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Correction: Under the heading “Experience from the First Year,” the percent increase in FY2012 over what was collected in FY2011 under the previous PILOT program was incorrectly reported. The correct percentage is 28.4. Both the PDF and text version below list the correct amount.
Historically communities with high concentrations of nonprofit institutions such as hospitals, colleges, and museums have struggled with the reduced tax base associated with these tax-exempt properties. For Boston, Massachusetts, the preponderance of tax-exempt property, combined with a high reliance on the property tax for local revenue, has made this impact particularly acute. Beginning in the early 1970s, Boston began seeking payments from its nonprofit organizations as a way of offsetting the loss of revenue and the increase in public service demands associated with the institutions it hosts.
Although these payments in lieu of taxes (PILOTs) expanded over time, the City of Boston remained dissatisfied with its PILOT program. The revenue from PILOTs represented a small fraction of the city’s overall budget, and the size of contributions from nonprofit institutions varied widely. Since 2008 Boston has developed and implemented a new approach to PILOTs that has received considerable national attention. This article examines the conditions that led to the development of Boston’s new PILOT program, describes its approach, and reports on the city’s experience in its first full year.
Constraints on Boston’s Tax Base
Boston traditionally has been at the center of any discussion regarding PILOTs. The confluence of several political, fiscal, and demographic forces has created a volatile mix for the city and its nonprofit institutions. Boston is the economic and cultural center of New England and is home to some of the world’s most renowned hospitals and universities. As the state capital of Massachusetts, Boston also hosts a large number of government office buildings and facilities. Among its more unusual challenges is the city’s small geographic size in relation to its metropolitan area. Boston is the 22nd largest city by population, but it represents the 10th largest metropolitan area. As a result, exempt institutions that service the entire metropolitan area are concentrated within the city’s relatively small boundaries. In fact, over 50 percent of Boston’s land area is exempt from taxation (figure 1).
Boston also has a revenue structure that is unique among its large-city peers, primarily because it has no income, payroll, sales, or other significant source of tax revenue. Instead, Boston relies heavily on the property tax, which represents two-thirds of all city revenue (figure 2). While New York or Chicago also have large amounts of institutional property exempt from the property tax, those cities are able to tax the incomes, sales, and other economic activity which the universities, hospitals, and other large nonprofit institutions generate. In contrast, Boston receives no direct compensating revenue associated with the economic activity that is generated by its vibrant nonprofit sector.
Further, the growth of the property tax in Boston is constrained by Proposition 2½, a statutory limit on the level of property taxes. The most significant limitation is that the property tax levy for existing properties can increase by only 2.5 percent per year. Proposition 2½’s other primary limitation is a cap on the overall effective tax rate of 2.5 percent. As Boston is well below this limit at 1.8 percent, the impact of exempt property is not a factor for this provision as it is in other Massachusetts communities. The combined impact of the concentration of exempt property, the high reliance on the property tax, and the limits placed on property tax growth by Proposition 2½ result in a more profound fiscal impact of exempt property in Boston than in most major cities.
Reconciling the Benefits and Costs of Nonprofit Institutions
Despite these fiscal impacts, Boston is fortunate to have a vibrant nonprofit sector. The city hosts some of the world’s most prestigious hospitals and universities that provide exceptional health care, research, and education to their clients. In addition to fulfilling their charitable missions, these large institutions are significant economic generators that form the backbone of Boston’s knowledge-based economy. The health care industry alone accounts for 125,000 jobs in Boston.
There is an economic disconnect, however, between the benefits of nonprofit institutions and the costs of providing their properties with tax exemptions. The benefits of Boston’s nonprofits do not stop at the city’s borders; the educational, scientific, and cultural benefits of Boston’s institutions accrue to the region, state, country and, in many cases, the entire world. Yet the cost of providing public services to these institutions and the loss in revenue from removing their properties from the tax base fall squarely on Boston’s taxpayers.
This point is critical to understanding the importance of PILOTs to a city like Boston. Many observers believe that the current interest in PILOTs is driven by the short-term fiscal stress associated with the recent recession. According to this school of thought, once the economy recovers and the municipal outlook brightens, the pressure for PILOTs will ebb. Boston’s experience contradicts this assertion. The city has struggled with the fiscal impact caused by its nonprofit sector over a long period, through good fiscal times and bad. It is this fundamental disconnect between institutional benefits and fiscal costs that is the ultimate source of this debate. Until these benefits and costs are better reconciled, financial tension between the city and its nonprofits will continue.
Measuring the Fiscal Impact of Tax-Exempt Property
The impact of tax-exempt property on the city as a whole has long been the focus of spirited public discussion in Boston. One question that has often been asked is how much nonprofit institutions would pay if their properties were fully taxable. For a long time this question could not be answered. Since tax-exempt property paid no property taxes, the city had little incentive to maintain accurate data and up-to-date assessments for institutional property. However, the continuing focus on the fiscal impact of exempt property clearly required an answer to this question.
