Chapter 2: Expanding Municipal Revenues

Dominic Burbidge
Dominic Burbidge is departmental lecturer in the School of Interdisciplinary Area Studies, Oxford University, and researcher at the Department of Politics & International Relations.
Nic
Nic Cheeseman is associate professor of African politics at Oxford University, the former editor of African Affairs, and the author of Democracy in Africa (Cambridge University Press, 2015).

Introduction

The costs that municipal governments face are likely to increase every year in line with the processes of urbanization taking place around the world. Thus, raising municipal revenues is among the most pressing challenges facing city leaders today. It would normally be assumed that a growing population increases the tax base proportionately, with a greater number of local residents simply paying in line with the greater number of services provided. However, this common assumption has been proven wrong on two counts. First, changing demographics go hand-in-hand with changes in lifestyle, economic specializations, and income distribution. These shifts mean that citizens do not always have the same needs from their local governments as before, and will change how they contribute to the funding of local government services. Second, local population increases do not usually lead to immediate adjustments by central governments in the amounts transferred to the municipal level. As the “front line” when it comes to delivering public goods and services, local governments often need to respond immediately to changing circumstances while there are time lags in altering rates of national government transfers.

In the face of this dilemma, municipal revenues are city leaders’ best asset. Because they are under the control of local authorities themselves, they can be made to shift in proportion to changing demographics and lifestyles in a way that strengthens the provision of public services. As a population changes, local governments are able to change too.

There are a number of different ways city leaders can increase the funds at their disposal, including new taxes on tourism, property taxes, levies on businesses, and fees linked to the provision of specific services. What is possible depends on careful navigation of legal, technical, and political constraints, which are different in each case. The chapter explains the options available to city leaders and weighs the pros and cons of different strategies. It considers how city leaders can best build public support for revenue generation, which is often critical to the success of their initiatives. To help guide the reader, the chapter provides three different perspectives on tackling this challenge: local government administration, economics, and local politics. Success in achieving stable expansion of  municipal  revenues  depends  on balancing these three perspectives and harnessing each of their strengths.

Municipal revenues are city leaders’ best asset. Because they are under the control of local authorities themselves, they can be made to shift in proportion to changing demographics and lifestyles in a way that strengthens the provision of public services.

What generates local government revenue?

Municipal revenues are raised from taxes or fees charged to local residents, usually in return for the goods and services the local government provides. The amount generated varies enormously among countries, as there is wide variety in countries’ legal provisions concerning what taxes and levies are allowed to be collected locally. Figure A displays the percentage of GDP collected through local government fees, with data taken from five OECD countries. The gradual upward trajectory over the past 15 years reflects the growing relevance of these types of fees and taxes for 21st century governance.

At this point it is important to delineate the differences between taxes and fees, and to provide examples of each:

  • Taxes refer to charges levied on citizens and businesses to enable the government to fund its core activities. Although taxes may be enforced for a specific purpose, such as to fund a particular infrastructure project or to deal with a specific challenge, they typically generate income that the government can allocate to a range of different activities as it sees fit. Depending on a country’s constitutional and legal framework, subnational taxes can include:
    • Property taxes
    • Income taxes (e.g., pay-as-you-earn, or PAYE)

    • Consumption taxes

    • Tourism taxes

    • Sales taxes (e.g., value-added tax, or VAT)

    • Business taxes

    • Trade taxes (excises)
       

  • Fees and levies (sometimes called “rates”) typically refer to charges directly incurred by citizens or companies in return for the delivery of specific services. They are therefore analogous to the kinds of charges that would be imposed by a private company. Subnational fees and levies can include:

    • Garbage collection fees

    • Electricity fees

    • Water fees

    • Permit and license fees

In seeking to expand municipal finances, the question is not only which of these can be added, but also which are already being used but are in need of reform or, in cases of gross inefficiency, in need of cutting.

