PROVIDING APPROPRIATE LEVELS OF REVENUE

Transcription

1 100 TH ANNUAL CONFERENCE ON TAXATION STATE REVENUE ADEQUACY AND OPTIMAL STATE PORTFOLIOS OF SALES TAX COMPONENTS Ray D. Nelson, Brgham Young Unversty Bryant R. Howe and Phllp V. Dean Utah Offce of Legslatve Research and General Counsel INTRODUCTION PROVIDING APPROPRIATE LEVELS OF REVENUE for state government functons s one of the core prncples of an optmal state tax system (Brunor, 2001). As part of both ongong budget plannng and tax reform efforts, state polcy makers and analysts often consder tax base and tax rate tradeoffs. Durng such delberatons, the plannng and analytcal horzon often focuses predomnantly, f not entrely, on revenue adequacy n the mmedate budgetng cycles. However, legslatve decsons that broaden the tax base and lower tax rates not only affect proxmate tax recepts, but also alter the long-term expected growth and volatlty of revenue streams. The present paper combnes four dmensons for evaluatng the revenue adequacy of alternatve tax proposals. The frst two consttute the tradtonal tax base and tax rate tradeoff. The thrd asks whether revenue wll grow suffcently to allow state government offcals to mantan the delvery of goods and servces consstent wth ther perceved publc mandate. The fnal characterstc questons the robustness of the revenue system so that the natural volatlty assocated wth the busness cycle does not unduly nterrupt approprate governmental functonng. In summary, evaluaton of revenue adequacy requres smultaneous consderaton of the tax rate, tax base, expected growth, and rsk of alternatve tax proposals. Prevous publc fnance research establshes that unque combnatons of tax codes and economc characterstcs cause tax recepts for each state to react dfferently to the busness cycle (Dye and McGure, 1991). Ths paper attempts to further ths understandng and focuses on the nteracton of tax rates, tax base breadth, expected growth, and volatlty. It begns by frst revewng and adaptng fnancal market portfolo concepts so that they apply to the state budgetng problem. Ths background provdes a framework for assessng alternatve tax systems usng state data. From these results, the mplcatons for tax polcy and reform are summarzed. SALES TAXES AS A REVENUE PORTFOLIO Because publc fnance shares much n common wth ts corporate counterpart, the well-developed applcatons of tested fnancal market models can also ad publc sector decson makers. Groves and Kahn (1952) lay the foundaton for modelng tax portfolos by researchng the tradeoff between stablty and growth. Buldng on the fnance lterature (Markowtz, 1959) that consders the rsk and return of equty portfolos, Whte (1983) adapts ths methodology to tax problems and derves an effcency fronter for the State of Georga. Berg, Marln, and Heydarpour (2000) make smlar calculatons for the Cty of New York. Msolek and Perdue (1987) recalculate the effcency fronter and emphasze the mportance of consderng real rather than nomnal revenues. Suyderhoud (1994) researches dversfcaton, balance, and fscal performance of state revenue sources. Snce revenue adequacy sn t the only objectve n good tax polcy, others consder the mx of taxes ncluded n a portfolo when takng nto account other objectves. Gentry and Ladd (1994), for example, also consder compettveness and equty. Harden and Hoyt (2003) nvestgate the effect of the tax mx on employment losses. The foundaton for consderng sales taxes as a portfolo of personal consumpton expendture components s establshed by Dye and McGure (1991). They calculate growth, standard devatons, and expendture share for a varety of personal consumpton expendtures (PCE) components. The present nvestgaton updates ther calculatons and presents the results n a tradtonal rsk-return effcency fronter context. Data based from Utah hstorcal tax recepts llustrate each concept. 479

