The Fiscal Impact of Annexation Methodology on Municipal Finances In North Carolina

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Introduction

Municipal annexation is often a contentious and emotionally charged event that affects millions of citizens and hundreds of municipalities each year in the United States.  During the 2000′s more than 93,000 annexations were conducted in the United States (USCB 2012).  These annexations provide a powerful mechanism through which a municipality can expand the territorial limits of their jurisdiction.  Successful completion of an annexation can result in additional revenues, population and customers for the annexing municipality.  Meanwhile, newly annexed residents can expect new public services, higher taxes, and different political representatives as a result of annexation actions.

Annexation is often portrayed as an economic windfall for the municipality completing the annexation and that financial considerations are a major consideration for annexing municipalities (Spain 1949; Rusk 2003, 2006; Heim 2006).  Spain (1949) and Heim (2006) both discuss the importance of annexation as a tactic for expanding a municipalities tax base and access resources.  Rusk (2006) linked a community’s fiscal health, measured by examining municipal bond ratings, with overall annexation activity.  This work built upon his previous analysis of ‘elastic’ vs. ‘inelastic’ municipalities around the country (Rusk 2003).  Likewise, opponents of annexation lay claim that the additional tax revenues collected by the annexing municipality will off-set any costs associated with the delivery of new public services to the annexed area.  However, many municipalities are all too familiar with the costs associated with completing an annexation.  In fact, numerous states require municipalities to complete benefit-costs analyses prior to the completion of an annexation (Steinbaeur et. al. 2002).  In the end, little research has been completed on the economic impact of annexation activity on the fiscal health of a municipality.

The majority of the literature on annexation has tended to disregard the fact that municipalities often have multiple methods by which to complete an annexation.  The state level of analysis of many studies results in a broad simplification of the annexation methodologies available to municipalities (Sengstock 1960; Hill 1978; Southern Growth Policies Board 1980; USACIR 1993; Palmer and Lindsey 2001; Steinbauer et al. 2002).  This results in a misleading categorization of annexation in a State by the most dominant annexation methodology utilized.  Smith and Wilse (2013) and Smith (2012) highlight the complexity of annexation methodology through examinations into municipal annexation activity in North Carolina.  These recent studies showcase the importance of taking annexation research beyond a simple typology and to begin to analyze annexation activity by the method of annexation implemented by a given municipality.

As a result, the purpose of this article is to examine the impact the method of annexation chosen by a municipality has on a communities fiscal well being.  Overall, more than 14,000 annexations conducted by 346 municipalities between 1990 and 2010 in North Carolina were analyzed.  A better understanding of the impact of annexation methodology on the fiscal health of municipalities is critical to helping elected officials, staff and citizens make informed decisions regarding the future growth trajectory of their respective communities.  The results of this analysis will help municipalities around the United States understand the impact that the method of annexation has on their financial prosperity and make more informed decisions on whether to grow and/or how to expand their geographic boundaries.

Fiscal Motivations Surrounding Annexation

A major subset of annexation research has been focused on the role of economic considerations and their relationship to annexation.  Municipalities see annexation as a means by which to collect additional revenue through direct (e.g. property tax and sales tax) and indirect (e.g. federal and state redistributive) revenue streams. These additional revenues can help to offset proposed tax increases on the existing citizenry or result in a decrease in tax rates for a community.  As a result, the economic influence of annexation has been discussed by numerous scholars over the past several decades (Bollens 1949; Mac-Manus and Thomas 1979; Fleischmann 1986; Rusk 2003; Smirnova and Ingalls 2007, 2008).

Beginning with Bollens (1949) examination into the annexation of fringe areas surrounding municipalities up to the most recent work of Smirnova and Ingalls (2007 and 2008), the economic benefits of annexations have been widely touted.  Rusk’s (2003) study revealed the importance of annexation on the fiscal health of existing municipalities.  He stated that municipalities that are able to grow their city limits (elastic) would be better able to capture fleeing tax revenue.  Inelastic municipalities will not have as great a chance to grow their population or tax revenues due to suburbanization and growth on the fringes of cities. Rusk (2006) built upon his previous work and revealed a link between annexation activity and municipal bond ratings.  This work determined that cities that were more activity in annexing surrounding territory had better bond ratings due to the fact that they could generate additional revenues without having to raise taxes.

