Some Governments May Hide a Budget Surplus to Justify a Tax Hike

ATLANTA — It’s yearly property tax collection season, and along with it may come questions of how those property taxes are used, and if there’s a tax increase — why? A new academic study suggests that when local governments collect a more in taxes than their budget requires, some finance officials quietly use accounting tricks to make that extra money disappear from public view — not to save it for a rainy day, but to keep the taxes coming.

The research, led by Amanda Beck of Georgia State’s J. Mack Robinson College of Business, along with Xi Chen of the University of Bristol and Gilles Hilary of Georgetown University, examined more than a decade of financial records from over 2,100 U.S. cities and counties. Their conclusion: Municipal administrators appear to manipulate their own financial statements to downplay budget surpluses, particularly after property values — and the tax revenue that comes with them — rise.

It sounds strange that anyone in government would want to hide good financial news. But the researchers argue the incentives work in reverse. Surveys cited in the study show that only about 3% of local officials want to return a surplus to taxpayers through rebates or tax cuts, while roughly 20% of citizens say that's exactly what they'd prefer. A visible surplus hands residents ammunition to demand lower taxes, but for unelected administrators who run the day-to-day finances of a city or county, a surplus provides money that expands what they can do, and, potentially, what they can earn.

“If the local government is wanting to raise property taxes, whether it be for reasons good for the community or selfish reasons like increasing their compensation, they’re still more likely to get push back if the community is aware there’s a budget surplus, so they want to minimize that reporting to avoid that opposition,” said Beck, an associate professor in Robinson’s School of Accountancy.

To test their theory, the team built a large dataset combining municipal financial statements, housing price data from the Federal Housing Finance Agency and information on local politics, union membership and government oversight structures, spanning 2005 to 2013.

They tracked two forms of accounting discretion, which are legal but flexible choices in how a government reports its finances. One involves shifting money between different funds. The other involves adjustments buried in accrual accounting, like how a government estimates unpaid taxes or pension costs. Both offer administrators room to make a surplus look smaller than it really is.

“Accounting judgements can be really hard to make, but you shouldn’t make them based on a reporting outcome you’re trying to achieve,” Beck said. “For example, if you’re trying to decide the life of a building and how to report depreciation expenses, whether you’re trying to report a deficit or surplus on this year’s financials shouldn’t have any bearing on that decision.”

The researchers looked at these accounting discretions to see if there was a connection between growth in housing values, which often results in increased property tax revenue, and a rise in government’s manipulating the revenue numbers to appear lower.

“Governments want to capture those property value increases as taxes, but there are laws that can prevent them from doing that when citizens oppose it. So, officials need to be able to justify raising those property taxes,” she said.

This connection was clear: When property values rose and a government already had a surplus on the books, it was more likely to use accounting maneuvers that offset the extra income — effectively erasing the appearance of a windfall.

That behavior was weaker in places with stronger financial oversight, such as governments subject to rigorous federal audits, and in states with strict caps on how much local governments can tax or spend. It was stronger, meanwhile, in places where property tax revenue is more tightly linked to home values, and — notably — in places where the compensation of municipal managers rises along with tax revenue.

“When incentives are high or when public opposition is high, that would give governments more of an appetite to manipulate the numbers,” Beck said.

Local governments control a striking share of the U.S. economy — nearly 10% of GDP — and, according to national surveys, Americans trust them more than state or federal government. Property taxes, meanwhile, are consistently ranked among the most unpopular taxes in the country.

“Governments need taxes, and citizens are always going to oppose tax increases. But it’s important for citizens to have the full picture of what their government is making a decision on rather than being manipulated to sway their opinion,” Beck said.