Raising Tax Rates Research Articles

Fiscal Illusion from Property Reassessment? An Empirical Test of the Residual View

The textbook view of the real property tax is that the tax rate is simply a residual, determined by dividing the revenue to be raised from the property tax by the taxable base of assessed values. As such, tax rate adjustment is automatic and changes in assessed values are neutral with respect to property tax revenue. Critics often claim that policymakers do not fully reduce the tax rate in response to increasing assessed values, allowing them to effectively raise revenue without raising tax rates. Using data from Virginia cities and counties between 2000 and 2008, this paper estimates the response of levy growth rates to property reassessment by taking advantage of a policy environment that offers a natural experiment in the execution of mass reappraisals. A timing lag in the implementation of updated property assessments to be used in setting the tax rate further allows the study to disentangle assessed value growth from other forms of economic growth, including the market values of property. Our findings provide partial support for the fiscal illusion critique, as mass reappraisals per se provide cover for politicians to raise levy growth rates; however, overall the growth in aggregate taxable assessed values is largely irrelevant.

Real Time Audit – It is the Time to Act?

The U.S. is facing one of its hardest economic crises. Its economy has not recovered from the 2008 downturn, and the light at the end of the tunnel is far, far away. The government and the Internal Revenue Service (“IRS”) are seeking revenue sources in order to reduce its budget deficit. However, raising the income tax rates is politically difficult and may lead to further loss of jobs. In this political situation, it is important to try to find ways to raise more revenue without raising tax rates. One possibility of doing so is “real time audit”: Auditing transactions when they occur, rather than months or years later.

Adopting the More Likely than Not Standard for Tax Returns

Under current law, a taxpayer may generally take a tax return position without penalty or disclosure if there is substantial authority that the position will be sustained if challenged. Taxpayers can therefore take positions that they believe are unlikely to be right, but might be. The disclosures under Financial Accounting Standards Board Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes,’’ show that companies have failed to pay billions of dollars of taxes they think are legally owed according to their tax returns. A country needing tax revenue should collect the taxes that are rightfully owed before it seeks to raise additional taxes, and the FIN 48 disclosures reveal billions of dollars lost to noncompliance. This proposal would require taxpayers to report on their tax return only positions that they believe are more likely than not correct. With this new higher standard, the tax system could rely on financial reporting standards to better enforce compliance with the tax law. For a more detailed discussion of this proposal, please see ‘‘Voluntary Compliance: This Return Might Be Correct, but Probably Isn’t,’’ in the spring 2010 issue of the Virginia Tax Review.The proposal is made as a part of the Shelf Project, a collaboration among tax professionals to develop and perfect proposals to help Congress raise revenue without raising tax rates. The deficit is now at $1.6 trillion or 11.2 percent of GDP, and government debt is projected to increase to 68 percent of GDP by 2019. In an impending revenue crisis, base-protecting revenue provisions that are ordinarily politically impossible become political necessities. Tax rates can’t be raised on this loophole-ridden tax base. Shelf Project proposals defend the tax base and improve the rationality and efficiency of the tax system. They are intended to raise revenue without raising rates, because the best tax systems have the broadest possible base to reach the lowest feasible tax rates. Shelf Project proposals are intended to eliminate the alternatives of 85 percent individual income tax rates or 35 percent federal sales tax rates. Alonger description of the Shelf Project and an inventory of its proposals after two years may be found at ‘‘Two Years of the Shelf Project,’’ Tax Notes, Jan. 25, 2010, p. 513, Doc 2010-150, or 2010 TNT 17-12.

Squeezed in and Squeezed Out: The Effects of Population Aging on the Demand for Housing

This paper examines how increasing longevity affects the housing choices of working age and retired people using a heterogeneous agent overlapping generations model that incorporates owner-occupier and rental sectors, credit constraints, detailed tax regulations, and a housing supply sector. Increasing longevity generally leads to declining home ownership rates among young people, with bigger declines if the government increases taxes and pensions rather than relying on additional private provision of retirement income. The model suggests raising tax rates to provide pensions can reduce the welfare of all agents, even those who are net beneficiaries, because they tighten credit constraints when young.

