Municipal governments all across the province are busily developing their budgets for the next tax year, which starts January 1, 2009.  Most will be trying hard to restrain their budgets.  The affects of the recession are now being felt full force and one can bet that taxpayers are not going to be receptive to paying substantially higher taxes.  Many city and local councils can expect vigorous public opposition to tax increases imposed to help close the revenue-expenditure gap.

But what is a responsible council supposed to do? After potential cuts reach a certain pain threshold, there will be tremendous pressure to raise tax rates.  But it is doubtful citizens are going to be as receptive to tax increases of the magnitude they swallowed last year. For instance in 2008 Vancouver residential taxpayers were stuck with an increase of almost 8%, almost 6% points higher than the rate of inflation. It doesn’t seem very likely that homeowners will have much appetite for a similar increase this year.

Part of the challenge for councils is to distribute the tax burden among different tax categories or property classes in a sensible and fair way.  The property classes each have their own tax rates or mill rates set by the councils as a percentage of market value of properties.  Getting the right balance of rates is challenging both politically and in terms of good policy.  There has been intense political lobbying over the past few years about differences in tax rates across classes of property. In particular business and industrial taxpayers have been active in protesting the fact that they typically pay tax rates that are significantly higher than homeowners as a % of the value of property.  These differences in most municipalities reflect a long standing view about fairness, responsibility and balance.

Last year Vancouver Council responded to this pressure by setting a lower rate of increase of taxes paid for business properties compared to residential properties. There was little public discussion about it, no doubt in part because the traditional anti-tax lobby, dominated by business, accepted it as a business friendly move.

While it is not clear what will happen this year if the same thing is done, it will not be surprising if there is a fairly strong negative reaction from homeowners, particularly if some vocal critics are inspired to take the lead.

An important question to ask is whether these differing rates of increases in property taxes are  the best way to help the business sector, if business needs or deserves a break.  The amount of tax paid by business depends on two things – the market value or sales price of business property and the tax or mill rate for business properties.  The market value of all business properties increases each year in response to the increase in the value of the small number actually sold.  This value is determined by the British Columbia Assessment Authority using formulae that relate properties that have not changed hands to comparable properties sold in the market.  Market values depend upon the revenue and costs including property taxes of businesses actually sold on the market.  The lower the taxes the higher the market values of properties actually sold, and the higher the value of all business properties on the tax rolls.

One of the clear results of a property tax break for business is that the market value of business properties increases in response to the lower tax rate. Indeed, based on the iron law of economics, the increase in property values will exactly offset a tax decrease.  In other words a tax cut or a lower rate of increase is in a short time translated into an offsetting increase in business property values.  Of course other things may affect property values as well, but that doesn’t change the argument about tax changes taken separately.

In part to deal with this potential erosion of tax changes, changes in property values are determined ahead of tax changes because assessments are done the year previous to the tax year.  In this way the municipality can shelter the property taxpayer from immediately having the gains of lower tax rates being undermined as a result of direct consequent increases in property values.  The municipality sets a target revenue number for business properties as a class each year, based on a rate against last year’s assessed values.  But what should be the basis for determining the share of revenue attributed to each class of property? Typically the question is approached by looking at the relative share by class of aggregate assessed values.  For instance, should business share of the change in the overall tax bill be proportionate to its share of the increase in total assessed values for all classes of property?  Or proportionate to its share of residential and business property values in aggregate?  Or a lower proportion, as the tax shift advocates propose? But because the tax rate will be an important factor in determining the following year’s assessed values, relative assessed values do not provide a fixed continuing basis for determining how much of the burden each class of property should bear.   Objectively, the relative shares can only be determined by drawing on some other means upon which to base the appropriate proportionate share of the tax load by class.

If the share is to be shifted in favour of a particular class, upon what underlying  principle is the proportion to be based?  If it is based on the relative aggregate assessed values for each class, changes in this proportion will be driven to a considerable degree by the relative changes in tax rates themselves.  Indeed it must be that the aggregate value of business properties is increasing more rapidly under this scenario so far as the affects of taxes are concerned, undermining in part through time the argument for tax relief.  There is something odd about following a principle for these purposes that has, as one of its major impacts, changes in assessed values through time that work against the principle.

There is also an important question about who really gains.  Since relative tax relief increases the market value of business properties over time, the cost of acquiring properties goes up and so too does the cost of doing business, eroding the benefit of the tax relief.  And this erosion falls immediately and most heavily upon new, usually young start-ups who are purchasing or renting property.  Indeed the supposedly preferred tax treatment puts the new and younger business operators at a competitive disadvantage, which is the opposite of what most people would want to see.

