Maxwell School, Syracuse University

SYRACUSE UNIVERSITY
The Maxwell School of Citizenship and Public Affairs


 PAI 735/ECN 635
 State and Local Government Finance

Professor Yinger

 

 

Case: Designing a Fare Structure for the Southwest County Transit District

The year is 1984 and the City of Boston is in serious financial trouble. Thanks to the passage of Proposition 2 , a statewide property tax limitation measure, Boston has been forced to cut its property tax revenues by 15 percent per year for the last three years, despite increasing costs for the public services it provides. Moreover, the State of Massachusetts does not permit Boston, or any other local government, to levy a local income or sales tax, so Boston, unlike big cities in most other states, does not have any other broad-based taxes to which it can turn. The State cushioned the blow from Proposition 2 for a few years through a transition aid program, but this extra aid is scheduled to end this year. As a result, the City will not be able to make ends meet unless the State either passes a new aid program or else empowers the City to levy some form of local income or sales tax.

As a policy analyst for a caucus of state legislators from Boston, you have been asked to determine which new revenue option is most clearly in Boston's interest. Your analysis and recommendation will be presented to the members of the caucus. If they accept your recommendation, they will then try to persuade other state legislators to vote for it. The quality of your analysis will, of course, influence how successful they are. Preliminary discussions in the caucus have eliminated several new revenue sources from consideration, and you must select and defend one of the following proposals:

1. Boston should be allowed to levy some form of local income or payroll tax.

2. Boston should be allowed to levy a local sales tax.

3. The State of Massachusetts should raise its income tax and use the new revenue to finance increased aid to its cities and towns.

4. The State of Massachusetts should raise the state sales tax and use the new revenue to finance increased aid to its cities and towns. The sales tax increase can take the form of either:

a. an increase in the sales tax rate, or
b. a broadening of the sales tax base to include all the categories listed in Table 5.

 

The members of the caucus has given you some specific instructions. They must be able to convince a majority of the state's legislators to support their recommendation, so your main job is to build them a very strong case. State (and defend) the criteria you use in selecting a revenue source and explain why your proposal meets these criteria. If you support a new local tax, you must specify and justify the provisions of that tax, such as its geographic coverage, whether it would be available to communities other than Boston, and who would set the tax rate. In addition, any proposal to increase a state tax must explain how that tax should be increased. Moreover, you have been asked to assume that every additional dollar of state taxes collected in Boston would be returned to Boston in the form of new state aid. This assumption may not accurately predict what an aid formula would actually look like, but the caucus does not want you to delve into the complexities of state aid -- at least not at this stage in the process. This assumption about state aid essentially holds every jurisdiction harmless and therefore seems, to the caucus at least, to be a reasonable starting point for any negotiations about a state aid formula. The caucus has said that you may briefly state how uncertainty about a state aid formula affects your recommendation, but it does not want you to dwell on this issue. Finally, the caucus knows that many state legislators will be skeptical about any proposal to help Boston, so it has asked you to rebut the major arguments that could be made against the proposal you recommend.

As a first step in your assignment, you have gathered background material about governmental and tax structure in Massachusetts, including some information that compares Massachusetts to other states. You should draw on this material in making your arguments.
 

Background Material


I. Governmental Structure in Massachusetts

Massachusetts contains 351 cities and towns, which have responsibility for the provision of a wide range of local public services, including education. Counties and special districts are relatively insignificant and have no taxing power of their own. Instead, the state legislature approves county and special district budgets, which are then billed to the cities and towns within their borders. County functions have shifted to the state over time. The state government took over a large share of welfare expenditure in 1968 and is currently in the process of taking over county courts.

II. Comparison of Massachusetts' Tax Structure with that in Other States

See Tables 1 and 2.

