State And Local Tax Mixes Vary Widely
There is no one right way to do state and local taxation. Few areas of law show more variety between the states, and even regional trends are elusive.
Washington State is at one extreme, with 62% of tax revenues coming from sales taxes, and no individual or corporate income taxes.
Neighboring Oregon State is at the other extreme, with sales taxes providing less than 10% of state revenues, while individual and corporate income taxes provide 44% of state tax revenues.
Alaska, which has no statewide sales or income tax but relies heavily on natural resource taxes, also has seen a sharp revenue decline as oil prices have fallen. According to the Tax Foundation, Alaska draws a nation-high 52.6 percent of its state and local revenue from a group of taxes that includes severance taxes on natural resources, stock transfer taxes, estate taxes and fees for hunting, fishing and driver’s licenses. Other states that rely heavily on this category of taxes include Delaware (34.1 percent), Wyoming (30.1 percent), North Dakota (20.7 percent) and Montana (18.8 percent).
Besides Oregon, Maryland (39.7 percent), Massachusetts (35.6 percent), North Carolina (32.7 percent) and New York (31.8 percent) are the other states that are most reliant on individual income taxes.
Sales taxes bring in 62 percent of state and local revenue in Washington state, more than in Nevada (58.2 percent), Tennessee (56.8 percent), South Dakota (54.1 percent) and Arkansas (53.2 percent). The sales taxes counted by the report include general sales taxes as well as “selective” taxes on products such as gasoline and cigarettes.
Property taxes, meanwhile, bring in 61.3 percent of New Hampshire’s combined state and local revenue, far more than in the next four states that rely most on property taxes: Vermont (42.1 percent), New Jersey (41.7 percent), Texas (41.6 percent) and Rhode Island (41.1 percent).
Colorado Is Typical
The breakdown in Colorado is (followed by the national average and difference from the national average):
Property Tax 30.4% (30.1%, +0.3%)
General Sales Tax 27.1% (23.5%, +3.6%)
Selective Sales Tax 8.2% (10.9%, -2.7%); Sales Tax subtotal 35.9% (34.4%, +1.5%)
Individual Income Tax 25.8% (22.6%, +3.2%)
Corporate Income Tax 2.7% (4.7%, -2.0%); Income Tax subtotal 28.5% (27.3%, +1.2%)
Licenses and Other Taxes 5.9% (8.2%, -2.3%)
Analysis
The Trends Don't Capture Conventional Wisdom About Colorado's Unique System
Given the strong incentive created by TABOR to use licenses and users fees that might be counted as taxes for the purposes of this study, it is surprising that Colorado raises a considerably smaller share of its revenues this way than other states. Colorado would have also been on obvious candidate to be high in this are as it has considerable resources subject to severance taxes. But, its economy is more diversified than the states that rely more heavily on these revenue streams.
It is likewise interesting that despite Colorado's constitutional limitations on property tax values for residential real estate created by the state constitution's Gallagher Amendment, which shifts the property tax base from residences to businesses, that property tax levels in Colorado are very close to the national average as a percentage of state and local tax revenues. Many observers had perceived that Gallagher encouraged local governments to favor sales taxes over property taxes.
Colorado is more prone than most states to favor general sales taxes over "sin taxes" and fuel taxes.
Colorado's corporate income tax collections are surprising low (almost half as large as a percentage of individual income tax collections). compared to its individual income tax collections. This is surprising given that it uses the federal tax code with little modification as the source of taxable income in each case. The cause could be something simple, like a much more widespread use of pass through tax entities in Colorado than in the average states, or an economy disproportionately made up of privately held companies than can use tax planning to reduce or eliminate corporate level taxes. But, it could also signal that Colorado lawmakers have been unusually generous in dishing out corporate tax breaks and have understaffed their ranks of corporate income tax collects at the Colorado Department of Revenue.
Colorado's Revenue Stability
Since general sales taxes are highly cyclic, and income taxes are somewhat cyclic, and Colorado relies upon these taxes to a greater degree than more stable sources of revenues like property taxes, Colorado's revenues follow boom-cycles slightly more than the would in a typical state.
The numbers available don't distinguish between the more stable components of income taxes, like taxes on payrolls, and less stable components of income taxes like capital gains, that have provided such a hard hit to New York State's state income tax collections. The numbers also don't distinguish between highly graduated state income taxes found in the East, that are more responsive to shifts in income among high income workers, and flatter income taxes like the one use in Colorado, the response to shifts in aggregate income without much regard to who is impacted by it (although the Colorado income tax base is still quite progressive, so income losses by the working class and poor have little effect on its tax collections).
