Meeting Local Needs with Fairer Local Taxes

When our communities are well funded, we can all thrive. Virginia’s cities and counties are tasked with running services that are the foundation of strong communities and robust economies. They maintain roads, run our libraries, build parks, and much more. They’re also the biggest source of funding for our public schools. The quality of services depends on how much money there is to pay for them, and that money comes from a variety of sources, including funds from the state and federal governments, as well as the locality’s ability to raise its own revenue. 

While revenue sources range from property taxes to local sales and use taxes to licensing fees,  localities are limited in their ability to raise resources. As a result, localities must overwhelmingly depend on sales and use taxes and property taxes, which do not account for ability to pay and are regressive, asking more of community members with the least. Meanwhile, households with the highest incomes pay the least in these taxes as a portion of their income, despite a higher ability to pay. In order to be able to make improvements to how they fund their essential services, localities need to be given permission to create new taxes from state lawmakers. Given current and looming constraints on local revenues, Virginia’s state lawmakers should consider options to expand local tax authority, with particular consideration for income taxes.

What is Local Tax Authority and Why is it Limited?

Virginia is considered a “Dillon’s Rule” state, meaning that localities can only act within the power and permission granted by the state government. The name Dillon’s Rule refers to two decisions made by Iowan Judge John F. Dillon in 1868, which affirmed that local authority is derived from state power and were later upheld by the Supreme Court. While Virginia in the past has debated granting greater authority to localities to self-govern (called “Home Rule”), our current constitution explicitly lays out that the authority of localities comes from what is granted by the General Assembly. Some other states have granted greater authority to localities to self-govern, ranging from more limited to more robust powers for localities.

The General Assembly shall provide by general law for the organization, government, powers, change of boundaries, consolidation, and dissolution of counties, cities, towns, and regional governments.

 – Constitution of Virginia, Article VII, Section 2

Every action a locality takes in Virginia is rooted in the state’s authority. From funding public schools to collecting garbage to paving roads, a locality’s entire ability to serve its residents has to be expressly given by the state of Virginia. This includes the power to raise the necessary revenue to fund essential services and achieve a community’s shared goals. And right now, that power is limited to the more regressive taxes that ask more of people with less.

A Closer Look at Local Revenue Options

The state constitution specifies that most property is set aside for local revenue purposes only. This includes property tax on land and buildings (“real property”), cars and other personal property, and various categories of property owned by businesses. At the same time, state code extensively lays out the administrative powers of localities to administer and collect property taxes. 

Even with extensive and explicit legislation clarifying the limits of local power, property taxes are what localities have the greatest authority over in order to fund local services. Consequently, like local governments in most other states, Virginia’s localities rely largely on property taxes for their revenues, which made up two-thirds (66%) of local revenues in cities and counties for the budget year that ended June 2024 (fiscal year 2024).

Localities are also given the authority to collect certain additional taxes, which comprise 17% of city and county resources. These include business license taxes, restaurant taxes, and occupancy taxes. Of particular note is the retail sales and use tax. This tax has both statewide and local portions. The 1% local sales tax option, which has been adopted in every city and county, is collected from sellers by the state, which then distributes the revenues to the locality where the sale is made. Some localities also have permission from the state to levy an additional 1% sales and use tax to be used for school construction if voters approve a ballot measure.

Changes are Needed to Increase Resources and Fairness

Limited local authority to raise resources ultimately limits a locality’s ability to meet the unique needs of its residents. Put simply, the state could further empower localities through two key options:

1. Grant localities more authority over the types of revenue they can collect or
2. Create a system similar to sales tax where the state collects a specified add-on and then distributes it to the locality where it is collected. 

Expanding local tax authority in some way would allow localities to raise revenue and potentially reduce their reliance on regressive taxes. There are some recent examples of changes to local tax authority, such as a constitutional amendment that allowed certain veterans and their surviving spouses to forgo paying taxes on their homes, as well as legislation that allowed select localities to opt-in to an additional sales tax to use toward school construction. This sales tax is in addition to the statewide retail sales and use tax, and like the other local portion, it is collected and distributed by the state to localities.

When considering state and local taxes together, Virginia has an upside-down tax code, where those with the lowest incomes pay more in taxes as a share of their income than the richest among us. Property taxes, mostly levied at the local level, and sales taxes, levied at the state and local levels are large contributors to this uneven structure. On average, most people pay a similar amount of property tax as a portion of their income in Virginia. The state constitution provides local governments with the option of lowering real property taxes for low-income and/or low-wealth seniors and people with disabilities, but local governments are not allowed to provide property tax relief or rebates for low-income working-age people as is done in some other states. On average, people with the lowest incomes in Virginia pay more in sales taxes as a share of their income. While a more fair income tax levied by the state (although it has much room for improvement), helps balance some of the impacts of property and sales taxes, overall, Virginia’s state and local taxes ask more of those with least.

Due to discrimination and barriers to educational opportunity and good-paying jobs, Black and Latino families are more likely to have lower incomes. As a result, this system of property and sales taxes, which does not fully account for ability to pay, asks more of Black and Latino families in particular. Black families make up 21% of families filing taxes in Virginia, but account for 29% of families making less $26,500 (the lowest 20% of incomes). Similarly, Latino families make up 13% of families filing taxes in Virginia, but account for 17% of families making less than $26,500.

