Local Nonproperty Taxes
Tax levies on non-property items provide another alternate source of local revenue. Some non-property items are more difficult to evaluate and equitably assess for tax purposes, however, making this alternative more costly for local governments to administer.
Significant reliance on non-property taxes by local government is a relatively recent phenomenon, having its genesis in the 1930's when property owners frequently were confronted with property taxes well beyond their capacity to pay--with consequent tax sales, etc. In some important ways, the shift to non-property taxes accompanied a basic shift from a rural to an urban economy and from an economy characterized by individual family ownership of small manufacturing plants to systems of national corporations. In a rural-agricultural society, the ownership of property was long understood to be a major indicator of wealth and, therefore, of an ability to pay taxes. Today, evidence of ability-to-pay is represented to a much greater degree by money income than by title to real property.
The major use of new taxes originated in the larger cities in the 1930's. Under permissive state legislation beginning in 1934, New York City adopted taxes on the gross income of utilities, on the gross receipts of business, and on retail sales. Initially, these non-property taxes were a temporary emergency measure for financing the city's public welfare program. They later became an important part of the city's regular revenue system, however. In 1938, New Orleans became the second large city to levy a general retail sales tax. In 1939, after a year's unsatis-factory experiment with a two percent sales tax, Philadelphia pioneered in the levy of an earned income tax under local taxing powers granted by the state in 1932.
General Retail Sales Tax
The sales tax, known in some form since the l9th century, was introduced into the states--originally by Mississippi in 1932--in the depression of the 1930's as traditional sources of revenue declined and expenditure needs (particularly in the welfare field) increased. By 1969, all but five states levied some form of sales tax. Alaska, Delaware, Montana, New Hampshire, and Oregon still do not levy a general retail sales tax (although restaurant meals are taxed in New Hampshire at 8%). Mississippi and Rhode Island have the highest state sales tax (7%), followed by Minnesota, Nevada, and Washington (6.5%) and Illinois and Texas (6.25%). Ten states collect a 6% sales tax. Many cities and counties add their own sales tax. Sales taxes account for over 20% of all general revenue and nearly 35% of all tax revenue collected by state and local governments.
Local sales taxes, like their state counterparts, are primarily taxes on retail sales of tangible personal property. However, the tax base may include one or more specific services, such as public utilities. The consolidated administration of state and local sales taxes requires that the base for the taxes imposed by both levels of government be either identical or nearly so.
Exemptions are dictated by various consideration and, thus, follow no uniform pattern. In some instances, there are exemptions for food, or food and drugs, in order to lighten the burden on the poor. This complicates administration and may substantially reduce yield. However, it goes far toward eliminating the regressiveness of the tax and gives more flexibility for using higher rates.
An added advantage of the sales tax is that some revenue is obtained from nonresidents. In the 1950's, the state of Ohio had a relative high sales tax but provided the tax payers with "chits," like green stamps, that could be returned for a tax credit at the end of the year. The theory was that transients would not turn in the chits and, therefore, would bear a higher portion of the tax. This same approach is used in some resort communities.
The sales tax is not inelastic, but varies less widely during business fluctuations (especially inflation) than do the yields of net income taxes. The tax also has the virtue of creating wide tax consciousness. It needs safeguards, however, against inequity, maladministration, and damaging economic effects:
The theory that what a consumer spends is a good measure of his or her taxpaying ability has obvious limitations. Thus, the tax is harshly regressive unless food for off-premises consumption is exempt.
For efficient, and equitable administration of the tax, there are requirements which are beyond the reasonable capacity of small munici-palities and are frequently not adequately met by larger jurisdictions. For administrative purposes, the retailers are the taxpayers. The success of what is, in effect, a self-assessed tax depends on their making complete and accurate collections, keeping acceptable records, and making satisfactory returns. Attaining such results calls for professional sales tax administrators backed by unambiguous regulations and equipped with competent staffs which include well-trained technicians to do thorough, periodic audits of all large taxpayers and a representative sampling of small taxpayers. The administrator must treat the taxpayers with consideration and provide good informational programs, but be able to detect and penalize carelessness and dishonesty. A fair arrangement, not always provided, is to allow the retailers to retain a small percentage of collections as compensation for costs.