III. Description of Massachusetts' Major Taxes

A. Individual Income Tax.

The individual income tax accounts for 43.4 percent of state tax revenue and is the mainstay of the state's tax system. The tax is a two-part levy, which taxes earned income (and interest on Massachusetts savings deposits) at 5 percent and unearned income (including other interest, dividends, and capital gains) at 9 percent. The recent addition of a 7 percent surcharge makes the current effective tax rate 5.375 percent on earned income and approximately 10 percent on unearned income. Taxable income equals gross income less exemptions and deductions. Exemptions equal $2,000 for the first family member, up to $2,700 for a working spouse, and $700 for each dependent. Deductions are permitted for Social Security contributions, medical expenses, and interest paid other than on home mortgages. (Note that the following federal deductions are not permitted for the Massachusetts income tax: home mortgage interest, property taxes, charitable contributions, and one-half of capital gains. On the other hand, Social Security contributions are not deductible in calculating the federal income tax.)

No income tax is imposed on total income below $5,000 for a husband and wife or $3,000 for a single individual. A tax credit for state sales taxes paid is allowed for low-income households. This credit equals $4 each for the taxpayer and his or her spouse and $8 for each qualified dependent.

See Table 3.

B. General Sales Tax

Retail sales in Massachusetts are taxed at a 5 percent rate. The following items are exempted from the tax base: food, clothing (except for articles costing more than $175), medicine, and all items subject to a selective sales tax in Massachusetts. In addition, the sales tax does not cover services.

See Tables 4 and 5.

According to the source cited in Table 5, extensions of the sales tax to "personal care and property maintenance services, automobile services, tobacco, long-distance telephone calls, motor fuels, and clothing all appear to be mildly regressive, whereas extensions to entertainment and alcohol appear to be roughly proportional. There is no evidence that the burden associated with any of the potential sales tax base extensions is progressive." However, the burden imposed by most of these extensions appears to be less regressive than the burden of the current sales tax.

Finally, this source also indicates that within the Boston metropolitan area, 41 percent of the services covered by the extensions are provided in the City of Boston.

C. Selective Excise Taxes

Massachusetts taxes gasoline, cigarettes, alcohol, and meals.

IV. City-Metropolitan Comparisons

Boston's relationship to its suburbs is rather unique, largely because Boston makes up only 20 percent of the population of its metropolitan area.

See Table 6.

In addition, Boston's ability to export taxes to nonresidents varies widely from one tax source to another. According to two scholars at Harvard's Kennedy School of Government, the export ratio (defined as dollars of taxes provided by nonresidents for every dollar collected from residents) is 1.11 for its property tax. Despite the success of Quincy Market and other downtown development, however, the export ratio for a general sales tax (with the current base) would be only about 0.13 percent, because most shopping in the area still takes place in suburban malls. In contrast, Boston's export ratio for a tax on all earnings from jobs in Boston would be about 2.10, thanks to the large number of people who commute from the suburbs to work in the city.

TABLE 1

MISCELLANEOUS FEATURES OF STATE-LOCAL REVENUE SYSTEMS, 1983-84

Tax Effort, 1983

Equity Features, 1984

 

 

 

 

 

 

Region and State

State-Local Taxes as a % of State Personal Income

Per Capita
State-Local
Tax  Revenue

State Government Percentage of State-Local Tax Revenue 1983

Exemptions
and Credits1

 

State Financed Circuit-Breaker Property Tax Relief Programs2

New England

Maine

12.10

1082

62.9

E

EHR

New Hampshire

  8.93

  951

36.1

NST

--

Vermont

12.18

1138

59.9

E,C

AHR

Massachusetts

11.76

1425

62.8

E,C,CL3

--

Rhode Island

12.03

1295

58.7

E,CL

EHR

Connecticut

10.38

1434

56.4

E

EHR

Mideast

New York

15.35

1889

48.5

E

LIHR

New Jersey

11.17

1457

56.3

E,CL

--

Pennsylvania

10.70

1169

60.6

E,CL

EHR

Delaware

10.92

1273

82.9

NST

--

Maryland

11.13

1350

59.7

E

AH,ER

D.C.

