November 22, 2010 — Virginia's state and local governments need each other's close cooperation to function effectively.

But in today's political and economic climate, the relationship has become badly frayed, a longtime state finance expert writes in the current issue of the Virginia News Letter, published by the University of Virginia's Weldon Cooper Center for Public Service.

The state relies on local governments to deliver core programs such as education, public safety and social services. In return, the state provides localities legal authority, financial and technical assistance and a helpful buffer between them and the federal government, writes Neal Menkes, director of fiscal policy for Virginia Municipal League and a former analyst for the state Senate Finance Committee and Department of Planning and Budget.

Today, "with real estate assessments and real property tax revenues in a nosedive since the housing bubble burst, local governments are looking to the state for help," Menkes writes. But political turmoil compounds this unhappy economic situation and "there is little confidence the commonwealth will come through."

A major issue is reduced state funding to localities for services such as education that the state requires and sets rules for, while one politically popular program – car tax relief – has received steady state funding. Menkes urges establishment of a statewide task force to examine the best ways to fund services and calls for more public debate on where resources should be channeled.

"The General Assembly is locked in a bitter partisan struggle – a struggle that could continue even beyond legislative re-districting and the November 2011 election," Menkes warns. "While some clamor for more money and resources for core programs, others shout for tax cuts and service reductions. Developing and enacting a state budget becomes increasingly difficult in an environment marked by widely different political agendas. Local governments end up waiting along the sideline for the fallout."

In addition to shrinking state aid, local officials expect a political assault from legislators on some local taxes, he adds. The state-local fiscal relationship is reaching a breaking point, he warns, and "something has to give."

The constitution of Virginia puts the General Assembly in charge of the relationship, Menkes observes. And Virginia follows a legal precedent, called Dillon's Rule, which limits powers of local governments only to those expressly granted by the state. The state's financial resources rely on income and sales taxes, while "localities must rely on more unpopular and complex taxes such as on real estate, utilities and business licenses."

Local governments provide close to half the funds spent on public education, but the state and federal governments drive the preponderance of education costs through their policy- and rule-making roles, he writes. The state in recent years provided less than one-third of the revenue for all of local government spending, while making mandates and requirements, he adds.

According to Menkes, five state programs make up more than 95 percent of the general fund dollars appropriated for financial assistance to localities: aid to K-12 education, aid to police departments, aid to funding for local constitutional officers, aid to programs for at-risk youths and families, and car tax relief. The car tax relief program established by Gov. Jim Gilmore costs some $950 million annually, Menkes notes. 

"In addition to requiring the substantial general fund appropriations, the car tax relief program irrevocably changed the state-local fiscal relationship," Menkes writes.

"The state basically took political control over this local revenue source, defaulting all future decisions on its use as a local tax to governors and the General Assembly. This year the General Assembly and the governor maintained appropriations for the car tax relief program while cutting state aid programs in public education, public safety and other services. Localities are spending more each year that is required to match state dollars in order to meet state Standards of Accreditation and Standards of Learning. But the car tax relief program has held steady, while state support in the other local aid categories has declined." 

Menkes urges three approaches to ease the situation.

First, the governor and legislature, as "senior partners," should agree not to further restrict local revenue authority, impose new spending requirements on services delivered by local governments, or shift state funding responsibilities onto local governments.

Second, the governor and the General Assembly, in concert with local governments, should establish a task force to develop legislative proposals for compelling state agencies to justify standards and regulations, including those in public education, in terms of costs and benefits.  The task force could also examine what services state and local governments should provide and how they can best be shared.

"We have not been in an economic and revenue squeeze like this since the Great Depression," Menkes writes. "Political leaders may now understand the need for action."

Third, as part of its own budget deliberation processes, the state needs to develop fiscal priorities.  For example, "Should education funding be afforded less priority than certain tax preferences?  Perhaps in some situations education programs should be cut, but that decision should be publicly debated ... and the fiscal priorities should be transparent to the public in both the proposed budget bill and the Appropriation Act. That is not the case today."