By: Casey Vander Ploeg, Senior Policy Analyst, Canada West Foundation
In late February/early March, Casey Vander Ploeg introduced the idea of a Penny Tax in the “1¢ Solution to a Billion Dollar Problem” series on www.letstoc.ca, igniting much interest around the community. Continuing the conversation, this blog is an expansion of that idea, delving to the heart of the rationale behind the Penny Tax.
A huge and growing infrastructure funding gap does not answer the question of why the penny tax should emerge as a policy option. Neither is that question answered by the fact that local governments in many countries around the world have access to similar types of taxes. The answer comes in the form of an argument that weaves together a number of considerations or perspectives that, when combined, show the penny tax as a fresh, creative, and innovative response that can neatly align local preferences with a locally-determined tax source. The penny tax would provide cities—but only if voters desire—with a supplement to the property tax.
The property tax attaches to only one aspect of the economy—real estate. As such, the tax base is relatively narrow and tax revenues do not always keep pace with population and economic growth. In contrast, a small local sales tax casts its net across the full range of activity in the economy, and unlike the property tax, growth in sales tax revenue does not have to be achieved by intentionally increasing the rate of tax. Sales tax revenues always track alongside the economy. A penny tax will allow cities to retain a small but important portion of the economic growth occurring within the local region, and then direct that to the infrastructure needed to accommodate the growth. Because federal and provincial governments have also reduced their sales tax rates, there is room to dedicate a small local penny tax to infrastructure.
Today's cities—particularly the large metros—provide services and infrastructure not only for the local citizenry but also for a broader regional population and a host of visitors, all of whom pay their residential property taxes elsewhere. This produces a “fiscal disequivalence” where the costs land disproportionately on local taxpayers. Not only does a small local penny tax helps ensure that all those who benefit from a city—commuters, truckers, tourists, shoppers, business travelers—also help pay for the infrastructure and services they use. A penny tax will also help remediate current patterns of urban growth, much of which occurs in “metro-adjacent” municipalities just outside the large “anchor” cities themselves. For some cities, this “donut growth” or “urban fragmentation” is meeting up with a lack of diversity in municipal tax tools to severely press their finances. For proof of this, just talk to officials at the City of Edmonton—a city-region comprised of some two dozen distinct municipalities.
Just as cities have grown in size, importance, and complexity, so have the issues with which they must contend. Many of these new responsibilities are directed toward “people” services and infrastructure as opposed to “property” services and infrastructure. The property tax is ill-suited to address services and infrastructure to people because the tax base is narrow. A small local penny tax would help increase tax diversity at the local level and provide an opportunity to better match revenue-raising capacity with current municipal expenditure responsibilities. In short, a penny tax would alleviate infrastructure’s need to better compete for scarce property tax dollars.
In many ways, the property tax makes less sense in the new economy. Property is no longer a key to creating wealth or income in an information economy. What is more, the property tax can also produce perverse subsidization effects that cause distortions and artificially increases the demand for infrastructure. For example, properties “close-in” tend to carry higher assessed values and thus pay more tax. Properties in the “far-flung” suburbs carry lower assessed values and pay less tax. But, the cost of servicing “far-flung” properties is higher. This amounts to a subsidy that breaks the link between those who pay and those who benefit. Since the suburbs contain the great majority of voters, it also leads to artificially increased demands for services and infrastructure because they are not the ones who are paying. In addition, many municipalities over-tax business properties relative to residential properties, which produce similar subsidization effects. These realities and perversions of the property tax—which are very difficult to reform—mean that the tax often looks and behaves like a capital tax, which is one of the worst taxes possible. Sales taxes, particularly value-added (VAT) sales taxes, are perhaps the most benign tax possible with the lowest marginal efficiency cost (MEC) to the economy. In other words, they do the least economic damage.
Only locally-raised taxes and locally-decided expenditures ensure the highest level of political accountability. To fund infrastructure, cities currently rely on the property tax. But because the tax is insufficient to meet all of their needs, federal and provincial governments have always come along with capital grants. In the revenue exchange, political accountability and transparency takes a huge hit. While the municipalities point their finger at the province, the province blames and shames the federal government. To the greatest extent possible, locally-decided expenditures should be recovered through locally-generated tax revenues. The penny tax can be part of this “re-jigging” of the municipal tax system.
A properly designed and implemented local penny tax stacks up very well against the various principles that should guide tax policy and tax reform. For taxpayers, a penny tax can be quite fair and equitable, particularly if the rate is kept low, if basic goods like groceries and pharmaceuticals are exempted, and various low income offsets are available like the current GST rebate. A 1% tax on every $1 spent is simple and straightforward, and because the tax rate is capped and the revenues are earmarked for infrastructure, accountability and transparency is strengthened. The accountability ante is also upped as the penny tax would be voter-approved and locally-levied. Administratively, sales taxes already exist federally and in most provinces. Because the tax machinery is already in place, the tax should be relatively easy and cost effective to extend.
The Heart of the Matter
At the heart of the rationale for a penny tax is the realization that Canada’s large urban centres are heavily and singularly dependent on the property tax. In many ways, this lack of diversity in tax tools constitutes a disadvantage when it comes to infrastructure investment. It is important to recognize the benefits that accrue from a diversity of tax tools and revenue levers.
No single tax is entirely fair or neutral with regards to investment patterns, economic distortions, or decisions about location and business inputs. Nor is every tax equally suited to generating predictable, stable and growing streams of revenue. No single tax source is equally suited to compensating for inflation, capturing growth in the local economy, or controlling for the problems with free-riding and fiscal disequivalence that inevitably result from more and more people filling the beltways around our cities. Tax diversity allows the unique disadvantages of one tax to be offset by the advantages of other taxes. The question certainly is all about a balanced tax regime for local governments.
A small local penny tax that combines the unique features we have identified is an excellent candidate to begin building better diversity in local taxation and meeting the infrastructure challenge in a way that is effective, efficient and equitable, as well as visible, accountable and transparent. Given the historically high degree of voter apathy in local elections, the penny tax will also stimulate voter engagement by asking them to participate in the process in a meaningful way.
You may also be interested in parts I, II, III, and IV of the "1¢ Solution to a Billion Dollar Problem” series.