2 NATIONAL TAX ASSOCIATION PROCEEDINGS Tax Rates and the Tax Base Many tax polcy nvestgatons focus on the nteracton between the rate and the base as jont determnants of tax revenue. Ths gves the well known relatonshp (1) R= r B, where R s the total tax revenue, r s the tax rate, and B s the tax base. As mentoned, those charged wth plannng and executng state budgets concern themselves wth the expected growth rates and ther accompanyng uncertanty that s often measured as a varance. Usng the expectatons operator, ths gves (2) E[ R]= r E[ B]. Smlarly the varance of the rate of change n tax revenues s [ ]= [ ] 2 (3) Var R r Var B. Ths means that the tax rate alters the expected value and varance of the tax base by a proporton due to the tax rate. Because sales tax rates are usually less than 10 percent, however, t can safely be concluded that the varaton n sales tax revenues s mostly due to changes n the tax base rather than the tax rate. Sales Taxes as a Portfolo Analogous to equty portfolos that are composed of an assortment of companes, sales taxes generate revenue from a varety of retal products. Just as ndustry groups react dfferently to the phases of the busness cycle, lkewse dfferent classes of retal products exhbt unque covaraton wth the aggregate economy. Formal representaton of sales tax revenues as a portfolo of dfferent types of products and servces begns by defnng B as the total of the ndvdual components where B = Σ B and B s the tax base for the th category of products. If b s the contnuously compounded growth rate or b = Δln(B ) and x s the proporton of the revenue comng from the th category, then the contnuously compounded rate of growth for the sales tax portfolo s: (4) b= xb. t Ths means that the total growth rate s the weghted average of the growth rates for each ndvdual tax. The expected growth rate for sales tax recepts b s smply the weghted sum of the expected growth rates (5) b= xe [ b]. Snce rsk s often measured by the varance of the growth rate, ths gves the equaton 2 2 (6) Var[ b]= x σ + x x ρ σ σ, j j j j j where σ s the standard devaton of the th category and ρ j s the correlaton between the th and jth categores. APPLICATION USING UTAH SALES TAX RECEIPTS Utah s unque among states n that ts ncome taxes are consttutonally earmarked for publc and hgher educaton. Lke most states, property taxes are generally consdered local taxes. Ths means that sales taxes generate the preponderance of General Fund revenues used to fnance state government functons such as transportaton, correctons, health and human servces, and general government. Consequently, the adequacy of fscal resources generated from sales taxes s an mportant ssue to the state. Sales tax polcy caused an nterestng poltcal contrast n Utah between 2004 and In 2004, Governor Olene Walker and her tax advsors proposed tax reform to broaden the sales tax base and lower the sales tax rate. She recommended expandng the base to nclude all fnal consumpton, ncludng personal consumpton servces. Because Governor Walker and her advsors were concerned about the neffcency and lack of transparency caused by mposng sales taxes on busness purchases, she proposed excludng those purchases from taxaton. Smultaneously, n a gubernatoral campagn whch ddn t nclude Governor Walker as a canddate, future Governor Jon Huntsman suggested removng the sales tax on food. In the 2006 and 2007 legslatve sessons, the Legslature and Governor Huntsman reduced the sales tax rate on food and dd not enact the Walker proposal to tax servces. More recently, the Utah Tax Revew Commsson (TRC), a group of ctzens and lawmakers who 480

