Guest Essayist: Nicholas Jacobs

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If, “in this world nothing can be said to be certain, except death and taxes,” in the United States, taxes are a little more certain than death. Americans, after all, pay taxes to not just one national government, but to at least two additional ones as well: their state and locality. Paradoxically though, the framers of the U.S. Constitution believed that by establishing a system of multiple governments with independent taxing authority, the total tax burden placed on citizens would be less than it would be if one gargantuan government existed.[1]

For anyone that has ever filed your own taxes, you know that it is highly technical and subject to precise calculations, lengthy procedure, and numerous exemptions. Yet, at its most basic level, the methods by which governments acquire money are political determinations — reflective of each community’s unique history, size, political culture, and available resources.[2] The variation across different levels of government and between governments of similar scale reflects the political diversity American federalism nourishes. Understanding that variation in all of its complexity is the first step towards evaluating how federalism, despite creating many governments, can actually reduce the total tax burden placed on the American taxpayer.

Financing Local Governments

Local governments receive about 17.6 percent of every dollar that Americans pay to government each year, totaling just over $1-trillion.[3] Historically, the revenue decisions reached at the local level had the largest influence on Americans’ day-to-day lives. Municipal corporations were the leading provider of government services, establishing school systems, transportation networks, and welfare assistance before the states and national government. Much of this system remains and over time, additional types of local government emerged, each with their own taxing and spending authority; unincorporated county-governments, consolidated government units, and independent school districts — like towns and cities — all collect revenues to operate.

Remarkably, taxes account for just two-thirds of all revenues local governments raise. Localities amass considerable sums by charging fees on the use of hospitals, sewers, harbors, and airports. Some even rake in a small amount through the sale of school lunches. These “user fees” are like taxes, but they are non-compulsory and are only paid by those who use the service (sometimes provided by a private entity). Like usage fees, most local governments also raise revenue from utilities, such as a city’s water supply or transit system. Many Americans might also live in local, special-purpose districts, which are established for specific functions, and which have separate budgetary powers.

When considering taxes — compulsory, generalizable, and unavoidable legal obligations to pay the government money — local governments have a more limited “base” on which to rely. By far, the largest source of tax revenue for local governments, nationwide, is the property tax, which accounts for nearly half of all money local governments raise. But some local governments also take in money by taxing personal income and through localized sales taxes, especially on food and alcohol sold in restaurants.

Local governments derive such a significantly high percentage of their revenues from property taxes largely because of historical circumstance (they were the easiest to assess and collect), but also because they are pegged to the relative cost of living in any one, localized political jurisdiction. For instance, the rate set by the city of Boston might make sense for a densely populated, urban community where people make high incomes, property values are high, and citizens expect expensive government services. That same rate, however, might bankrupt the small family farmer in Western, Massachusetts, who owns considerably more land, and expects much less from government.

Financing State Government

State governments rely on all the same techniques as do local governments, including property taxes on possessions such as automobiles, and usage fees on services, such as parks and highways (tolls). However, there is much more variation between the states in how government finances itself.

Most states (46/50) have a general sales tax – a percentage added to each commercial transaction in the state, which retailors and merchants deliver to the state government. Sales taxes account for nearly half of all tax revenue raised by states. However, that percentage varies drastically. Some states, such as New Hampshire and Montana, do not have a general sales tax (although both states charges sales tax on specific goods such as food and lodging).  Other states, such as Tennessee and Arkansas, impose sales taxes that approach 10% on all goods purchased within the state.

Most states (43/50) also levy a state-wide income tax, which accounts for about 37% of all tax revenue at the state-level. Like the sales tax, these rates vary, and often move in relation to the state sales tax. For instance, Maine levies a 7.15% tax on the highest levels of income, which is one of the highest rates in the country; however, it charges just 5.5% on goods and services, one of the lower sales tax rates in the U.S.

This variation is important, and represents a healthy federal system. Decisions over what type of revenue source to tap generally reflect a state’s particular economy and the livelihoods within them. Taxpayers generally want to limit the amount of burden placed on themselves, so most governments try to “export” their state’s tax base. Property taxes paid on vacation homes, gasoline taxes paid by visiting motorists, and purchases made by tourists are all examples of how state governments get money from non-residents. In Nevada, nearly 80 percent of state taxes come from sales taxes, where in Illinois, state governments rely on a broader base of economic activities, including a 7% tax on corporate income, which brings in the state $3.3-billion each year.

The difference between taxing property, sales, and income is also reflective of underlying political beliefs. Most states that rely more on income tax revenues use a “progressive” rate, so that individuals who earn higher annual incomes pay more tax. In contrast, most budgeters consider sales tax to be a “regressive” measure. Although not pegged to income, individuals with lower incomes, on average, pay a higher proportion of their annual income in sales taxes than do individuals with higher incomes. Importantly, the determination to impose one type of tax over another is not a technical or objective calculation: it is the result of competing ideas about fairness, and varied expectations for government spending, which federalism encourages.

Nicholas Jacobs is a Faculty Research Associate in the School of Civic and Economic Thought and Leadership at Arizona State University, where he also serves as the assistant project director of the Living Repository of the Arizona Constitution. He has published numerous scholarly articles on intergovernmental politics, American political history, and the American presidency.  

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[1] Vincent Ostrom. 1987. The Political Theory of a Compound Republic: Designing the American Experiment, Second Edition. Lincoln, NE: University of Nebraska Press.

[2] Otto A. Davis,, M.A.H. Dempster, and Aaron Wildavsky, “A Theory of the Budgetary Process,” The American Political Science Review 60 (1966): 529-547.

[3] All figures, referenced in the following two sections on state and local finance, including the data graphed in Figure 1 are drawn from the U.S. Census Bureau’s 2016 State & Local Government Finance Historical Dataset, which is publicly available at https://www.census.gov/data/datasets/2016/econ/local/public-use-datasets.html

 

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