Chapter 1: Local Government Financing

Port of Vancouver

Most local governments in British Columbia are governed under the Community Charter and the Local Government Act. There are some exceptions, such as the City of Vancouver, the Islands Trust, and various resort municipalities governed under separate legislation. However, whether it’s BC’s largest municipality, the new Sun Peaks Mountain Resort or the Village of Hazelton, municipal legislation regulating the financial scope of a local government is virtually the same across BC – and that scope is quite limited.

Local governments are not allowed to run deficits, even during periods of recession, making them particularly vulnerable to the boom-and-bust cycle of a resource-based economy. Their primary source of revenue is the ability to tax real property within their jurisdiction, and levy charges for municipal services. Taken together, property taxes and sales of services account for 88.5 per cent of own-source revenues for local governments in British Columbia in 2008.

BC’s municipalities are not allowed to collect sales taxes, income taxes, royalties, or various other taxes collected by the provincial and federal governments. They are also not allowed to borrow money without the approval of electors by referendum, a democratic safeguard to protect against reckless decision making.

Local governments in British Columbia have long struggled to establish an equitable financing model that recognizes the growing responsibilities of local government. Tensions between the provincial government and the Union of BC Municipalities (UBCM) and its member governments are not new. Indeed, the history of financial relations between these two levels of government has often been challenging. From the 1940s onward, the issue of local government financing arose regularly with reports and studies on the issue published in every decade.

The high point for municipal – provincial financing relations occurred in 1978. In that year, according to a 2008 UBCM policy paper, the province introduced a revenue-sharing program that “…provided a guaranteed share of major provincial revenue sources including personal and corporate income taxes, sales and fuel taxes and natural resource revenues. This share of provincial revenue was used to finance unconditional operating transfers and conditional operating and infrastructure support to local BC governments.”

Over the last 32 years, much of that funding has dwindled and the proportion allocated to unconditional grants has shrunk, with much more of the funding becoming conditional and tied to specific capital projects. By 1993, less than half of the funding was unconditional.

This trend continued throughout the 1990s. According to the UBCM, “general unconditional support was eliminated in 1997, although some grants to small communities continued.” This prompted the UBCM to publish the study “Financing Local Government” in 1998. The 1998 UBCM study recommended giving more flexibility to municipalities; improved reporting standards; removing restrictions on existing revenue instruments; access to new sources of revenue; a new police cost-funding formula for small communities, and continued provincial support for small communities.

As a result of UBCM’s advocacy work, traffic-fines sharing was introduced in 1999 and raised to 100 per cent in 2004, while support for small communities has been maintained and expanded. The federal government began, in 2005, to share gas-tax revenues with local governments under an agreement with the UBCM and the provincial government. In addition to these revenue-sharing programs, the federal and provincial governments have continued to fund capital projects through the Canada – BC infrastructure Program, the Municipal Rural Infrastructure Fund and the Building Canada program.

Other specifically targeted, provincially-mandated programs in areas such as wildfire prevention, seniors housing and community tourism have been introduced to meet certain narrowly-focused needs. However, like most provincial and federal transfer programs, they are mostly restricted to capital infrastructure or are one-time grants that do not provide for ongoing operating expenses and do not provide financial stability for local governments.

In 2006, the Federation of Canadian Municipalities (FCM) presented a paper titled, “Restoring Municipal Fiscal Balance.” The FCM paper called for broad-based reform that would clarify roles and responsibilities of the different levels of government, develop a plan to tackle the infrastructure deficit, diversify municipal revenue tools, invest in public transit, and reform various administrative and governance practices.

According to Vancouver Mayor Gregor Robertson, the need for municipal finance reform is just as great today. At an FCM-sponsored event in May 2010, the mayor of BC’s largest municipality reaffirmed that, “Canada is way behind other countries in restructuring so that cities are empowered to take care of their own needs.”

The balance of this chapter reviews the recent municipal financing trends for BC’s local governments and discusses their implications for future economic viability, as well as their primary impacts on residents and businesses.

Trends in Local Government Financing

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BC’s local governments receive the largest part of their revenues from three chief sources: property taxes, sales of goods and services, and transfers from other governments.

Property taxes are an own-source revenue (i.e., a revenue that is solely derived and managed by the city). They are based on a charge on the assessed value of land and improvements.

Sales of goods and services are another own-source revenue and the vast majority are calculated on the basis of volumes of services delivered. However, because there is very little individual property metering, the volumes are generally proportionately allocated to properties. They are essentially a tax on property calculated on a different basis than the standard property tax.

