For the vast majority of citizens, municipal government is the most visible, and arguably most important, level of government, the one closest to home and the primary provider of the basic services on which our quality of life depends. However, the state fiscal crisis in 2002 painfully revealed the vulnerability of local services to the state’s revenue sharing policies. Budget cuts reduced state aid to cities and towns in 2003 and 2004 by almost $1 billion, or 14 percent after adjusting for inflation, a shortfall that remains essentially unchanged today despite the modest aid increases of the last two years.

In response, local leaders raised property taxes and hiked fees to shore up local finances that were already being overwhelmed by double-digit increases in the cost of providing health coverage to municipal employees. However, even those efforts were not enough to maintain fiscal balance: Communities were forced to reduce the number of police, firefighters, teachers, and other municipal workers by more than 14,000—the sharpest decline in the nation between 2001 and 2005, according to—and to cut a wide range of services from libraries and public health to maintenance of local roads and bridges.

The aid cuts had another important consequence. In the 1990s, local reliance on the property tax fell as the state took on a greater role in funding poorer school districts; now, that progress has been reversed as the burden of funding shifts back from the state income tax to the local property tax. As a result, property taxes as a percentage of total local receipts climbed to 53.8 percent in 2005, the highest level since 1982.

Like other observers, the Massachusetts Taxpayers Foundation traces the recent difficulties of our cities and towns to longer-term, structural problems in the underpinnings of local finances. Municipalities are constrained in raising revenues by the requirements of Proposition 2 ½ and by state laws that confer on them little authority to develop other local revenue sources. Cities and towns face major cost pressures in areas such as health care, which by statute they have minimal ability to manage effectively. And with local governments heavily dependent on state aid—roughly one quarter of municipal revenues comes from the Commonwealth—erratic levels of state assistance periodically wreak havoc on their budgets and the services they can provide. During the 1989-92 recession, for instance, cities and towns were left reeling as the Commonwealth slashed local aid by a staggering 35 percent in order to balance the state budget.

In order to address one of the structural problems in municipal finance—the inconstancy of state aid—the Massachusetts Taxpayers Foundation proposes that the Commonwealth set aside 40 percent of annual tax revenues for local aid. Under this proposal, 40 percent of revenues from the income, sales, and corporate taxes (the state’s three main taxes) would be dedicated to Chapter 70 education aid and to non-school aid now financed in part by Lottery revenues, which have been flat in recent years. Currently, total local aid comprises less than 30 percent of tax receipts. While the 40 percent commitment would require roughly $1 billion more in aid, that increase would simply bring state assistance back to inflation-adjusted 2002 levels, plus a modest increase of roughly 5 percent, or about $275 million.

Dedicating a fixed percentage of state tax revenues to localities would have a profound impact on municipal finances. First proposed by the Municipal Finance Task Force chaired by Sovereign Bank New England chairman John Hamill, this earmarking of state revenues would remove the annual local aid allocation from the roller coaster of the state budget process, ensuring that local aid accounts—and local services—would remain one of the state’s top priorities during bad fiscal times. If constructed appropriately, it would provide certainty to local officials about the level of aid that could be counted on as they develop their annual budgets. Given the magnitude of dollars involved and the state’s continued tight finances, the new revenue-sharing policy would need to be implemented over several years. But a similar approach—dedicating a fixed percentage of sales tax revenue—has been successfully used in recent years to stabilize state funding for the MBTA and school building assistance.

It would provide certainty to cities and towns.