14.46

2132

N.A.

E

LI,EHR

Great Lakes

Michigan

12.45

1370

56.5

E

AHR

Ohio

10.26

1106

57.0

E

EH

Indiana

  9.05

  905

64.4

E

--

Illinois

10.41

1255

51.5

E

EHR

Wisconsin

13.18

1425

63.5

E

AHR

Plains

Minnesota

13.22

1473

70.7

E,CL

AHR

Iowa

10.85

1171

59.2

E

EHR

Missouri

9.19

931

57.1

--

EHR

North Dakota

10.27

1100

70.3

E

EHR

South Dakota

9.58

914

50.8

C

EH

Nebraska

10.81

1146

53.9

E

--

Kansas

9.66

1129

57.2

C

EHR

Southeast

Virginia

9.97

1044

58.5

--

--

West Virginia

11.18

972

77.0

E

EHR

Kentucky

10.07

888

78.9

E

--

Tennessee

9.09

804

59.6

--

--

North Carolina

10.18

911

72.7

--

--

South Carolina

10.53

878

73.7

C

--

Georgia

10.32

973

62.8

--

--

Florida

9.04

968

60.2

E

--

Alabama

9.36

806

73.3

--

--

Mississippi

10.03

769

77.3

--

--

Louisiana

10.45

1051

65.0

E

--

Arkansas

9.23

771

74.6

--

EH

Southwest

Oklahoma

10.26

1123

70.8

--

ER

Texas

9.30

1032

55.6

E

--

New Mexico

11.66

1041

80.1

C

EHR

Arizona

10.84

1064

65.3

E

EHR

Rocky Mountain

Montana

12.55

1179

53.3

NST

EHR

Idaho

Wyoming

20.23

2443

58.6

C

--

Colorado

9.77

1166

47.9

E

EHR

Utah

11.30

963

62.5

--

EHR

Far West

Washington

11.44

1306

74.6

E

--

Oregon

11.95

1229

54.5

NST

AHR

Nevada

10.25

1214

72.0

E

ERR

California

10.83

1337

66.1

E

EHR

Alaska

33.03

4908

87.0

NST

--

Hawaii

12.87

1457

77.2

C

AR

1 E means food is exempt from the state sales tax; CL means clothing is exempt;
C indicates that an income tax credit is provided. NST indicates no state general sales tax.

 

TABLE 2

SOURCE OF STATE-LOCAL GENERAL REVENUE, 1983*

 

Taxes

 

 