Given the scarce resources available for a project to value exempt property, Boston needed to be creative in coming up with a method to generate reliable assessments while minimizing the costs of collecting data. At the city’s disposal was a particular type of tax return that nonprofit institutions are required to file annually, as well as broad statutory authority to request from property owners the information necessary to value their properties. Boston was able to leverage these tools to collect detailed information on the property owned by nonprofit institutions—specifically, the physical characteristics (size, age, condition) and uses. Most major institutions maintain accurate data on their property holdings. Once the assessors had access to these data, they were able to plug the information into the city’s computer-assisted mass appraisal system (CAMA) to generate assessments for the properties. Site inspections were performed to verify the information provided by the institutions and to ensure the accuracy and reliability of the CAMA-generated assessments.
The resulting assessments were then shared with the institutions. Each was given the details on the valuation estimates for their real estate holdings and provided with an opportunity to meet with assessors to review the results and raise any concerns. The city incorporated this feedback to complete the final value for the properties. Given that this was the city’s first effort to generate assessments for nonprofit property, this review step provided a valuable check of valuation data quality as well as an opportunity to share the preliminary results of the revenue impact of their property tax-exemptions with each institution.
The analysis, which was completed in 2009, revealed that educational and medical tax-exempt property would have generated $347.9 million in revenue if it were taxable (City of Boston 2010). To put this amount in perspective, it would equate to approximately one-quarter of the city’s total tax levy of $1.4 billion in Fiscal Year 2009, and would be equivalent to roughly half the revenue generated by the office, retail, and hotel properties that make up the commercial tax levy (figure 3).
PILOT Task Force
Once the assessment information was used to determine the amount of tax each institution would pay in a nonexempt scenario, a number of shortcomings of the current PILOT program became apparent. While the former program was considered one of the more successful PILOT programs in the country, the amount of realized revenue appeared small when compared with the revenue that exempt properties would generate if they were taxable. PILOT payments from educational and medical institutions in 2009 totaled $14.5 million, or 4.2 percent of what institutions would pay if their properties were taxed, and equivalent to just 1 percent of the city’s property tax levy. In addition, the level of participation varied widely among institutions. Some institutions made substantial contributions under the program, while others made limited payments or chose not to participate at all.
To address these concerns, Boston Mayor Thomas M. Menino appointed a task force to review the PILOT program and asked it to:
The PILOT Task Force membership drew from a wide spectrum of participants: two leaders each from local colleges, nonprofit hospitals, and Boston’s business community; and one each from the city council, public sector unions, and community-based organizations. The Task Force met over a two-year period to explore both the benefits and costs to Boston of hosting its nonprofit institutions and how these factors should be considered in the PILOT process. Also key was the discussion on how to ensure that institutions contribute to the program on a consistent basis. In December 2010, the Task Force recommended the following PILOT guidelines to Mayor Menino.
PILOT Program Should Remain Voluntary
The Task Force members believed a legal or statutory requirement for PILOTs runs counter to the spirit of partnership between the city and its nonprofit institutions. That partnership is critical to encouraging broad and uniform participation.
All Nonprofits Should Participate
Much of the PILOT discussion previously focused on hospitals and universities. The Task Force, however, felt all nonprofits that own tax-exempt real estate within the city should contribute to the PILOT program. To protect smaller institutions with fewer resources, the PILOT program was limited to those nonprofits with property valued at more than $15 million.
Determining PILOT Payments
Many alternatives were considered for the basis of PILOT contributions, including a per-student or per-hospital-bed fee, or a charge based on the amount of land or building area. The Task Force determined that a charge driven by the assessed value of the institutions—reflecting size and quality of real estate holdings—would result in the most equity. There was a general consensus that nonprofits should contribute some amount toward their consumption of essential services such as police and fire protection, as well as public works such as street cleaning and snow removal. These services consume approximately 25 percent of Boston’s budget, and the Task Force found that a PILOT equal to 25 percent of an institution’s fully taxable amount was reasonable.
Credit for Community Benefits
The public benefit provided by nonprofit institutions was a major focus of the Task Force, which recommended that institutions receive up to a 50 percent credit on their PILOT in exchange for community benefits. This credit recognized the significant inkind contributions made by nonprofit institutions that directly benefit Boston residents. The credit was limited to 50 percent of the PILOT amount to ensure significant cash contributions from each institution. However, the Task Force felt that if an exceptional opportunity for a program or service were available, the 50 percent cap could be exceeded at the city’s discretion.
While the Task Force did not offer detailed specifics on the services that were eligible for PILOT credit, it did provide general guidance on the types of services that should qualify. To be eligible, community services must directly benefit City of Boston residents, support the city’s mission and priorities, offer ways for the city and nonprofit to collaborate to meet shared goals, and be quantifiable.
Phase-in Period
Finally, the Task Force recommended that the new PILOT formula be phased in over a period of not less than five years. Given the change in scope of the city’s PILOT program, the Task Force understood that institutions would require time to make the necessary adjustments in their budget and financial plans to accommodate increased PILOT amounts.
Implementing the New PILOT Program
When Mayor Menino accepted the Task Force recommendations in December 2010, the city needed a plan to implement the new PILOT program. First, letters were sent to all institutions that fell within the criteria of the program. Each letter included a copy of the new PILOT guidelines and an analysis detailing the calculation of the PILOT that the city would request under the new formula. Each letter also indicated that the city would seek a meeting with each institution in the coming months to discuss the new program.