Of course factors other than taxes affect increases in aggregate market values in each class as well.  If prices of residences rise more rapidly than business properties because of demand, there will be a more rapid growth in assessed values of residential properties compared to business properties without any additional servicing costs.  But we can also ask, is this a good reason to increase the share of taxes paid by homeowners? Perhaps, but then the opposite should hold when business properties in aggregate increase in market value at the same rate or more rapidly than home prices, as could very well be the case in a number of municipalities over the next few years.  Will there then be a pause in the shifting of the tax burden when this happens?

It is time for a principled discussion by councils and their taxpayers about the reasons for and affects of the tax shifts that some are pursuing away from business and to homeowners, and for transparency about the shifts.  Otherwise tax changes go to those who push the hardest and who are most successful at winning the lobby game.  This never a good basis for setting tax rates but it is a particular concern now when homeowners and new start-up businesses are under financial pressure and thus very vulnerable to tax burdens.

And if business needs special help, it might be better to look at things that will be more effective in terms of results, like targetted support for young start ups, as well as high growth and high value sectors, knowledge dependent hubs and small independent business.  Or to lobby hard for a lower corporate tax rate for small business.  More on this last point another time. But these arguably make a lot more sense than blanket property tax shifts from business to residential taxpayers.

July 2 marked the deadline to pay local property taxes and many homeowners are justified in asking, “Why are my taxes rising so steeply?”

Part of the answer is that local governments in British Columbia are among the least supported in Canada by provincial financing, and the amount of such support has dropped dramatically over the past ten years.

For example, the BC government provided about $5,325 million to municipal governments in 2007-2008, compared to about $8,850 million in 1997-1998. Over the same period, off-loading has been substantial and local government costs have increased markedly.

Taxpayers in Vancouver have been especially burdened. Notwithstanding unprecedented growth in the property tax base, residents experienced a tax increase of almost 8% in 2009,and there is little relief in sight.

Approximately a quarter ofthis increase was due to a shift of the tax load from businesses to residents, and city council has vowed to continue shifting the tax burden onto residential taxpayers. Furthermore, there is little likelihood of any reduction in cost pressures in the near future. Indeed with the Olympics in 2010, additional cost pressures are almost a certainty.

It is highly unlikely that residential taxpayers will be willing to accept tax increases in the 8%-10% range in coming years. The 2009 increase, at a time when inflation is below 2% and wages are generally frozen, failed to galvanize focused opposition. Arguably this was because of the unusual silence of the city’s business organizations, the usual lead voices in anti-tax campaigns. This silence was no doubt intended to reward the city for the tax shift from commercial to residential property, but it seems unlikely that it can be counted on to continue in the future.

The danger, of course, is that in the next budget cycle, tax resistance will blossom into a full-blown tax revolt in the face of rising costs. If so, councillors will find that further tax increases could very well be at the cost of their electoral survival. In an effort to bring tax increases in line with inflation, cuts in programs and services could become inevitable. The hopes and dreams of progressive citizens could be smashed by a revenue crunch that few saw coming.

There has been virtually no public discussion of this impending crisis in local government finance. The province, with its own financial crisis, has no inclination to reverse its abandonment of local government, and city councillors don’t see any point in stirring up voters and employees until they absolutely have to.

This is short-sighted. It is essential that a dialogue begin between taxpayers and their elected city councils. Tax increases on the same scale as those of 2009 will almost certainly be unacceptable. Other alternatives must be explored and pursued.

The real problem is that local governments have been starved of finances over the past decade. They have been forced to rely almost exclusively on one source of revenue – the property tax base – which includes the local property tax and property-based user charges. In British Columbia, these together make up about 85% of municipal revenue, the highest proportion in Canada.

The only alternative to ever growing charges on property is to expand the tax base of municipalities.The heavy reliance on property taxes is not sustainable if local services are to survive in the form we now know them. A tax revolt cannot be disavowed as simply a matter of speculation.

Sales taxes, including fuel taxes, are an option, much as is the case in many cities in the United States. One advantage of such taxes is the burden is extended to tourists and visitors who draw on local services but contribute little to their costs. New, reformed business taxes that are fairer than property taxes are another possibility. And there are several other possibilities.

But the important point is that we need to start talking about these matters. Cities in particular are vulnerable to a wrenching fiscal crisis if we do not turn our attention to these matters.

This article first appeared on ThinkCity.