Tax Cap:
Expect Diminished Local Services In The Future
By NICK GREIFER, Northwest Municipal Conference
This article examines the effect of the tax cap on
Collar County schools and municipalities. In brief, the
impact to date has been minimal. Although it may have
restrained tax revenues among some jurisdictions, in
general it has not proven to "work" yet. However, in the
future the tax cap should limit property tax collections.
Moreover, financing traditional local services like
schooling, policing and fire fighting will become more
difficult because of both the cap and unfunded mandates. Ultimately, "capped" communities could have
fewer services of poorer quality.
I. TOO EARLY TO KNOW OVERALL IMPACT
OF TAX CAP
Studies Not Conclusive. The two primary studies of
the aggregate effect of the tax cap were conducted by
the Illinois Department of Revenue and Professor Richard Dye (University of Illinois and Lake Forest College). The Dye study reports two major findings. The
first finding is that about 300 of the 706 jurisdictions in
the study do not tax up to the PTEL (Property Tax
Extension Limitation law) limit. What this means is that
non-home rule governments have in effect capped
themselves at a rate lower than mandated by state law.
Why has this occurred? It is not clear. Proponents of
the tax cap would argue that these "self-capping" governments were scared — by PTEL — into collecting
fewer property tax dollars. However, these governments could have just as easily been encouraged by
PTEL and taxed up to the limit, as a defensive means of
" getting as much this year" to offset unexpected costs in
future years. Perhaps a better explanation is that many
of these communities are simply financially conservative — responding to local voters' preferences.
The second major finding is that tax revenue for
some jurisdictions is lower than what it would have
been if the tax cap were not in force. The Dye study
concludes that taxes by "capped" communities are
about $94 million lower than it would have been. In
contrast, the 300 self-capping communities could have
collected $18 million more if they had taxed to the
PTEL limit.
It is difficult to know the general impact of the cap
on tax collections. Other factors could explain some or
all of the slowdown in tax growth. For example, Professor Dye readily acknowledges that the economic recession of the 1980's might explain the slowdown. Also, the
more property tax alternatives a local government has,
the more it can hold down property tax increases voluntarily. Municipalities have more alternative revenue
sources (like user fees) than schools.
The Department of Revenue concluded that the tax
cap reduced collar county property taxes primarily because tax collections grew more slowly in the first three
years under PETL than before. However, it is too early
to say what caused the decline in revenue growth. As
mentioned, other factors like the recession may have
caused all or part of the slowing of property tax collections. Not only did tax collections decline during the
1980's recession, they also declined during and shortly
after the 1980's recession (when the cap was not yet in
effect).
"Uncapped" Municipalities Have Raised Property
Tax Increases More Slowly Than "Capped" Communities.
As the table below indicates, Home Rule (HR)
governments have had smaller increases in property tax
revenues than Non-Home Rule (NHR) municipalities.
In a survey of Lake County municipalities over 1,000 in
population, the Northwest Municipal Conference
found that HR units increased property taxes more
slowly than did their NHR counterparts. THIS IS IN
SPITE OF THE FACT THAT HOME RULE UNITS
WERE NOT "CAPPED." This is contrary to the theory
of the property tax cap — that it is needed to control
spiraling property taxes. Plainly HR communities
showed self-restraint in their financial management.
Type of Municipalities Growth in Property Tax Revenues 1989-1994
Home Rule, Lake County 13% (Adjusted for inflation)
Non-Home Rule, Lake County 19% (Adjusted for inflation)
Why have uncapped HR communities been able to
restrict property tax growth? First, HR communities
have a greater number of revenue options that allow
them to diversify away from property taxes. Secondly,
January 1995 / Illinois Municipal Review / Page 19
collar county NHR communities possibly had greater
population growth. The higher costs associated with
growth resulted in greater tax collections.
A comparison of municipalities in northern Cook
County and parts of Lake County (served by the
Northwest Municipal Conference) came to the same
conclusion: HR municipalities have had lower increases
than their NHR counterparts. Also, Professors Dye and
Therese McGuire arrived at a similar finding in a recent
study. The study compared 102 HR and 101 NHR municipalities, in terms of 1987-1993 property tax growth.
Like the NWMC study, this study found that uncapped
municipalities held property tax increases below
capped municipalities' increases.
Although Aggregate Impact Not Known, Impact
Being Felt By Certain Jurisdictions. Schools. In spite
of the uncertain impact so far, there are indications that
the tax cap is "biting" into some local governments'
budgets. The Dye/McGuire study, comparing 143 metropolitan schools not capped against 145 capped metropolitan schools, suggests that capped schools have
been affected financially. Uncapped schools' property
tax revenues increased faster than those capped.
According to an Illinois Senate Democratic Task
Force survey of collar county schools, 121 schools responding to the survey have had cap-related problems.
As one collar county school put it, the school has been
hit by a "Triple whammy in a growing district: tax cap,
lower state aid, but more students." The most widespread impact to date has been increases in class size.
(See table below.)
Cap-Related Problem Affected Schools
Increased Class Size 80
Cutbacks in Equipment Purchases 70
Cuts in Library Services/Class Materials 69
Reduction in Teachers 49
Reduction in Other Staff 34
Fewer Extracurricular Activities 34
Fewer Courses Offered 33
Municipalities. With respect to municipalities, the
impact to date seems modest. The Northwest Municipal Conference conducted a non-random survey of 20
villages and cities in the five collar counties. In general
the municipalities stated that the impact has been modest, except for issuing bonds. Of the 15 participating
communities: 10 had not shifted to other revenue
sources because of the cap; 11 or more had maintained
the level of each municipal service; 11 or more continued to provide each service in the same way (e.g.,
had not reduced the quality of service).
