Financial Planning and Management in Public Organizations by Alan Walter Steiss and Chukwuemeka O'C Nwagwu

REVENUES AND EXPENDITURES IN THE PUBLIC SECTOR

Historically, the United States has relied on a mixed private-public economic system. Our economy is built primarily on the private sector--on the "invisible hand" of supply and demand in the market place--with the public economy used when the market system fails to satisfy social goals.

Rationale for Public Sector Economics

The rationale for public sector economic activity includes: (1) the provision of public goods (parks and recreational facilities, primary and secondary education, public health facilities and programs, etc.); (2) the allocation and distribution of resources (public welfare, differential incidence in the costs and benefits of public programs); (3) correction of market imperfections, including natural monopolies, externalities, and others; and (4) the provision of collective risk.

Provision of Public Goods

Public goods cannot be effectively supplied by the marketplace because private entities cannot exact a price for each unit of benefit. Once supplied, no one can be excluded from accessing the benefits of a public good. The costs of public goods must be subsidized through other sources of revenues. Direct payments are largely voluntary (as with "contributions" in support of some public service), and some consumers are "free riders." When public goods are under supplied or unsupplied, government assumes production of the good or service and exacts a price from consumers in the form of taxation.

Allocation of Resources

Public sector policies address the allocation of resources--the distribution of wealth, stabilization, and growth. In addition to directly producing and supplying public goods and services, governments may encourage or discourage the production and consumption of other goods and services via the regulation of economic behavior (for example, through tax incentives or tax levies, performance standards, inspections, codes).

Policies impacting the distribution of wealth are primarily the responsibility of the federal government, and to a somewhat lesser extent, state governments. Such policies are affected, however, by the incidence of the tax burden at the local level and by local program costs and benefits. Stabilization and growth of the economy are concerns of local governments in terms of maintaining an adequate tax base, an adequate level of public service, and appropriate level of capital investment, and reasonable stability of public revenue. These concerns have resulted in a "scramble for rateables," that is, efforts to attract economic activities (industry and commercial developments) into a community, the tax revenues from which exceed the cost of providing essential public services.

Correction of Market Imperfections

The provision of certain goods and services can benefit from economies of scale (lower costs, greater efficiencies). Such situations in the private sector, however, may lead to monopolistic pricing. When such economies of scale have social benefit, government may assume ownership of these natural monopolies (for example, a public utility) and/or regulate the pricing of these goods and services.

The allocation of resources at the local level is achieved through the budget process and other legislative and administrative constraints on economic behavior. Fiscal management and budgeting at the local level is complicated by the complexity of economic interrelationships produced by over 78,000 units of local government, often with functional and/or geographic overlapping responsibilities. This multiplicity of jurisdictions and balkanization of responsibilities makes it very difficult to achieve appropriate economies of scale in the delivery of public services.

Collective Risk

The demand for public services and facilities changes as a function of growth and the social and economic characteristics of the community. Governmental responsibilities have expanded in recent years--in the provision of social services, in dealing with environmental matters, and in many other areas. This expansion has come about in some areas because of citizens at the local level demanding more services. In other instances, the pressure for an expanded local role has come largely from mandates and requirements imposed by state and federal government.

In most cases, private enterprise will not undertake the provision of these services or will do so only at a price that precludes all citizens from participating in the benefits. Therefore, government supplies the good or service "free," via financing from a general tax source.

Local revenues have tended to increase at a slower rate, however, creating an ever widening fiscal gap for many localities. In economic terms, it is said that local government revenues are relatively inelastic, that is, most local sources of revenues are not particularly responsive to changes in the overall economy. This inelasticity is attributable, in part, to the tax structure which forces local governments to rely heavily on local property taxes. Under fiscal pressures, property taxes have proven to be relatively unresponsive in meeting increasing demands for public services and facilities.

There is a growing body of evidence to indicate that the deterioration of urban infrastructure in the United States is a serious problem of national scope. Articles in the popular press, research sponsored by various federal agencies, and congressional hearings have contributed to increased national concern and debate as to the status of water and sewer systems, health and educational facilities, streets, bridges, and so forth in our cities and towns. What was once viewed as a New York City problems (everyone is familiar with the near defaults that have plagued "the Big Apple" since the sixties), is not recognized to be a much more widespread problem.

Unfortunately, recognition of the seriousness and magnitude of the problem comes at a time when resources are constrained at all levels of government. A pronounced declines in aggregate local spending for capital improvements have been evident since the 1960's. During recent period of fiscal pressures, many local governments also have deferred maintenance spending as a "temporary measure" to ease their financial burdens. Such spending deferrals, however, have only multiplied future repair needs and investment requirements. Therefore, public officials and administrators have had to confront a number of difficult, complex, and often politically sensitive decisions.