The subsequent meetings were a critical step in the implementation, providing a forum for each institution to ask questions about the program and to voice concerns. While these sessions were designed originally to provide information to the institutions on the new program, they also provided significant, valuable feedback for the city that in turn offered further guidance on the rollout.
The city’s previous PILOT program included contracts that laid out the terms of each institution’s PILOT commitment. While the contracts were useful as a reference, their value as a legal instrument was questionable since PILOT payments remained voluntary. For example, the city had never sought to enforce payment under a PILOT contract. As the city faced the question of whether contracts would be employed in the new program, the notion of negotiating, drafting, and executing over 40 contracts with institutions was daunting. Given that the guidelines already provided the details of each institution’s requested participation, the city felt those documents should form the basis of the relationship with the institutions and decided to forgo the use of PILOT contracts.
Experience from the First Year
In October 2011, requests for payment of the first installments for FY2012 were sent to all participating institutions, and the results were impressive. The city collected a total of $19.5 million in cash payments, a 28.4 percent increase over what was collected in FY2011 under the previous PILOT program. This represented over 90 percent of what the city requested—an extraordinary level of participation given the first year of a new, voluntary program (figure 4). Boston also received an equivalent level of contributions in the form of community services provided by the nonprofit institutions, consistent with the PILOT guidelines.
A key component of the program’s initial success was the emphasis on promoting a sense of partnership between the city and its institutions. Based on its prior experience, the city understood that a more confrontational approach would not be effective in the short or long term. At the same time, the institutions needed to recognize that as charities they have a level of accountability to their host communities. This accountability was encouraged in part by providing a high degree of transparency in the process. Task Force meetings were open to the public, and materials used during the deliberations were posted on the city’s website.
This theme of transparency continued in the implementation phase of the program. Information detailing each institution’s participation in the program, from cash payments to the community services provided, was also posted on the city’s website. Institutions that had less than full participation in the program were given the opportunity to communicate their reasons. Specific details on the community services delivered by the institutions were also disclosed, providing an opportunity for institutions to highlight and promote their valuable service contributions.
The Importance of Community Services
In its discussions with nonprofit leaders during the implementation of the new program, the city discovered that institutions have a decided preference for providing community services over making cash payments. Given that service delivery is at the core of most nonprofits’ charitable missions, this was not surprising. Conversely the city generally places a higher value on cash payments, which provide flexibility in applying resources to meet the highest-priority service needs of the community.
To reconcile these two divergent preferences, the city has recognized that it must further develop its ability to harness the community-service portion of the PILOT program to meet its service demands. Currently community benefits often are offered by the institutions based on their own initiative. While these services have value to the city and its residents, they may not be among the city’s current service priorities. Even in cases where specific requests for services came directly from a city official to fill a near-term service gap, such ad hoc requests lack the prioritization and review that is associated with a more disciplined budgeting process.
Requests for PILOT services should be planned and prioritized to maximize their value to the city. Under such a structure services are more likely to either reduce or replace the cost to the city of providing a service, or to provide a new service to meet a priority that the city had been unable to deliver previously. Through careful planning, directing institutional resources to priority areas reduces the city’s financial commitment and makes it is easier for the city to forgo cash in favor of institutionally preferred services. This planning process is also beneficial to the institutions, as they are better able to budget for their PILOT service commitments. As the program continues through its phase-in period, the ability of the city and institutions to work cooperatively on a structured approach to community services will be critical to the continued success of the PILOT program.
Closing Thoughts
The process Boston has followed to construct its new approach to PILOTs was both thoughtful and inclusive. The expertise and perspectives of the Task Force members, combined with the city’s decades of experience on the issue of exempt property, led to program guidelines that were recognized as fair and reasonable. The process also demonstrated that for a PILOT program to be successful the city and its institutions must be partners, not combatants.
This philosophy has formed the basis of Boston’s approach to the implementation of its new PILOT program. And, despite its early success, there is still much work to be done. The city needs to balance its need for revenue with the institutions’ preference for services. If city officials and local institutions can continue to work cooperatively on the PILOT program, a balance can be struck that will work to the mutual benefit of the institutions, their constituents, and the residents of Boston.
About the Author
Ronald W. Rakow has been commissioner of the City of Boston Assessing Department since 1992, and he took on the additional role of deputy chief financial officer in 2011. He was appointed in 2010 to the Board of the Massachusetts Convention Center Authority, and is currently serving as the chair of the Research Committee of the International Association of Assessing Officers (IAAO).
References
City of Boston. 2010. Mayor’s PILOT task force final report and recommendations, December.
City of Boston Assessing Department. 2009. Exempt property analysis: Educational and medical institutions, Fiscal Year 2009.
City of Boston Assessing Department. 2012. FY 2012 PILOT recap. http://www.cityofboston.gov/Images_Documents/FY12_Second_Half_PILOT_Status_Report_for_Web_tcm3-33007.pdf
City of Boston Office of Budget Management. 2012. Fiscal year 2013 adopted budget. http://www.cityofboston.gov/budget/default.asp
The Great Recession of 2007–2009 and the sluggish recovery since then have produced extraordinarily large state budget gaps. Even as the fiscal condition of most state governments is slowly improving, many central cities have only recently begun to feel the full impacts of the economic slowdown and the disruptions to the housing market.
