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: Revenue Options for Boston(1)

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 Income 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. 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 Incomea 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