3 100 TH ANNUAL CONFERENCE ON TAXATION advse the Governor and Legslature on tax polcy ssues, began to develop an ntal framework to change Utah s retal sales tax nto a broad-based household consumpton tax. A workng group of the TRC frst adopted a set of gudng prncples and then outlned a household consumpton tax where all goods and servces (ncludng health care servces) consumed by households would be subject to the sales and use tax. They tentatvely exempted all busness purchases of goods and servces from tax leves. Narrowng the tax base by excludng food mght be especally mportant when consderng revenue flows over the entre span of the busness cycle. The boom tmes that generated the fscal surpluses that enabled the partal removal of the sales tax on food durng the 2006 and 2007 legslatve sessons mght possbly create a fscal challenge durng a recesson. The queston about the effects of reducng the sales tax on food on long-term revenue growth and rsk gves rse to an mportant queston about how the dfferent components of retal sales that are ncluded n the tax base affect tax recepts durng dfferent phases of the busness cycle. UTAH S CURRENT SALES TAX BASE Mkesell (2003) notes the varety among the statutorly defned state sales tax bases. As states determne the breadth of ther sales tax base, crucal decsons center on the ncluson of food, servces, and busness nputs. Another ssue questons whether products already subject to excse taxes should also be ncluded n the sales tax base. To llustrate and compare the relatve breadth of state sales tax bases, Mkesell suggests a rato of the mplct sales tax base to personal ncome to show the dversty among the 45 states that mpose a sales tax. Utah mposes ts sales tax on more servces than do most other states. Accordng to the 2004 state survey of sales taxaton of servces conducted by Category Table 1 Hstorcal Expected Growth and Rsk for Utah s Sales Tax Portfolo Share of Base Growth Rate Mean Retal - General Merchandse Retal - Motor Vehcles Wholesale - Durable Goods Retal - Food Stores Retal - Mscellaneous Retal - Eatng & Drnkng Retal - Buldng & Garden Manufacturng Electrc & Gas Retal - Furnture Communcatons Servces - Auto & Repar Servces - Busness Retal - Apparel & Accessores Servces - Amusement & Recreaton Wholesale - Non-Durable Servces - Hotels & Lodgng Prvate Motor Vehcle Sales Constructon Fnance, Insurance & Real Estate Mnng Servces - Educaton Servces - Personal Transportaton Servces - Health Publc Admnstraton Occasonal Retal Sales Agrculture, Forestry, Fshng 11.3% 11.0% 9.3% 8.2% 6.9% 6.3% 5.9% 5.5% % % 3.2% % 1.9% % 1.0% 0.9% % 0.3% 0.3% 0.2% 0.2% 9% 5% 9% 10% 12% 9% 10% 9% 12% Rsk Std Dev 5% 3% 10% 10% 14% 5% % 14% 4% 24% 1 21% 24% 23% 481

4 NATIONAL TAX ASSOCIATION PROCEEDINGS the Federaton of Tax Admnstrators, Utah and Arzona ted for 21 st place n mposng the sales tax on 58 of the 177 dstnct servce types dentfed n the survey. Utah mposes ts sales tax on several categores of servces ncludng telephone and telegraph, moble telecommuncatons, admsson or user fees, repars or renovatons of tangble personal property, cleanng or washng tangble personal property, tourst accommodatons use for less than 30 consecutve days, and laundry or dry cleanng servces. Usng Mkesell s mplct sales tax based to personal ncome rato, he concludes that Utah s rato of.575 makes t the seventh hghest among those states. The proposed framework of tax base breadth, tax rate, expected growth, and rsk generates nsghts nto the characterstcs of current tax polcy. The statstcs n Table 1 summarze Utah State Tax Commsson hstorcal data from fscal years 1980 through Ths table reports mean growth rates and standard devatons for dfferent Standard Industral Classfcaton (SIC) categores. SIC categores are ordered by ther relatve mportance n the current sales tax system. The share of tax base column uses 2006 data, whereas the mean growth and standard devaton columns are calculated for the entre perod. As shown n Table 1, retal sales consttute almost 50 percent of the sales tax base. Other major components of the sales tax base are varous busness categores and taxable sales by wholesalers. Fgure 1 fosters analyss of the nformaton presented n Table 1. The bubble chart plots the growth and rsk characterstcs of dfferent personal consumpton and busness expendtures that are taxed n Utah. The sze of each bubble s proportonal to the percentage of the tax base derved from that category. The bubbles n Fgure 1 depct the top 10 most mportant contrbutors to the base. One concluson mmedately apparent from ths graph s that the top 10 categores, whch account for nearly three-fourths of the sales tax base, have comparatvely low rsk as measured by ther standard devatons. Many of these major contrbutors Fgure 1: Major Components of Utah Sales and Use Tax Base Expected Growth and Rsk 482