Major complications in the administration of taxes, due in part to the multiplicity of different local administrative arrangements and in part to differences in ordinances and regulations as to substantive and procedural aspects of the local sales tax.
When sales taxes are imposed in one jurisdiction and not in others in the same local trade area, they tend to disturb inter community economic relations. A good enforcement program, including audits of taxpayer records, is essential and somewhat costly. Experience indicates that these administrative and economic weaknesses can be mitigated by making the local tax a supplement to the state tax (where there is a well-administered one).
Gross Receipts Taxes
Gross receipts taxes are imposed on businesses and occupations and are measured by the gross income of the undertaking. In reporting municipal revenue, the Census groups these taxes with general sales taxes. This method of taxing business, or the privilege of engaging in business, is used by many municipalities. In some areas, gross receipts taxes have replaced former flat-rate business licenses; in others, it has been the product of new, permissive tax legislation.
In a few instances, this tax is a broad-based, general business tax. More often, it is imposed only on some kinds of businesses. For example, localities in Pennsylvania impose a mercantile tax on wholesale and retail businesses. Usually, gross receipts tax rates are low and often uniform for businesses within the same class. When levied at uniform rates on all kinds of enterprises, the gross receipts tax bears no relationship to the profitability of the entity being taxed. The tax is on gross receipts and, therefore, hits low profit businesses relatively harder than those with a high profit margin.
Selective Sales Taxes
Numerous municipalities levy excise taxes on specific commodities or services in lieu of applying a general retail sales tax. Some use both the general sales tax and separate special excises. Public utility taxes have the advantage of being good revenue producers, without requiring heavy administrative expense. The legal, and frequently political basis for a utility tax is that the levy is imposed for the privilege of exercising a franchise. The tax is almost always passed on to the consumer, however. Tobacco taxes have been used by state governments since the original enactment of a cigarette tax in Iowa in 1921. In 1969, North Carolina became the 50th state to enact such a selective sales tax. Local taxes on tobacco are limited to a relatively few states but often where authorized, is used extensively. (The tobacco tax in New York City yielded over $100 million in 1980.) Admission and amusement taxes have been regarded as particularly well-suited for local use. They are readily administrable; they tax so-called nonessential expenditures; they obtain revenue from nonresidents using local facilities; and they are, to some extent, benefit taxes--recouping some of the expense of such special services as police, fire protection, traffic regulation, and inspection. They are a minor source of local revenue, however.
The levy of highway user taxes--motor fuel tax and motor vehicle license tax--give wide recognition to the benefit principle in taxation. The theory is that each highway user should pay a tax that (1) results in collections which are at least roughly related to the cost of providing him with highway service; (2) covers, in the aggregate, the overall cost of highway service less some imprecisely determined allowance for collective benefits; and (3) allows all such revenue to be applied to highway purposes. So literally is this theory applied that most states provide tax exemption for fuel not used in highway transportation, and the federal government and the great majority of state governments tamper with sound budget practice by earmarking highway user taxes.
In most states, there is a remission to the local governments of considerable portions of the state-collected motor fuel taxes--based on the amount collected within the county or municipality. While the local levy of motor fuel taxes was prevalent in many states in the 1920's and 1930's, today only a few counties and municipalities are involved in locally administered fuel taxes. The preference is to share in the state collected tax on a formula basis. Motor vehicle license taxes are widely used as a local non-property tax; some localities require such licenses of nonresidents as well as residents.
Business license taxes, unless they have received systematic and frequent revisions, are likely to be discriminatory and to bear little relation to benefits received or the ability to pay. Alcoholic beverage taxes provide the base for large amounts of public revenue; the local share is small, however. At the local level, alcoholic beverages may be taxed in two ways: by selective sales or excise taxes or by license permits or fees.
