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inking of Tax Policy as a Portfolio
Judith I. Stallmann and omas G. Johnson
Introduction
One function of government is to provide
goods and services that citizens need and want
but which are not provided effectively by
the private sector (police, courts, education,
roads, economic security, etc). In order to
provide these services, the government must
impose taxes to pay for them. Tax policy
is an important dimension of economic
development policy for two reasons. First,
investors are more likely to invest, and
employees are more likely to take jobs, in
states and localities where taxes are perceived
to be lower (Bartik 1994, Wasylenko 1997).
Second, investors are more likely to invest,
and employees are more likely to take jobs
in states and localities where public services
are perceived to be higher quality and more
accessible. Obviously better services are
generally more costly so the most attractive
states and localities are those that carefully
strike a balance between, and choose the right
mix of, taxes and public services. us the
right mix of taxes, and tax reform to obtain
that mix, can be a direct, immediate and long-
term strategy for economic development.
is report summarizes the criteria used by
economists to evaluate state tax systems and
then applies the criteria to Missouri state and
local taxes to indicate how various income
groups fare under Missouri’s tax system. It
concludes with recommendations about
how the system could be revised, without
necessarily increasing the overall level of state
and local taxes.
Criteria for Evaluating Tax Systems
A state can tax virtually anything that it
chooses but the objective is to develop taxes
and a tax system that serve the broad needs
of society in an efficient, fair and supportive
way. Taxes may be evaluated according
to their economic efficiency, the extent
to which they keep the state competitive,
as well as their administrative simplicity,
revenue adequacy and fairness. Using these
criteria it is clear that there is no single
best tax and that relying on a single tax
exposes the state to shortcomings on many
of the criteria. Of particular concern at the
moment is an adequate and stable revenue
stream for state government. A portfolio of
taxes, similar to a portfolio of investments,
allows the balancing of the negative aspect of
one tax with positive aspects of another tax.
Consequently, selecting taxes and designing
a tax system for state and local revenues is a
process of trade-off and compromise between
the following desirable features:
Administrative simplicity - Is the tax easy
to comply with and to administer or do the
administrative costs use a large proportion of
the revenues collected?
Competitiveness - Does the tax encourage
business or individuals to leave Missouri or
limit the state’s ability to attract business?
Efficiency - Does the tax interfere with
efficient allocation of resources and consumer
choices?
1
December 2008
Judith Stallmann is Pro-
fessor of Agricultural and
Applied Economics, Ru-
ral Sociology and Pub-
lic Affairs. Community
Development Extension
Specialist. University
of Missouri-Columbia.
stallmannj@missouri.edu
Institute of Public Policy
Missouri Legislative Academy
Harry S Truman School of Public Affairs
October 2011
omas G. Johnson is
Frank Miller Professor of
Agricultural and Applied
Economics and Professor
of Public Affairs.
University of Missouri-
Columbia. johnsontg@
missouri.edu
Report 14-2011
University of Missouri
Revenue adequacy - Does the tax allow the state to meet the
needs of its citizens in good times and bad?
Equity - Is the tax fair? Equity refers to the principle of
ability to pay. A progressive tax charges a higher percentage
to wealthier taxpayers while a regressive tax does the opposite.
Most people accept the proposition that a regressive tax, one
that imposes a greater proportional burden on those with
lower incomes, is not equitable.
Administrative simplicity and cost effectiveness:
A simple tax system is one that is easy for the taxpayer to
understand and one that is both easy and inexpensive for
the public sector to administer. Research finds that personal
and corporate income taxes and the property tax have higher
administrative costs than other types of taxes in the current
state tax portfolio. Because the property tax is assessed locally,
the state has almost no administrative costs for this tax, while
some of the costs of sales tax administration are borne by the
private sector that must collect the tax and forward it to the
state. Tying state income taxes to the federal tax, as Missouri
does, lowers the state’s administrative costs.
Economic competitiveness: A competitive tax system does
not handicap the ability of firms to compete with those
located outside the state and does not limit the state’s ability
to attract new business. In 2007, Missouri ranked in the
bottom ten states in the nation in terms of overall taxes
per capita and per $1,000.00 of income (Cox, Morris and
Leatherman, 2010). is suggests that in general, Missouri
should be competitive for business.