A number of indicators have been flashing signs of local government fiscal distress. From its peak in 2008 through May 2012, local government employment has fallen by 528,000, or 3.6 percent (U.S. Bureau of Labor Statistics 2012). The media has also been reporting large cuts in public services in some cities. Newark, New Jersey, has been forced to make substantial cuts in municipal employment, as well as imposing significant increases in taxes and fees. Stockton, California, is reportedly on the verge of bankruptcy. A number of counties in New York State are either in or close to fiscal receivership, and the school district of Providence, Rhode Island, which comprises half the city’s total budget, is facing a nearly $40 million shortfall for the coming academic year.
The most recent comprehensive data on central city finances are from the U.S. Census Bureau for the year 2009. In the absence of more recent data, we have developed a forecasting model of the revenues of the nation’s largest central cities, based on a specially constructed multiyear database. We focus on large cities not only for their sheer size, but also because they are crucial to the economic success of their surrounding regions.
The prosperity of cities depends on effective public services, provided at competitive tax rates. The deep recession, reinforced by the decline in housing prices and extensive housing foreclosures, has put pressure on local tax revenues and local public services. Deep cuts in state aid to many local governments have only added to the fiscal pain. Given the ongoing sluggishness of the U.S. economy, the prospects for a robust recovery in revenues over the next few years are highly uncertain.
The Difficulty of Comparing City Revenues
The U.S. Census Bureau provides the only comprehensive source of fiscal data for cities. Information is collected separately for each type of governmental unit–general-purpose municipal governments, which include cities and towns; independent school districts; county governments; and special districts. Because the delivery of public services is organized in very different ways in different cities, direct comparisons of revenues across cities by source can be highly misleading.
While some municipal governments are responsible for financing a full array of public services for their residents, others share this responsibility with a variety of overlying governments. For example, Boston, Baltimore, and Nashville have neither independent school districts nor county governments serving local residents. Each of those municipal governments is responsible for providing core municipal services, plus education, public health, and other social services. By contrast, municipal governments in El Paso, Las Vegas, Miami, and Wichita collect only about one-quarter of the revenues that finance the delivery of public services within their boundaries. The remaining three-quarters are the responsibility of one or more independent governments serving city residents, and in some cases people who live beyond the city boundaries as well.
To illustrate the difficulty in making revenue comparisons, census data indicate that in 2009, the City of Tucson, Arizona, which relies heavily on a local sales tax, collected only 14 percent of its total tax revenue from the property tax, while Buffalo, New York, collected 88 percent of its tax revenue from the property tax. However, when we take account of the revenues paid by city residents to their overlying school districts and county governments, the situation is reversed. Property taxes accounted for 68 percent of the total local tax revenue paid by Tucson residents, but only 50 percent of tax revenue paid by the residents of Buffalo. In the latter case, the county government relies heavily on sales tax revenue.
Our approach to dealing with the variation in the organizational structure of local governments across the country is to account for all local government revenues received by governmental entities that provide services to city residents and businesses. The basic idea is to include all revenues collected by a central city municipal government and by that portion of independent school districts and county governments that overlay municipal boundaries. We refer to the result of this calculation as a “constructed city” government.
To create constructed cities we take the following steps. For cities with independent school districts that are coterminous to city boundaries, we combine the school district and municipal values of all revenue variables. For school districts that cover a geographical area larger than the city, and for cities served by multiple school districts, we use data on the spatial distribution of enrollments to allocate a pro-rata share of total school revenues to the constructed city. For each school district serving a portion of the central city, we draw on geographical information system (GIS) analysis of census block group level data from the 1980-2000 decennial censuses to determine the number of students in each school district that live in the central city.
For counties, we allocate the portion of revenues associated with city residents on the basis of the city’s share of county population. Because geographic boundaries are not readily available, and fiscal data is intermittent, our calculations do not take account of special districts. For the country as a whole, special districts are relatively unimportant, and failing to include them should do little to distort fiscal comparisons among central cities.
Constructed city revenues are calculated for the nation’s largest central cities for the years 1988 through 2009. The source for the data is the quinquennial Census of Governments, and, for noncensus years, the Annual Survey of State and Local Government Finances. The sample includes all cities with 2007 populations over 200,000, except those with 1980 populations below 100,000, and all cities with 1980 populations over 150,000 even if their 2007 population was below 200,000. In 2009, the population of the 109 central cities in our sample was 58.9 million, equaling 60.3 percent of the population of all principal cities within U.S. metropolitan statistical areas.
While prior studies have recognized the importance of overlying jurisdictions, they have been less systematic in taking account of the variations in governmental structure. Carroll (2009) ignores overlying jurisdictions, while Inman (1979) and Sjoquist, Walker, and Wallace (2005) use dummy variables as a partial adjustment. Ladd and Yinger (1989) focus on the revenue capacity of municipal governments by adjusting for the capacity “used up” by overlying governments.