Income Taxes
In its broadest application, an income tax applies to: (1) the gross income from salaries and wages of residents earned both within and outside the city; (2) the gross income from salaries and wages of nonresidents earned within the city; (3) the net profits of professions and unincorporated businesses of residents from activities wherever conducted; (4) the net profits of professions and unincorporated businesses of nonresidents from activities conducted within the city; and (5) the net profits of corporations from activities conducted within the city. Individual and corporate income taxes accounted for 17.5% of all general revenue and 25% of all tax revenue collected by state and local governments in 1992.
The tax on salaries and wages generally provides no personal exemptions or deductions. Tax credits are sometimes specified in the case of overlapping jurisdictions or non-residents, however.
The local income tax has created problems of double taxation in two ways, its levy by overlapping governments and its application to personal income both at the place of origin of the income and at the domicile of the taxpayer, i.e., a person may live in City A and work in City B, both of which levy income taxes, and be subject to the tax in both places. In Pennsylvania, there are numerous instances of income taxes being levied by both the municipality and school district serving an area. A statutory rate limitation of one percent is maintained by a required sharing of the rate where there is tax duplication--either equally, by mutual agreement, or on some other basis. In Louisville, and overlapping Jefferson County, both of which levy a 1.75 percent tax, the county allows taxpayers subject to the city tax a credit against the county tax. To avoid the potential for double taxation, Pennsylvania municipalities, other than Philadelphia, provide for tax crediting that gives priority to the place of residence. Under this arrangement, the municipality of residence imposes the tax. In Ohio, the cities have worked out various tax crediting or reciprocity arrangements that give priority to the place of employment.
Licenses, Permits and Service Charges
Most local governments have broad responsibilities in the supervision of various kinds of business and other activity within the community. For example, building construction is regulated by building codes with part of the enforcement consisting of the examination of plans and issuance of building permits, along with varying degrees of inspection to see that the construction is basically in accordance with the plans. In like manner, licenses are issued for food vendors and permits are required for parades, circuses, and a host of other activities.
In most situations, a fee is charged in conjunction with the issuance of the license or permit. If the fee charged is less than, or generally in the magnitude of, the cost of the administration of the government's activities in the field, the payment is entitled to be classified as a license or permit.
Service charges, based on the benefit principle, generally bear a direct relation to the cost of providing the service, thus freeing tax funds for other applications. As defined by the Bureau of the Census, service charges are: amounts received from the public for performance of specific services benefiting the person charged and from sales of commodities and services--except by city utilities. They include fees, assessments, and other disbursements for current services, rents and sales derived from commodities or services furnished incident to the performance of particular functions, the gross income of commercial activities and the like--such as parking lots and school lunch programs.
Miscellaneous General Revenue
Interest earnings consist of earnings on deposits and securities, other than the earnings of insurance trust funds or employee retirement systems. The sale of property involves receipts from the sale of real property and improvements thereon, but excludes receipts from the disposition of commodities, equipment, and other personal property and from the sale of securities. Special assessments, like taxes, are imposed on a property. They are compulsory, for public purposes, and require formal assessment. They differ from taxes in that they are related to a specific benefit, need not be uniform throughout the jurisdiction, and generally allow no exemptions.
While no one revenue source is very large, taken together charges and miscellaneous account for nearly 30% of all general revenue received by state and local government. Further, these sources of local revenue increased by over 213% in the period for 1980 to 1992, out pacing the growth in all other sources of general revenue.
Intergovernmental Revenues
Intergovernmental revenues can be categorized as to source and function. Local revenues in this category may be derived from either the federal or the state government. The reporting system of the Census Bureau does not provide data as to the amount of state aid to local governments which, in fact, is flow-through federal funds paid to the state and then passed on to local governments. Therefore, the fact that state intergovernmental transfers often are 3 to 4 times that of the federal government is somewhat misleading.
Intergovernmental revenues may be given in the form of grants-in-aid or shared revenues. The function of grants-in-aid is two-fold: (1) to assist disadvantaged municipalities in the provision of needed public services in an attempt to effect stabilization, equalization, and support of such governments; and (2) to provide impetus for the expansion of particular functions. Such grants usually are provided for specific purposes and the receiving government is required to meet a set of minimum standards.