Each option for revenue generation must serve a dual aim of making local government financially sustainable and fostering a general culture of tax compliance among citizens. Even if a tax or levy is profitable for local government, it should be administered in a way that enhances citizens’ feelings of inclusion and ownership, and that makes citizens proud to pay their taxes. In this way, the administration of each tax or levy has repercussions for the way taxes in general are viewed by the citizenry, affecting levels of compliance and citizen-led mechanisms of accountability. This is particularly significant in new democracies and less-developed contexts, where the idea of tax payment at the subnational level may be relatively new, and the enforcement mechanisms to ensure compliance may be limited.

Figure
A
:
OECD local government user fees as a percentage of GDP, 1990–2014
Figure A
Note:
The graph shows the five OECD countries with the longest longitudinal dataset. Data on locally generated user fees is not inclusive of user fees collected at the state or provincial level. Countries that only collect user fees at the state or provincial level were excluded from analysis.

A government perspective: Expanding municipal revenues through internal reform

Significant and sustained revenue is essential if cities are to provide services to their populations, and to upgrade their infrastructure to cope with increasing numbers of residents. Most cities receive a portion of their income from central government transfers, but are empowered to collect certain revenues locally. A predictable and sustainable income stream is essential to ensure that key financial commitments, such as the salaries of government officials, can be met not only in the short-term but also in years to come. Thus, most experts recommend that, where possible, city governments generate a diverse portfolio of income streams so that they are not dependent on any given flow of revenue. This requires city leaders to think about how revenue can be generated not just from different taxes, but also from taxes on a diverse range of economic activities. Building a city’s income in this way ensures that a shock to one part of the economy will not undermine its revenue base.

The source of income also matters for other reasons. A number of academic studies have found that the more dependent subnational governments are on central government transfers to fund their budget, the more likely they are to embrace national policy priorities. This can stymie local innovation and make it difficult for city leaders to respond to local concerns.

Hargeisa

Four starting principles can help guide thinking about expanding revenue collection.

  1. The greater the share of revenue generated locally, the more the local authority will be able to set its own priorities, free from national agendas and constraints.
  2. A diverse portfolio of revenue sources is impor-tant to ensure a local authority can cope with shocks to any specific income stream.
  3. The greater the share of revenues raised through fees and levies, the more careful and account-able local authorities are likely to be in their expenditures.

  4. Long-term stability and self-sufficiency is key, so government should manage expectations of tax and levy generation to ensure that targets given to tax collectors can be communicated reasona-bly to citizens.

As discussed in Chapter 1, many governments have found it beneficial to earmark certain tax or fee payments towards specific goods that citizens enjoy, because voluntary compliance is more likely when citizens consider their payments worthwhile. In a local government context, this link is often already present when fees are paid by citizens for specific services such as garbage collection or parking spaces. However, it is important to note that the manner in which money is collected can also greatly affect citizen perceptions. For example, issuing receipts for parking fees can help citizens feel that the money is accounted for and less likely to be misappropriated. When public infrastructure is being developed, a simple sign saying the upgrade is funded by the city’s tax contributions can go a long way towards helping local residents see the benefits of paying their taxes.

However, one of the least explored strategies for expanding municipal revenues has nothing to do with choosing what fees to charge but, instead, looks at enhancing the training of tax collectors. Collecting taxes is a difficult job, and one that lies at the forefront of many citizens’ dissatisfaction with poor local public service provision. As such, it is important to bear in mind that government employees can suffer from:

  • Lack of awareness of the good things the collected money goes towards
  • Lack of training on how best to collect taxes and fees, especially those fees newly introduced
  • A preference to do things according to an outdated system, even though that older method may involve serious costs and impose an undue bureaucratic burden on local residents
  • A low opinion of their profession in the eyes of citizens, and a feeling that there is little to no upward career trajectory
  • A low salary, increasing the attractiveness of short-term gain through corruption
  • A feeling that some policies they are implement-ing are ultimately unfair to citizens, without knowing of a safe route for communicating this to their superiors

These challenges to the work of tax collection can be allayed through additional training, the widening of channels of communication with superiors, and affirmation of the value of tax collectors’ work. In this way, effective public relations exercises about the benefits of tax payment can help both taxpay-ers and tax collectors fulfil their roles.