Constructed City Revenues
Figure 1 displays the average share of total general revenues that came from each revenue source in the 109 constructed cities in 2009. The most important sources are state aid (34 percent) and property taxes (27 percent). User fees and charges contributed 16 percent, while taxes other than the property tax contributed 13 percent.
Sources of revenue vary enormously among constructed cities. For example, 60 percent or more of general revenue came from state and federal aid in Springfield (Massachusetts), Fresno, and Rochester, while aid contributed less than 20 percent of revenues in Atlanta, Dallas, and Seattle. The reliance on the property tax also varies across cities, with over 90 percent of tax revenue coming from the property tax in Providence, Boston, and Milwaukee, but less than 30 percent in Philadelphia, Birmingham, and Mobile.
Because the importance of counties and independent school districts varies enormously, revenue comparisons that rely only on data from municipal governments are highly misleading. For example, in 2009 per capita general revenue of the city government of Pittsburgh was $1,958, while the per capita revenue for Baltimore was $5,306. However, per capita revenues in the two constructed cities were nearly identical. This pattern is not atypical among cities.
Comparing per capita revenues across central city municipal governments overstates the differences across cities because it forces us to compare city governments that have very different sets of public service responsibilities. Utilizing the concept of constructed cities provides the basis for more accurate intercity comparisons, and allows us to generate comprehensive revenue forecasts for the cities in our sample.
Forecasting Revenues for Constructed Cities
To forecast general revenues for 109 constructed cities for the four years from 2010 to 2013, we sum projections for five separate revenue streams: property taxes; nonproperty tax revenues; nontax own-source revenues; state aid; and federal aid (Chernick, Langley, and Reschovsky 2012). We use econometric models fitted with actual and projected metropolitan area–level data to forecast the three sources of own-raised revenue. We then make a range of projections about intergovernmental revenues based on information from surveys and published revenue estimates.
Property Tax Revenues
Predicting the exact relationship between changes in tax revenues and changes in the size of the tax base is particularly difficult in the case of the property tax. Property tax rates are adjusted much more frequently than sales or income tax rates to reflect changes in assessed values and revenue needs. Predicting the revenue impact is further complicated by the existence in some states of legislatively or constitutionally imposed limits on tax rates, changes in tax levies, or changes in assessed values. Major changes in the fiscal relationships between state and local governments, such as school funding reforms, are often motivated by the goal of reducing reliance on the property tax.
Although property taxes are generally levied on all real property, comprehensive data on property values over time and across states do not exist. Thus, researchers have had to focus on changes in housing prices. Data collected on the Lincoln Institute’s website, Significant Features of the Property Tax (2012), indicate that in the large majority of states where data are available residential property accounts for well over half of total property value.
Figure 2 demonstrates the relationship since 1988 between housing prices in the United States and per capita local government property tax revenues. Inflation-adjusted housing prices rose steadily from 1998 until 2006, but by 2011 they had fallen by 25 percent. Per capita property tax revenues followed a similar pattern, with sharp growth beginning in 2001 and continuing until 2009, three years after housing prices peaked.
The lag between changes in housing prices and changes in property tax revenues occurs because changes in assessed values, on which property taxes are levied, typically lag behind changes in market values. The lag may be as little as a year, in cities with annual reassessments, or longer in cities that reassess less frequently or have explicit policies to phase in changes in market value.
The housing price indices for our 109 constructed cities indicate very different patterns of boom and bust in different parts of the country. Willingness of city residents to support increases in property taxes may reflect both changes in the value of their homes and changes in their income. Furthermore, as property tax rates are often adjusted in response to changes in other revenue sources, changes in state aid are likely to affect changes in property tax rates and revenues. To capture these various factors, we estimated a statistical relationship between annual changes in per capita property tax revenues and lagged changes in housing prices, metropolitan area personal incomes, and per capita state aid. Data on property tax revenues are for the years 1988 through 2009. Our statistical model also accounts for city-specific factors that remain constant over time.
The results of our analysis indicate a statistically significant relationship between changes in property tax revenues and changes in housing prices, lagged three years. Our results also indicate that changes in personal income two years ago lead to current year changes in property taxes revenues. This suggests that the impact of the decline in housing prices from 2006 to 2012 and reductions in personal income during the recession will exert negative pressure on property tax revenues from 2009 until at least 2015. Changes in state aid were found to be statistically insignificant.
We estimate that, on average, a 10 percent change in housing prices in our constructed cities results in a 2.5 percent change in tax revenues. This implies that the average city will offset about three-quarters of the revenue effect of falling market values by raising effective tax rates.
To forecast changes in per capita property tax revenues, our coefficient estimates are combined with actual and projected values of metropolitan housing prices, personal income, and state aid, which are then added to actual 2009 property tax revenues to calculate annual per capita revenue for each year between 2010 and 2013. Adjusting for inflation we find that per capita property tax revenue in the average constructed city will decline by $40 or 3.1 percent over the period from 2009 through 2013. Predicted changes range from increases of about 14 percent in the Texas cities of Lubbock and San Antonio to declines of 20 percent in some cities in California, Arizona, and Michigan, where the bursting of the housing bubble was most severe.
