Wednesday, June 3, 2009

A State and Local Tax Primer

NOTE: Apparently the figures are too hard to see so scroll down for a Scribd version of the original document.

A couple of weeks ago I wrote an initial post trying to better understand the facts in the Oregon tax debate so that I, and my readers, can make informed judgements about the suggested changes to Oregon's tax structure.  It is a pretty complicated thing to make any real blanket statements about, so I decided to do what any good economist does - go to the person with the comparative advantage.  In this case, Fred Thompson.  Take it away Fred:



Most states are in fiscal hot water, regardless of their tax structures

Figure one shows the year-over-year quarterly changes in state revenues from major tax sources for all fifty states. Because this is a sum, it tends to smooth out inter-state variations owing to differences in tax rates and bases, income recognition policies, and the like. The figure also suggests that the portfolio effect from relying on a variety of tax types is pretty small.

Figure 1


State tax revenues are volatile; Oregon’s are more volatile than most.

Figure 2 shows year-over-year quarterly changes in total state revenues over the past ten years. While the fluctuations are less dramatic than in Figure 1, the revenue trend is nevertheless characterized by a lot of volatility. These fluctuations are largely driven by underlying changes in the real economy. Another way of putting it is that the systematic component of state revenue growth is driven by changes in GDP. Variations in state product is one explanation for state-specific deviations from the systemic component of state revenue growth; differences in state tax structures and tax administration is another; the rest is random noise.

Generally speaking the more progressive the overall tax structure the greater its volatility. States that rely heavily on a progressive personal income tax, for example, tend to have more volatile revenue growth than states that rely on more regressive tax sources. That is the bad news. The good news is that the elasticity of revenue with respect to income is approximately ergodic. You tend to obtain about the same results over a moment in time that you get over a period of time. What that means is that revenue structures that are more volatile because they are more progressive, also tend to grow revenue faster over time, even without increases in tax rates or coverage.

Figure 2


Oregon state relies heavily on progressive personal income taxes, as seen in Chart 1.

Chart 1

Moreover, while Oregon’s PIT is characterized by a flat marginal tax rate, its pattern of exemptions, exclusions, and deductions renders it highly progressive on average, especially where the household is treated as the unit of analysis, rather than the individual. (I’d like to see the state eliminate the first step of its PIT and expand the EITC, but that is a subject for another time).


Oregon is a low tax state

That claim is true whether one looks at state taxes alone or state and local taxes combined (although that claim would have to be somewhat qualified, if one were to take local user fees into account – these are now the highest in the US by most measures). It is also true whether one looks at average taxes paid or taxes as a proportion of disposable income.

One might ask, how did that happen? It wasn’t very long ago that Oregon was near the top of the tax tables – in the top quartile in terms of taxes paid per capita and the top decile in terms of tax take as a share of disposable income. The answer is fairly straightforward: caps on the rate of growth in the property tax (Measures 5 & 47), the inability of the state to increase taxes (see Figure 3), and changes in corporate-income tax assessment that were supposed to be revenue neutral that weren’t. Oregon also spends more of its tax revenues on tax rebates than any other state (the Kicker).

Figure 3

A State and Local Tax Primer A State and Local Tax Primer patrick_emerson6704

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