tax reform state and local governments today: some ideas on how to reform taxes; how do state and...
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Tax reformState and local governments
Today: Some ideas on how to reform taxes; How do state and local governments affect behavior?
Today
More topics that affect behavior Can taxes be reformed so as not to distort
behavior as much? How do state and local governments affect
everyday lives?
Tax reform
Economic waste due to taxation is estimated to be as much as $1 trillion per year Note that $1 trillion is about 8% of annual GDP
How can this be changed?
Tax reform
Current tax codes seriously distort behavior People work less (labor tax) Sub-optimal investment decisions (lock-in effects
due to the capital gains tax) Some people advocate a tax system that
reduces waste
What about a consumption tax? Taxes on consumption have some appeal
Vary tax rates based on externalities Encourage consumption of goods and services with
positive externalities Discourage consumption with negative externalities
Progressiveness issue is probably not justified Lifetime sales taxes paid (as a % of lifetime income) is
about the same for each income bracket Easy to administrate International competitiveness could increase for
the US
What about a consumption tax? Some negative aspects of a consumption tax
Confusion about how much each good should be taxed Example: The “snack tax” in California
Taxed: Wrapped slices of pie Not taxed: A slice of pie served on a plate
Tax evasion due to smuggling and underground economies What happens when you change the tax system?
Those that saved over the years get increased tax burden Those that borrowed over the years get decreased tax burden
What are some ways to tax consumption? National retail sales tax
To replace federal taxes, a federal retail tax of about 35% would be required
Problem: Tax evasion could become a serious problem once the sales tax rate exceeds 10% Many states already have a sales tax about 6-8%
What are some ways to tax consumption? Value-added tax (VAT)
Popular in Europe Mostly consumption-based Capital investments are not part of the taxable base
Involves taxing the additional value at each stage of production
See Figure 21.2, p. 487
Problems with consumption taxes Distortions still occur Consumption taxes will not solve all of the
trade problems in the US Household labor is still sheltered from
taxation
Summary: Tax reform
Many people would like to see more consumption taxation and less labor taxation
Substantial evasion of a national retail sales tax would be possible if the tax completely offset personal income taxes
A value-added tax has appeal, but has its own disadvantages
State and local governments State and local governments are playing a
bigger role in taxation 1960: 12.2% of state tax collections were from
individual income taxes 2002: 35%
Marginal income tax rates are still small compared to federal government Highest bracket in 2006: Vermont (9.5%) California not far behind: Highest bracket is 9.3%
Single taxable earnings above $44,814 in 2007
Centralization in the US
Centralization Centralization ratio =
Central government expendituresTotal government expenditures
In the US, the centralization ratio is less than one-half
State and local governments
How do people alter their behavior based on state and local governments? The Tiebout model
Vote with your feet within your home country Public education Property taxes Grants between different levels of government
The Tiebout model
People rarely leave the US due to government policy
Mobility in the US due to government policy is substantial
Tiebout makes many assumptions in his model Not a perfect description of the real world Gives a good idea of how people decide what
community to live in
Tiebout’s assumptions
Government activities generate no externalities Individuals are completely mobile People have perfect information with respect to each
community’s public services and taxes There are enough different communities so that each
individual can find one with public services meeting her demands
The cost per unit of public services is constant so that if the quantity of public services doubles, the total cost also doubles
Public services are financed by a proportional property tax Communities can enact exclusionary zoning laws—statutes
that prohibit certain uses of land
Advantages with the Tiebout model Tailoring outputs to local taxes
Each person or family lives in a community they like One size does not fit all Tastes and preferences differ from person to person
Fostering intergovernmental competition People in government generally want people to
live in their community
Advantages with the Tiebout model Experimentation and innovation in locally
provided goods and services States and cities can try new programs These studies often result in quasi-experimental
studies by economists The analyzed results lead to good information for
governments throughout the nation
Efficiency issues with the Tiebout model Externalities
Both negative and positive Many public goods are not at the local level
Scale economies in provision of public goods Per-person cost often decreases as the number of
users increases Inefficient tax systems
Different states and cities often compete to get large businesses to locate in their area
Scale economies in tax collection
Public education
For families, voting with their feet often involves finding a good elementary and secondary education for their children You often must live within a certain area to be
able to go to a particular school
Recall: Quality of public education Quality of education is hard to quantify Besides the obvious aspects of class size
and total spending, there are different criteria that affect education Unionization of teachers Parents’ choices of their kids’ curriculum Size of school School-sponsored sports and activities
What about low-income areas? Local governments typically raise money for
education through property taxes Many families with lower incomes would not want as
much spent on schooling Additional K-12 funding provided by the Department of
Education Money helps to “level the playing field” About $20 billion in 2003 to special education and
“disadvantaged” California and some other states also provide district power
equalization grants to “level the playing field”
Property taxes
Property taxes are based on an assessed value Assessed value is the value assigned to a piece
of land or property for tax purposes How does a land tax affect behavior?
See Figure 22.2, p. 522 Effective rate depends on the assessed value
relative to the actual value of the property Example: Proposition 13 (Prop 13) in California
Prop 13
In June 1978, California voters limited the amount that the assessed value could go up, as long as ownership did not change Prop 13 also required a 2/3 majority for additional
state and local property taxes Why?
When housing prices go up significantly, some owners were forced out of their homes since they could no longer afford the property tax
What about structures?
Land taxes are capitalized in the price of land Recall Chapter 14, p. 320
Property taxes typically tax both land and structures How does a tax on structures affect behavior?
Example with perfectly elastic supply curve for structures See Figure 22.3, p. 523
Final topic: Intergovernmental grants Matching grants from a state or the federal
government has become commonplace Requires cost sharing between different levels of
government How is behavior affecting by nonmatching grants?
See Figure 22.6, p. 533 …matching grants?
See Figures 22.4 and 22.5, p. 530 and 532, respectively
Summary: State and local governments The Tiebout model predicts that people “vote with
their feet” within their home country Public education is extensively financed through the
state and local levels of government Property taxes provide much of the funding for public
education Prop 13 has limited the ability to tax property in CA
Grants from the federal government are used to encourage certain projects within states and cities