Local governments would still need some protection against sharp swings in aid levels during economic downturns. Had a 40 percent revenue-sharing policy been in place during the recent recession, in fact, local aid would have declined more than twice as much as it actually did. That’s because the state built up a large stabilization fund in the 1990s, and was able to partially buffer cities and towns from the severe drop in state revenues in 2002. But in the absence of such reserves, a guaranteed 40 percent of state tax revenues could make a big difference in local budgets. Indeed, if such a revenue-sharing plan had been in force in 1989-92, cities and towns would have faced state aid cuts only about one-fourth as large, in inflation-adjusted terms, as the ones they had to absorb.

ome might argue that the present pinch on local budgets is essentially of cities’ and towns’ own making—the product of overly generous salaries, excessive staffing, and other profligate spending. But in its recent comprehensive review of local finances, the Municipal Finance Task Force found no evidence of a spending spree: In 2003, the average annual wages of municipal employees in the state were 6 percent below those of state workers and almost 13 percent below those of private sector employees, while as recently as 1990 the average wages of all three groups were essentially the same. Researchers at the Federal Reserve Bank of Boston have found that the number of municipal employees per 10,000 residents in Massachusetts is 10 percent below the average for the 50 states.

Others might point to the doubling of Chapter 70 school aid in the 1990s as evidence that municipalities are well provided for. However, most of that additional aid went to the state’s poorest school districts in order to meet the constitutional mandate that all districts be funded at a level sufficient to provide an adequate education for every child. And the added aid came with an important string attached: Local contributions to schools had to rise at least at the same rate as local revenues. In fact, communities have contributed significantly more to education than the law required—about $875 million, or 11 percent, more in 2005, according to the state Department of Education. Since the enactment of education reform in 1993, local school spending (excluding state aid) has grown more rapidly than non-school spending—an increase of 81 percent for schools versus 70 percent for other purposes. Cities and towns have hardly taken advantage of the increase in school aid to fatten their non-school operations.

One other potential objection to more local aid bears examination—that the additional property taxes generated by new construction have been more than enough to pay for increases in local budgets. It is true that cities and towns have benefited from substantial new construction over the last seven years, adding an average 2.7 percent a year to local tax bases, more than the growth in tax revenues from existing properties allowed by Prop. 2 ½. What must be recognized, however, is that new construction brings new demands for local services. In fact, roughly two-thirds of the new construction has been residential, the kind of development that places the greatest strain on local budgets.

In order to ensure that dedicated income, sales, and corporate tax dollars go where they are most needed, aid reform should go hand-in-hand with a thorough reworking of the state’s formulas for allocating assistance to individual cities and towns. At the same time, local officials should be given the tools to manage their costs—and be required to demonstrate that they have used those tools to deliver services more cost-effectively.

One area—health insurance for municipal employees —must be addressed as soon as possible. It makes little sense for the Commonwealth to provide major increases in local aid only to have the additional dollars soaked up by local health care costs that are rising twice as rapidly as the state’s.

At present, cities and towns are extraordinarily constrained in their ability to manage health care expenses, largely because of strictures imposed by state government. A host of cost-management strategies—ranging from changes in cost-sharing arrangements with employees to the introduction of innovative and efficient health plan designs—are difficult, sometimes almost impossible, for local officials to implement. While it is unreasonable to expect that Massachusetts cities and towns—or any other single group of employers—can turn back the nationwide tide of health care inflation, state officials can give cities and towns modest tools to cope with the cost pressures they face.

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Meanwhile, both lawmakers and taxpayers have the right to demand that tax dollars be managed effectively at the municipal level. While the evidence suggests that most communities are using their resources wisely, it is striking that the basic financial data needed to make apples-to-apples comparisons of spending between those communities simply do not exist. Accountability for the use of the newly dedicated tax revenues must be built in from the beginning, by developing a Commonwealth-wide system for benchmarking the costs of delivering basic services in each city and town.

Dedicating 40 percent of tax revenues to municipalities will be an extraordinary commitment of the state’s resources. But given the deep-rooted structural problems in the fiscal relationship between the Commonwealth and its cities and towns—problems more than two decades in the making—such a commitment is essential if we are to have any hope of stabilizing local finances and preserving both our quality of life and our potential for future economic success.

Michael J. Widmer is president and E. Cameron Huff senior research associate of Massachusetts Taxpayers Foundation.