings tax with a higher property tax rate. Who would the new winners and losers be? The burden currently borne by nonresident workers would shift entirely to city residents. True, this taxbase may grow in the absence of the earnings tax. But in Payne’s calculations, a couple who lived in a city house appraised at $200,000 and drove vehicles appraised at a combined $35,000 would be called on to pay $2,212 more in property taxes in such a grand swap. To break even or better, they’d need to be earning at least $221,200 between them; otherwise, their overall burden would increase.
Wealthy retirees currently living in valuable homes in, say, the Central West End and Lafayette Square would see a bigger burden overall. So would low-income seniors, though Missouri does have a circuit breaker program to help them with taxes and rent. (Boardman says other states and localities have expanded the eligible age range for their circuit breaker programs to protect more people with low income, including renters, who, to some extent, would shoulder the costs of higher property taxes.)
So a complete swap of one tax for another would be a system-wide shock. Less extreme would be a tweaking of both. Boardman suggests the city might amend rather than end the earnings tax by reimagining it as a sort of graduated income tax (similar to the federal variety) that encompasses capital gains and other income streams. Similarly, he says, the city could make its property tax more progressive so that the rate increases as the real estate’s value does. Or maybe it could introduce real estate transfer taxes.
Some proposals are a bit more “out there” but intriguing nonetheless. I know that the free-marketeers at the Show-Me Institute as well as Boardman at ITEP are watching with great interest the prospect of Detroit switching to a two-tier property tax—a system wherein land is taxed more than the buildings sitting on it; it’s designed to discourage speculation. Show-Me explored that idea at length years ago, but it has rarely been tried IRL. Then you have the trend of cities arranging for payments in lieu of taxes (PILOTs) from universities and nonprofits, which are currently exempt.
It’s not entirely clear how much blessing the city would need from Jefferson City to try any of these out. Proably a lot, and they’d probably ignite legal fights.
One cliché in tax-policy circles, Auxier tells me, is to say that tax reform is inherently hard because it creates new winners and losers. But when talking about such tradeoffs, at least you’re being honest about it, he says. What worries him—and he has noticed this especially in Republican-controlled states—is the zeal to scrap a local income tax with only a vague promise to figure out an alternative later. “It does not end well,” Auxier observes. “There’s nothing wrong with a person who believes the income tax is not the best way to tax, but when you do the easy thing first and hand-wave away the hard stuff, that’s when you run into problems. Because the money doesn’t come and somebody’s gotta pay more.”
If St. Louis’s future has $50 million budget hole in it, then somebody will indeed have to pay more—and 94 percent of American localities suggest an imperfect but evidently plausible solution. The question is whether the city and state legislature will want to hear it.