 

An economics perspective: Expanding municipal revenues through efficient taxation

In addition to administrative feasibility, it is import-ant to think about taxes’ economic impact. Economists ask whether a tax is being collected efficiently. By this, they do not mean whether the tax is being collected quickly, but rather how it affects other parts of the economy. It may be that a tax is so high that it is slowing the economy as a whole, or placing an undue burden on doing business in particular sectors. To succeed in expanding municipal revenues, it is crucial to be aware of taxes’ and fees’ effects on local economic growth. Even though the provision of public services tends to help speed economic growth by providing things that would be costly for individuals to provide on their own, it is important not to impose taxation levels that are rejected by the public or that lead to a fall in overall revenues because they discourage economically productive activities.

To help understand what should count as efficient taxation, the economist Arthur Laffer helped describe the relationship in graph form, outlining how the tax rate relates to government revenue. Before the “Laffer curve” was popularized, it was commonly assumed that the more a government taxes, the more it receives in revenue. Laffer helped explain, however, that after a certain point businesses and the population can be taxed too much, such that the decrease in economic activity caused by the taxes reduces overall government revenue. Figure B presents the graph.

As the tax rate increases, the amount of government revenue at first increases. However, at a certain point any further increase in the tax rate will not increase government revenue as citizens stop seeing the value in doing business or spending their money, or international companies take their production chains elsewhere. City leaders must be aware of this dilemma, and tailor their decisions regarding local taxes and fees to ensure they are economically efficient. For example, they should consider questions such as: Given all of the fees and taxes that local residents pay, is the overall total an undue burden on their economic activity? Does effective taxation require greater data and knowledge sharing between local and national governments to ensure there is a clear picture on how local entrepreneurs are to continue producing goods and services, and ensure their employees receive a fair wage?

Figure
B
:
The Laffer curve
The Laffer curve

It is also important to consider the different costs of collecting taxes, which vary depending on the type of tax. After reviewing the costs of collection, it may become evident that a certain tax or fee does not generate sufficient revenue for the local authority. This is not necessarily a reason for immediately abandoning it, however. The following checklist should be consulted before deciding to abandon a tax:

  • Is the decrease in revenue from this tax a short-term dip or a long-term trend? If the former, it could be advisable to avoid whole-sale change until the longer-term trends become clear.
  • Is the tax’s lack of profitability caused by unnecessarily high collection costs? Rather than abandoning the tax, it could be that a different way of collecting would render its relatively low revenue stream profitable.
  • Is the tax connected to the provision of a good or service that citizens deem essential? If so, although the removal of the tax could save money, there could be large and potentially destructive repercussions in removing its associated services, which could under-mine confidence in the local government as a whole.
  • Will the current costs of administering the tax be entirely removed if the tax is abandoned? At times, employee and institutional costs are not eliminated when a tax is cancelled. There must be some evaluation, therefore, of whether the network of personnel, institutions, and administration will remain a burden on local government even if a tax is cancelled. If so, the municipal government will not save money overall by abandoning the tax.

A political perspective: Expanding municipal revenues through democratic dialogue

A third, again complementary, point of view can be found by examining the challenge from the perspective of local populations and their relationship to the political sphere. Most constitutions encourage a clear distinction between the civil service and politicians. This is, of course, a very positive thing, as it helps avoid the manipulation of government employees for the purposes of short-term political goals. A clear separation of roles also helps protect civil servants by making sure they are chosen based not on their political opinions or party affiliations, but on their professional expertise. These lines of distinct professional roles should not be crossed. However, there is still a need for understanding different actors’ goals in order to implement any reform successfully. Nowhere is this more the case than in expanding municipal revenues. Taxes are often unpopular, which makes an increase in local taxes or fees something that a local politician will often want to oppose. In the context of local political leadership, how can a tax increase find public support?

Increasing municipal revenues and garnering public support need not be in opposition to one another. Indeed, the two can run in tandem if there is the right leadership on the part of city leaders. The provision of public goods and information about how tax revenue is being used can have a strongly positive impact on citizens’ willingness to pay taxes. If citizens feel the fees, levies, and taxes they pay are being put to good use, this increases trust in, and support for, the government itself. This makes sense both for purposes of tax compliance and for obtaining support for tax reform from local politicians.