Property Taxes

Although the property tax is under considerable criticism especially as the mainstay of local support for public education, the stubborn fact is that this tax has for centuries demonstrated its capacity to withstand severe and protracted attacks. More research, political controversy, and literature is generated each year on this tax than any other local government revenue source because of its past and present importance and because of its almost universal use as the principal element of income of local governments. It continues to be the most important single source of local government revenues in the United States. The valuation of the property subject to taxation serves as the primary base upon which debt limits of local governments are constructed.

Property Taxes in the Local Revenue Structure

American local governments have traditionally relied heavily on the property tax for the greater part of their revenues, but this reliance is gradually diminishing. From 1922 through 1952, the portion of total revenues derived from the property tax decreased from 72% to 43%. Following a period of some stabilization, the percentages decreased further; by 1972, property taxes accounted for only 36% of total local government revenues. Based on the most recent data available (1996), property taxes represent only 14% of total general revenue available to local governments.

Thus, in the 50-year period, 1922-1972, the property tax was cut in half in terms of its relative importance as a source of support of local government. And over the next 20 years, the relative contribution of local property taxes was cut in half again

The absolute amounts derived from the property tax rose from about $3.0 billion in 1922 to $40.9 billion in 1972. Moreover, in 1972, it was still the largest single source of income for local government. By 1980, however, intergovernmental transfers from state sources ($81.3 billion) surpassed property taxes ($68.6 billion) as the prime source of income for local governments. In 1996, property taxes accounts for $209.4 billion of the $689.0 billion in local tax revenue sources.

The property tax has widely differing degrees of importance in both the entire revenue structure and the tax structure of local government. The availability of state and federal aid and the use of non-property taxes, such as income taxes and sales taxes, necessarily results in a lessened dependence on the property tax. Property taxes are more significant in school districts, counties, and smaller municipalities than in large cities which have a greater diversity of taxing sources available to them (see Exhibit 2). Special districts depend very heavily on service charges.

General Description

The phrase "property tax" is ordinarily used to describe a group of taxes which are levied on the value of different kinds of property determined by the individual states to be subject to taxation--usually on an ad valorem basis, i.e., according to value.

Local property taxes usually take two forms:

(1) Real Property Tax levied on the assessed valuation of taxable land and improvements, thereupon

(2) Personal Property Tax is, or has been at one time or another, applicable to the assessed value of taxable tangible personal property, e.g., furniture and equipment, automotive equipment, animals, and inventories, and taxable intangible personal property, e.g., money, stocks, bonds, and other assets representing a property right that is not tangible in character.

During the long history of the property tax in financing government, the primary theoretical justification has been that, inasmuch as the ownership of property constituted a fair index of wealth, it was appropriate to require contributions in support of public services in proportion to the accepted measures of wealth, i.e., ownership of property. In the early America, it was customary for almost all real and personal property to be subject to taxation. The list of exemptions was very small.

As municipalities grew, however, it became increasingly difficult to secure realistic appraisals of household effects and also of intangible wealth. By the end of the 1920's, exemptions had been extended in most states to very large portions of tangible personal property. In addition to the traditional categories of churches, cemeteries, schools, and public property, exemptions to real property taxes currently included in several states the elderly, veterans, "homesteads" (southern tier states), new industry (south), mining enterprises (west), and nonprofit organizations.

Tax Assessment

In the assessment process, the assessors prepare a listing of all properties to which the governing body has applied a tax rate. Real property is classified as to use; personal property is classified on the basis of its tangible and intangible characteristics.

The principal functions of the assessment process are:

(1) To assure that all properties appear on the tax roll, with a proper notation as to the taxable status of each property.

(2) To ascertain values under which each taxable property can be made to bear its equitable share of the tax load.

The first of these elements requires the development and maintenance of comprehensive, accurate set of assessment records.

For decades, the assessed valuation of both real property and personal property relied largely on the periodic reporting by owners of lists of the property which they owned that was subject to taxation. Personal reporting is still the primary method by which personal property is taxed, ordinarily because the tax assessor has few alternate sources of information--or, if assessors have access to this information (e.g., from federal personal income tapes), they may be reluctant to use these sources.

The basic objective of the assessment process should be to determine values which are internally consistent in order that taxpayers can be subject to the same effective millage rates. If a reasonable degree of internal consistence is achieved, it matters little in terms of tax equity whether the assessment process results in a typical pattern of 30% of market value or 50% or 100%.

