Technological Change and Tax Policy: The Future of State and Local Tax Structures

By Bonnett, Thomas | Government Finance Review, December 1998 | Go to article overview
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Technological Change and Tax Policy: The Future of State and Local Tax Structures


Bonnett, Thomas, Government Finance Review


As the economy shifts from goods to services and electronic commerce becomes a significant force in the economy, state and local taxing bodies are confronted with new challenges and questions.

Editor's note: The report "Is the New Global Economy Leaving State-Local Tax Structures Behind?" was prepared by the National League of Cities, the National Conference of State Legislatures, and the National Governors Association. Sections of the report and executive summary are reprinted and adapted with permission.

Prominent economic, social, demographic, and technological trends are threatening to erode the tax revenues of states and cities. The mainstays of these tax systems are the income, property, and sales taxes. Together, they generated 75.9 percent of total state and local tax revenues in FY 1994. Each is a prominent revenue source for state and local governments: the property tax generated 31.5 percent, the sales tax generated 23.8 percent, and the personal income tax generated 20.6 percent of total state-local tax revenues in FY 1994.

The most significant fiscal trend over the past 20 years has been the declining share of federal support to state and local governments, which has placed a much greater burden on current state and local taxes. Federal grants-in-aid to state and local governments averaged 21.5 percent of their total spending over the 1990-95 period. This is well below the 26.5 percent peak that occurred in 1978. Consequently, state and local governments have had to rely much more on their own tax revenue sources to generate sufficient revenue to provide services required by the public. Further, the recent trend of Congress pushing more responsibilities to state and local governments will place additional burdens on the current state-local tax structure.

If these two trends were to continue, federal grants-in-aid support to state and local governments would remain at modest levels for some time, and burdens would increase as well. That prospect increases the importance to state and local leaders of maintaining a state-local tax structure that will continue to generate adequate revenues with which to support valuable public services. The continued effectiveness of the tax structure is essential to maintain the autonomy of state and local governments. State and local leaders concerned with the independence and responsiveness of their governments should be sensitive to the stability of the state-local tax structure. The major vulnerability of the current state-local tax structure is its inability to adapt to increased mobility.

The current tax structure was built decades ago when the industrial economy produced tangible goods. The shift to the new service economy is the best-documented challenge to the current tax structure, but other social, demographic, and technological trends pose difficult challenges as well and could jeopardize the future viability of the current state-local tax structure. Each of these trends has important tax implications.

Exhibit 1

EMPLOYMENT GROWTH
(in millions)

                        1979              1992               2005
Projected

Manufacturing           21.0              18.4               17.5
Services                16.8              28.4               41.8

Source: Monthly Labor Review (November 1993), Bureau of Labor
Statistics

Economic Transformation

The magnitude of the shift over the last half-century from an economy based on manufacturing goods to one dominated by knowledge-based and personal services is often not well understood, but it poses several challenges to current tax policies. In 1959, services constituted less than 40 percent of the Gross Domestic Product (GDP), while goods production constituted roughly half. In 1994, services were almost 65 percent of the GDP while goods production was approximately 37 percent. In short, there has been a dramatic shift in how the modern economy creates wealth.

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