Other Locally Raised Revenues
As demonstrated in figure 1, revenue raised from local sources other than the property tax in the average constructed city accounts for a little over one-third of total revenues. These revenues come from local government sales taxes, income taxes, user charges, fees, licenses, and other miscellaneous sources. The importance of these revenue sources varies tremendously across cities, ranging from 6 percent of general revenues in Springfield (Massachusetts) to 60 percent in Colorado Springs.
As we did in forecasting property tax revenues, we started by estimating the statistical relationship between annual changes in revenues and changes in metropolitan area personal income, lagged one year. We estimate separate equations for tax revenue from taxes other than the property tax and for local-source revenue from nontax sources. Using the coefficients from our estimated equations and actual and forecast data on metropolitan area per capita personal income, we forecast a $20 per capita (2.1 percent) increase in tax revenue from sources other than the property tax and a $29 (1.2 percent) increase in nontax locally raised revenues over the four-year period between 2009 and 2013.
State Aid to Cities
Over the past few years, most state governments have faced large budget shortfalls. Budget adjustments have occurred mainly on the spending side, and in many states there have been large reductions in state aid to local governments. To forecast reductions in state aid through 2013, we draw on a survey of changes in state education aid between 2008 and 2012 by the Center on Budget and Policy Priorities (Oliff and Leachman 2011). We assume that the reported percentage change in each state’s education aid applies to the school districts in every constructed city in that state, and that the same percentage change in aid applies to noneducation aid as well.
Given the uncertainty over future legislative actions, we make three alternative predictions. The base case assumes that state aid stays constant in real terms from 2012 to 2013. Our best case assumption is that state aid increases in each city by 3 percent in that period, while our worst case is that state aid changes by the same amount in real terms as in 2011–2012, i.e., an average reduction of about 6 percent. Under our base case, per capita state aid is forecast to decline by $153 (9.5 percent) between 2009 and 2013.
Federal Aid to Cities
Cites receive federal grants through a myriad of different programs. In the past few years, fiscal pressure at the federal level has led to a number of proposals to sharply reduce such spending. President Obama’s FY2013 budget calls for large cuts in a wide range of programs that provide revenue to cities. Based on alternative assumptions about Congressional actions, we take as a base case assumption a 15 percent reduction in federal aid between 2009 and 2013, a worst case of a 37.7 percent reduction in federal grants between 2009 and 2013 (the current budget proposal), and a best case of a 9.5 percent cut.
Total General Revenues
General revenues are defined as the sum of the five sources of revenues discussed above. Adding up the forecasts, we predict that on average inflation-adjusted per capita general revenues will decline between 2009 and 2013 by 3.5 percent ($169). Though the variation in revenue forecasts across the nation is substantial, nearly three-quarters of central cities face some level of reductions (figure 3). The largest projected revenue declines are in California and Arizona, where 11 cities have declines of greater than 10 percent. There is no particular regional pattern to the cities where we forecast growth in revenues. For example, per capita revenue growth in excess of 3 percent is predicted for such diverse cities as Atlanta, Cincinnati, and Lubbock.
Figure 4 groups constructed cities by their census division. Above-average revenue declines are forecast in the Pacific, Mountain, and South Atlantic divisions. Revenues are declining in the central cities in these regions because they are facing a combination of reduced property tax revenues and sharp reductions in state aid. By contrast, in the East and West South Central divisions, real general revenues remain largely unchanged because declines in state aid are offset by increases in property taxes. The opposite is true in New England, where property tax reductions are offset by state aid increases.
Forecasting future levels of state and federal aid to central cities is extraordinarily difficult. Our approach is to choose a range of estimates for 2012–2013 changes in intergovernmental aid. From the cities’ perspective, our worst case calls for steep cuts in both state and federal aid, while our best case calls for smaller cuts in federal aid and modest increases in state aid. When combined with cities’ own sources of revenue, under the worst case scenario, real general revenues will decline by $295 per capita (6.1 percent) between 2009 and 2013. This decline is $126 per capita more than our base case forecast. Even under our best case, we forecast that on average general revenues will decline by $116 per capita or 2.4 percent over the four-year period.
Conclusions
These predicted reductions in revenue place many of the nation’s largest central cities in uncharted territory. While these revenue declines may appear modest, they contrast quite sharply with the resiliency of city revenues following the previous three recessions. For example, real per capita revenues grew by a robust 17 percent in our 109 constructed cities during the four years following the recession of 1981–1982. Given the severity of that recession, the current revenue declines highlight the unprecedented magnitude and duration of fiscal pressure on cities that has resulted from the housing market collapse and the Great Recession in 2007–2009.
Demographic and economic trends, such as the aging of the population and the persistence of high poverty rates, contribute to the rising costs of providing government services in central cities. In many cities legally binding pension and health care benefits for retirees constitute a large and growing component of total compensation. Facing both rising costs and reduced revenues, many central cities have no choice but to implement substantial cuts in locally provided public services. There is little question that these reductions, when combined with projected cuts in federal and state government programs that provide direct assistance to city residents, such as Food Stamps, Medicaid, and unemployment insurance, will cause substantial harm to central city economies.