Cleaning Compensation for Services Out of Capital Gain

In general, preferential capital gains rates are not and should not be available for compensation for services. The tax bracket system attempts to adjust the level of tax to the standard of living for which the money is spent. Allowing some taxpayers to avoid the higher tax brackets for their compensation when the rest of the nation is subject to the ordinary rates is a kind of favoritism or caste system. The value of services should be set by market demand derived from real consumer utility. Tax should not distort the relative pretax values of services. Compensation for services is also not what is traditionally thought of as capital gain. Capital gain is gain from the appreciation of invested capital because of market forces beyond the taxpayer’s control. The lower rate on capital gain offsets perceived over-taxation of invested capital. There is a double tax under the income tax of both invested amounts (orchard) and profit from investments (apples). Tax on compensation, however, is a first and only tax; compensation has no basis because there has been no prior taxation of an investment. Capital gain rates, moreover, arose out of a tradition that capital gain had to be preserved for the benefit of heirs. The castle and manor were supposed to be part of the inheritance no matter what they were worth. Compensation has never been thought of as a necessary part of a taxpayer’s inheritance. This proposal would codify the general ideal that compensation for services is ordinary income, not capital gain, and apply it uniformly. It would amend section 1221 to provide that capital asset does not include gains attributable to labor input, compensation for services, no matter by what the form realized, and property whether tangible or intangible, held by the taxpayer whose personal effort created the asset or added substantially to its value. The proposal would eliminate capital gains rates now available for songwriters, inventors, and amateurs who make an asset for the first time. The proposal would, however, make C corporation stock a capital asset even when the shareholder creates or improves corporate assets as an amelioration of the double tax on corporate income. Sweat equity put into unincorporated sole proprietorships and partnerships, however, would be taxed as ordinary income when realized. If a taxpayer has basis in an asset, the proposal would allow the taxpayer to elect to allocate gain from a single asset between compensation, which would be ordinary, and appreciation of basis, which could qualify as capital gain, using a general index of appreciation, the taxpayer’s history of basis, and withdrawals from the asset of at least going interest rates. However, the accounting would be complicated, sometimes adverse to the taxpayer, and limited in value, so taxpayers might not make the election. This proposal is made as a part of the Shelf Project, which is a collaboration among tax professionals to develop and perfect proposals to help Congress raise revenue without raising tax rates. The deficit is $1.6 trillion or 11.2 percent of GDP, and federal spending over the next decade will be twice that. In the impending revenue crisis, base-protecting revenue provisions that were not possible under ordinary politics become political necessities. Tax rates cannot be raised on this loophole-ridden tax base. Shelf Project proposals defend the tax base and improve the rationality and efficiency of the tax system. They are intended to raise revenue without raising rates because the best tax systems have the broadest possible base to reach the lowest feasible tax rates. A longer description of the Shelf Project is found at The Shelf Project: Revenue-Raising Projects That Defend the Tax Base, Tax Notes, Dec. 10, 2007, p. 1077, Doc 2007-22632, or 2007 TNT 238-37.

Constitutional tariffs, incidental protection, and the Laffer relationship in the early United States

This article explores an early attempt to establish a constitutional constraint on tariffs utilizing the Laffer Curve relationship. In 1842 John Calhoun suggested that the curve’s revenue maximization apex could be used to differentiate between “Revenue” and “Protective” tariffs independently from the non-judiciable question of legislative motive. When admitted that a tax must actually be collected to remain constitutionally valid, the apex functions as a de facto upper tariff rate constraint. Despite subsequently falling in disfavor, Calhoun’s argument illustrates the importance of political economy on the constitutional level by recognizing conditions that induce policymakers to rationally raise tax rates at the expense.

The underground economy and its macroeconomic consequences

This study develops a dynamic general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.

An Analysis of the Underground Economy and its Macroeconomic Consequences

This paper develops a dynamic computable general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.

