State and Local Tax Policy Primer

March 7, 2014

A state's choice of tax instrument determines the efficiency, equity and collectability of the tax, says Justin Ross, assistant professor of public finance and economics at the School of Public & Environmental Affairs at Indiana University.

Ross looks at four tax policy instruments: individual income taxes, consumption taxes, real property taxes and corporate taxes. How does the choice of tax instrument impact revenue, fairness and collection costs?

According to the study, five criteria should be used to evaluate tax policy: economic efficiency, equity, transparency, collectability and revenue production. Using these criteria, Ross analyzed the most common state tax tools and determined which states were collecting the most revenue from each type of tax.

  • Individual income taxes exist in 41 states and some localities. The taxes are generally progressive, and collectability is generally high because it is based on federal tax returns. In 2011, Pennsylvania collected $1,864 per capita in individual income taxes, the highest among all states.
  • Consumption taxes are sales taxes on goods and services. The sales tax is often preferred to other taxes that punish savings and investment and earnings; however, because consumption declines with income, the tax is generally regressive. This is why food is generally exempt from the sales tax. States collect an average of 30 percent of their revenue from a general consumption tax; in 2011, 17 states' sales tax collections exceeded their income tax revenues.
  • Real property taxes are the main source of local revenue, and how equitable the tax is depends on how accurate the property value estimation is. In 2011, Vermont collected $1,525 per capita in property taxes -- the highest of all the states -- followed by Wyoming ($500) and Arkansas ($327).
  • Corporate income taxes are generally a small portion of state revenues, and they are very inefficient. In 2011, per capita corporate income taxes were at $1,003 in Alaska and $443 in New Hampshire. Four states do not collect corporate income taxes -- Washington, Nevada, South Dakota and Wyoming.

In total, Georgia had the lowest total state tax collection per capita in 2011, at $1,639, followed by South Carolina, South Dakota and Arizona. The states collecting the most per capita were Alaska -- at $7,708 -- followed by North Dakota ($5,627) and Wyoming ($4,347).

Source: Justin M. Ross, "A Primer on State and Local Tax Policy," Mercatus Center, February 25, 2014.

 

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