The unfair structure of our current tax code is on top of a history of local tax assessment being used as a tool to price out and displace communities of color from their own property. Historically, Black families in Virginia faced discrimination in overassessment in real property tax, making the cost of property more expensive for Black families already facing discrimination in access to financing, wealth, and housing. This increased the likelihood of Black families being delinquent on their taxes, and made it easier for local governments to seize Black-owned property. Even though this is illegal, Black and Latino families still face higher-than-normal property tax assessments, largely due to residential segregation resulting from historic and systemic factors, which leads to differences in assessment of neighborhood characteristics.

Expanding tax authority and local revenues could help restructure Virginia’s tax code more toward ability to pay as well as away from a system that has historically been weaponized against communities of color to enforce segregationist outcomes and limit wealth building.

The Local Income Tax Option: What Is It and What Do Other States Do?

Many other states use local income taxes to help fuel investment in their communities. In total, 15 states permit some or all localities to collect taxes on incomes under a variety of circumstances:

• The scope and types of applicable income vary. 
• Some states collect the tax and distribute it to localities, others allow the localities to collect the tax themselves. 
• Structures vary, with some localities in some states using flat income tax rate structures and others using graduated structures, where people pay a higher tax rate as their ability to pay increases. 
• In some states, local income taxes are widely adopted, while in others, just a few localities use income taxes.

• In neighboring Maryland, every county has a local income tax. Maryland’s local income tax is simple to administer and could provide a good model for Virginia to use in creating its own local option. While localities set their own rates, Maryland’s income tax is collected and distributed by the state, lowering the burden of collection for localities.

This is not even a novel idea for Virginia. Starting in 1989, some localities in Northern Virginia and Hampton Roads could have adopted a local income tax up to a 1% flat rate on individual and corporate income through voter approval if it went toward transportation. However, no locality opted to do this. In 2013, this law was repealed, ending the option for localities.

Allowing a local income tax would also address a current unfairness about Virginia’s school funding system: the local composite index that determines what share of school costs the state will pay and what will be left to the locality uses total local income as one of its measures of local capacity, but local governments aren’t allowed to tap into that capacity to pay for school costs.

Broader local taxing authority, including a local income tax, won’t solve all the problems facing Virginia communities that are struggling the most to meet residents’ needs. The state has a critical role in making sure students and families in places with fewer jobs and lower incomes still have access to high-quality schools and functioning local governments. Ultimately, the state needs to pay its fair share of costs. But for every locality, being able to pay for some of their costs with a local income tax rather than being heavily reliant on property taxes and regressive sales taxes would advance fairness and allow people in each city and county more ability to meet the needs of their community as they see fit.

Modeling a 1% add-on in Virginia

While there are many options to consider and worth studying, a simple way to implement a local income tax would be for the state to authorize localities to opt in to a local add-on to Virginia’s top individual income tax bracket. People in Virginia pay 5.75% on annual taxable income (i.e. annual income after adjustments, subtractions, and deductions) over $17,000, Virginia’s top income tax bracket.

Adding one percentage point (1% add-on) for local revenue would make the top rate 6.75% on annual taxable incomes over $17,000. If using Maryland’s model, the revenues from this new 1% add-on could go to the locality of residence. To simplify administration, income tax collections could still be administered by the state, but distributed to the locality where the tax was collected, similar to how the state collects and distributes the local portion of the sales and use tax. The tax would only apply to the types of income subject to the state individual income tax. 

Even a 1% income tax add-on could mean significant new revenues for localities— generating nearly $2.7 billion for counties and cities in Virginia, or $320 per capita, according to fiscal year 2023 and tax year 2022 data. This is equivalent to paying the average salary for over 40,000 Virginia teachers. Overall, a 1% income tax add-on would boost city and county revenues by 10%. See the map below for a locality breakdown.

An income tax add-on could be used to replace the 1% local sales tax as it applies to groceries, lower the personal property tax on cars, or invest in local services our communities rely on, such as quality public education. It would also provide localities greater flexibility in navigating uncertain economic futures without having to rely so heavily on regressive taxes.

Another option  that would further gear our tax code toward fairness would be to apply a higher local income tax only to higher incomes. While this option is more difficult to model by locality due to available data, it would certainly generate critical revenue for communities and have the wealthy pay more of their fair share. Lawmakers could also consider allowing localities to adopt an add-on to the state corporate income tax, which is a flat 6% on corporate profits.

An Increasing Need for Greater Authority

Many of Virginia’s cities and counties are struggling to meet their revenue needs. Unfortunately, they are often faced with a difficult choice: raise the tax rates they have control over, which often ask more of people with less, or cut important services in their communities. With growing pressures, such as a slowing economy and canceled federal grants, choices on what to fund and how are becoming even more critical. Granting additional tax authority to localities to levy income taxes could lessen these difficult choices. Instead, greater authority would allow localities to protect existing programs and services and make new investments that will help everyone in our communities thrive.