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Commentary: What's good about the city earnings tax?

This article first appeared in the St. Louis Beacon, July 22, 2009 - Few local public finance issues generate more controversy than the Earnings Tax.

The city of St. Louis imposes a tax of 1 percent on all the wages earned within the city by both residents and non-residents. City residents who work outside St. Louis must pay the 1 percent tax on their wages as well. In addition, the city collects a one-half percent tax on the payroll of businesses that have employees working within the city of St. Louis and a one percent earnings tax on all profit generated within the city limits.

The only other city in Missouri with an earnings tax is Kansas City. In the country, major cities in 17 states impose earnings taxes.

As with all taxes, the earnings tax has its share of detractors. For example, a recent Beacon voices article asserts that the tax is one of the causes for the decline in personal income in the city of St. Louis between 1990 and 2007. The article, written by two University of Missouri economists, goes on to say that the earnings tax might even be responsible for shifting economic advantages to suburban and even out-of-state areas.

The plain truth of the matter is that St. Louis, like most older cities in the Midwest and Northeast, has experienced dramatic decreases in population over the past half-century, due in large part to public policies in housing and transportation that favor suburban over urban areas and to a de-industrializing U.S. economy. Furthermore, many other cities in the South and West were able to annex adjacent land, thereby retaining a large share of their region's population and wealth.

However, a city boundary set in stone in 1876 has prevented St. Louis from doing what some others could do. The result has been that the city's share of regional population, and thus wealth, is decreasing faster than its share of employment.

In 2000, for example, St. Louis City had 13 percent of the region's population (348,189 out of 2,603,607), but 21 percent of the region's workers (262,981 out of 1,252,570). Fully 180,501, or 69 percent of those 262,981 workers, were non-city residents -- a number roughly equal to the entire population of Salt Lake City, Utah, and greater than the combined populations of Florissant, Chesterfield, University City, Kirkwood and Clayton. These commuters and the firms that employ them demand public services including roads, public safety, building inspections, etc.

Without the much-maligned tax, the city would have to pick up the whole tab for services that benefit both commuters and residents alike. City residents cannot handle the burden of paying for these services alone.

If the Earnings Tax were to suddenly vanish, city residents would see a $180 million shortfall (out of $460.5 million in general revenue) in their city's budget that would have to be made up by increases in other taxes and fees, or deep, painful cuts in essential services including police and fire protection. This translates into $1,215 per employed citizen of St. Louis city. Thus, as a matter of good public policy, non-city residents who also benefit should pay for their share of those services.

Other central cities without earnings taxes have other options to help pay their bills. For example, some cities rely more heavily on property taxes, simply because they have more property owners. Others levy entertainment taxes on sports, conventions, etc. St. Louis' hands are tied. Its ability to tax real property in the city is restricted by the state and therefore that tax rate cannot be adjusted to cover this gap. Besides, exchanging the earnings tax for higher property taxes might encourage employment in the city but discourage real estate investment and home buyers.

Raising entertainment taxes would reduce attendance at Blues, Cardinals or Rams games and hurt restaurant, hotel and convention profits - amenities that benefit and increase the attractiveness of the entire region. Severe cut backs in public services or the loss of those amenities would act as a disincentive for businesses to locate or stay here. Bottom line: Eliminating the Earnings Tax would not only damage the city's revenues in the short-term, it would also hurt the city and region's long-term economic future.

Critics who say the Earnings Tax is distortionary gloss over a key point in the whole discussion. In fact, all taxes, except the flat tax, distort economic decisions. Thus, there will always be a trade-off between generating enough revenues to pay for needed public services and more private consumption.

It pays to heed Winston Churchill's advice, however; regarding a less than perfect solution to another vexing problem, he said that "democracy is the worst form of government except all the others that have been tried." Thus, in trying to maintain an adequate level of services in St. Louis, the Earnings Tax is the worst tax except for all the other alternatives.

Its detractors find it easier to criticize the tax than it is to come up with a realistic and viable alternative that will work in St. Louis' unique context.

Robert Cropf chairs the Department of Public Policy Studies at St. Louis University. Rob Ryan is a research associate at Saint Louis University's College of Education and Public Service in the Office of Community and Social Research.