Revenue Diversification and the Financing of Large American Central Cities

The housing crisis and the recession have placed tremendous fiscal pressure on the nation’s central cities. Cuts in state government fiscal assistance to their local governments, plus shrinking property tax bases are challenging the ability of local governments to continue providing their current levels of public services. Although the property tax remains the main source of revenue for local governments in the U.S., a number of governments, especially those in large cities, have diversified their revenues by adding other revenue sources, particularly local sales and income taxes.

This paper analyzes the financing of the nation’s largest central cities from 1997 to 2008. Because expenditure responsibilities vary among city governments and because overlying governments play different roles, we develop the concept of constructed governments in order to allow us to compare the revenue-raising policies of large central cities. The authors utilize these data to explore whether revenue diversification supports higher levels of government spending. States that allow their local governments to diversify their tax instruments are implicitly inviting more direct competition with their own fiscal powers. Using central city fiscal data and information of state sales tax rates, the authors also explore vertical tax competition between states and their large cities.