Smirnova and Ingalls (2007, 2008) also examined the effects of annexation laws on central city growth and prosperity. Their 2007 study focused on the influence of state annexation laws on the growth of a group of selected southern cities. The results of this study revealed that more restrictive annexation requirements led to increased levels of political fragmentation and less tax revenue for central cities (Smirnova and Ingalls 2007).  In a 2008 comparison of cities in North and South Carolina, Smirnova and Ingalls determined that North Carolina’s more liberal annexation laws ‘‘made it easier for cities to annex making central cities borders more elastic contributing to the vitality of the central cities and their urban regions’’ (19) compared to South Carolina cities which have a more limited power to annex property and people.  The major deficit in these analyses is that all annexation activity is treated the same.

 

Annexation in North Carolina

North Carolina municipalities have four methods through which to complete an annexation.  Municipalities can go through the General Assembly of North Carolina and complete what is termed a ‘legislative’ annexation.  According to recent research only 1.1% of all annexations completed in North Carolina between 1990 and 2010 have been legislative annexations (Smith 2012).  Secondly, municipalities can complete one of two kinds of voluntary annexations:  voluntary contiguous or voluntary non-contiguous (satellite).  The voluntary form of annexation accounted for 89.5% of all annexations during the study period, with voluntary contiguous and voluntary non-contiguous annexations accounting for 65.7% and 23.8% respectively.  Finally, a North Carolina municipality may elect to complete an involuntary annexation if the territory under examination meets a set of State determined tests for urbanity.  Involuntary annexations accounted for 9.3% of all annexation activity between 1990 and 2010.

The method of annexation that is utilized to complete a boundary change transaction can have dramatically different fiscal impacts on the annexing municipality.  For example, during the study period both forms of voluntary annexations did not require the extension of any public utilities (e.g. water and/or sewer) as a result of annexation. As a result, the major capital costs associated with water and sewer extensions could be bypassed by a municipality through the use of voluntary annexation mechanisms.  Contrarily, the use of involuntary annexation methods brings with it the requirement that major water and sewer trunk lines be extended in addition to other public services to areas being annexed under this form of annexation.  Finally, the use of legislative annexation actions can result in a negotiated agreement and either favor the municipality or entity being annexed depending on the politics involved.

 

Data and Methodology

The data utilized for this empirical analysis of annexation and the fiscal health of municipalities comes from a variety of sources.  The annexation data was collected from the North Carolina Secretary of State’s Office, which is the repository of all annexation activity for North Carolina.  Municipalities in North Carolina are required by General Statute to inform the Secretary of States’ Office of any annexation activity.  The other data that was utilized to explore the relationship between annexation methodology and the fiscal health of North Carolina municipalities was obtained from the “Log Into North Carolina”  (LINC) website that is maintained by the NC State Data Center and includes data collected by North Carolina governmental agencies and the US Census Burea.

After collecting the required data, a multiple regression analysis was conducted to examine the relationship between the percentage of change in the municipal tax rate during the study period and a variety of independent variables including: annexation methodology (e.g. voluntary contiguous, voluntary non-contiguous, involuntary and legislative), population, population density, per capita municipal expenditures, per capita municipal revenues, per capita utility expenditure, total property valuation, municipal growth rate, county growth rate, and metropolitan status.

 

Findings

At the time this abstract was submitted the multiple regression modeling was still being completed.  It is hypothesized that involuntary annexation activity will have the largest influence on municipal health as measured by percentage of change in the municipal tax rate.  Involuntary annexation activity should have the largest impact do to the statutory requirements that municipalities share in the utility costs of extending service to newly annexation areas.