• Missouri’seectivecorporateincometaxislow
in comparison with other states. e combined
corporate income tax and franchise license/tax
per capita and per $1,000.00 of income rank in
the lowest 10 states.
• Missourialsoranksamongthelowesttenstates
on personal income tax per capita and per $1,000
.00 of income.
• Missouri ranks in the bottom 20 states on
both property taxes per capita and per $1,000.00
of income. us the state should be competitive
for all types of firms, including capital intensive
firms.
• Missouriranksinthebottom20statesonsales
taxes per capita and in the middle 10 states in sales
taxes per $1,000.00 of income. is is the tax on
which Missouri ranks the highest. Missouri’s two
major cities are located on state borders. Because
the neighboring states have higher sales tax rates
than Missouri, it is likely that significant sales are
made to residents of Illinois and Kansas.
• Somestatesmaintainarelativelylowtaxrate,
but increase licenses, fees, and miscellaneous
taxes and charges. Missouri ranks in the bottom
10 states on licenses fees and miscellaneous taxes
per capita and in the bottom 20 per $1,000.00 of
income.
Missouri ranks among the lowest states in overall taxes. It
also ranks low on the individual taxes. Its highest rank on
an individual tax is in the middle 10 states on sales taxes per
$1,000.00 of income. If tax rates alone determined the rate
of economic development, Missouri would have one of the
most robust economies in the country.
Economic efficiency: An efficient tax system does not
interfere with the efficient allocation of resources or consumer
choices, that is, it does not encourage businesses and/or
individuals to make economic decisions based upon their tax
consequences.
• A broad-based tax is more ecient than the
same tax with a narrow base, in part because
it is more difficult to avoid the tax. Because a
broad-based tax is difficult to avoid, firms and
individuals will not make decisions just to avoid
the tax.
* A broad-based sales tax would tax all goods
and services, including internet sales. e
authors estimate that the state may have
lost approximately $26 million in internet
sales tax revenues in 2009. Services are the
fastest growing part of the national economy
and generally are not subject to sales tax
(Tannenwald, 2001). A broader base provides
the same revenue at a lower tax rate.
* A broad-based personal or corporate income
tax would have few exemptions, deductions
and tax credits.
• Taxing goods which have deleterious
consequences increases efficiency. Pollution
is an example. Taxing polluting goods (such
as gasoline), or the pollution itself, will reduce
their use, resulting in lower costs to others and
increased efficiency.
• Taxing goods with lower sensitivity to price
changes (inelastic supply or demand) will create
a smaller inefficiency than taxing other goods.
Examples include:
* Land: e supply of land does not change as
price goes up or down. e supply of real estate
in the short run is also relatively inelastic.
Missouri Legislative Academy
Report -
inking of Tax Policy as a Portfolio
2
University of Missouri
* Food: e overall demand for food does not
change as much with price as the demand for
other consumer goods
Taxing goods based on their elasticity would result in
different tax rates for different goods. is is an example of
where there would likely be a trade-off between efficiency
and administrative costs. But the result would be overall
lower tax rates and greater economic efficiency.
Revenue adequacy: An adequate tax system is able to
generate sufficient revenue to meet public needs as population,
incomes and the economy grow or decline. Each tax has its
own response to an economic cycle. is is the idea behind
portfolio management of private investments - a balanced
portfolio provides a trade-off between risk and short run and
long run revenues. Applied to taxes it means that a portfolio
of taxes, rather than a reliance on a single tax, will provide
more stable revenue performance.
A recent article published by the Kansas City Federal Reserve
(Felix 2008) shows that among the states in the Tenth
District, Missouri has the most volatile tax revenues.
• ForMissourithecorporateincometaxrevenues
are the most volatile.
• Personal income tax revenues are the second
most volatile. Capital gains, particularly from
stocks, contribute to the volatility of income tax
revenues.
• e general sales tax revenues are the next
most volatile. Diversifying the sales tax base by
including services may reduce volatility.
• Selectivesalestaxrevenues—alcohol,cigarettes
and gasoline - are the least volatile. e quantities
consumed grow less slowly than income, but also
do not decline much in a downturn.
