Tax reform State and local governmentsTodayTax reformSlide 4What about a consumption tax?Slide 6What are some ways to tax consumption?Slide 8Problems with consumption taxesSummary: Tax reformState and local governmentsCentralization in the USSlide 13The Tiebout modelTiebout’s assumptionsAdvantages with the Tiebout modelSlide 17Efficiency issues with the Tiebout modelPublic educationRecall: Quality of public educationWhat about low-income areas?Property taxesProp 13What about structures?Final topic: Intergovernmental grantsSummary: State and local governmentsTax reformState and local governmentsToday: Some ideas on how to reform taxes; How do state and local governments affect behavior?TodayMore topics that affect behaviorCan taxes be reformed so as not to distort behavior as much?How do state and local governments affect everyday lives?Tax reformEconomic waste due to taxation is estimated to be as much as $1 trillion per yearNote that $1 trillion is about 8% of annual GDPHow can this be changed?Tax reformCurrent tax codes seriously distort behaviorPeople work less (labor tax)Sub-optimal investment decisions (lock-in effects due to the capital gains tax)Some people advocate a tax system that reduces wasteWhat about a consumption tax?Taxes on consumption have some appealVary tax rates based on externalitiesEncourage consumption of goods and services with positive externalitiesDiscourage consumption with negative externalitiesProgressiveness issue is probably not justifiedLifetime sales taxes paid (as a % of lifetime income) is about the same for each income bracketEasy to administrateInternational competitiveness could increase for the USWhat about a consumption tax?Some negative aspects of a consumption taxConfusion about how much each good should be taxedExample: The “snack tax” in CaliforniaTaxed: Wrapped slices of pieNot taxed: A slice of pie served on a plateTax evasion due to smuggling and underground economiesWhat happens when you change the tax system?Those that saved over the years get increased tax burdenThose that borrowed over the years get decreased tax burdenWhat are some ways to tax consumption?National retail sales taxTo replace federal taxes, a federal retail tax of about 35% would be requiredProblem: Tax evasion could become a serious problem once the sales tax rate exceeds 10%Many states already have a sales tax about 6-8%What are some ways to tax consumption?Value-added tax (VAT)Popular in EuropeMostly consumption-basedCapital investments are not part of the taxable baseInvolves taxing the additional value at each stage of productionSee Figure 21.2, p. 487Problems with consumption taxesDistortions still occurConsumption taxes will not solve all of the trade problems in the USHousehold labor is still sheltered from taxationSummary: Tax reformMany people would like to see more consumption taxation and less labor taxationSubstantial evasion of a national retail sales tax would be possible if the tax completely offset personal income taxesA value-added tax has appeal, but has its own disadvantagesState and local governmentsState and local governments are playing a bigger role in taxation1960: 12.2% of state tax collections were from individual income taxes2002: 35%Marginal income tax rates are still small compared to federal governmentHighest bracket in 2006: Vermont (9.5%)California not far behind: Highest bracket is 9.3%Single taxable earnings above $44,814 in 2007Centralization in the USCentralizationCentralization ratio = Central government expendituresTotal government expendituresIn the US, the centralization ratio is less than one-halfState and local governmentsHow do people alter their behavior based on state and local governments?The Tiebout modelVote with your feet within your home countryPublic educationProperty taxesGrants between different levels of governmentThe Tiebout modelPeople rarely leave the US due to government policyMobility in the US due to government policy is substantialTiebout makes many assumptions in his modelNot a perfect description of the real worldGives a good idea of how people decide what community to live inTiebout’s assumptionsGovernment activities generate no externalitiesIndividuals are completely mobilePeople have perfect information with respect to each community’s public services and taxesThere are enough different communities so that each individual can find one with public services meeting her demandsThe cost per unit of public services is constant so that if the quantity of public services doubles, the total cost also doublesPublic services are financed by a proportional property taxCommunities can enact exclusionary zoning laws—statutes that prohibit certain uses of landAdvantages with the Tiebout modelTailoring outputs to local taxesEach person or family lives in a community they likeOne size does not fit allTastes and preferences differ from person to personFostering intergovernmental competitionPeople in government generally want people to live in their communityAdvantages with the Tiebout modelExperimentation and innovation in locally provided goods and servicesStates and cities can try new programsThese studies often result in quasi-experimental studies by economistsThe analyzed results lead to good information for governments throughout the nationEfficiency issues with the Tiebout modelExternalitiesBoth negative and positiveMany public goods are not at the local levelScale economies in provision of public goodsPer-person cost often decreases as the number of users increasesInefficient tax systemsDifferent states and cities often compete to get large businesses to locate in their areaScale economies in tax collectionPublic educationFor families, voting with their feet often involves finding a good elementary and secondary education for their childrenYou often must live within a certain area to be able to go to a particular schoolRecall: Quality of public educationQuality of education is hard to quantifyBesides the obvious aspects of class size and total spending, there are different criteria that affect educationUnionization of teachersParents’ choices of their kids’ curriculumSize of