What is required is to identify what services or goods citizens think are most important, and to begin by demonstrating a real commitment to using tax revenues to improve these areas, thereby publicly demonstrating the link between tax payment and service provision. When this is done well, tax payment and service delivery can interact to generate a positive cycle. If greater government revenue is used to provide highly visible public goods (e.g., roads, hospitals, public parks), this is likely to increase public support for the local government and local politicians together.

Political leaders often lack high-quality information about the least-well-provided services in their juris-diction, which means they can sometimes neglect to improve those items most in need of reform. This problem is often especially pronounced in Africa, where comprehensive data on local service provision is often difficult to collate. Such data deficiencies can lead to inefficiencies in the distribution of resources, with too many goods and services deployed in some places and too few in others. At first it can seem that politicians are simply biased towards a particular area, but the real reason may be that they are simply unaware of the benefits to be gained from diverting small amounts of government resources to help previously neglected areas.

Budget plans must therefore start with an effective mapping exercise to record what is already being provided and to identify priorities that jointly make sense to civil servants, politicians, and citizens. This should involve assessing which areas, and which citizens, live farthest away from key services, and so are in greatest need. Civic engagement and public participation are critical to this process, because they offer an important and valuable mechanism to gather ideas and share information on what the government plans to do.

Lagos skyline

Case study
1
:
Lagos, Nigeria, under Governor Fashola

In 2007, Babatunde Fashola won the governorship, having been chosen as successor to the previous governor, Bola Tinubu, with a modest majority. In the years that followed, he furthered Tinubu’s earlier efforts to expand state revenues by introducing a new consumption tax on hotels and eateries, and pursuing higher levels of tax enforcement throughout Lagos State. These measures initially drew criticism from some sectors, but because these resources were channelled into issues of major public concern— reducing crime, improving roads, providing health clinics, etc.—they actually increased his popularity over time. Significantly, his political strategy, including a heavy emphasis on the link between tax payment and public service delivery, built support for the expansion of the tax net. Ultimately, he won the 2011 elections with a significantly increased majority, securing just over 80 percent of the vote.

Civic engagement and public participation offer a range of very important benefits to municipal governments. Recent research shows that “greater access to public information together with effective public engagement can help reduce corruption and enhance socioeconomic development.”1 Most obviously, effective participation and communication means that local governments are more likely to implement policies that match citizens’ preferences, and are more likely to be given credit for doing so. Less obviously, significant benefits can be reaped in terms of revenue generation and popular support for the government. The case study explains how Governor Fashola of Lagos, Nigeria, successfully expanded local government revenue generation while increasing his vote share through successfully communicating the value of these tax increases to local citizens.2

One of the most important issues to keep in mind when seeking to build a social contract and increase tax payment is the difference between regressive and progressive forms of taxation. Regressive taxes are those that have a uniform rate, applied to everyone regardless of each person’s income level (e.g., sales tax or value added tax [VAT]). Progressive taxes modify the rate of payment based on the payees’ income or wealth level (e.g., income tax). Regressive taxes are generally understood to affect poorer citizens disproportionately. There is also a second important difference when it comes to the form of taxation: Citizens tend to be more aware that they are paying direct taxes, such as income tax, than indirect taxes, such as VAT. As a result, researchers have often suggested that direct taxes are more significant when it comes to forming an effective social contract around tax payment and public service delivery.

These variations are relevant because when evaluating which local taxes or fees will expand municipal revenues, it is important to pay attention to citizen perceptions of fairness, which can be connected to whether the tax is being progressively or regressively administered. At the same time, it is not as simple a question as saying that all progressive taxes are fairer than their regressive counterparts. For example, while a sales tax on diamonds affects everyone who buys diamonds, it is mainly the rich who buy diamonds in the first place, and so it is they who will pay the regressive tax in this case. It is also possible to make certain goods, such as food, books, or shoes, exempt from regressive taxes altogether, which means an increase in regressive taxes need not affect all consumption groups in the same way. All these points help to demonstrate how deci-sions regarding the expansion of municipal revenue must keep in mind the effect on the local economy as a whole, and local citizens’ perceptions of the fairness of taxes and fees.

