No sale: Effects of the government sector's decline in employment.

In considering the economic outlook for 2002, it seems that the area with the lowest potential may well be the government sector, which is in the late stages of a recession and in the middle of a long-term downward trend. Although some citizens suspect that governments are a drain on economic development, most accept the premise that a region's economy draws strength from such government services as fire, emergency, and police protection; the judicial system; public health and social services; education; and those entities that contribute to energy, transportation, and communication. This sector of the Memphis economy is large, essential to the rest of the economy, and in decline. The 2002 forecast is for weak revenue growth and stagnant or declining employment.

Of the Memphis Business Journal's list of the twenty largest local employers, half are government enterprises. Memphis Light, Gas & Water employs 2,534; The University of Memphis accounts for 3,200 workers; and University of Tennessee employment in Memphis is higher than that of First Tennessee National Corporation. The largest local employer, FedEx Corporation, employs some 30,000 locally--but Memphis City Schools, the city of Memphis, the U.S. government, and the Naval Support Activity in Millington have a higher collective number of workers. These and other government employers, including suburban cities, accounted for 16.1 percent of the area's jobs in 1990. By 1995, sector employment had fallen to 14.7 percent; by 2000, it had decreased to 13.5 percent. The sector's current share of total employment is at 84.0 percent of its 1990 share. Although total employment in the Memphis area grew at an average annual rate of 2.1 percent during the 1990s, government employment increased just 0.3 percent per year.

Although some see the decline in government sector employment as a positive sign for overall economic efficiency, the news is not always good for citizens or businesses. With fewer judges, court clerks, and other employees, legal disputes take longer to resolve. Having fewer employees in county records offices or tax, license, and permit offices means longer waits. A smaller pool of school employees means less supervision and, in all likelihood, decreased attention to difficulties in individual learning. A reduction in police, firefighters, and emergency service workers creates a slower reaction time and a decrease in specialized skills.

The source of the sector's stagnation is on the revenue side. A city of Memphis contract grant with The University of Memphis' Bureau of Business and Economic Research includes tax forecasts and analyses. The city of Memphis is most dependent on two revenue sources: taxes on retail sales and taxes on real and personal property. The state of Tennessee has no property tax and, therefore, relies most heavily on the sales tax. Both the property tax and the sales tax have economic characteristics that make it difficult to fund government employment growth to match inflation and increases in population. Property tax revenue grew 48.0 percent between 1995 and 2001, but much of that growth came in 2001 as the result of a 21.7 percent increase in the tax rate. Because of negative changes in the property tax for several years between 1995 and 2001, increases between 1995 and 1999 cumulated to less than 4.0 percent. In fact, a study of property taxes reports that, under existing tax law and procedures, growth in existi ng property values and inflation has no impact on property tax revenue. Only new construction, annexation, and increases in the property tax rate cause property tax revenue to increase.

Sales taxes grow with inflation and economic development, but not proportionately. From the end of fiscal year 1995 through the end of 2001, national retail sales increased by 39.8 percent--from $208.6 billion to $291.7 billion--and the GDP grew a cumulative 40.7 percent. A large portion of that growth stemmed from inflation of nearly 17.0 percent. During the same period, Tennessee sales tax revenue growth totaled 34.8 percent. However, the city's share of state sales tax revenue grew 32.3 percent. Memphis' local option sales tax revenue grew only 23.9 percent, from $76.8 million in 1995 to $95.2 million in fiscal year 2001. Tennessee sales tax growth did not match national growth in retail sales, and neither did Memphis' share of state sales tax. The sales tax tied most directly to the local economy grew even less. Local government divisions that need to grow with inflation and economic growth have revenue sources that deliver severe revenue shortfalls.

Judging government services by common business standards, we would rate real growth and funding as inadequate. Strong businesses grow at rates that match or exceed inflation and growth in the rest of the economy but must limit their attempts to increase revenue by raising prices. Although government tax rate increases may be necessary to maintain revenue growth, the political consensus is that tax rates are too high.

While revenue growth is too slow, it sounds paradoxical to claim that tax levels are excessive. Sales taxes are high in Memphis and the state because both rely heavily on limited sources. Both governments are becoming aware that they are effectively "losing market share." Just as customers may transfer their business if one company's prices are higher than those of its competitors, consumers respond to the area's relatively high sales tax rate.

The city of Memphis' reliance on the property tax produces a tax rate that is high in comparison to alternative business locations. Real estate investors and entrepreneurs investing in plants and equipment are showing predictable reactions to in-city property rates that are double or more the rates available in rival political jurisdictions. Excessive reliance on the property tax will also cause the city to lose its "market share" of the single-family residential market. This will translate into demographic changes that will hurt city revenue from local, state, and federal sources. Growth in the Memphis share of state-shared sales taxes was less than growth in the Tennessee state sales tax because the city's share depends on municipal growth. Memphis is losing its population growth to other municipalities.

In the next year, the state and Memphis-area governments face the threat of inadequate revenues. The shortfalls come from sluggish growth trends and are compounded by the ongoing recession. Current projections for fiscal year 2002 give Memphis about 3.2 percent overall growth in revenue, despite the fact that sales faxes are suffering declines due to recession conditions. For Tennessee overall, revenue growth will be positive but the projected 1.2 percent growth is small by historical standards. A forecast 1.9 percent decrease in sales tax revenue will be the main negative element in the state budget.

Many believers in fiscal policy are calling for the government to cut taxes and increase spending in the face of business cycle decline. They believe that the government's fiscal policy can have a multiplier effect and mitigate the recession. However, state and local constitutional provisions against running budget deficits mean that local government employment, cuts may be large. Through a multiplier effect, those cuts would then worsen the impact of the recession for local and state economies, even if the federal government stimulates the national economy. Memphis City Revenues vs. Tennessee State Revenues, 1995-2002

Memphis City Revenue (millions)

Retail Sales Tax

Property Local Option State Shared Other Revenues 1995 $ 93 $77 $32 $ 120 1996 93 82 33 119 1997 92 87 35 124 1998 93 88 36 134 1999 97 99 38 143 2000 108 98 41 149 2001 137 95 42 148 2002 (*) 146 93 41 155

Memphis Tennessee State Revenues (millions)

City

Revenue

(millions)

Retail Sales

Total Tax Other Revenues Total 1995 $322 $3,452 $2,277 $5,729 1996 327 3,366 2,380 6,046 1997 338 3,891 2,499 6,390 1998 351 4,070 2,682 6,752 1999 372 4,317 2,693 7,011 2000 396 4,590 2,984 7,574 2001 421 4,653 3,022 7,675 2002 (*) 435 4,653 3,202 7,765 (*)= Forecast. Notes: All numbers rounded to the nearest million.

Richard D. Evans, Ph.D., is professor of economics at The University of Memphis. Prior to 1978, he taught at Lincoln University of Missouri and Wright State University. His teaching specialties are real estate, forecasting, and organizational economics. Other research includes risk analyses of educational and occupational income distributions, housing price trend forecasting, and the efficiency of real estate markets' adjustments to changes in economic conditions. This report was compiled during the third year of a City of Memphis/Bureau of Business and Economic Research grant to forecast tax revenue.