While the governments serving central city residents must continue to search for ways to reduce costs without harming service quality and to explore potential new sources of revenue, it is also critically important that the federal government and state governments take an active partnership role in mitigating the adverse impact of the recession on the nation’s central cities.
About the Authors
Howard Chernick is professor of economics at Hunter College and the Graduate Center of the City University of New York. He specializes in the public finances of state and local governments, both in the U.S. and abroad.
Adam H. Langley is a research analyst in the Department of Valuation and Taxation at the Lincoln Institute of Land Policy, where he has coauthored papers on property tax incentives and relief programs, nonprofit payments in lieu of taxes, and state-local government fiscal relationships.
Andrew Reschovsky is a professor of public affairs and applied economics in the Robert M. La Follette School of Public Affairs of the University of Wisconsin-Madison and a visiting fellow at the Lincoln Institute of Land Policy. He conducts research on property taxation and other aspects of state and local public finance.
Note: This article is a condensed and updated version of the article published in Publius in 2012.
References
Carroll, Deborah A. 2009. Diversifying municipal government revenue structures: Fiscal illusion or instability? Public Budgeting & Finance 29(1) (Spring): 27-48.
Chernick, Howard, Adam Langley, and Andrew Reschovsky. 2012. Predicting the impact of the U.S. housing crisis and “Great Recession” on central city revenues. Publius: The Journal of Federalism 42(3).
Inman, Robert. 1979. Subsidies, regulation, and taxation of property in large U.S. cities. National Tax Journal. June.
Ladd, Helen F., and John Yinger. 1989. America’s ailing cities: Fiscal health and the design of urban policy. Baltimore: The Johns Hopkins University Press.
Oliff, Phil, and Michael Leachman, 2011. New school year brings steep cuts in state funding for schools. Washington, DC: Center on Budget and Policy Priorities (October 7).
Significant Features of the Property Tax. 2012. Cambridge, MA: Lincoln Institute of Land Policy. http://www.lincolninst.edu/subcenters/significantfeatures-property-tax
Sjoquist, David L., Mary Beth Walker, and Sally Wallace. 2005. Estimating differential responses to local fiscal conditions: A mixture model analysis. Public Finance Review 33(1) (January): 36-61.
U.S. Bureau of Labor Statistics. 2012. Current employment statistics survey. Seasonally adjusted employment. http://www.bls.gov/data
This policy brief covers key issues surrounding the use of nonprofit payments in lieu of taxes (PILOTs): payments made voluntarily by tax-exempt nonprofits as a substitute for property taxes. It describes the current use of PILOTs in the United States, explores some reasons why nonprofits offer PILOTs and why there is growing interest in these payments, weighs the pros and cons of PILOTs, and offers recommendations.
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Across the globe, implementing the Paris climate agreement is expected to cost more than US$12 trillion over 25 years.
So it’s not surprising that much of the conversation since the agreement was finalized in December has been about climate finance. And one of the big topics in climate finance—particularly among city leaders—is “green bonds.”
But what exactly are green bonds, and why should local authorities care about them? Here’s a brief explanation of the major issues.
What Is a Green Bond?
A green bond is a type of debt instrument much like any other bond—except that the proceeds must be earmarked for projects that produce a positive environmental impact.
The first bonds marketed this way were issued by the European Investment Bank in 2007 and World Bank in 2008. Since then, other development banks, corporations, and governments have joined the trend. According to the Climate Bonds Initiative, a research group that tracks the market, total green-bond issuances shot up from US$3 billion in 2012 to about US$42 billion in 2015.
Local authorities represent a growing slice of this market. They see green bonds as one tool that could help pay for renewable energy, transit systems, and water infrastructure, among other things.
The U.S. state of Massachusetts sold the first municipal green bond in June of 2013, followed a few months later by the city of Gothenburg, Sweden. Other recent issuers include the city of Johannesburg; the transit authorities of New York City, Seattle, and London; and the water authority of Washington, DC.
Are Green Bonds Any Different Than Other Municipal Bonds?
Not really. The mechanics work the same as any other municipal bond issuance. The main difference is the environmental aims of whatever the city is using the bond proceeds to pay for.
In addition, green-bond issuers face some additional paperwork—essentially to prove to investors that their money is actually being used to benefit the environment.
To some degree, green bonds are a marketing tool. Labeling a bond that will pay for subway repairs as “green” makes it more appealing to investors. “The reality is a lot of cities are issuing green bonds, they’re just not calling them that,” says Jeremy Gorelick, who teaches municipal finance at Johns Hopkins University in the U.S. city of Baltimore.
That may be true in advanced economies such as the United States, where a mature municipal-bond market has been functioning for more than a century. In the developing world, most cities are unable to issue bonds at all, and for a variety of reasons. In many countries, cities need to obtain legal authority from their national governments to issue a bond in the first place. They also have a lot of work to do in terms of establishing creditworthiness.
Gorelick, who is advising the city of Dakar, Senegal, on its efforts to issue its first municipal bond, recommends that cities in this situation not aim for the bond market right away. He says they can first try borrowing from central governments or their related municipal development funds before approaching development finance institutions for concessionary loans or commercial banks for market-rate debt. The idea is to build creditworthiness and the sort of transparent accounting that bond investors active in debt capital markets will demand.
