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Measuring State Fiscal Capacity: Alternative Methods and Their Uses

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Measuring State Fiscal Capacity: Alternative Methods and Their Uses AN INFORMATION REPORT MEASURING STATE FISCAL CAPACITY: ALTERNATIVE METHODS AND THEIR USES ADVISORY COMMISSION ON INTERGOVERNMENTAL RELATIONS Washington, D.C 20575 September 1986 M-150 PREFACE Over the years, the Advisory Commission on Intergovernmental Relations (ACIR) has been concerned with improving existing methods of measuring the ca- pacity of individual states to raise revenues. For the first time in our ser- ies of reports on fiscal capacity, we present a wider variety of measurement methods, and discuss alternative uses for each in light of these methods' prac- tical and theoretical strengths and weaknesses. In March 1982, ACIR adopted the following resolution: The Commission finds that the use of a single index, resident per capita income, to measure fiscal capacity, seriously misrepresents the actual ability of many gov- ernments to raise revenue. Because states tax a wide range of economic activities other than the income of their residents, the per capita income measure fails to account for sources of revenue to which income is only related in part. This misrepresentation results in the systematic over and under-statement of the ability of many states to raise revenue. In addition, the recent evidence suggests that per capita income has deteriorat- ed as a measure of capacity. Therefore, The Commission recommends that the federal govern- ment utilize a fiscal capacity index, such as the Repre- sentative Tax System measure, which more fully reflects the wide diversity of revenue sources which states cur- rently use. The Commission also recommends that the sys- tem be further developed so as to improve the accuracy of the underlying data and the consistency of the me- thodology, and that Congress authorize sufficient funds and designate an appropriate agency to periodically pre- Dare the tax ca~acitvestimates. More recently, a report of the U.S. Department of the Treasury entitled Studies of Federal-State-Local Fiscal Relations and its technical appendices have highlighted the continuing interest--and cont roversy--in measuring fiscal capacity. Per capita personal income is criticized as a flawed indicator. The Treasury study develops a new measure of fiscal capacity, "Total Taxable Re- sources", that is based on the economic concept of comprehensive income. It also points out that in allocating grant funds, measures of fiscal capacity should be coupled with indicators of the cost of government services. This report has benefitted from that study and extends some of its work. In order to lay the basis for the best possible formulas for grants in aid, the Commission has initiated a comprehensive study of formula design, including measures of fiscal capacity and their use in allocating funds. The present volume is an important step forward in ACIR's ongoing research in formula de- sign, with particular respect to the fiscal capacity issue. In future research, ACIR will be expanding its work on formulas and measures of fiscal capacity in its continuing effort to improve grant design by making grant formulas more responsive to interstate differences in fiscal capacity. This informatioh report, Measuring State Fiscal Capacity: Alternative Methods and Their Uses, presents estimates for 1984 of tax capacity and tax ef- fort according to the Representative Tax System and Representative Revenue Sys- tem, estimates for 1981 through 1984 for Gross State Product and Total Taxable Resources, and estimates of Gross State Product for earlier selected years. It represents an attempt to provide elected officials, analysts, and citizens with factual and comparative data on the relative economic well-being and fiscal performance of the individual states. We hope the information in this report will meet this objective. Robert B. Hawkins, Jr . Chairman ACKNOWLEDGMENTS AND RELATED REPORTS This report was written by Carol E. Cohen, Mark David Menchik, and Max B. Sawicky. Sawicky wrote the Introduction and Chapters 1-3. Cohen wrote Chapter -4 and prepared the Representative Tax and Representative Revenue System esti- mates. Menchik edited the text and oversaw production of the publication. MacArthur Jones prepared the graphics. The research was conducted under the general supervision of Lawrence A. Hunter, research director. Full responsibil- ity for the content and accuracy rests, of course, with the Commission and its staff. We would also like to thank Robert Lucke, who provided technical assistance in producing the RTS estimates, John T. Carnevale, of the Off ice of State and Local Finance, U.S. Department of the Treasury, who did the calculations of Gross State Product and Total Taxable Resources for the years 1981-84, and Pro- fessors Helen F. Ladd and John Yinger for their summary of their report on the fiscal capacity of U.S. cities. Estimates of Gross State Product for earlier years are taken from a report released by the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce in May 1985, entitled Experimental Estimates of Gross State Product by Industry, BEA Staff Paper 42. The RTS has a long history. In 1962 the Commission published its first es- timates in an information report, followed by a 1972 report extending the mea- sure to include certain classes of local government. The third Commission re- port on the subject, Tax Capacity of the Fifty States: Methodology and Esti- mates (M-134) was issued in March 1982; it contained estimates for 1979. The 1982 report analyzed the difference between the personal income measure, the Representative Tax System method, and other methods for measuring fiscal capac- ity. It remains the basic document explaining the RTS method and its value. In June 1982, 1980 estimates were released in mimeograph form. In September 1983, ACIR published 1981 Tax Capacity of the Fifty States (A-93), containing the 1981 estimates and the Commission recommendation about measuring fiscal ca- pacity. The report 1982 Tax Capacity of the Fifty States (M-142), contains the 1982 figures and also includes experimental alternatives to the standard RTS, which are further developed in the present volume. The most recent report, issued in April of this year, was entitled 1983 Tax Capacity of the States (M-148). John Shannon Executive Director CONTENTS Preface ................................................................... iii Acknowledgments and Related Reports ....................................... v Introduction .............................................................. 1 Chapter 1 Types of Fiscal Capacity Indices ............................... 3 Overview ....................................................... 3 Comparison of the Indices ...................................... 3 Availability .............................................. 3 Comprehensiveness ......................................... 7 Individuals ' Taxpaying Ability vs . Governments ' Revenue- Collecting Potential ................................... 7 Components of the Fiscal Capacity Measures ................ 8 Concepts of the Underlying Revenue Source ................. 8 Per Capita Personal Income ..................................... 9 Definitions and Alternative Sources ....................... 9 State-Local Tax Deductibility ............................ 10 Lack of Comprehensiveness ............................. 11 Gross State Product ............................................ 11 Definition ................................................ 12 Components ................................................ 12 Conclusion ................................................ 13 Total Taxable Resources ..................................... 14 Export-Adjusted Income ........................................ 16 The Representative Tax System and the Representative Revenue System...................................................... 17 Tax Effort ......................................... 21 Chapter 2 The Uses of Fiscal Capacity Measures ........................... 23 Regional Analysis .............................................. 23 Use of GSP ........................................... 23 Use of RTS/RRS ............................................ 25 Use of TTR ................................................ 25 Regional Policy ................................................ 26 Using GSP ................................................. 26 -vi i - Comparative Fiscal Policy Analysis ............................. Ability to Pay Taxes ....................................... Burden on Statutory Tax Bases ............................. Fiscal Equalization Policy ..................................... The Equalization Concept in Brief ......................... Equalization Policy ....................................... Chapter 3 Ends and Means in Fiscal Capacity Measurement .................. The RTS Recapitulated: The Problem of the Ease of Taxation..... The Policy Question ............................................ Chapter 4 The States' Fiscal Capacity as Reflected in Alternative Measures .................................................... 1984 Fiscal Capacity: Regional Patterns........................ How the Indices Compare: 1984.................................. Changes in the Fiscal Capacity of States and Regions: 1981-84 .. Summary and Conclusion ......................................... Chart. Figures. Graph. Map. and Tables Chart 1 Uses of Capacity Measures ...................................... Figure 1 Prominent Features of the Fiscal Capacity Measures: A Comparative Description ..................................... Figure 2 The
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