MEASURING THE FISCAL CAPACITY AND EFFORT OF STATE AND LOCAL AREAS ADVISORY COMMISSION ON INTERGOVERNMENTAL RELATIONS WASHINGTON, D. C. 20575 March 1971 M-58 For sale by the Superintendent of Documents, U.S. Government Printing Office Washington, D.C. 20402 - Price $1.75 PREFACE This report picks up where the Commission's 1962 report, Measures of State and Local Fiscal Capacity and Tax Effort, left off, in examining ways to quantify (a) the relative financing capability of States and their local governments and (b) the extent to which these governments actually utilize this capability. The 1962 report on this subject was concerned only with entire States (including their political subdivisions). No attempt was made to develop capacity and effort measures for areas smaller than States. Neither was any attempt made to look beyond tax-raising capacity to consider the financing capacity available from nontax revenue sources and from boirowing. Nor were comparative measures developed separately for State governments and local governments. In all these respects the present report breaks new ground. Improved measures of fiscal capacity and fiscal effort would serve the ends of several INTERGOV objectives. It has recommended both to the Federal Government and the States that they increase emphasis on equalization of local resources in the distribution of their grants among eligible jurisdictions. It has urged State and local governments to make more effective use of their revenue resources and to encourage, in various ways, the mitigation of interstate and inter-local tax load differentials. The availability of meaningful fiscal capacity and fiscal effort measures would help to serve these and related policy ends. The Commission's concern with these measures stems in part out of its responsibilities in the area of Federal grants-in-aid and in part out of its interest in State and local tax policies and practices. Under Public Law 86-380, 86th Congress, the INTERGOV Commission is required, among other duties, to- "(1) bring together representatives of the Federal, State and local governments for the consideration of common yroblems, "(2) provide a forum for discussing the administration and coordination of Federal grant and other programs requiring intergovernmental cooperation; "(3) give critical attention to the conditions and controls involved in the administration of Federal grant programs." Conforming to INTERGOV policy for information reports, the results of the research investigation are presented without advising policy positions or recommendations. The report, however, provides extensive background for later consideration of policy issues by the Commission. Publication of this information report was approved by the Commission at its meeting on September 1 1, 1970. Robert E. Merriam Chairman ACKNOWLEDGMENTS This research report was carried out primarily by the Special Projects Staff of the Commission, under the direction of Allen D. Manvel. Donald J. Curran and Raymond J. Krasniewski participated responsibly in the design and conduct of the study, and L. L. Ecker-Racz served throughout as a part-time consultant. Dr. Curran was the principal author of chapters 3,4,7, and 8, and Mr. Manvel of other portions of the report. Mr. Krasniewski's work included the handling of complex data for various revenue sources, especially the property tax. The project benefitted also from assistance by John J. Callahan, an economist on the Commission's permanent research staff. Mrs. Evelyn Bowie carried out manual statistical operations, and Mrs. Ruthamae Phillips provided secretarial assistance. The study required extensive computer processing of economic and financial data. Plans for the econometric analyses were developed in consultation with Dr. E. William Dinkelacker of Georgetown University, who also devised the necessary computer programs. Computer processing was carried out by Econotron, Incorporated. Most of the data underlying this report were obtained from the Bureau of the Census and the Office of Business Economics, including in each instance a number of special tabulations and research efforts, as more fully explained in Chapter 5 and Appendixes A and D. Appreciation for their very effective aid in this respect is due especially to Robert E. Graham and Edwin J. Coleman of the Regional Accounts Division of the Office of Business Economics; and to Sherman Landau, Geneva Hines, Rebecca Dove, and Gertrude Whitehouse of the Governments Divison, Bureau of the Census. In addition, certain data initially developed by the Commission Staff for the Urban Mass Transportation Administration was adapted for use in this study. The project benefitted also by comments and suggestions received from a number of fiscal scholars and public officials, both by a planning session held when the study was getting under way, and by their review of a preliminary version of this published report. The study was financed primarily from a grant made for this purpose by the Ford Foundation. Ths support was supplemented from Commission resources. John Shannon Assistant Director Taxation and Finance Wm. R. MacDougall Executive Director FOREWORD Traditionally, policymakers have relied on two kinds of economic indicators to measure relative fiscal capacity and tax effort of State and local governments: For purposes of Federal grants to States and for interstate financial comparisons, use is sometimes made of estimates of per capita personal income. For purposes of State financial aid to local governments, notably for educational purposes, frequent reliance is placed on the value of taxable property on local areas' tax rolls. Although useful, each of these kinds of indicators leaves much to be desired as a measure of governments' fiscal capability. At the State level, for example, resident personal income fails to reflect closely the potential of certain revenue sources, such as severance taxes in States like Louisiana, New Mexico, Texas, or Wyoming, motor fuel taxes in tourist-oriented States like Maine or Vermont, or gambling taxes in Nevada. And locally, the property tax base pertains to only a portion of available financing resources. Nationally, about two-fifths of all own-source revenue of local governments is obtained from non-property sources. The problems with "traditional" indicators of governments' financing capability are multiplied when one considers the potential interest of Federal policymakers in comparative measures for areas smaller than States or for particular local jurisdictions. This interest has been stimulated by the notable growth of Federal-local grants, and more recently by the widening discussion of revenue-sharing arrangements that include "pass through" features designed to target some money specifically toward local governments. In this context, a question arises that is not encountered in making intra-State comparisons alone, such as those needed for State-local grants arrangements: How to deal, in a nationwide context, with the marked interstate differences that exist in the relative financing roles of the respective States and their local governments? Clearly, any given per capita amount of "local government revenue capacity" or even of "actual local government revenue" means different things where (as in New Jersey) local governments account for a major portion of State-local financing and where (as in Hawaii) the State government plays a predominant role. Especially in a nationwide context, then, neither of the "traditional" indicators of relative fiscal capacity, taken alone, meets the need for meaningful comparative measures of the financing capability of the governments that serve various areas. For similar reasons, no other single indicator serves well. But if, as this suggests, account should be taken of various characteristics that affect the fiscal capacity of particular governments, two further questions arise: (1) Just what measurable characteristics should be taken into account? and (2) How much weight or importance should be given to each in order to arrive at a summary or composite indicator? Some of these problems were dealt with in our earlier report. It included estimates of State-local tax capacity in each State, based on an innovative "representative tax system7' approach. With that approach, total tax capacity was defined as the amount of revenue that would have been obtained by applying to taxable resources within each State the national-average rate of each of the various types of State and local taxes. A comparable concept is currently employed in Canada. A program of "revenue equalization grants" instituted there in 1967 distributes financial aid to each of the Provincial (State) governments found to have less per capita revenue-raising capacity-as similarly estimated on an average-rate basis for each of the various kinds of revenue sources actually used by Provincial governments-than the national average. The handling of "capacity" in the present study resembles that of the earlier ACIR report, by dealing separately with many different sources and weighing them according to their relative nationwide importance in State-local finances. However, it goes beyond taxes to deal also with charges and other nontax sources (which supplement State-local tax revenue by about one-fourth). Further, it provides summary State-by-State measures of "over-all fiscal capacity and effort" that take account of debt issuance as well as revenue. And it extends the "average-financing- system" approach separately to State and local