The final major source of revenues for local governments are transfers from senior levels of government, so are not own-source revenues. Transfers may be for specific purposes, in which case the local government is essentially acting as the administrative agent of the transferring government. Alternatively, transfers may be for general purposes, in which case they supplement the revenues supporting general services.

Table 1Tables 1 and 2 provide data on local government and provincial government revenues from 2000 to 2008. When comparing these figures, remember that Table 1 is expressed in thousands of dollars, while Table 2 is expressed in millions of dollars.

Table 2

Charts A and B trace the trend lines for own-source revenues of local governments and the provincial government since 2000. The dots are the actual amounts and the line represents the trend.

Chart A

Chart B

While local government own-source revenue growth was more stable over most of the past decade, these revenues grew at a faster rate than provincial own-source revenues and the provincial economy as a whole. These results show that in order to meet the expenditure demands placed upon them, local governments were compelled to impose a more rapidly-growing burden of taxes and goods and service charges on their taxpayers than the provincial government placed on provincial taxpayers. Local government own-source revenues increased by 51.2 per cent from 2000 to 2008, while provincial government own-source revenues increased by only 33.7 per cent from 2000 to 2009.

Furthermore, as noted earlier, these two major revenue streams account for 88.5 per cent of own-source revenues for BC’s local governments in 2008. In comparison, property taxes and sales of goods and services account for only 16.7% of all local government and provincial government own-source revenues collected in BC in 2008. One of the explanations for this is that local governments are restricted to a much narrower range of revenue sources than is the province.

The burden of local government revenue-raising being concentrated on only two sources suggests that resulting economic distortions may be quite large. Furthermore, the vulnerability of local governments to weakness in either source is quite high.

Chart C

Charts C and D show the distribution of local revenues between sales of services and property tax since 2000, as well as the trends between 2000 and 2008. The rate of growth of sales of goods and services has been somewhat higher than that of property tax revenues, with sales increasing from 59.9 per cent of property tax revenue in 2000 to 67.0 per cent in 2008.

Chart D

It appears that local governments are showing some inclination to shift the burden to user charges over time. The reason is not entirely clear, although it may be in part because user-charge increases receive less public attention and thus are subject to less taxpayer resistance. For example, in Vancouver the property tax for 2010 was increased by over four per cent for residential property owners, while the increases in charges for services was about 12 per cent. The latter increase received little atttention in the media, even though it will result in an increase in payments by property owners of about $50 million, compared to an increase of about $20 million in property tax payments.

There has also been a change in transfers from senior levels of government in the past decade. Chart E shows the amounts and trends in aggregate transfers over the last decade. As can be seen, transfers are now almost entirely for specific purposes.

Chart E

Transfers increased by about 42.4 per cent over the period, which is almost exactly the same rate as the growth in provincial own-source revenues, but considerably less than the 51.2 per cent rate of growth in local government own-source revenue. When transfers fail to keep pace with the growth in own-source revenue, local governments necessarily become more dependent on their own-source revenues.

Over time, this trend towards greater self-financing will contribute to the growing infrastructure deficit as needed investments are delayed for lack of funds. In addition to the upfront capital costs, the ongoing operating expenses of new infrastructure must also be taken into account.

Think City surveyed mayors, councillors and senior staff in local government throughout British Columbia from November 2009 to February 2010 (for full details see Appendix A). From this survey, the infrastructure deficit emerged as a primary source of concern for local governments.

Impact of BC’s Municipal Revenue Changes: Housing Costs

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For residents, municipal revenue changes over the past decade have primarily translated into higher housing costs. In some BC municipalities, shifting the property-tax burden of commercial and industrial property owners to residents further increases these costs. These increased housing costs come at the same time BC is dealing with an over-heated real estate and rental market, where housing costs have increased faster than wages, inflation or gross domestic product (GDP).

Residential property taxes and the related goods and service fees (e.g., water, sewer, and solid waste) are based on the assessed value of the property, multiplied by the mill rate. For example, the current mill rate for residential properties in Vancouver is $3.25 per $1,000 of assessed value. Thus, the combined annual property tax and user fee costs for the average residential property worth $781,000 is approximately $2,543 per year. When a local government increases its own-source revenues from property taxes or fees for services that are linked to property ownership, both residential property owners and tenants are forced to pay higher housing costs.