  • 1. Transparency & Accountability Initiative, Budgets: A Guide to Best Practice in Transparency, Accountability and Civic Engagement Across the Public Sector (London, Transparency & Accountability Initiative, 2011).
  • 2. For further description of the Lagos case study, see Nic Cheeseman, “Why Lagos Is the Best Stop for Governors Out to Transform Counties,” Daily Nation, 30 August 2013. Available from http://mobile.nation.co.ke/News/Why+La- gos+is+the+best+stop+for+governors/-/1950946/1974342/-/format/xhtml/-/wc5t6f/-/index.html. See also Diane de Gramont, Governing Lagos: Unlocking the Politics of Reform (Washington, Carnegie Endowment for International Peace, 2015).

Public–private partnerships: Costs versus benefits

Public–private partnerships (PPPs) came into vogue in the late 1980s as a way to help expand government activities while avoiding the inefficiencies normally associated with government service delivery and procurement processes. For the purposes of expanding municipal revenues, there are many potential benefits to partnering with the private sector—for example, when it comes to the difficult job of tax collection—but also some potential pitfalls.

The benefits include gaining efficiency in tax collection by incentivizing collection performance, and encouraging competition among tax collection service providers. Further, PPPs can allow public sector employees to learn management and leadership skills from their counterparts in the private sector. Additionally, partners usually share in the risks of failure, which is particularly relevant when deploying a new tax collection initiative.

In terms of potential costs, PPPs generate fresh ideas and manpower for the government, but mean that a cut of revenues goes to private providers in order to cover their fees. This reduces the overall amount that goes to local government—although of course this may still increase through a PPP if the total amount of revenue collected goes up by a greater amount. The use of the private sector can also give the impression among citizens that the tax or levy is not going to the government at all but to a third party, reducing citizen trust in government. Additionally, the private sector may have less-direct channels for citizen accountability. This is relevant in cases where private operators break the law, where there is an increase in corruption, or where citizens feel themselves to have been mistreated. Because private partners cannot be removed by citizens through normal democratic channels, it can take longer to identify these issues. It is thus particularly important for the government to establish good oversight mechanisms where this strategy is pursued. Finally, private actors often have less legal authority over citizens who fail to comply with tax payments, which means that they can struggle to enforce the collection of unpopular taxes. This can increase the costs to local government of following up on cases of tax evasion.

These pros and cons show that the choice to engage in PPPs should be guided by an informed awareness of how suitable a particular tax or fee is for third-party implementation, and how partner-ships can be established to ensure transparency and effective coordination.

Conclusion

This chapter has reviewed various mechanisms and strategies for expanding municipal revenues. In particular, it has explored the issue from three distinct, but complementary, perspectives: government, economists, and political leaders. Each helps us to see core issues at stake. Expanding municipal revenues is not simply a question of increasing the number of taxes and fees, but also of exploring how taxes can be implemented that are both efficient and locally popular. Ideally, local government revenue should be considered by citizens to be fair, appreciated by the whole economy as conducive to growth, and understood by politicians to be a necessary part of their communication strategies and relationships with voters.

The preceding discussion has generated the following checklist for considering how a city leader can increase his or her municipality’s revenues:

  • Are there taxes, levies, or fees that other countries regularly use that my municipality could adopt?
  • Do local residents of my area view the taxes and fees we charge as fair? Do they feel they are getting something back for what they are charged?
  • Are the collectors of taxes and fees in my local area properly trained? Do they see the purpose behind the money they collect? Are they paid enough to ensure they do not need to seek supplementary income?
  • Are the taxes and fees that we charge efficient? Do they lead to a decline in overall revenues, or inhibit the growth of the economy and therefore stifle future tax revenue?
  • Do local politicians understand the value of local government revenue generation? Are they committed to communicating the work done by local government in this regard, and do they realize the political capital they can obtain through showing citizens how important tax payments have been to the provision of services and infrastructure?