Region and State

Property

General

Incoe

All Other

General Revenue

Charges and Misc. Federal Aid

New England

Maine                   

22.7

13.0

13.0

11.2

13.2

23.3

New

36.5

0.0

5.8

15.2

17.7

20.0

Vermont

21.9

6.2

12.8

14.2

14.8

25.5

Massachusetts

22.9

8.0

23.8

7.7

12.4

21.9

Rhode Island

23.2

9.6

13.7

9.4

15.2

21.4

Connecticut

29.0

16.6

8.1

13.8

11.8

15.5

Mideast

New York

20.8

12.4

23.2

8.2

12.8

18.0

New Jersey

28.4

10.0

12.6

14.2

16.4

15.1

Pennsylvania

16.3

10.3

17.9

16.2

14.5

20.7

Delaware

7.7

0.0

24.1

20.5

22.0

18.3

Maryland

15.6

8.9

23.5

11.6

18.0

18.3

District. of

13.6

10.2

16.3

9.3

7.1

42.2

Great Lakes

Michigan

24.2

9.2

18.0

6.7

19.0

19.1

Ohio

19.4

11.3

17.3

12.1

19.6

16.9

Indiana

19.2

17.0

11.4

7.9

22.7

18.2

Illinois

23.8

14.5

12.1

12.1

13.2

19.2

Wisconsin

23.2

11.0

18.9

8.5

17.0

17.8

Plains

Minnesota

16.1

9.3

20.9

10.4

19.4

16.6

Iowa

23.8

10.0

14.0

10.6

21.1

16.7

Missouri

15.4

16.9

14.4

12.2

16.7

19.6

North Dakota

13.7

9.3

4.1

20.3

20.2

19.7

South Dakota

20.8

15.3

0.2

12.5

15.8

24.7

Nebraska

22.9

12.3

10.1

10.0

21.8

16.2

Kansas

22.3

11.3

13.8

9.0

21.4

16.0

Southeast

Virginia

18.1

9.8

17.4

15.8

17.2

16.9

West Virginia

10.3

21.7

10.4

13.2

17.1

21.8

Kentucky

10.2

12.0

17.6

16.8

14.1

23.6

Tennessee

13.1

21.0

3.5

13.5

21.0

23.0

North Carolina

13.4

11.0

19.2

13.7

17.9

21.0

South Carolina

13.4

13.2

16.1

11.9

18.7

20.0

Georgia

13.8

13.3

14.3

9.0

23.3

21.9

Florida

19.8

18.6

2.1

17.2

20.3

15.5

Alabama

6.0

14.1

11.0

17.2

25.1

21.5

Mississippi

10.3

18.4

6.6

12.8

25.3

23.9

Louisiana

7.2

18.7

6.0

19.3

23.2

18.4

Arkansas

10.9

13.6

13.7

13.6

19.0

21.5

Southwest

Oklahoma

10.2

13.1

12.4

25.0

16.8

17.6

Texas

14.5

0.0

22.2

20.8

14.7

 

New Mexico

5.4

14.5

2.1

17.2

23.8

23.4

Arizona

18.5

11.3

9.5

24.2

13.3

 

Rocky Mountain

Oklahoma

10.2

13.1

12.4

25.0

16.8

17.6

Texas

14.5

0.0

22.2

20.8

14.7

 

New Mexico

5.4

14.5

2.1

17.2

23.8

23.4

Arizona

18.5

11.3

9.5

24.2

13.3

 

Far West

Washington

16.9

27.6

0.0

13.6

17.8

17.9

Oregon

22.0

0.0

21.3

10.0

16.8

19.0

Nevada

10.6

18.7

0.0

25.6

22.5

14.9

California

15.3

16.9

17.9

8.9

16.6

18.9

Alaska

7.1

0.7

4.7

28.8

28.2

8.0

Hawaii

11.1

24.4

15.0

9.9

13.8

19.7

 

 

 

 

 

 

 

Source: Advisory Commission on Intergovernmental Relations, Significant Features of Fiscal Federalism, 1984.
* Entries are percentages of total revenue from each source. They sum to slightly less than 100 percent for each state because interest earnings are omitted from the table.

TABLE 3

EFFECTIVE TAX RATES FOR THE MASSACHUSETTS INDIVIDUAL INCOME TAX
BY TOTAL MONEY INCOME, 1982*
 

     

Without Federal Offset

With Federal Offset

Income Class (money income)

Number of Returns

% of Total Returns

Tax as a %
of AGI I

Tax as a % of Money Income

Tax as  a % of AGI

Tax as a % of Money Income

Less than $5,000

276,852

10.4%

0.67%

0.26%

0.67%

0.26%

$5,000-9,999

480,257

18.1

1.26

1.13

1.26

1.13

$10,000-14,999

403,477

15.2

2.58

2.30

2.58

2.30

$15,060-19,999

332,684

12..5

3.35

3.11

3.26

3.02

$20,000-24,999

272,354

10.2

3.71

3.43

3.49

3.21

$25,000-29,999

195,394

7.4

3.81

3.50

3.41

3.11

$30,000-34,999

177,791

6.7

3.99

3.65

3.45

3.14

$35,000-39,999

150,241

5.7

4.06

3.77

3.25

3.00

$40.000-44,999

106,277

4.0

4.19

3.96

3.11

2.93

$45,000-49,999

73,050

2.8

4.36

4.17

3.12

2.99

$50,000-69,999

78,913

3.0

4.93

4.45

3.20

2.90

$70,000 and over

107,326

4.0

5.40

4.55

2.99

2.52

Total or average 2,654,612 100.0% 2.89% 2.64% 2.50% 2.29%
Source: Massachusetts Income Tax Simulation Model.
The effective tax rate is the tax burden expressed as a percentage of income.