Why Are Cities So Interested in Green Bonds?
There are many reasons. The key one is that investors really want green bonds in their portfolios right now. As a result, municipal issuers have seen sales of green bonds “oversubscribed”—a good problem for a city to have.
When Gothenburg issued its first green bonds in 2013, “we didn’t know if there would be any interest from investors,” says Magnus Borelius, Gothenburg’s head of treasury. Within 25 minutes, investors had placed €1.25 billion worth of orders—many times more than expected—and Gothenburg had to begin turning them away. “We were overwhelmed,” Borelius says.
Cities benefit from strong investor demand in a number of ways. Most important, it means they can attract new kinds of investors, diversifying the pool of people and institutions with an interest in their city. “It’s good to have a lot of investors know you have access to capital,” Borelius says. Since issuing green bonds, he adds, “we’ve had increased contact with investors—they’re more interested in the city, and they’re coming to visit us.”
Strong investor demand “puts the issuer in an advantageous position,” says Lourdes Germán, a municipal finance expert with the Lincoln Institute of Land Policy. Local authorities can use their leverage to increase the size of their offering, demand a longer payback period, or seek better pricing. While some cities have reported getting more favorable pricing on green bonds, Germán says issuers shouldn’t count on it. “It remains murky whether calling it ‘green’ gets better pricing,” she says.
What’s in It for Investors?
A growing number of investors want to see their money going toward environmentally sustainable projects. Some are motivated by the fight against climate change; others are simply hedging climate risks in their portfolios.
The result is that more pension funds and private-asset managers these days have some kind of mandate to think green. For example, last month, the Swedish public pension fund AP2 said it was allocating 1 percent of its €32 billion portfolio to green bonds. When you’re talking about huge institutional investors, commitments like this add up quickly.
On top of that, municipal bonds, at least in established markets like the U.S., are generally viewed as safe investments. So green bonds issued by cities are particularly desirable. “Institutional investors have a fiduciary duty and won’t invest in a product that won’t deliver a return,” says Justine Leigh-Bell, a senior manager at the Climate Bonds Initiative. “We have here an investment-grade product by blue-chip issuers where the risk is low.”
How Do You Know If a Bond Is “Green”?
There are no hard rules around that—which is a concern for both investors and environmentalists. However, the market for green bonds is evolving quickly, and some voluntary standards are emerging for issuers.
One, developed largely by large banks through the International Capital Market Association, is called the Green Bond Principles. Another was developed through the Climate Bonds Initiative and is known as the Climate Bonds Standard. The People’s Bank of China also recently released its own guidelines on green bonds.
Nobody has to use these standards, but there’s a strong push in the direction of doing so. “If I called my fire truck ‘green,’ investors might raise an eyebrow,” Germán says. “But it’s a two-sided market, so there’s some check and balance. An issuer will raise that money only if an investor believes it’s really for a green purpose.”
A growing number of municipal issuers are seeking out third-party opinions to validate their bonds’ “greenness.” That’s what Gothenburg does. The Swedish city also has created a “green bond framework” to be transparent with investors about what the city considers “green” and how it selects projects.
“It’s still early days in this market,” says Skye d’Almeida, who manages the sustainable infrastructure finance network for the C40 Cities Climate Leadership Group. “So it’s very important to avoid any ‘greenwashing’ scandals where cities say they issued a green bond and investors find out down the track that it wasn’t green. That would erode confidence in the market. So having some independent party verify and being very transparent about the use of the proceeds is something cities should be prepared to do.”
Does It Create a Lot of Extra Work or Cost for the City to Issue a Green Bond?
Some. Leigh-Bell puts the cost of an independent review at between US$10,000 andUS$50,000, depending on who is doing the review and other factors. That’s a rounding error on deals that are often valued in the hundreds of millions of dollars.
Issuing green bonds can create extra work for city staff. Ahead of an issuance, there’s the need to scour the city’s capital investment plans for projects that qualify as green. Afterward, there’s work involved in tracking the use of proceeds and reporting that information to investors. According to d’Almeida, these jobs have the positive side effect of forcing people to work across their silos—finance staff must collaborate with transportation or environmental staff, for instance.
Borelius says that has been the case in Gothenburg. “The first question people ask me about green bonds is, ‘How much extra work is it?’” he says. “If you don’t put treasury people and sustainability people at the same table, it will be a lot of extra work. But if you’re issuing a green bond, you should have that in place.”
Johannesburg Mayor Mpho Parks Tau agrees that mobilizing around green bonds has paid organizational dividends. Asked recently if labeling bonds “green” is mostly about marketing, the mayor responded that the exercise has been useful for aligning local government as an institution around his environmental agenda. “We are able to say to the institution, actually, the bulk of our capital program is going to be about sustainability.”
Christopher Swope is managing editor of Citiscope.
Image credit: Dennis Tarnay, Jr. / Alamy
This article originally appeared at Citiscope.org. Citiscope is a nonprofit news outlet that covers innovations in cities around the world. More at Citiscope.org.
