This article examines the effect of the tax cap on Collar County schools and municipalities. In brief, the impact to date has been minimal. Although it may have restrained tax revenues among some jurisdictions, in general it has not proven to "work" yet. However, in the future the tax cap should limit property tax collections. Moreover, financing traditional local services like schooling, policing and fire fighting will become more difficult because of both the cap and unfunded mandates. Ultimately, "capped" communities could have fewer services of poorer quality.

I. TOO EARLY TO KNOW OVERALL IMPACT
    OF TAX CAP

Studies Not Conclusive. The two primary studies of the aggregate effect of the tax cap were conducted by the Illinois Department of Revenue and Professor Richard Dye (University of Illinois and Lake Forest College). The Dye study reports two major findings. The first finding is that about 300 of the 706 jurisdictions in the study do not tax up to the PTEL (Property Tax Extension Limitation law) limit. What this means is that non-home rule governments have in effect capped themselves at a rate lower than mandated by state law.

Why has this occurred? It is not clear. Proponents of the tax cap would argue that these "self-capping" governments were scared — by PTEL — into collecting fewer property tax dollars. However, these governments could have just as easily been encouraged by PTEL and taxed up to the limit, as a defensive means of " getting as much this year" to offset unexpected costs in future years. Perhaps a better explanation is that many of these communities are simply financially conservative — responding to local voters' preferences.

The second major finding is that tax revenue for some jurisdictions is lower than what it would have been if the tax cap were not in force. The Dye study concludes that taxes by "capped" communities are about $94 million lower than it would have been. In contrast, the 300 self-capping communities could have collected $18 million more if they had taxed to the PTEL limit.

It is difficult to know the general impact of the cap on tax collections. Other factors could explain some or all of the slowdown in tax growth. For example, Professor Dye readily acknowledges that the economic recession of the 1980's might explain the slowdown. Also, the more property tax alternatives a local government has, the more it can hold down property tax increases voluntarily. Municipalities have more alternative revenue sources (like user fees) than schools.

The Department of Revenue concluded that the tax cap reduced collar county property taxes primarily because tax collections grew more slowly in the first three years under PETL than before. However, it is too early to say what caused the decline in revenue growth. As mentioned, other factors like the recession may have caused all or part of the slowing of property tax collections. Not only did tax collections decline during the 1980's recession, they also declined during and shortly after the 1980's recession (when the cap was not yet in effect).

"Uncapped" Municipalities Have Raised Property Tax Increases More Slowly Than "Capped" Communities. As the table below indicates, Home Rule (HR) governments have had smaller increases in property tax revenues than Non-Home Rule (NHR) municipalities. In a survey of Lake County municipalities over 1,000 in population, the Northwest Municipal Conference found that HR units increased property taxes more slowly than did their NHR counterparts. THIS IS IN SPITE OF THE FACT THAT HOME RULE UNITS WERE NOT "CAPPED." This is contrary to the theory of the property tax cap — that it is needed to control spiraling property taxes. Plainly HR communities showed self-restraint in their financial management.

Type of Municipalities               Growth in Property Tax
                                                 Revenues 1989-1994
Home Rule, Lake County             13% (Adjusted for inflation)
Non-Home Rule, Lake County      19% (Adjusted for inflation)

Why have uncapped HR communities been able to restrict property tax growth? First, HR communities have a greater number of revenue options that allow them to diversify away from property taxes. Secondly,

January 1995 / Illinois Municipal Review / Page 19

collar county NHR communities possibly had greater population growth. The higher costs associated with growth resulted in greater tax collections.

A comparison of municipalities in northern Cook County and parts of Lake County (served by the Northwest Municipal Conference) came to the same conclusion: HR municipalities have had lower increases than their NHR counterparts. Also, Professors Dye and Therese McGuire arrived at a similar finding in a recent study. The study compared 102 HR and 101 NHR municipalities, in terms of 1987-1993 property tax growth. Like the NWMC study, this study found that uncapped municipalities held property tax increases below capped municipalities' increases.

Although Aggregate Impact Not Known, Impact Being Felt By Certain Jurisdictions. Schools. In spite of the uncertain impact so far, there are indications that the tax cap is "biting" into some local governments' budgets. The Dye/McGuire study, comparing 143 metropolitan schools not capped against 145 capped metropolitan schools, suggests that capped schools have been affected financially. Uncapped schools' property tax revenues increased faster than those capped.

According to an Illinois Senate Democratic Task Force survey of collar county schools, 121 schools responding to the survey have had cap-related problems. As one collar county school put it, the school has been hit by a "Triple whammy in a growing district: tax cap, lower state aid, but more students." The most widespread impact to date has been increases in class size. (See table below.)

Cap-Related Problem                                    Affected Schools
Increased Class Size                                                  80
Cutbacks in Equipment Purchases                               70
Cuts in Library Services/Class Materials                       69
Reduction in Teachers                                                49
Reduction in Other Staff                                             34
Fewer Extracurricular Activities                                  34
Fewer Courses Offered                                              33

Municipalities. With respect to municipalities, the impact to date seems modest. The Northwest Municipal Conference conducted a non-random survey of 20 villages and cities in the five collar counties. In general the municipalities stated that the impact has been modest, except for issuing bonds. Of the 15 participating communities: 10 had not shifted to other revenue sources because of the cap; 11 or more had maintained the level of each municipal service; 11 or more continued to provide each service in the same way (e.g., had not reduced the quality of service).

