(c) 2008 The McGraw ‑ Hill Companies 1 The Public Finance Context

(c) 2008 The McGraw ‑ Hill Companies 2 The Federal System: Sources of Revenue for Schools Local school districts –Primarily property taxes State government –Sales taxes –Income taxes Federal government –Income taxes

(c) 2008 The McGraw ‑ Hill Companies 3 Assessing and Understanding Taxation Tax Yield = Tax Rate x Tax Base

(c) 2008 The McGraw ‑ Hill Companies 4 Criteria for Evaluating Taxes The tax base Yield Equity Economic effects of the tax Administration and compliance

(c) 2008 The McGraw ‑ Hill Companies 5 Tax Base The entity to which a tax rate is applied –Wealth –Income –Consumption –Privilege

(c) 2008 The McGraw ‑ Hill Companies 6 Yield The amount of revenue a tax will produce Goal is broad-based taxes with low rates Stability –Taxes that offer a consistent yield over time are desirable from a planning perspective Elasticity –Measures the percentage change in yield compared to the percentage change in the base

(c) 2008 The McGraw ‑ Hill Companies 7 Tax Equity Measures the “fairness” of a tax Horizontal equity –Equal tax treatment of individuals in the same or equal circumstance Vertical equity –Different tax treatment of individuals at different circumstances (i.e., ability to pay)

(c) 2008 The McGraw ‑ Hill Companies 8 Vertical Equity Progressive taxes –As the ability to pay increases, the proportion of income taxed increases Regressive taxes –As the ability to pay increases, the proportion of income taxed decreases Proportional taxes –As the ability to pay changes, the proportion of income taxed remains the same

(c) 2008 The McGraw ‑ Hill Companies 9 Other Equity Issues Tax incidence –Who actually pays the tax? Income taxes Sales taxes Property taxes Impact of income transfers

(c) 2008 The McGraw ‑ Hill Companies 10 Economic Effects Goal is a neutral impact on the economy Tax policy can impact individual or corporate behavior –Income tax deduction for mortgage interest –Different tax rates across jurisdictions (i.e.. sales tax differences) Broad-based, low-rate taxes create the fewest economic distortions

(c) 2008 The McGraw ‑ Hill Companies 11 Administration and Compliance The more complex the tax, the greater the costs of administration and compliance –Maintaining and gathering records –Computing the tax liability –Remittance of the tax liability –Collection –Audit –Appeal –Enforcement

(c) 2008 The McGraw ‑ Hill Companies 12 Analysis: Income Tax Largest source of revenue for the federal government Used by 41 states –Three more states tax interest, dividends, and capital gains Differences in how income is measured

(c) 2008 The McGraw ‑ Hill Companies 13 Analysis: Income Tax Generally high yield Most progressive of the major forms of taxation in the United States Reasonably stable until the 1990s High elasticity –Indexing of tax brackets has reduced the elasticity

(c) 2008 The McGraw ‑ Hill Companies 14 Analysis: Income Tax Economic effects –Can be neutral –Many deductions and measurement issues change this Costly to administer –To governments –To taxpayers

(c) 2008 The McGraw ‑ Hill Companies 15 State Income Tax Reform Broaden the base Reduce the rate Increase values of personal exemptions, standard deductions and earned income credits to eliminate the poor from tax rolls Index the entire tax structure so revenue increases are not the result of inflation

(c) 2008 The McGraw ‑ Hill Companies 16 Analysis: Sales Tax Most common state tax In use by 45 states Basis is consumption –But many states exempt certain purchases Food Medicine Clothing up to a certain expenditure level

(c) 2008 The McGraw ‑ Hill Companies 17 Analysis: Sales Tax Not as elastic as income taxes Probably more stable than income taxes Less stable than property taxes Horizontal equity is high—tax rates are generally uniform within a jurisdiction Vertical equity—sales taxes tend to be regressive because consumption as a percent of income declines as income rises

(c) 2008 The McGraw ‑ Hill Companies 18 Analysis: Sales Tax Economic effects depend on the mobility of products and the disparity of rates across jurisdictions Administration costs generally lower than for income or property taxes Seem to be more politically acceptable –Michigan 1994, for example Exportable—levied on nonresidents

(c) 2008 The McGraw ‑ Hill Companies 19 Analysis: Property Tax Mainstay of local government financing Basis is wealth –Real property –Personal property (some states) Assessment issues –Determining true or market value –Setting alternative assessed values Different land use (i.e., farming ) State laws that distort assessed value (i.e., California’s Prop. 13)

(c) 2008 The McGraw ‑ Hill Companies 20 Analysis: Property Tax Relatively inelastic Revenue is generally stable Equity –Disagreement about the regressivity or progressivity of the property tax –General agreement it is regressive at income levels below $20,000

(c) 2008 The McGraw ‑ Hill Companies 21 Analysis: Property Tax High administration costs –Assessment –Levy and collection of the tax Property tax relief –Homestead exemptions –Circuit breakers –Tax deferrals –Property tax limitations

(c) 2008 The McGraw ‑ Hill Companies 22 Analysis: Lotteries First introduced in New Hampshire in 1964 Small portion of education revenues Lotteries are a tax General agreement lotteries are regressive Revenue has shown to be relatively unstable Revenues flatten out over time High administration costs (often as much as 2/3 of revenue) –Advertising and selling tickets –Prizes