Direct federal aid to local governments began in the 1930's with relief programs and was extended to low-income housing construction and payments in lieu of taxes. During World War II, federal aid centered on public works and services and on government-financed housing projects. Two important post-war aid programs were the Federal Highway Act of 1944 and the Federal Aid Airport Act of 1949. In 1960, 46 federal aid programs to local governments were underway and by 1970, Congress was "dangling almost 500 large and small conditional aid carrots collectively worth about $25 billion a year before State and Local Governments." With the 1972 budget, the emphasis shifted to revenue sharing away from the categorical grants.
General revenue sharing was adopted by the federal government to apportion part of federal revenues to local governments with few, if any restrictions as to project or purpose. Such revenues increased as the personal income tax base of the federal government grew. In 1974, Congress enacted special revenue sharing legislation in the field of urban renewal, model cities, and certain other programs. This marked the beginning of a return to the array of categorical grants by the federal government to state and local governments.
On February 18,1981, in a document entitled America's New Beginning: A Program of Economic Recovery, President Reagan proposed the elimination of most direct federal support for local government, with other federal programs folded into block grants or receiving severe cuts in funding levels. Although Congress made a number of changes in the format of the block grants and provided somewhat more transitional funding than Reagan proposed, most of the President's proposals with were enacted. Except for some support for urban transportation planning, area-wide aging funds, and some transition funding from HUD, EDA, and DHHS, the federal government, in effect, withdrew its financial support from local governments that took over thirty years to build. Federal revenue sharing programs were finally abolished in 1986.
Federal aid to state and local governments shrank significantly during the Reagan and Bush administrations, both as a percentage of the gross domestic product and as a percentage of state and local government expenditures. The recession of 1990-91 pushed many state and local governments to near crisis conditions. In 1992, for example, the state of California confronted a budget deficit in the range of $12 billion, resulting in significant cutbacks in services, layoffs of public employees, and reductions in formula funded programs for local governments. The Clinton administration has evidenced little interest in across-the-board increases in aid to state and local governments. Given the nation's concerns with the federal budget deficit, however, this lack of new initiatives is hardly surprising. It appears that most local governments will continue to operate under considerable fiscal pressures for some time to come.
Shared taxes represent a proportional allocation to localities of a tax collected or imposed by a higher level of government, usually the state but in some cases, a regional taxing authority. Except for motor fuel taxes, which usually are dedicated to road improvements, there generally are no requirements specified and shared taxes may be used for any purpose. The sources of these shared taxes may include a state sales tax (usually allocated by the locus of the retail activities), a state income tax (which may be allocated by the locus of economic activities or by residence of the income earners), or even a state property tax.
With the ever-increasing gap between local ability to provide services and the cost of such services, states have stepped in with grants-in-aid and shared tax programs. Other alternatives to direct state assistance include: (1) state assumption of performance of services, thus obviating the need for local financing; and (2) increased state technical assistance in areas such as investment and marketing. When distributed on the basis of need, state aid should consider relative economic capacity, local tax effort, legal restrictions on taxing ability, and fixed service costs. This basis of distribution, however, can perpetuate inefficient units of local government. Nonetheless, the state should accept some measure of responsibility because: (1) the state uses local units as vehicles of administration; (2) the state sets minimum standards and procedures with regard to selected functions or activities; (3) the state sets legal limits on local borrowing and taxation; (4) the state has a greater economic capacity; and (5) in some instances, the state acts to channel federal funds.
A mismatch still exists among governmental levels in the financial responsibility for provision of public services. This imbalance is caused by (a) the widespread practice of forcing the local property tax to serve as the primary underwriter of both local general government and the local school system; and (b) the heavy burden that welfare expenditures have placed on state and local governments. With the major exception of public education, state aid distribution formulas generally fail to recognize variations in local fiscal capacity to support public services. Few if any states have a state aid program that constitutes a "system."