Comments and Discussion

Comments and Discussion Sanjeev Gupta and Steven Radelet Sanjeev Gupta: Christopher Adam and David Bevan's paper makes an important contribution to fiscal adjustment literature. By analyzing fiscal adjustment in both Organization for Economic Cooperation and Development (OECD) and developing countries, the authors enrich our understanding of what sustains fiscal reforms and how the fiscal behavior differs across countries by income levels. Many studies have analyzed episodes of fiscal adjustment in industrial countries, but similar studies for developing countries, and in particular low-income countries, are rather limited. In this way Adam and Bevan's paper fills a void in the literature by building on the strengths of existing methodologies. Adam and Bevan's paper confirms findings of Gupta and others, which are based on a sample of low-income countries but rely on a different measure of fiscal consolidation.1 In particular for developing countries as a whole, they find that revenue increases and fiscal history, including the number of previous failures, are critical for sustaining fiscal adjustment, while expenditure reductions play a minor role. This contrasts with findings in the literature on industrial countries, where expenditure reductions dominate the sustainability of fiscal adjustment. The policy implications stemming from these results are far reaching. While there will continue to be a need for improving efficiency of public expenditures in developing countries, the scope for raising additional revenue for sustaining fiscal adjustment cannot be overlooked. In general, the ratios of revenue to GDP in these countries are relatively low, in part [End Page 215] because of weak administration and pervasive tax exemptions. This implies that revenue increases could be achieved without raising tax rates. In order to explore different options for designing policies, however, Adam and Bevan's paper would need to find out more. For example, do wage cuts contribute to sustained fiscal consolidation? Does the composition of spending matter? The research on fiscal adjustment in low-income countries carried out by staff of the International Monetary Fund suggests that a reallocation of spending from current to capital outlays fosters growth2 and is positively related to the persistence of adjustment. This may be due to the positive impact of capital spending on income growth, which in turn has a positive impact on the probability of sustaining fiscal consolidation. Additional work for a wider sample of developing countries would be needed to confirm this. Further research is also needed to understand the channels through which initial fiscal and macroeconomic conditions impact on the persistence of fiscal adjustments in developing countries. Although the Adam-Bevan paper reports evidence on the impact of macroeconomic variables (such as inflation, growth, and exchange rates) on sustaining fiscal adjustment in these countries, the channels through which this happens—including whether the relationship is linear or nonlinear—are not clear. The paper provides a useful typology of the definition of fiscal consolidation and persistence in applying survival analysis: mdash level approach (a specified threshold for the deficit); mdash gradient approach (reduction of the deficit at some specified minimum rate); mdash and composite approach. Each approach has its own strengths and weaknesses. The work carried out by the IMF used what they refer to as the gradient approach, while Adam and Bevan prefer the level approach. There are some difficulties in the use of the level approach. First, it imposes a common threshold on what is clearly a diverse group of countries facing different policy environments. The revised version of the paper rightly assesses the robustness of empirical results by taking into account disparity in circumstances facing middle- and low-income countries. But this approach does not fully capture diversity in effort required by countries for achieving fiscal sustainability as the overall fiscal deficit that is consistent [End Page 216] with sustainable debt—expressed in nominal or net present value terms—varies from country to country. This is confirmed by work done by staff of the IMF on debt sustainability, which points to a variation in country-specific thresholds for a sustainable debt ratio.3 The latter is sensitive to such factors as export growth, current account balances, and commodity price developments. In addition, access and exposure to international capital markets are important determinants of fiscal...

An Analysis of the Underground Economy and its Macroeconomic Consequences

This paper develops a dynamic computable general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.

Tax Competition, Income Differentials and Local Public Services

This paper examines strategic tax setting between fiscal authorities in the presence of mobile workers who locate across these jurisdictions in response to differing tax structures and congestable local public amenities. We find that the nature of the tax setting outcomes depend crucially on the proximity between cities. For “distant” cities with the same size populations, the pressure on tax rates of a more mobile workforce depends on the whether mobile workers are net beneficiaries or net contributors. If mobile workers are either high or low income earners, cities lower tax rates. If mobile workers are middle income earners, cities raise tax rates. For “close” or neighbouring cities, workers locate in one of the cities and tax rates and local public amenities are dispersed.

Gambling Taxation: Public Equity in the Gambling Business

Government's intrinsic role in sustaining a viable gambling industry, and its significant revenue stake in industry profitability, can make the public effectively shareholders in the industry. An important social cost of gambling is the potential for corruption of democratic processes through close industry and government links. Government can increase gambling revenues by expanding the tax base, rather than by raising tax rates. Gambling tax rates have fallen in recent decades, while revenues have increased dramatically. This paper analyses the forces encouraging governments to give excessive priority to protecting gambling revenues. It finds gambling taxation is regressive, and increasingly so as access widens. ‘Children, madmen and fools' are significant to the market. The transition to a goods and services tax, along with the recent inquiry by the Productivity Commission into gambling, provides an opportunity for gambling policy to be made in a coherent social and economic framework, rather than as ad hoc and short‐term solutions to State governments' revenue problems. Such an outcome rests on the Commonwealth government playing a leadership role.