• Generallytheproperty tax isthemost stable
revenue source, although during the current
housing crisis they have fallen significantly in
some states, particularly on both coasts (Felix,
2008).
Equity or fairness: e equity of taxes is typically evaluated
by looking at the distribution of the tax relative to the
taxpayer’s ability to pay. However, it is not clear how much
of a difference in income constitutes a different ability to pay,
nor what tax rates are equitable at different income levels.
Data assessing the equity of Missouri’s tax system are
presented in the table below.
• e property tax (mainly a local tax) is
regressive because it is passed on to renters in
their rent and because their home is the major
asset of middle class families.
• Takencollectively,statesalesandexcisetaxes
are regressive.
• estate incometaxesandcorporate income
taxes are progressive. In addition to the lower
tax rate on the first $9,000.00 of income, other
provisions of the law contribute to the tax being
progressive. Examples of these provisions include
the property tax circuit breaker for low income
households and deductions of a percentage of
public pensions and social security income for
those with incomes below a particular threshold.
• While there is a mix of regressive and
progressive taxes, overall the state and local tax
system of Missouri is regressive.
Report -
inking of Tax Policy as a Portfolio
3
Missouri Legislative Academy
Percentage of income paid in state and local taxes by income group
Top 20%
Income Group
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Next 15%
Next 4%
Top 1%
Income Range
Less than
$17,000
$17,000 to
$31,000
$31,000 to
$50,000
$50,000 to
$81,000
$81,000 to
$156,000
$156,000 to
$412,000
$412,000 or
more
Average Income in Group
$10,000
$24,200
$40,400
$64,300
$107,300
$226,900
$1,170,600
Sales& Excise Taxes
6.00%
5.30%
4.30%
3.70%
2.70%
1.80%
0.90%
Property Taxes
2.80%
2.30%
2.40%
2.40%
2.40%
2.20%
1.30%
Income Taxes
0.80%
2.10%
2.80%
3.30%
3.70%
4.00%
4.40%
Corporate Income Tax
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.10%
TOTAL TAXES
9.60%
9.60%
9.50%
9.40%
8.90%
8.00%
6.60%
Federal Deduction
–0.0%
–0.1%
–0.3%
–0.6%
–1.2%
–1.2%
–1.2%
TOTAL TAXES AFTER
OFFSET
9.60%
9.50%
9.20%
8.80%
7.60%
6.70%
5.40%
Note: Table shows 2007 tax law updated to reflect permanent changes in law enacted through October, 2009
Source: Institute on Taxation and Economic Policy. "Who pays state and local taxes?" 3rd edition. 2009.
http://www.itepnet.org/whopays3.pdf
Report -
inking of Tax Policy as a Portfolio
4
University of Missouri
Missouri Legislative Academy
Middlebush
University of Missouri
Columbia,
http://ipp.missouri.edu
Suggested Citation
Stallmann, Judith I., and omas G. Johnson. (). “inking
of Tax Policy as a Portfolio” Report -. Retrieved [Month
Day, Year], from University of Missouri Columbia, Institute of
Public Policy Web site: http://ipp.missouri.edu
Missouri Legislative Academy
Recommendations
Tax policy is always a contentious political issue. e
criteria outlined here provide tools that can be used to
assess the merits of a given proposal, as well as existing
state tax policies. Although easily expressed, it is difficult
for states to craft and maintain tax structures that balance
these criteria, so no portfolio will be perfect. In addition,
economies change continuously while tax systems change
very little.
Based on the principles above, we suggest that the economy
of the state would be stimulated by a series of revenue-
neutral tax reforms that include:
1. Broadening the sales tax base to include
services and internet sales;
2. Reducing exemptions, deductions, credits
and incentives in the corporate and personal
income taxes;
3. Minimizing the administrative costs for
citizens and the state by simplifying compliance
procedures;
4. Increasing relative dependence on excise and
pollution taxes; and
5. Increasing relative dependence on land taxes.
6. Reducing the dependence on general sales
taxes;
7. More reliance on progressive taxes, such as
the income tax, to assure that the tax system at a
minimum is not regressive.
Bibliography
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