TABLE 4
EFFECTIVE SALES TAX RATES
FOR MASSACHUSETTS AND THE U.S. AVERAGE

Effective tax rate1

Income class Massachusetts         

U.S. Average2

Less than $5,250

1.09

5.02

$5,250-7,000

1.11

3.49

$7,000-8,750

0.99

3.12

$8,750-10,500

0.95

2.87

$10,500-12,250

0.95

2.75

$12,250-14,000

0.94

2.64

$14,000-17,500

0.93

2.47

$17,500-21,000

0.94

2.34

$21,000-26,250

0.86

2.20

$26,250-35,000

0.86

2.06

$35,000-43,750

0.84

1.97

$43,750-52,500

0.88

1.91

$52,500-61,250

0.87

1.83

$61,230 and over

0.73

1.63

Source: Donald Phares, Who Pays State and Local Taxes? (Oelgeschlager, Gunn and Hain, 1980). The income classes are Phares' 1976 incomes inflated to 1982 levels using estimates from Data Resources, Inc. on personal income growth in Massachusetts between 1976 and 1982.
1
The effective tax rate is defined as average tax payment divided by average income for each income class.
2
Average for the 45 states that have a general sales tax.

TABLE 5
MASSACHUSETTS SALES TAX REVENUES
Actual and projected(Millions of dollars)
 

1985 sales tax revenue - current base, 5% Projected revenues from base expansion

$1,300


Personal services

(e.g. shoe repair, beauty shops)


70


Automobile services
(e.g. auto repair and rentals)


44


Entertainment services
(e.g. movies, bowling)


49


Miscellaneous
(e.g. alcohol, cigarettes, hotels)


237


Total


400


Total projected revenues with expanded


$1,700

TABLE 6

CITY-METROPOLITAN FISCAL COMPETITION, 1980


City

City/Suburban
Income
a

City Tax/
Income

% Tax
Property
c

City Empl.
Per Capita

City/SMSA
Employment

City/SMSA
Population

Boston

.83

.134

99

.45

.18

.20

New York

.72

.144

45

.41

.79

.78

Philadelphia

.74

.082

24

.37

.38

.36

Baltimore

.68

.075

64

.39

.45

.36

San Franciscod

.87

.058

48

.50

.37

.31

Boston

.83

.134

99

.45

.18

.20

New York

.72

.144

45

.41

.79

.78

Denver

.94

.047

34

.43

.37

.35

St. Louis

.72

.074

16

.38

.19

.19

Houston

.98

.029

55

.52

.67

.55

Atlanta

.79

.044

54

.41

.22

.21

Chicago

.71

.038

44

.41

.41

.42

Cleveland

.63

.047

29

.37

.26

.30

Sources: U.S. Department of Commerce, Local Government Finances in Selected SMSA's and Large County         Areas, 1979-1980
U.S. Department of Commerce, Census of Population and Housing, 1980
U.S. Department of Commerce, City Government Finances, 1980.
a City per capita income divided by suburban per capita income.
b City tax revenues per capita divided by city income per capita.
c Percentage of locally raised tax revenue from the property tax, including auto excise revenue.
d The San Francisco SMSA has two central cities: San Francisco and Oakland.

1. This case was written by John Yinger solely for the purposes of class discussion. It is based on an earlier version co-authored with Howard Bloom and Helen Ladd.

 

 

Trustee Professor of Public Administration and Economics