Nothing Left to Lose: Only Radical Strategies Can Help America’s Most Distressed Cities

Edward W. Hill and
Edward W. Hill Former Brookings Expert
Jeremy Nowak
Jeremy Nowak Former Brookings Expert, Distinguished Visiting Fellow - Drexel University’s Lindy Institute for Urban Innovation

June 1, 2000

When we first started work on this article, we called it “Cities Forgotten by Their Regional Economies.” But as we reflected more on the competitive position of distressed central cities, we realized that the title was wrong. Cities have not been forgotten by their regional economies; rather, all too often, the opposite has happened. Distressed central cities have not, or perhaps cannot, react to changes in their current competitive positions within their regional economies.

The urban employment renaissance of the 1990s has been largely confined to a few large central cities, bypassing many others and avoiding scores of formerly industrial small to mid-sized central cities. Our challenge is to understand why distressed central cities?such as Camden, New Jersey, or Detroit, Michigan?have had trouble adjusting to competitive realities and then to try to devise public policies that allow them to uncover their competitive advantages.

Our subject is not poverty; it is the competitive viability of distressed central cities. Cities can help relieve poverty only by creating opportunity. They will become places of opportunity only when their assets are competitive in their regional economies. And they can do this only by creating environments in which city assets are part of self-sustaining, self-organizing markets?housing markets, labor markets, and markets for business locations.

Federal, state, and local governments can help reconnect distressed central cities to their regional economies but only as long as there is sufficient political will to do so. The proposals we offer are so disruptive to the current state of redistributive local politics that we expect, initially, they will be adopted by cities only in response to a severe municipal fiscal crisis. Once the value of these proposals is demonstrated, competitive forces will lead more cities to cooperate with state and federal governments and reconfigure their economic environments.

We offer a four-part mechanism for reconnecting distressed central cities to their regional economies: long-term restructuring and lowering of municipal taxes; careful examination and strengthening of public administration and management; development of procedures and funding for the assembly of land and renewal of infrastructure; and expansion of the earned income tax credit to make work pay for low-income families.

Distressed cities cannot undertake these reforms on their own. They need both political and fiscal freedom to change the usual way city business is conducted. Meaningful reform will take place only with the aid of a powerful outside agent, working with a tough operating agreement, that will give local politicians someone else to blame for the necessary, painful restructuring. The federal government’s major role is to make up for revenue shortfalls over a 10-year period as the city radically reduces its tax rates, creating an environment in which it can reestablish the value of its assets and assure a competitive future.

Thanks to the mid- to late 20th-century revolutions in transportation and communications, central cities are now just one of many competing jurisdictions that offer assets on the supply side of regional product markets. The days when cities could redistribute income are gone for all but a very few of the largest American cities?and even their ability to redistribute income is limited. Not only has the competitive position of America’s cities eroded, but the deadweight of the institutional baggage from the past?political cultures and expectations, management practices and union contracts, and the politics of operating in the current federal system?inhibits or prohibits meaningful reform. If changes are not made to both the bundle of services provided and the taxes charged, city governments will continue to be managers of decline, their competitive position will continue to erode, and their regional economies will continue to bypass them.

The Needs of Distressed Cities: The Camden Case

Camden, New Jersey, once an industrial inner-ring suburb of Philadelphia, illustrates all too well the plight of a noncompetitive city. The reason for state and federal involvement in the affairs of these places is pragmatic. Higher-level governments are locked into a strategy of pouring money into the city coffers simply to keep basic municipal services functioning. There is no pretense of attempting to fix fundamental problems. Nor is there any way for the state and federal governments to withdraw their financial support without the city collapsing. Indeed, the higher-level governments have no exit strategy?they cannot get out using current tools because the assets of the city cannot revive in any meaningful way.

How bad off is Camden? Twelve percent of all its buildings have been abandoned; 40 percent of its adults have no high school diploma; 35 percent of households have incomes below the poverty level; and single mothers head 38 percent of the households. Camden is an economic failure. Its housing market has failed. Its residents are not vigorous participants in the regional labor market. Its tax roll cannot support its own municipal government. Outside of the waterfront, which has been taken over by the state, the county, and the Delaware River Port Authority, the city is not a viable site for business. Ideally the city would be disincorporated, but no unit of government will take the resulting pieces either through municipal annexation or as unincorporated territory.

Camden raises about $30 million a year in local taxes and other revenues toward its operating budget of $80 million. Each year, the state provides $50 million just to plug that budget deficit, leaving the city with no capital budget. This $50 million budget infusion from the state is equivalent to the annual payments on a $714 million non-reducing bond issue. That means that nearly three-quarters of a billion dollars of the state’s wealth is tied up in municipal life-support?a flow of funds that just maintains the current incompetent level of municipal services.

Camden’s constant struggle to raise money keeps housing values extremely low. In Camden the typical price for a row home is $20,000 to $45,000 (in a metropolitan market where the median house sells for $120,000). Over the 1990s, a church-sponsored community development corporation (CDC) in one Camden neighborhood made an all-out effort to revive its 1,200-house community. It purchased, rehabilitated, and sold 100 abandoned row houses, raising the average house value in the neighborhood from $20,000 to $45,000; increasing the total capitalized value of the neighborhood from $24 million to $54 million. Regrettably, even these heroic efforts are not enough to revitalize the neighborhood because city hall is a prominent countervailing force.

