Localities Are Getting Creative with Taxes to Overcome Their Financial Challenges
One hundred ten billion dollars. That is the amount of funding that local taxing jurisdictions received from the federal government as part of the American Rescue Plan Act (ARPA). This funding, while helpful, still leaves localities with long-term financial challenges due to a decrease in overall federal and state funding.
Localities, like state and federal governments, also have financial responsibilities related to funding pension programs, providing services, and implementing federal and state mandates. All of these responsibilities are putting tremendous pressure on the localities’ financial resources. Compounding the issue, traditional methods of raising revenue no longer provide them with adequate monetary resources to fund operations. As a result, localities are now faced with finding and implementing non-traditional taxing regimes that will allow them to create fiscal stability.
Localities face several limitations at both the federal and state levels when it comes to imposing new taxes. For example, their authority to raise taxes has been affected by voter initiatives or state legislators that limit the types of taxes imposed or the rate imposed on existing taxes. However, the tax regimes that have served communities with revenue raising measures for decades are no longer sufficient to continue to meet their obligations.
In addition, the same demographic shifts and technological changes that have affected state budgets are also playing a significant role in decreased revenue at the local level. These shifts were most likely accelerated by the pandemic, where we saw a transition from temporary remote workers to remote work becoming a permanent fixture in many work environments.
As a result of these limitations and demographic shifts, localities must become more innovative when it comes to raising revenue. Like the states, localities are turning their attention towards areas like nexus, expanding tax bases, and wealth and business taxes.
We are beginning to see evidence of these shifts towards a more stable revenue base. Portland enacted new personal income taxes and Seattle instituted a payroll tax expense. San Francisco enacted a new tax on businesses with highly compensated executives.
Another emerging trend is the application of the Wayfair decision to local sales taxes as well as to income and gross receipts taxes. A growing number of states are beginning to assert nexus over businesses that have no physical presence within the locality. In response to Wayfair, Philadelphia adopted a bright line economic nexus standard for the imposition of the Business Income and Receipts Tax (BIRT). Businesses with no physical presence in the city are considered to have nexus if they have generated at least $100,000 of Philadelphia gross receipts and have sufficient connection with the city under the U.S. Constitution to establish nexus. The city’s regulation has no effect on the application of protections afforded under P.L. 86-272.
Change is coming, and whether that change is rapid or involves a more controlled rollout of local initiatives will depend on the locality. As we see more and more local jurisdictions adopt new taxing regimes, the hope is that they exercise some degree of reasonableness. Local jurisdictions will need to strike a balance between the need for more stable revenue streams and constitutional and legislative limitations. Taxpayers will need to remain diligent and challenge unreasonable or unconstitutional exercises of power by local jurisdictions.
By Thomas M. Frascella, J.D., Director, Tax Strategies, State and Local Tax Group Leader.
Thomas M. Frascella can be reached at Email or 215.441.4600.