Cap Creates Inefficiency in Financing Capital Improvements. In the survey of municipalities, about half of the 15 communities stated that the issuance of general obligations (GO) bonds had been curtailed or hampered. While CO bonds issued prior to the cap are not subject to the cap, newly issued CO bonds need to be authorized by referendum. A municipality that fails to pass a GO bond referendum can: (1) not issue any bond, or (2) find a different type of non-referendum bond.

Under the first option, any school or municipality would have to cut back on services. For example, a municipality that had floated bonds, say, every several years for "life safety" tasks prior to the cap would no longer have funding for that task. As a result, there would be an immediate cutback in this service. Under the second option, local governments would seek out different types of non-referendum financing. However, they would have to use revenue bonds or other financing techniques which, to finance the same capital improvement, cost more than general obligation bonds. As one village put it, "We have lost the ability to issue [general obligation] debt which is increasing our borrowing cost which will have a long-term cost for the village."

To illustrate the inefficiency created by the PTEL, consider a municipality trying to finance a $10 million dollar recreational facility. In the past this could have been funded by GO bonds; under PTEL this could be funded by revenue bonds but not GO bonds. A conservative estimate of the higher interest rate cost of this type of revenue bond is 1%. In today's economic environment, this translates into about $830,000 in additional costs.

II. TAX CAP SHOULD HAVE MORE
    PRONOUNCED IMPACT IN THE FUTURE

Cap's Cumulative Effect Should Constrict Future Spending. The tax cap has a cumulative effect. Because tax increases are constrained in one year, in the second year the tax cap is applied to a smaller base than it could otherwise be. In the third year and subsequent years, the constrained tax increase is applied to a smaller and smaller tax base. Put differently, a school or

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municipality that increases taxes by only 1% instead of say 5% (which was the effective cap in 1991) forgoes revenue in that year, and that revenue can never be recouped.

There is indirect evidence that this cumulative impact is happening. Fewer and fewer localities are voluntarily taxing below the cap; instead they choose to tax to the cap limit.

Impact May Be Felt First By Schools Because They Lack Revenue Options — And Cannot Avoid Costs of Expanding Enrollment. Which local governments will feel the cumulative impact of the tax cap first? While this is difficult to predict, schools may be hurt first. They simply have fewer alternatives to the property tax. Moody's Investor Service views "school districts as the class of government with the most risk exposure to the cap because of their reliance on property taxes as a funding source."

As noted earlier, one collar county school reported being hit by the "triple whammy" of caps, lower state aid, and increased enrollment. In essence they cannot effectively control the revenue side of their budget because the caps are state-imposed and state aid is obviously state-controlled. On the expenditure side of their budget, they cannot control the increase in enrollment which drives up their cost of doing business. That is, they legally cannot refuse to instruct new students that enter their jurisdiction. And they cannot control costs caused by various state and federal mandates.

Degraded Services and Fewer Services May Be in Store for Illinois. What does the future hold for Illinois localities? The answer may lie in other states that have already passed similar property tax limits. In California, localities have operated under Proposition 13 since 1978. This required localities to: (a) roll back taxes to 1% of market value (e.g., $1,000 tax on a $100,000 home); (b) assess the value of homes at 1975 prices, for residents living in their homes at that time; and (c) limit, after 1975, annual increases in the assessed value of homes to 2%. The impact upon municipalities, not surprisingly, has been a reduction in services. According to the Lincoln Institute for Land Policy, California cities cut the following expenditures on services (adjusted for inflation and population growth): General Government services — 21%; Public Works — 15%; Health & Public Aid — 14%; Recreation — 11%; and Public Safety Services — 6%. The Illinois Economic and Fiscal Commission reached a similar conclusion.

In 1981 Massachusetts adopted Proposition "2 1/2" which (a) limited property taxes to no more than 2 1/2% of the market value of a home, and (b) capped growth in property tax levies to 2 1/2% annually. According to Mike Peddle, a Northern Illinois University professor, this law affected Massachusetts municipalities "terribly."

They were hurt by two factors: the cap which limited growth in revenues and the recession of the late 1980s which limited all municipal revenues. Professor Peddle said a representative example of the state impact was Worcester, Massachusetts; this municipality had to "pink slip" about 40% of its work force in one year. The Illinois Economic and Fiscal Commission came to a similar conclusion for Massachusetts schools.

Cap Could Be Disastrous During High Inflation. PTEL limits property tax extensions to the lesser of 5% or inflation. This exposes local governments to inflation-driven cutbacks. In the very first year of the tax cap, with inflation running high the state imposed the 5% cap. As a result, collar county governments saw their real "purchasing power" decline. This probably will occur again in the future, given that caps have already failed to keep pace with inflation. More importantly, local governments will be vulnerable to national and even international events that force up inflation.

III. TAX CAP, WITH UNFUNDED MANDATES,
      SQUEEZES LOCAL GOVERNMENTS

The tax cap has serious implications for local governments' ability to perform basic functions like education and policing. Given the new "predatory" federalism marked by unfunded mandates, the cap will be especially burdensome. As shown in a 1993 Illinois Municipal Review article, there are many state and federal mandates that, together, amount to a significant part of municipal budgets. Eventually these factors should result in fewer local services and/or lower-quality services. •

The ILLINOIS MUNICIPAL REVIEW continues to be an open forum of expression for municipalities. Articles appearing in the Review do not necessarily express the views of the League or its staff but those of the various authors.

January 1995 / Illinois Municipal Review / Page 21