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The Public Finance Context

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The Federal System: Sources of Revenue for Schools

• Local school districts – Primarily property taxes

• State government – Sales taxes– Income taxes

• Federal government – Income taxes

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Assessing and Understanding Taxation

Tax Yield = Tax Rate x Tax Base

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Criteria for Evaluating Taxes

• The tax base

• Yield

• Equity

• Economic effects of the tax

• Administration and compliance

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Tax Base

• The entity to which a tax rate is applied – Wealth– Income– Consumption – Privilege

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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

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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)

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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

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Other Equity Issues

• Tax incidence – Who actually pays the tax?

• Income taxes

• Sales taxes

• Property taxes

• Impact of income transfers

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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

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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

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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

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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

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Analysis: Income Tax

• Economic effects – Can be neutral – Many deductions and measurement issues

change this

• Costly to administer – To governments – To taxpayers

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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

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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

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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

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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

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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)

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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

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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

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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