Unfortunately, property values may have a relatively weak relationship to the homeowner’s ability to pay. Furthermore, while assessed property values are certainly a contributor to an individual’s wealth and net worth, the relationship between property value and income is less direct. As a result, this form of taxation disproportionately impacts lower-income people.

Retired homeowners, for example, often own property but live on relatively modest incomes. The provincial tax-deferment program exists to help in these and other hardship situations. Unlike low-income homeowners, low-income tenants do not benefit from any of the policies that subsidize home ownership, such as the annual home owner grant. Low-income tenants do pay higher housing costs, however, because landlords pass their increased property-related costs along to tenants in the form of increased rents.

Moreover, because housing is a basic necessity rather than a discretionary spending choice, the increased cost of property taxes and related fees falls most heavily on those who are already most exposed to the costs of BC’s inflated housing market. In this sense, higher own-source revenues linked to property assessments can work to erode the benefit of other public policy initiatives in areas such as poverty reduction, child tax credits, income assistance and affordable housing measures.

Many of BC’s local governments also recognize the inequity of the property taxes and user fees that contribute to municipal coffers. In Think City’s survey of local government leaders, 52.8 per cent of respondents agreed or strongly agreed that local governments should look at their tax policies through the lens of tax fairness for lower-income people.

In addition to annual increases in property-related taxes and fees, residents have also been impacted by increases to the proportion of the overall property tax burden they bear. Several local governments have adjusted their property tax regimes – mostly to reduce the proportion paid by business property owners and to increase the proportion paid by residential property owners. The City of Vancouver’s tax shift has attracted the most attention, but other local governments have pursued similar policies in recent years.

A more extreme version of this type of shifting is the recent tax revolt initiated in several resource-based municipalities in 2009 by large industrial property owners. Taxes were initially withheld and in turn local governments closed the resulting revenue gap by hiking residential property taxes and related fees, or cutting public services, or both.
In Port Alberni, for example, residents were assessed a 23.6 per cent increase on their property tax bill, industrial property owners received a 6.9 per cent cut in taxes, and commercial businesses saw no increase in 2010.

Impact of BC’s Municipal Revenue Changes: Industrial Property Tax

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In March of 2010, the BC government established a process called the industrial property taxation review, a policy review that could dramatically restrict the ability of local government to tax industrial property owners.

Over the last two years, the BC Business Council and a group of large industrial taxpayers have mounted a campaign to reduce industrial property-tax rates in British Columbia. The industrial property taxation review comes on the heels of the $24-million in tax relief for heavy industry in the 2008 budget. Also, Premier Campbell announced an industrial property tax credit on October 22, 2008, which provides a rebate of 50 per cent of school property taxes to light and heavy industry. Big business will also benefit from the HST, which will shift approximately $2-billion in provincial sales tax from business to consumers.

Crofton MillThe industrial property tax issue really came to a head when Catalyst Paper, the largest pulp and paper company in BC, refused to pay its taxes in the four municipalities where its pulp mills operate: Campbell River, Powell River, North Cowichan, and Port Alberni. Instead of paying the $23 million in taxes assessed, Catalyst Paper CEO Richard Garneau said the company could only afford to pay $1.5 million to each municipality – about one quarter of the amount they were owed.

As the economy worsened, other industrial companies such as TimberWest, West Fraser, and Zellstoff Celgar also began to withhold their property taxes. Their main complaint is that industrial property taxes in BC are higher than in other competing jurisdictions.

The municipalities responded by taking Catalyst Paper to court, and, in December of 2009, the BC Supreme Court ruled that municipalities have the right to set tax rates as they see fit. Justice Peter Voith wrote that the courts have traditionally been unwilling to encroach on the authority of local government in this regard, and that essentially this was a political issue, not a legal one.

Catalyst Paper responded to the court decision by continuing to refuse to pay its taxes, launching an appeal, and stepping up its lobbying and public relations efforts.

Pressure on the government steadily increased as big business, local politicians, and labour leaders stepped forward to demand tax concessions for the industrial sector. In the throne speech in early February 2010, the government promised a review of the industrial property-tax issue.

On March 10, the government announced that the review would look into the issue and report back by the fall of 2010. The steering committee for the review is composed of senior bureaucrats, industry representatives, and municipal politicians. There was no mention of any public process or opportunities for public involvement.

In British Columbia, municipalities mostly have free reign to set their own property tax policies. Provincial regulation has crept into certain areas, such as railways and ports, but it now appears the province is contemplating further restrictions on the taxation authority of local governments. According to Think City’s survey of local government leaders, more than one in seven municipalities said they had difficulty collecting taxes from large, industrial taxpayers as a result of the recent industrial tax revolt.