On the other hand, a general rule of 100% of market value helps to increase equity among taxpayers because of the resistance of taxpayers to accept a valuation of more than 100%. Where valuations are but a small percentage of market value, the coefficient of dispersion tends to be high; where the ratio of assessed to market value is high, the coefficient of dispersion tends to be low.

The application of any required tax rate levy will then produce needed revenue and also (if tax rate limits permit) provide ample revenue to the local government. But, many local governments operate under legal restraints as to the tax rate. In those circumstances the general ratio of assessed valuation to market value becomes very important. Also, the debt limit is typically expressed in terms of a percentage of taxable property values. If the law fails to adjust borrowing limits to a realistic basis, various circumventions occur, including the creation of "debt authorities," the creation of special districts in order to avoid either tax or debt limits, or the development of various types of subsidiary debt.

Suggested improvements in the assessment field often cite the need for trained assessors subject to state regulation in order to attain equalization of assessed valuations. The key needs are: (1) a workable assessment law that lends itself to good administration; (2) large assessment districts; (3) a competent, professionally trained staff with a well structured internal organization, adequate pay, protection against dismissal for doing a good job; and (4) adequate financial support. State supervision is frequently cited as a necessity in achieving the foregoing, including substantive equity between taxpayers both within a taxing district and also between taxing districts.

Advantages and Disadvantages

Property taxes are levied proportional to the market value of the property, which is taken to be an approximate measure of the wealth of the owner (ability to pay). Property taxes are also assumed to be an approximate measure of the share of the community's expense accountable to the property (the burden it places on the community). The property tax has been widely criticized for not being a very good approximation on either count. Property taxes are regressive with regards to ability to pay, because it is well established that as income rises, the proportion of wealth spent on land and improvements for housing decreases. Although clearly an inexact measure, it has the advantages of being a tax that is relatively difficult to avoid paying, hence easy to collect, as compared to income and sales taxes. Land and and buildings cannot be easily hidden from the tax collector.

The property tax has proven to be very durable in spite of the predictions by experts of its demise. It remains the mainstay of local government revenues because of the ability to adapt its structure to the preferences of different groups in society. For example, local officials can target tax relief to deserving groups or can shift the tax burden to segments of the community with greater ability to pay. Local property taxes can also be structured as an incentive to attract business investments. In spite of its considerable shortcomings, it strong ties to local control and local politics probably ensure that the property tax will persist.

The principal advantages claimed for the property tax are:

(1) The property tax has a great degree of stability. Especially in periods of economic adversity, it continues to be a consistently high producer of income--with lesser amounts of downward adjustments than would be the case for income, sales or gross receipts taxes.

(2) Many local government services are for the benefit of property and the occupants of property. The property tax, therefore, provides a manner in which contributions can be required of the owners and/or occupants of property in some degree proportionate to the services being rendered, e.g., police protection, fire protection, refuse collection and disposal.

(3) Absentee property owners who benefit from local services are required to pay their "fair share" through the property tax.

(4) Property taxation is difficult to evade, facilitating tax administration --collection and enforcement--by local governments.

(5) The property tax has a valuable social effect in that the owners of properties which are nonproductive or of marginal value are encouraged to develop the properties or to sell them to others. Thus, a man and wife or a widow who occupies a house suitable for a large family may be encouraged to vacate the house which can then serve a broader social purpose through occupancy by a large family.

(6) The ownership of property is an index to a part of a person's wealth and, therefore, falls more heavily upon the wealthy family with large holdings than upon the poor person who owns property, or occupies only small amounts of taxable property

(7) Property taxes have enabled local governments to maintain relative autonomy from state and federal control, thereby countering the tendency toward the centralization of power at higher levels of government.

In spite of its longevity, the property tax is unpopular with may taxpayers because it represents a tax on unrealized gains--a tax on wealth rather than on income. [1] The property tax is particularly onerous for those who are "property rich" but "cash poor," such as elderly residents living on a fixed income.

Among the other disadvantages frequently cited are:

(1) The tax is regressive in the sense that it tends to absorb (in the case of residential property) a greater proportion of the income of low income families than higher income families.

(2) The increasing list of exemptions tends to accentuate the inequities inherent in the tax.

(3) The yield is not as flexible as some other kinds of taxation. As a result, in periods of inflation, assessments fail to rise in relation to actual changes in value.

(4) The problems of administration are very substantial. Concerns about inequitable appraisals and reappraisal give rise to taxpayer anxieties. Where efforts are made to perform the assessment function on a current and more equitable basis, administration tends to become rather expensive in relation to yield.