5 100 TH ANNUAL CONFERENCE ON TAXATION Fgure 2: Medum Components of Utah Sales and Use Tax Base Expected Growth and Rsk also exhbt slower growth rates. The graph also dentfes the Retal-General Merchandse category as a source of steady revenue smultaneously wth a hgh growth rate. Contrast ths wth Retal-Food Stores whch also has lttle rsk but grows at a much lower rate. Retal Furnture has a hgh growth rate and relatve low level of rsk. Manufacturng offers slower growth but sgnfcantly more rsk. The second group, the moderately mportant personal consumpton expendtures classfcatons dentfed n Fgure 2 that together account for a lttle more than 20 percent of the tax base, tends to exhbt hgher expected growth but wth correspondngly hgher varablty. Busness Servces, Amusement and Recreaton Servces, and Communcatons all grow rapdly wth moderate rsk. Constructon and Prvate Motor Vehcle Sales grow more slowly and erratcally. In general, many of the categores n ths group add to the potental growth rate wth only moderate addtons to rsk. The thrd category of expendtures dentfed n Fgure 3, whch makes up approxmately 5 percent of the tax base, generally have hgher growth rates but also have accompanyng hgher levels of rsk. Because they add nsgnfcantly to the base, however, none of these mnor categores currently have a very mportant mpact on the overall portfolo of personal consumpton expendtures. SUMMARY AND CONCLUSIONS A clear focus on revenue adequacy and a longer plannng horzon wll foster legslatve and executve analyss that consders how base and rate adjustments affect the current budgetng cycle as well as those n the future. Augmentng the analyss framework to four dmensons by ncludng consderaton for future growth and rsk can lessen the uncertanty of busness cycle mpacts on state fnances. Because of the promnence and mportance of sales taxes among state revenues sources, the sales tax base, tax rate, potental growth, and rsk all comprse crtcal nputs nto government plannng. The mean-varance effcency fronter graph from 483

6 NATIONAL TAX ASSOCIATION PROCEEDINGS Fgure 3: Small Components of Utah Sales and Use Tax Base Expected Growth and Rsk tradtonal fnance applcatons can be augmented n a bubble chart to depct all four of these dmensons smultaneously. Ths allows decson makers to fnd broad bases of consumpton expendtures whch allow correspondngly desrable low rates. They can also dscover that broad bases often also have correspondngly lower levels of rsk. The current levels of ncreasng state fscal stress may further attempts to bolster the declnng sales tax base by ncreasng the number of taxable servces ncluded n the sales tax base. In an economc downturn, smple ncreases n sales tax rates may not generate adequate revenue. When government offcals and ther analysts encounter such an eventualty, they may well want to consder the addtonal effects that broadenng the base and lowerng rates can have on future expected growth rates and rsk. If such research occurs soon, t could sgnfcantly nfluence and promote fscal adjustments that would nsure adequate fnancng of demanded government servces. References Berg, Janne, John Tepper Marln, and Fard Heydarpour. Local Government Tax Polcy: Measurng the Effcency of New York Cty s Tax Mx, FYs Publc Budgetng & Fnance 20 (Summer 2000): Brunor, Davd. State Tax Polcy : A Poltcal Perspectve. Washngton, D.C.: Urban Insttute Press, Dye, Rchard F. and Therese J. McGure. Growth and Varablty of State Indvdual Income and General Sales Taxes. Natonal Tax Journal 44 (March 1991): Gentry, Wllam M. and Helen F. Ladd. State Tax Structure and Multple Polcy Objectves. Natonal Tax Journal 47 (December 1994): Groves, Harold M. and C. Harry Kahn. The Stablty of State and Local Tax Yelds. Amercan Economc Revew 42 (March 1952): Harden, J. Wllam and Wllam H. Hoyt. Do States Choose Ther Mx of Taxes to Mnmze Employment Losses? Natonal Tax Journal 56 (March 2003): Markowtz, Harry. Portfolo Selecton; Effcent Dversfcaton of Investments. New York: Wley,

7 100 TH ANNUAL CONFERENCE ON TAXATION Mkesell, John L. General Sales Taxes n Fscal 2002: The Recesson Ends, But Revenues Show Lttle Recovery. State Tax Notes 30 (November, 2003): 543. Msolek, Walter S. and D. Grady Perdue. The Portfolo Approach to State and Local Tax Structures. Natonal Tax Journal 40 (March 1987): Suyderhoud, Jack P. State-Local Revenue Dversfcaton, Balance, and Fscal Performance. Publc Fnance Quarterly 22 (Aprl 1994): Whte, Fred C. Trade-Off n Growth and Stablty n State Taxes. Natonal Tax Journal 36 (March 1983):

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