An Analysis of Alternative Revenue Sources for Local Governments
In this paper, David L. Sjoquist and Andrew V. Stephenson evaluate the property tax, local sales tax, and local income tax using a standard set of criteria, including efficiency, equity, tax base mobility, ease of administration, fiscal disparities, tax diversification, and other relevant factors.
In comparing the efficiency of the three local taxes, Sjoquist and Stephenson rely on the concept of benefit tax and the measure of excess burden. They argue that a market-value-based property tax and the local income tax could resemble a benefit tax if collections are spent on services that enhance property value and income. The local sales tax does not seem to have any linkage between its tax base and the usage of revenue. They also review the literature on measuring the deadweight losses of these taxes. Because local income tax rates are generally flat, this tax scores well in terms of generating less economic distortion within the taxing jurisdiction. The property tax could lead to welfare gains only if it taxes land more heavily than buildings. Exemptions and the high rates of local sales taxes do alter resource allocation, thus creating inefficiencies.
In terms of equity, Sjoquist and Stephenson evaluate local taxes based on their ability to tax commuters who benefit from local services that they do not pay for. They assert that the local sales tax is most effective among the three levies in collecting revenue from nonresident shoppers and tourists. The local income tax is less effective than the sales tax because it does not always tax non-resident workers. Among the three taxes, the property tax performs the worst because its tax base is limited to local properties that are mostly owned by residents. However, for central business districts, taxing business property owners who do not reside in the city where they work could be useful.
Sjoquist and Stephenson also find that the local sales tax is much more regressive than the property tax. However, when tax assessments are based on acquisition cost, variations in assessment ratios between new and old properties are huge, creating horizontal inequality. There is no existing study on the distribution of the local income tax burden on different income groups.
Evidence on tax base mobility of the property tax and local sales tax is mixed and varies across cities. Estimated values of the elasticity of the property tax base with respect to the differential tax rate fall between –0.15 and –1. Comparing these estimates with the values of the elasticity of retail sales with respect to the differential sales tax rate that ranges from –0.2 to –4, the local sales tax base appears to be more mobile than the property tax base. No conclusion can be drawn for the local income tax because of insufficient studies.
The total administrative cost of the property tax is higher than that of local sales and income taxes due to the requirement of periodic tax assessments. Its compliance costs are lower than those of the two other taxes because property tax evasion is difficult. If a local sales tax could be piggybacked onto the state sales tax and have the same tax base as the state base, its administration would be greatly simplified. Although the local income tax can also be piggybacked on the state income tax, it is still necessary to identify the jurisdiction in which the individual lives and works, thereby making its administration a bit more complicated than the administration of the local sales tax.
In sum, existing studies show that the property tax performs better than local sales and income taxes in efficiency, tax base mobility, and compliance. If its assessed taxable base could be based on market value, the property tax would also score well in fairness. The local sales tax is a useful instrument to avoid free riding by commuters. It can also be administered inexpensively if taxes are collected by the state utilizing the same tax base. Because the local income tax is not widely used, there is not enough evidence to evaluate this instrument.
This paper was presented at the Lincoln Institute’s Land Policy Conference of 2009 and is Chapter 15 of the book Municipal Revenues and Land Policies.