A Cost-Benefit Analysis of the Thailand Taxpayer Survey

We investigate whether more resources should be devoted to a Thai tax enforcement program which is aimed at bringing small businesses into the tax system. We show that the appropriate criteria for determining whether more resources should be devoted to tax enforcement is whether the Atkinson–Stern condition for the optimal provision of a publicly-provided good is satisfied, or equivalently, whether the marginal cost of finds obtained through additional tax enforcement, SMCFp, is less than the marginal cost of funds obtained through raising tax rates, SMCFt. In our base case scenario, the SMCFp is 11.60 which exceeds our estimate of the SMCFt for an across-the-board increase in income tax rates on wage earners. The use of pro-poor distributional weights makes expanding the survey less attractive if the alternative way of obtaining additional tax revenue is an across-the-board income tax rate increase, while aversion to tax evasion makes it more attractive.

The international importance of low tax rates1

G‐7 economies raised tax rates in the 1990s, unlike the 1980s. Yet many developing nations continued to bring their highest tax rates down. Economic growth among 19 countries with low or falling tax rates averaged 5.8% a year from 1990 to 1996, up from 4.5% in the preceding decade. At the same time, annual GDP growth among G‐7 countries slowed to 1.7%, down from 2.9%.

Will bounty-hunting revenue agents increase enforcement?

While the final version of the 1986 Tax Reform Act retained budget funding of the IRS, the Senate proposal to finance spending from audit revenues represented a seriously debated alternative that continues to receive attention as a method for increasing enforcement. At one level, the ultimate failure of the proposal is puzzling. Given Congress's unwillingness to raise tax rates to cover spending, the budget deficits of the 1980s must be financed from some other source — inflation, borrowing or increased enforcement. Turning the IRS into a bounty-hunting agency would seem to be a straightforward way of producing extra revenue.

Fringe benefits, income tax exemptions, and implicit subsides

Tax exemptions for fringe benefits implicitly subsidize employment and consumption. This paper presents a partial equilibrium model of optimal compensation which permits exact measures of subsidy magnitudes and distributions. Under proportional taxation, tax exemptions represent savings of approximately 5–10 percent of compensation costs to individual employers or employees. As much as 80 percent of this saving represents reduced income tax payments. Alternative income tax schemes might achieve specific policy goals with fewer distortions. If government raises tax rates to insure that exemptions for benefits do not reduce tax revenue in the economy as a whole, the net gain is much smaller, approximately 1.5 percent of compensation.

Why Some States Adopt Lotteries and others Don'T

In 1963, New Hampshire reintroduced the state-sponsored lottery in the United States. By late 1986, more than half of the 50 states had lotteries in operation or had approved lotteries through referenda. Of the scholarly journal articles that have analyzed the economics of state lotteries, most have been concerned with the regressivity of the implicit lottery tax. In this article, we address the more important question of why any such regressive tax, especially one in the form of legalized gambling, would be adopted in lieu of higher sales, property, or income taxes. Using a model of rational legislator behavior developed from public choice theory, we generate and test empirical models that explain the pattern of lottery adoption across states and the timing of such adoptions. In general, a given state will have a higher probability of adopting a lottery as an alternative source of state revenue, and will tend to adopt a lottery earlier, the greater the overall tax burden on the voters of the state, the greater the expected return from a lottery in the form of spendable revenue, the greater the difficulty in raising tax rates on other bases, and the fewer the number of poor people in the state.

The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross Section Approach

The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross Section Approach

Wealth Neutrality Revisited: Guaranteed Tax Base Formulas and Local Choice in Public Education