The impact of capitalized local tax values was clearly demonstrated in 1999. The city reassessed all the properties completed by the CDC over the previous four years. The original tax bill of $1,500 (3.3 percent of market value) on the typical row house increased to $2,200 (5.0 percent of market value). Assuming a 7 percent discount rate, the market value of the properties decreased by $10,000 because of the $700 increase in property taxes.

There are limits to what a CDC can accomplish. It cannot provide basic services or replace local government. The words of the CDC director forcefully bring the point home: “The municipality is absolutely necessary to the long-term health of this neighborhood and it is absolutely absent. We ultimately cannot do the streets, and we need them done. We cannot do the sewers, and we need them done. We cannot reduce taxation, and we need it done. And we cannot reduce drug trafficking, and we need it done. . . .”

Like all distressed cities, Camden suffers from a conflict in goals. The goals of creating opportunity and building assets, of preserving financial values in neighborhoods, and of promoting social mobility and wealth-building among neighborhood residents run squarely against the goals of city hall?meeting payroll, preserving the politics of public employment, and fending off default. While Camden’s condition may be extreme, it is not unique. Scores of central cities in the nation have no hope for a competitive future under current urban public policies.

Policy Reform

Reconnecting distressed central cities to their regional economies is possible, but it requires immense political will. Together, federal, state, and city governments can craft a package of reforms that could immediately benefit severely distressed urban municipalities. The reform package would create an economic environment that supports private-sector productivity and, through productivity enhancement, creates jobs. It requires a combination of tax cuts, public-sector managerial reforms, a new package of financing for land assembly, and an expansion of the earned income tax credit.

The effort must be led and coordinated by the domestic equivalent of the International Monetary Fund, be it a part of the Department of the Treasury or an independent agency. Wherever it is located, the agency must be able to execute a rigorous operating agreement with the participating city and its state government. The agreement must have clear sanctions, including an end to federal participation in the city’s fiscal reorganization if the city or state does not fulfill its commitments.

Step One: Reforming the Tax Structure

The rescue effort begins with radical municipal tax reform, with the federal government making up for revenue shortfalls for 10 years. That 10-year window gives tax reform a chance to succeed and gives the private sector a chance to grow. It also allows the city to make staffing reforms without having to ask public employees to bear the entire burden of reconnecting the city to its regional economy.

Real estate developers and businesses will not respond immediately to tax reform, even if tax rates are radically lowered. Time is needed to assemble, clear, and retitle an inventory of marketable land. Business will need time to understand, and believe, the changes that are taking place?especially in the way the city is administered. The increase in local tax revenue triggered by the full package of reforms is not likely to be evident for three to five years.

As a first step, cities should abolish all business taxes that inhibit the location of startup firms or discourage investment in productivity-enhancing equipment or practices, including all forms of gross receipts or turnover and net profits taxes. Cities should also replace the business property tax with a tax on the market value of land, coupling the land tax with the broader use of business improvement districts or tax increment finance districts to pay for major infrastructure investments. Land taxes, which may initially be extraordinarily low, even zero, in some especially distressed neighborhoods, have several advantages over property taxes in keeping a city’s economy competitive. They discourage speculative land banking. They encourage businesses to place as much capital on property as is economically justifiable because non-land forms of real property are not taxed. They strongly encourage city government practices that preserve the value of land. And, finally, they are a powerful incentive to maintain properties.

Local personal taxes commonly take three forms: sales taxes, wage or income taxes, and property taxes, the latter being the most common. A residential property tax has two components?a land tax and a tax on the value of the structure. The land component of the residential property tax should be assessed on an equal basis with the business land tax, again providing incentives to develop in neighborhoods with low land values, as well as preventing speculative land banking.

Not many central cities are allowed to assess resident and nonresident wage or income taxes, but for those that can, these taxes are an important source of municipal income. Wage taxes enable cities to receive revenue for services provided to nonresident workers. They should not, however, be raised to uncompetitive levels, and they should not be assessed on capital gains or stock options. Either could drive businesses and wealthier individuals from the city.

Step Two: Reforming Public Administration

A management improvement task force should review city operations to learn which municipal products and services are genuinely necessary. The task force should also compare overall city staffing levels with those of other, similar-sized cities. Not all struggling cities have too many workers. For many, the problem is that the work force is too small and, after years of fiscal bloodletting and of instability and penury, lacking in competent senior-level management. All distressed cities have dispirited, ineffective work forces reflecting years of neglect in training, capital, and leadership. Dynamic, competent mayors who can attract talented staffs can make great differences in the performance of and perceptions about a city. But alone, they have neither the financial resources nor the flexibility to hire enough people to turn around the performance of the city.

Once the task force identifies the managerial holes in the city’s bureaucracy, the state must make a commitment to fill them. Because the environment in the municipal work force is often too risky to attract any but the most daring public professionals, the state may have to lend executives to the city for an extended period or allow newly hired professionals to move into the state’s civil service system.