Local governments, big business, and most economists agree that municipalities are far too dependent on property taxes as a single revenue source and they need alternate sources of financing. But simply shifting the property tax burden from business to homeowners, as Vancouver and several other communities are doing, is not an equitable solution.

If the provincial government intends to further regulate municipal property taxes, the whole issue of municipal financing must be taken into consideration. Subsequently, local governments need to be compensated with alternate revenue sources.

The City of Trail has recently joined the District of Kitimat in calling for a rigorous independent analysis to be conducted to determine the statistical causality between municipal property taxation and industrial activity. Many local governments throughout BC are concerned that important policy decisions about industrial property taxation could soon be made without detailed economic analysis.

In an open letter copied to all BC local governments, Trail Mayor Dieter Bogs wrote:

“In the absence of proceeding in this way, we are very fearful of the eventual outcome, which may provide major industry with marginal short-term profit gains but do nothing to address potential macro-economic problems and the long-term sustainability of industry that most likely extends far beyond the annual municipal property tax levy.”

Impact of BC’s Municipal Revenue Changes: Competitive Edge

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When it comes to the primary impact of BC’s recent municipal finance changes on businesses, FCM studies assert that the commercial component of increased property tax and goods and service fees has an impact on the competitiveness of business, making it more difficult for cities to attract business investment and human resource talent. Simply put, people and money are mobile and will seek out more favourable environments in which to operate.

Tax competition among adjacent Canadian municipalities can have a destructive effect on revenues as residents and businesses seek out lower tax jurisdictions. Where low-tax jurisdictions or unincorporated areas exist adjacent to municipal boundaries, the discrepancies in property tax rates can sometimes be very significant. Residents and business in these areas often benefit from the municipal infrastructure and services but do not contribute their fair share of the costs.

Another consideration is the impact of tax competition between countries on various industries. For example, exporting firms are very important to the health of the overall BC economy. Exporting firms selling to international markets are competing against other firms that benefit from more favourable property tax regimes. These businesses are often in the manufacturing, processing, and distribution sectors of the economy. This is a very valuable sector of the economy because it generates higher economic multipliers and higher paying jobs than the service or retail sectors.

Finally, besides lower taxes, there are other incentives that competing countries offer businesses to attract human-resource talent with that Canadian municipalities currently cannot match. In a 2006 report titled, “Our Cities, Our Future”, the mayors of Canada’s largest cities make the case that Canadian cities are competing with cities around the globe that are able to draw upon a much wider and more diverse range of revenue sources to finance the infrastructure and public services required to support a twenty-first century economy.

According to the mayors’ report:

“Cities in the United States and Europe have access to other revenue sources such as income, sales and selective sales taxes. In the US, 16 states permit municipal governments to collect local income taxes. Couple the access to these revenue sources with federal programs ... that provide US cities with access to over $100 billion for transportation infrastructure, and Canadian municipalities quickly lose any competitive advantage.”

The Future of Municipal Financing in British Columbia

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The historic trends of the three major funding mechanisms of BC’s local governments suggest that continued reliance on these sources may prove troubling in the future.
Over the decade just ended, local governments have relied upon higher rates of increases in property taxes and goods and service user fees, compared to the growth of provincial government own-source revenues. This raises questions about the viability of the current revenue model for municipalities in the face of the troubling economic pressures felt by many residents and businesses.

Furthermore, senior government transfers are not keeping pace with the growth of municipal own-source revenues, which in turn creates additional upward pressure on the growth-rate of the two other revenue sources. Given the state of the finances of senior governments, it is also very unlikely that transfers will grow as rapidly in the coming decade.

In addition to these weaknesses undermining the capacity of local economies to grow as they have in the past, it is also very doubtful whether the recovery from the recession will be as rapid and as complete as is commonly thought. These factors together could seriously impede the ability of local governments to enjoy the revenue buoyancy of the past decade.

Looking into the future, the economy of the new decade will likely be much different than the past one for local governments. Forward-thinking policy development, at both the local and provincial level, is required to respond to global environmental changes; population changes; new and expanded demands on local governments, and a transitioning BC economy.

It is clear that a more comprehensive and reliable revenue-sharing system is needed to provide certainty and stability for municipalities in the years ahead. As well, alternative revenue sources should be developed for financing the expanding needs of BC’s municipalities.

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