URRENT research interest in school finance stems from reforms aimed at narrowing the range of expenditure variations among school districts. These reforms have attempted to compensate for tax base differences by providing state matching aid inversely proportional to tax base.' While expressed in different forms in different states and variously termed Percentage Equalization,' District Power Equalization (DPE), or Guaranteed Tax Base (GTB), these formulas, in their basic form, amount to the state guaranteeing all districts the same tax base per pupil, call it v*. Districts taxing themselves at a tax rate, r (adjusted at the state level to compensate for assessment variations so that r reflects the rate on true market value), are guaranteed revenue equal to rv*. The difference between what is raised locally in a district, rv, and the guarantee at that tax rate is provided through the state aid formula.2 In practice, legislative limitations on aid formulas in most states have led to richer districts maintaining a tax base advantage. For example, districts with a tax base above v* can raise more revenue at the same tax rate than districts at vor below. Also, placing limits on reimbursable expenses (e.g., not to exceed E* = r*v*) means that beyond a certain point, even in districts with tax bases below v*, raising tax rates will not engender any additional state matching aid, as would be required under a strict guarantee. Hence, while the introduction of GTB formulas provided a theoretical improvement, these limits made them equivalent to the foundation aid formulas they were intended to replace, effective improvement coming only when the limits were made more generous.3 In studying these reforms, research has concentrated on models relating current operating expenditures to the following: tax base, some price term reflecting the local share in the matching formula, block grants, and demographic variables. The most popular form has been the single equation log-linear model4 where coefficients are elasticities, which allows for easy comparability of the effects of the independent variables. However, the assumption of constant elasticities and the lack of interaction terms can be misleading in capturing behavioral responses and in making projections. This may be especially true when one is using data from less than equalized systems, where districts are operating in a tax and expenditure range different from what would occur under a fully (tax base) equalized system and when there are different responses to the state aid formula depending upon relative tax burden and educational need. For example, the expenditure response to state aid in poorer districts may be high for small increments in state aid, but, as district expenditures move beyond minimal requirements, increases in state aid may go increasingly into tax relief, depending upon the tax burden. The richer districts, in terms of property, generally face a price of one, i.e., no matching aid at the margin. However, most legislation guarantees some minimal funding for these districts. In order to make aid formulas fully effective, either poorer disReceived for publication October 1, 1981. Revision accepted for publication April 16, 1982. * The American University. This work was supported by National Science Foundation Grant Number SES-8013080. I am indebted to Anthony Boardman for getting me interested in the topic, to Robert Summers, Anita Summers, Janet Pack and Ralph Ginsberg for moral and intellectual support, to numerous people in the Michigan state government, especially Bob Witte and Bob Bosscher, for their expertise and cooperation, and to the School of Public and Urban Policy, University of Pennsylvania, for its encouragement of this research. I Usually property per pupil, which we denote by v. 2 I.e., state aid per pupil is r(v* v). The local share, or net price that the district pays per dollar of educational expenditure, denoted a, is a = v/P*. Under GTB, districts control expenditure levels through their choice of tax rate. 3For a detailed analysis of aid formulas see Reilly (1982). 4 Initially postulated by Feldstein (1975). Park and Carroll of Rand (1979), Black et al. (1979, 1980), and Johnson and Collins (1978, 1979) also use the same model. Other models of local expenditures have been used by Akin and Auten (1976), Barro (1972), Gatti and Tashman (1976, 1978), Grubb and Michelson (1974), Inman (1971, 1978), Ladd (1975), Lovell (1978), Slack (1980), Stem (1973), Welch (1981), and Wentzler (1980).

The effect of tax elasticity on government spending

Elasticity measures the extent to which a tax structure generates revenue in response to increases in taxpayer income without a change in statutory tax rates. While elasticity depends in part on propensities to engage in taxable activity, its main dependency across political units in the United States is on the progressivity of the income tax. States with highly progressive income taxes tend to have elastic tax structures. It has been proposed that greater elasticity in the tax structure generates a greater volume of public spending [3, 5, 12]. This proposal generally rests on the concept of 'fiscal illusion', the illusion being that if the legislature does not enact a statute raising tax rates, taxes have not increased. It follows that states with elastic tax structures experience greater increases in tax revenues without having to go through the throes of a tax increase, and those states will spend more. We admit to being supportive of the idea that elasticity drives spending. We also admit to the usual discomfort that economists feel when they lean on notions conflicting with the assumptions of 'rationality' that undergird the conventional utilitarian analysis. But, we proceed with the hope that there will be a reconciliation of this conflict. One could build a competing theory based on public choice notions to explain the hypothesis that elasticity breeds spending. Assuming that the median voter prevails, it is obvious that we could specify individual demand functions for public goods such that if cost allocation were made progressive to income, spending increases would result. But, there is difficulty in propping up such a notion in the face of Tiebout mobility [11 ]. Similarly, if we assumed that tax sharing arrangements were prescribed