Cap Creates Inefficiency in Financing Capital Improvements. In the survey of municipalities, about
half of the 15 communities stated that the issuance of
general obligations (GO) bonds had been curtailed or
hampered. While CO bonds issued prior to the cap are
not subject to the cap, newly issued CO bonds need to
be authorized by referendum. A municipality that fails
to pass a GO bond referendum can: (1) not issue any
bond, or (2) find a different type of non-referendum
bond.
Under the first option, any school or municipality
would have to cut back on services. For example, a
municipality that had floated bonds, say, every several
years for "life safety" tasks prior to the cap would no
longer have funding for that task. As a result, there
would be an immediate cutback in this service. Under
the second option, local governments would seek out
different types of non-referendum financing. However, they would have to use revenue bonds or other
financing techniques which, to finance the same capital
improvement, cost more than general obligation bonds.
As one village put it, "We have lost the ability to issue
[general obligation] debt which is increasing our borrowing cost which will have a long-term cost for the
village."
To illustrate the inefficiency created by the PTEL,
consider a municipality trying to finance a $10 million
dollar recreational facility. In the past this could have
been funded by GO bonds; under PTEL this could be
funded by revenue bonds but not GO bonds. A conservative estimate of the higher interest rate cost of this
type of revenue bond is 1%. In today's economic environment, this translates into about $830,000 in additional
costs.
II. TAX CAP SHOULD HAVE MORE
PRONOUNCED IMPACT IN THE FUTURE
Cap's Cumulative Effect Should Constrict Future
Spending. The tax cap has a cumulative effect. Because tax increases are constrained in one year, in the
second year the tax cap is applied to a smaller base than
it could otherwise be. In the third year and subsequent
years, the constrained tax increase is applied to a
smaller and smaller tax base. Put differently, a school or
Page 20 / Illinois Municipal Review / January 1995
municipality that increases taxes by only 1% instead of
say 5% (which was the effective cap in 1991) forgoes
revenue in that year, and that revenue can never be
recouped.
There is indirect evidence that this cumulative impact is happening. Fewer and fewer localities are voluntarily taxing below the cap; instead they choose to tax
to the cap limit.
Impact May Be Felt First By Schools Because They
Lack Revenue Options — And Cannot Avoid Costs of
Expanding Enrollment. Which local governments will
feel the cumulative impact of the tax cap first? While
this is difficult to predict, schools may be hurt first.
They simply have fewer alternatives to the property
tax. Moody's Investor Service views "school districts as
the class of government with the most risk exposure to
the cap because of their reliance on property taxes as a
funding source."
As noted earlier, one collar county school reported
being hit by the "triple whammy" of caps, lower state
aid, and increased enrollment. In essence they cannot
effectively control the revenue side of their budget
because the caps are state-imposed and state aid is
obviously state-controlled. On the expenditure side of
their budget, they cannot control the increase in enrollment which drives up their cost of doing business. That
is, they legally cannot refuse to instruct new students
that enter their jurisdiction. And they cannot control
costs caused by various state and federal mandates.
Degraded Services and Fewer Services May Be in
Store for Illinois. What does the future hold for Illinois
localities? The answer may lie in other states that have
already passed similar property tax limits. In California,
localities have operated under Proposition 13 since
1978. This required localities to: (a) roll back taxes to 1%
of market value (e.g., $1,000 tax on a $100,000 home);
(b) assess the value of homes at 1975 prices, for residents living in their homes at that time; and (c) limit,
after 1975, annual increases in the assessed value of
homes to 2%. The impact upon municipalities, not surprisingly, has been a reduction in services. According to
the Lincoln Institute for Land Policy, California cities
cut the following expenditures on services (adjusted for
inflation and population growth): General Government
services — 21%; Public Works — 15%; Health & Public
Aid — 14%; Recreation — 11%; and Public Safety Services — 6%. The Illinois Economic and Fiscal Commission reached a similar conclusion.
In 1981 Massachusetts adopted Proposition "2 1/2"
which (a) limited property taxes to no more than 2 1/2% of
the market value of a home, and (b) capped growth in
property tax levies to 2 1/2% annually. According to Mike
Peddle, a Northern Illinois University professor, this
law affected Massachusetts municipalities "terribly."
They were hurt by two factors: the cap which limited
growth in revenues and the recession of the late 1980s
which limited all municipal revenues. Professor Peddle
said a representative example of the state impact was
Worcester, Massachusetts; this municipality had to
"pink slip" about 40% of its work force in one year. The
Illinois Economic and Fiscal Commission came to a
similar conclusion for Massachusetts schools.
Cap Could Be Disastrous During High Inflation.
PTEL limits property tax extensions to the lesser of 5%
or inflation. This exposes local governments to
inflation-driven cutbacks. In the very first year of the
tax cap, with inflation running high the state imposed
the 5% cap. As a result, collar county governments saw
their real "purchasing power" decline. This probably
will occur again in the future, given that caps have
already failed to keep pace with inflation. More importantly, local governments will be vulnerable to national
and even international events that force up inflation.
III. TAX CAP, WITH UNFUNDED MANDATES,
SQUEEZES LOCAL GOVERNMENTS
The tax cap has serious implications for local governments' ability to perform basic functions like education and policing. Given the new "predatory" federalism marked by unfunded mandates, the cap will be
especially burdensome. As shown in a 1993 Illinois Municipal Review article, there are many state and federal
mandates that, together, amount to a significant part of
municipal budgets. Eventually these factors should result in fewer local services and/or lower-quality services. •
The ILLINOIS MUNICIPAL REVIEW continues to be an open forum of expression for
municipalities. Articles appearing in the Review
do not necessarily express the views of the League
or its staff but those of the various authors.
|
January 1995 / Illinois Municipal Review / Page 21
|