The biases in Colorado's revenue mix, however, are mitigated somewhat by its diversified economy. Natural resources economy driven states like Alaska, are heavily impacted by commodity prices. New York State's tax revenues are deeply influenced by Wall Street's health which has a huge fiscal impact on the state even though it involves only a modest share of the state's total population. Michigan's economy is dominated by the manufacturing sector. Colorado, after periods when its economy was dominated by gold and silver, by coal, by farming and by oil and gas, has finally achieved a diversified economy that isn't thrown off by a single industry bust. Its diversified economy and diversified tax base, together, have put it in a better than average position in the wake of the Financial Crisis.
Where Are The Interesting Colorado Tax System Stories?
Colorado is interesting not because its mix of revenue sources is odd, but for two other reasons.
First, TABOR has kept state tax collections low. This has kept state spending on programs like education, and in particular high education, low and has encouraged deferred maintenance of state infrastructure. The lack of state funds has also encouraged local governments to secure revenue (particularly sales tax revenues) that, in most states, would be collected at the state level and distributed to local governments through state grants. Colorado's local governments, as a result, have more economic autonomy, but also more cyclic revenue streams than most local governments.
Secondly, the Gallagher Amendment and the heavy use of retail sales taxes as a revenue source by local governments makes the revenue interests of municipalities and businesses deciding where to locate within a metropolitan area particularly intense. Residential developments with their artificially low property tax valuations and lack of a retail sales base, are artificially unattractive to existing local governments, since the services that these communities need exceeds the level of taxes that they generate. Retail sales developments, which provide sales tax revenues and inflated property tax valuations, a highly sought after by competing local governments. Office and manufacturing developments which pay property taxes at above average levels but don't generate sales taxes are relatively neutral, but still generally generate more tax revenues than it costs municipalities to provide them with services.
The land use contests between local governments play out in a variety of ways, but tax issues are frequently drivers of that drama in Colorado.
Implications
One state and local tax proposal that I have favored for Colorado, for a variety of reason, is a revenue switch. In my view, municipalities should give up their sales taxing power to the state in lieu of increased use of property taxes, school districts should discontinue property taxation in lieu of state funding, and the state should use some combination of increased sales and income taxes to make up for funds that school districts would lose if they go out of the property tax business.
My revenue switch proposal keeps total state and local sales and property tax revenues, and government funding at all levels, very similar. But, this would give the State of Colorado a single sales taxing authority, which would provide administrative advantages, simply interstate sales tax collection efforts, and reduce the revenue uncertainties faces by local governments that don't have the resources to do elaborate economic projections and consider contingencies in their budget processes. It would also discourage intrastate competition for sales tax revenues that can lead to an excessive focus on developing new residential areas in unincorporated areas and excessive efforts to attract new mall developments even when the metropolitan area as a whole is overbuilt with respect to shopping malls.
The demise of school property taxes would allow most municipalities to replace the lion's share of their lost sales tax revenues with property tax revenues. Some municipalities would have to charge higher property taxes than others to provide services, based upon the size of their property taxes bases, but these disparities are less troubling at the municipal government level than they are in the state's K-12 education system where there is an expectation that every child in the state should have equal educational opportunities. Municipalities provide the every day basics of life, and a stable tax base for municipalities would insure that basics like police and fire department services, street cleaning, trash collection and the like could continue without regard for economic boom and bust cycles, given the state a solid foundation.
Near complete state funding of school districts would allow Colorado to travel down a path it has already gone far down where statewide school choice is the norm, and every child is on an equal footing regardless of where that child lives. Children unlucky enough to live in a place with a weak property tax base shouldn't have inferior educations. Increased states sales tax revenues acquired from municipal governments, and the generally broad, if regulated, power of the government to collect taxes, would be well suited to this task.
A shift of school district funding away from municipal governments (and removal of school board members from the property tax collecting system) would also cause decisions about school attendance to be less entangled with decisions about zoning and home buying. While geography obviously influences the school choices that parents make, in a purely state education system, it would play a much less dominant role than it does today.
This plan wouldn't change the basic mix of state and local taxes in Colorado, which isn't the problem. Colorado is typical on that front. But, by better matching taxes to the entities that are best suited to impose them, Colorado tax policy could produce more sensible school funding, more stable municipal finances, and intergovernmental competition for development could return to fundamentals rather than artificial tax issues.
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