Local Tax Revenues and the Tax Base

1. Local Tax Revenues and the Tax Base

2. “High taxes, sometimes by diminishing consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be draw from more moderate taxes.” Adam Smith, The Wealth of Nations

3. New York bust nets counterfeit cigarettes, $6M in fake tax stamps Thursday, April 10, 2008By DAVID B. CARUSO from The Southeast MissourianThe Associated Press NEW YORK — Millions of dollars' worth of counterfeit tax stamps were seized and a Jordanian man arrested as part of a major undercover investigation into tobacco smuggling in New York….The fake stamps would have allowed unscrupulous cigarette dealers to evade nearly $6.1 million in state and city taxes, authorities said.

4. It is a signal advantage of taxes on articles of consumption that they contain in their own nature a security against excess…If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds.” Alexander Hamilton, Federalist Papers, No. 21.

5. T* Tax Revenues = rate x base Tax Rates t* Revenue Hills-The Laffer Curve

6. Evidence at the Federal Level • Income tax revenues grew in the 1980s after the Reagan income tax rate cuts. • Growth in tax revenues was likely due to continued growth in income, not because the decline in tax rates stimulated workers to work so much harder. • Reagan actually raised taxes during his term. • No strong evidence (if any) that US was on negatively sloped portion of Laffer curve.

7. City and County Tax Rates and the Base • Recent research by Haughwout, Inman, Craig, and Luce (2004) found evidence of local revenue hills in four cities: Houston, Minneapolis, New York, and Philadelphia • Easy to see gas stations on the Missouri side of the Emerson bridge, but not the Illinois side. Until recently, wide gap in gas excise taxes between the two states.

8. Why Revenue Hills Might be more Likely at Local Level • People can more easily choose where to shop in response to differential sales tax rates. • Local governments “compete” by offering tax breaks, etc. • Online shopping is becoming a more effective substitute for shopping at a bricks and mortar business. • Residence is chosen with an eye toward local school quality and property tax rates.

9. Taxes and Competition between Public and Private Sectors • Private goods and services compete with publicly provided goods and services. • People who want high quality schools may vote against school tax increases and send their children to private schools. • Private vs. Public water delivery/trash pickup. • Dahlhousie, Kimbeland country clubs vs. Jaycee golf course in Cape/Jackson

10. Taxes and the tax base • Value of public services provided by tax increases may be fully or partially capitalized into property values. • Various tax revenue sources (sales taxes and property taxes) may compete with each other. • Ex: Passage of a sales tax increase might make it harder to pass a school levy increase.

11. The Cost Disease of the Public Sector • Baumol and Bowen (1966, 1967) • Productivity grows slower in public sector than in the private sector. • Education, police protection, courts, etc. are labor intensive; not much opportunity for capital/labor substitution. • Private sector- entrepreneurs search for ways to substitute high cost labor for low cost capital.

12. Cost disease cont. • Workers in the private sector earn higher incomes because they use more capital and become more productive. • Workers in the public sector have to earn as much as their private sector counterparts. • Consequence of slower public service productivity growth is that costs per unit of output rise in public sector relative to private sector. • Governments need more and more revenue to finance the same amount of public services.

13. Missouri Local Government Revenue from Own Sources, billions of dollars

14. 1990-2006

17. A simple model of sales taxes • How do sales taxes change as income changes? • How do sales taxes change as property values change? • How do sales taxes change over time? • Data from 1990 to 2006, SE Missouri Counties • Sales taxes per capita = f( Income per capita, AV per capita, time)

18. Results • When per capita income changes by 1%, sales taxes per capita change by 1.32%. • When per capita assessed valuation changes by 1%, sales taxes per capita change by 0.1% • Holding per capita income and assessed valuation constant, sales taxes per capita are falling by about 4% each year. • Why? Internet, shift over time in consumer preferences toward services (health care, education) that are not taxed. • Transportation has made it easier to purchase where sales taxes are relatively lower.

19. Things to consider when designing local tax/spend policies • Substitution between various taxes-pass one kind of tax (sales) might make it harder to increase another kind of tax (property). • Citizens choose where to work, live, and shop, partly based on tax rates and level of public services. • Holding income and property values constant, sales taxes per capita have been falling since 1990. • Cost disease of the public sector means taxes will have to rise to continue current levels of public services.