(5) The tax tends to discourage improvements because in the process of making improvements, or even of careful current maintenance, values are held above levels than would otherwise exist and these, in turn, require higher tax payments.

(6) The lump sum payment requirements (annual or semi-annual) are a burden on some residents.

(7) Differentials between adjacent taxing districts result in unnatural competition both for the location of new residential developments and for the location, or relocation, of economic activities necessary to the sustenance of the entire economic/social community.

The property tax is also politically regressive--the value of a person's property in the community is strongly correlated with the person's political standing in the community. [2] Local citizens, rising to speak to the city council or local zoning board, often introduce themselves by asserting: "I am a taxpayer." The implication, of course, is that some people in town are not taxpayers, and therefore, their views should count for less.

Renters are seen as transients, as having little or no stake in the community. There are certain inequities in the burden on the public budget place by renter households versus owner households. Renters tend to live at higher densities per acre of land and on smaller floor areas, which tends to make their accountable tax value per household smaller than that of homeowners. Also, in some cases, renters are younger families and tend to have more children and hence put a larger burden on the school system, relative to the dollars of tax support that they provide.

Renters do not receive credit for the support that they do provide to the system. The owner of the rental property is billed for the tax that is collected through the rent from the tenant. Federal policy reinforces this regressive concept of ownership and taxation by permitting homeowners to include property taxes as an itemized deduction from taxable income. The federal income tax deduction is seen as a means to promote home ownership. [3] Renters cannot take this deduction because they do not own the property. [4]

Donald Krueckeberg has proposed as "resident's property tax" as a means of achieving greater equity and recognizing the stake that renters have in the community. He suggests that:

The effect of tax credits or income-tax deductions for property-tax payments by tenants will be to decrease housing costs by the amount of the income tax sheltered in the property tax, thus increasing the affordability of housing. It will also cost the state and federal government money in lower collected taxes and perhaps cost local government more cost in administration. But the benefits are to the renters and the costs will be borne across the board, as they should be. These are the costs of fairness. It is unfair to forgive that income tax to owners and not to renters. [5]

Improvements

Improvements are needed in property tax administration. Taxpayers in many states are demanding better equalization. Court decisions are affecting the levy of property taxes. Some state governments are renewing their interest in property tax administration. Tax assessors are reassessing their own procedures.

Changes in property tax laws are continually being made during the various state legislative sessions. The majority of these laws are concerned primarily with clarifying existing laws and providing various types of property tax relief. Equalization has received much attention within the general area of clarifying existing laws. Georgia, Arizona, Nebraska, and New Mexico, for example, are striving for greater uniformity through statewide reassessment programs.

The state courts also have been active in the area of equalization, primarily regarding the use of fractional valuations among various classes of property within a state and those valuations in use which differ from what is specified in state statutes. Although 23 states had adopted full-value assessment by the early 1970's, there was a time lag in the conversion and only three states had actually made the conversion by the mid-70's. Since that time 10 additional states have made the conversion, and 10 more states have adopted full-value assessment practices.

Alternatives

Increased use of state and federal levels in the performance of governmental functions is a first alternative to use of the property tax. A closely related alternative is increased state and federal financing of local governments. The downside to this dependency on state and federal funding is the loss of local autonomy in determining and setting priorities. There is a tendency to structure grant programs in such a way that local authority regarding the use of these funds is severely regulated.

Another remedy might be the imposition of user charges to finance certain public services--for example, recreational activities, transportation improvements, parking facilities--rather than general taxes. User charges and fees are the most rapidly growing source of local revenues. The shift to such charges has occurred, in part, because of taxpayer resistance against higher tax burdens, particularly in terms of increased property taxes, and, in part, because of the decline in federal assistance to local governments. [6] The luster and political appeal of user charges may soon be tarnished, however, because of equity considerations--the concern for low income consumers who may be deprived of certain services if user charges are levied. A related consideration is the possible reductions in staffing of these facilities that inevitably accompanies declines in the use of services.

Another alternative is a tax on the value of land alone or heavier tax rates on land values than on buildings, since land value is a consequence of collective investment, community development, and population growth. This type of tax: (1) does not interfere with decisions as to how the land is used, (2) encourages improvements since these would not result in increased taxation, and (3) turns back the ever increasing tide toward negative land use, particularly in core cities. It has its pitfalls, however. There are administrative problems as regards valuing land and buildings separately, and revenues under this system might not adequately replace current property tax earnings. Again, there can be a tax on land value increments so that the government can recoup what is an unearned increment to an individual owner. This type of taxation has the same pros and cons as land value taxation.

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