One in an occasional series of articles appearing in The Weekly on municipal finance and the work of NLC's Future of Public Finance Initiative.
Property and sales taxes are familiar revenue sources for many local governments. In the last 20 years, more localities are choosing a less common option -- local taxes on income.
By 1997, localities in 15 states had been authorized to levy income taxes. Four of these states -- Colorado, Delaware, New York and Washington -- restrict (enumerate) the income tax to specific municipalities. Some larger cities, including Baltimore, New York City, St. Louis, and Kansas City, Mo., have also been granted additional authority from their state legislatures to levy local incomes taxes.
Two Types of Income Tax
Two types of income tax are levied by localities. The most common type is a graduated tax on earnings. Columbus, Ohio, and Baltimore County use this method, which also allows localities to set the local tax rate. Less common is the head tax, which stipulates that everyone must pay a flat rate. Denver, Colorado and Mukilteo, Wash., use local head taxes.
Columbus institutes a 2 percent municipal income tax, collected by the Columbus Income Tax Division. The city is allowed to levy a 1 percent income tax by state law. The additional 1 percent was approved by city voters.
Maryland counties also have the authority to set the local income tax rate, but the mechanism for collection is different. While all counties in Maryland can levy an income tax, the tax is collected by the state with the state's own income tax revenue. Often called a piggyback tax, this mechanism reduces the administrative burden of collecting the tax at the local level.
The local income tax raises a number of concerns. First is the ease of administrating and enforcing the tax. Piggyback taxes are favored in some localities because they lesson the administrative burden of tax collection. Localities also need the resources available to enforce compliance. For example, if those responsible for paying the tax are not convinced that there is a penury for non-compliance, they might not pay the tax.
Another concern is determining which jurisdictions receive revenue from the tax. Many people work in one city, but live in another city, resulting in some workers having to pay income taxes in both cities. Which municipality receives the person's income tax dollars?
The answer varies from locality to locality. In Cincinnati, Ohio, a resident of the city who is subject to a municipal or county income tax in another jurisdiction is only responsible for paying the higher of the two taxes. In other instances, people may have to pay some income taxes in both jurisdictions.
Differences in local income tax rates may also create competition among jurisdictions.
While a 2.5 percent income tax may appeal to …