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State and Local Options with the Feds Reneging

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With Congress declining to provide them with financial relief, the general expectation is that states will now need to cut their budgets because their respective constitutions require a balance of revenues and expenditures. Senate Majority Leader Mitch McConnell has shown no inclination to help. First, he argued that to do so would simply be a “blue state bailout.’ And now, with the tier of “red” states recent suffering, he says it would support “Obamacare’s continuance.”

Regardless of the merit of these positions, it appears that the states have been thrown back on their own resources. What options are open to them? They could impose drastic budget cuts, which would arguably affect not only social programs but just about all their commitments across the board (state and local share programs both). Few political leaders or policy pundits see this as a real possibility, or as adequate.

Some other observers, like economist and columnist Paul Krugman, suggest that governments could float bonds, even though this would place the states in dire straits for many years to come. Presumably this would find sympathy with conservatives, who want to cut government down to the bare bone. And one can’t bond operating expenses, anyway. If bonds were backed at the Federal level, as Krugman proposes, this would be less burdensome to states. But there has been little or no discussion of this and other options.

This leaves states to their own budgetary and fiscal solutions. The latter do not offer a palatable range of alternatives. The array of state and local tax regimes that currently prevail (in all the states) do not reflect a sound balance of revenue streams that textbook fiscal planning typically calls for. They everywhere reflect instead a hodgepodge of tax designs that evolved as historical circumstances demanded.

Early on, state and local governments relied on property taxes, both real and personal. So-called personalty, contrasted with realty, ceased to be a basis of tax revenue when it was clear that it was easily evaded and inequitable. The tax base of real property initially meant land values because buildings were modest and weren’t worth much. But improvement values grew as their development became imposing, and the taxes on realty grew more on improvement values relative to land. And their component portions gradually evinced very different economic dynamics. Whereas taxing land components followed all the attributes of sound tax the theory––fairness, efficiency, neutrality, stability, simplicity, administrability, and transparency, taxing improvement components had significant downsides. Yet little attention was given to this distinction, even while the real property tax increased as a part of the revenue stream of governments, especially at the local level.

Still, as Henry George observed, writing in 1879:

In every civilized country, even the newest, the value of the land taken as a whole is sufficient to bear the entire expenses of government. In the better developed countries it is much more than sufficient.

This claim has been corroborated in recent analysis by economists like Joseph Stiglitz, who have now concluded a century later that:

Not only was Henry George correct that a tax on land is nondistortionary, but, in an equalitarian society [in which we could choose our population optimally], the tax on land raises just enough revenue to finance the (optimally chosen) level of government expenditures.

For whatever reasons, however, state governments, and in some cases local governments, ignored these insights, and gradually moved to adopt other tax regimes. Taxes on income were initially levied on the unearned income of an elite few, but these taxes gradually spread to an ever-wider population and to cover wage earners as well. When state income taxes were piggy-backed on Federal revenue designs, they became an ever-more accepted, even while property tax regimes continued, and there was less review of their soundness.

The demand for greater government revenue––what one anti-government pundit has referred to as “the greedy hand,” led to still other sources of public finance. Gradually other tax bases were targeted: not just property and income, but financial transactions, more generally called sales taxes. More recently still, as resistance to sales taxes has grown, attention has shifted to “user fees.” And now, as well, to sources like licenses and permits, sumptuary (sin) taxes, gambling exactions, and others too various to enumerate here. All this has led to inequities, inefficiencies, instability, and distortions in our economy beyond our capacity to analyze. The tax regimes, especially at the state and local levels, are like a house of cards! While once justified, rightly or wrongly, by tax designers as a balanced “three-legged stool,” they are now just the opposite, unbalanced and a veritable hodgepodge, as noted earlier.

We are now seeing a crash in both our public financial structures and in our economy generally. The real property tax, once the justification for public school finance because of its stability, no longer serves as such. In fact, there is substantial evidence that the failure to sufficiently tax real property explains boom-bust cycles.

The answer is to shift the conventional property tax to land value, while at the same time improving assessment on these parcels. How to do this:

  1. Update and improve the assessments of real property, especially for the land component, and gradually shift the tax burden off improvements.
  2. In the same fashion, shift the proportion of the revenue regimes off taxes on sales transactions and onto the taxation of land rent.
  3. Phase out the nuisance taxes, permits, fees, licenses, and other levies that incur, what economists call, “excess burdens” on economic productivity.
  4. Help public understanding of the destructive impact of excess burdens, also called “deadweight loss,” that reduce the general wealth and efficiency of our economy. Make clear that every tax except that on the rental values of land sites costs us as much as 20 percent lost marginal productivity.

These proposed steps, though not a quick fix, will, if implemented, go far toward restoring stability and health to our economy.

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