Stop Chasing Population Growth: The Real Secret to Boosting Tax Revenue

Introduction:

Population growth is one of the most significant factors influencing the financial health of local governments. It affects everything from infrastructure needs to economic activity. One particularly dynamic area where this relationship plays out is in sales tax revenue—a key funding source for many municipalities. Municipalities can receive sales tax revenue via two streams: Direct Sales Tax, or revenue received directly from sales completed in the municipality, and State Sales Tax Revenue Sharing which provides municipalities with a share of state sales tax revenue based on a municipality’s population size. Direct Sales Tax Revenue is the most common source of revenue for municipalities, but approximately one in five U.S. states disburse sales tax revenue to municipalities based on population. By examining a real-world example, this article explores the interplay between population growth and sales tax revenue, offering insights for local government officials and policymakers.

Population Growth and Residential Changes:

Consider "City A," a fast-growing municipality in the western United States. Over the past two decades, its population expanded rapidly, transforming it from a small town into a significant urban center. The city’s residential landscape evolved alongside its population, shifting from predominantly single-family homes to a more diverse mix of housing types, including townhomes, apartments, and accessory dwelling units (ADUs), as shown in the chart below:

This growth did not occur in a vacuum. The city’s population increased immensely, adding thousands of new residents, even as growth slowed over the last four years (see the following table):

Such rapid expansion posed both opportunities and challenges for city administration, particularly when balancing the demand for services with the ability to fund them through tax revenues.

Sales Tax Revenue:

Sales tax revenue in City A grew dramatically, increasing fivefold over a 12-year period. This growth stemmed from two key factors:

1. Direct Sales: As the city’s population grew, so did local economic activity. Businesses expanded to meet the needs of the rising population, leading to increased direct sales and, consequently, higher sales tax revenue.
2. Population-Based Revenue Sharing: In City A’s state, a portion of sales tax revenue is distributed based on the city’s share of the state population. As the city’s population grew relative to others, its share of this revenue increased.

Over time, the city’s reliance on these revenue streams shifted. The proportion of sales tax revenue derived from direct sales rose steadily, signaling a growing local economy and increased commercial activity. However, this trend also highlighted a potential vulnerability: a significant portion of revenue still depended on external demographic factors beyond the city’s control.

Risks and Strategic Considerations:

Population growth brings both rewards and risks. For cities like City A, one risk is that as population growth slows—or as other cities grow faster—the share of population-based sales tax revenue may decline. This underscores the importance of fostering local economic development to sustain and grow direct sales revenue.

Additionally, cities must consider the long-term sustainability of their financial models. Rapid population growth often drives up operational and infrastructure costs, potentially outpacing revenue gains. For City A, over 50% of general fund revenues depended on sales tax—a potentially precarious reliance if growth patterns shift.

Opportunities for Local Governments:

?Local governments can draw several lessons from City A’s experience:

• Encourage Commercial Development: A robust local economy reduces dependence on external revenue sources and mitigates risks associated with demographic changes.
• Diversify Revenue Streams: Exploring alternative funding mechanisms can provide greater financial stability.
• Plan for Buildout: Understanding future growth limits and adjusting projections accordingly can help manage expectations and ensure fiscal sustainability.

Conclusion:

The relationship between population growth and sales tax revenue is complex and multifaceted. While growth brings opportunities for increased revenue, it also requires careful planning to address potential risks. By strategically managing growth and fostering a thriving local economy, municipalities can position themselves for long-term financial health.