The task force should also analyze management practices, the capital equipment available to the work force, and the skills and training required to carry out tasks. Employees and their unions should be included in these reviews, for they know more about how their jobs are, and can be, performed than anyone else. Few workers want to come to work and do a terrible job.

Another administrative issue is possible public-sector corruption. Often, what appears to be corruption is incompetence?or the reaction to it?as people try to get around a dysfunctional bureaucracy. But corruption can be real and can result from the breakdown of fiscal controls and inattention to day-to-day management. The task force itself should address managerial breakdowns. A vigorous audit of the city’s operations should deal with financial controls and corruption. Prosecutions, if required, should not drag on forever. Petty corruption should be handled administratively to allow the city’s business to resume as quickly as possible.

Distressed cities have problems with the low level of human capital among their residents. Addressing that problem requires federal investments in training. But the money will largely be wasted if it is funneled through the dysfunctional municipal bureaucracies that typify distressed cities. Does anyone seriously believe that the administration of former District of Columbia Mayor Marion Barry could deliver a quality work force training program with a low-rent patronage system of government?

Step Three: Assembling Land and Renewing Infrastructure

Distressed cities have collections of abandoned land that are liabilities, while newer suburbs have inventories of vacant land that are assets. To regain their competitiveness with outlying areas, which have only to clear and develop former farmlands, cities need to take title to abandoned urban properties and clear and assemble them into marketable parcels?and do so without lengthy and expensive court procedures.

It is difficult to find “typical” numbers on the cost of acquiring and clearing urban land. In a number of sites in two places, MidTown Corridor in Cleveland, Ohio, and an industrial redevelopment area in the city of Euclid, Ohio, the recent cost of acquiring and clearing an acre of land ranged from $200,000 to $300,000, while the cost of developing former farmland on the edge of the metropolitan area ranged from $25,000 to $50,000 an acre. The $150,000 to $275,000 cost differential represents the difference in annualized profits at a 15 percent rate of return of $22,500 to $41,250 an acre, not including other operating cost differentials that may favor the suburban site, such as insurance. There is also the question of offsetting subsidies: greenfield sites routinely receive some sort of heavily discounted subsidy for infrastructure such as gas, water, roads, and highway access, while inner-city sites typically receive loan financing, if anything. From the viewpoint of the economy we need to ask if the city site represents at least $22,500 in net social benefit. From a private financial perspective, the answer is often “no.”

The undertaking will be expensive (but it is not clear if it is more expensive than the current ineffective approach to urban renewal). The Department of Housing and Urban Development is in a position to help fund the land assembly program. The Economic Development Administration has long-standing institutional expertise in infrastructure investment. Because recycling urban land entails many environmental problems, the Environmental Protection Agency should develop land reuse standards, devise protection from legal liability for reusing land, and provide demonstration funds to finance the cleanup. EPA can also help cities maintain, upgrade, and replace basic sewer and water infrastructure. The Department of Transportation can help reconnect cities to the highway system. In all cases, the county and state should also commit funds. Finally, a legal task force at the state level should accelerate the legal process of land taking and assembly.

The cities themselves should devote all, or nearly all, of their Community Development Block Grant funds to physically renewing their neighborhoods. State government should match funds invested by the cities in rebuilding neighborhood infrastructure.

Federal and state funding to recycle abandoned urban land, along with the federal 10-year guarantee of municipal finances, is a powerful incentive for cities to embark on economic and political renewal.

Step Four: Making Work Pay

Key to any city’s opportunity agenda is the ability to make work pay. Cities that agree to participate in our dramatic reform proposals can make work pay without interfering with market-based wage-setting mechanisms by expanding the earned income tax credit (EITC) for low-wage workers within their borders.

Crediting both the employer and employee portions of the federal Social Security taxes and paying the credit to adult low-wage earners on a sliding scale similar to that used for the current EITC can go a long way toward making work pay. The Social Security accounts of low-wage earners in a reforming city can be credited for these earnings either by using money from the federal government’s general fund or by increasing the upper income limit on the Social Security tax and redistributing these funds to the accounts of the low-wage earners. States and cities should also help make work pay for low-income workers by creating state and local EITCs, where state and local wage and income taxes are credited for low-wage-earning adults.

Toward a 10-Year Experiment

We offer this proposal as the basis for a voluntary experiment with a new partnership between city, state, and federal governments. Fixing the real competitive disadvantages of distressed cities?outdated tax structures, broken political cultures, uncompetitive staffing levels, vacant and abandoned land, and an inappropriate array of public services?requires the radical experimentation and state and federal support described above. Cities cannot address their competitive disadvantages on their own. State and federal governments have to become partners with them in reform. That partnership cannot be based on old entitlement and categorical models of federal and state aid or on new lines of leaky buckets carrying federal funds through the corridors of statehouses to the desks of big-city mayors. These proposals involve some degree of risk and an enormous amount of change in inter- and intra-governmental relationships. But for many cities, there is very little left to lose.