Technological change and tax policy: the future of state and local tax structures.

• Author: Bonnett, Thomas

As the economy shifts from goods to services and electronic commerce becomes a significant force in the economy, state and local taxing bodies are confronted with new challenges and questions.

Editor's note: The report "Is the New Global Economy Leaving State-Local Tax Structures Behind?" was prepared by the National League of Cities, the National Conference of State Legislatures, and the National Governors Association. Sections of the report and executive summary are reprinted and adapted with permission.

Prominent economic, social, demographic, and technological trends are threatening to erode the tax revenues of states and cities. The mainstays of these tax systems are the income, property, and sales taxes. Together, they generated 75.9 percent of total state and local tax revenues in FY 1994. Each is a prominent revenue source for state and local governments: the property tax generated 31.5 percent, the sales tax generated 23.8 percent, and the personal income tax generated 20.6 percent of total state-local tax revenues in FY 1994.

The most significant fiscal trend over the past 20 years has been the declining share of federal support to state and local governments, which has placed a much greater burden on current state and local taxes. Federal grants-in-aid to state and local governments averaged 21.5 percent of their total spending over the 1990-95 period. This is well below the 26.5 percent peak that occurred in 1978. Consequently, state and local governments have had to rely much more on their own tax revenue sources to generate sufficient revenue to provide services required by the public. Further, the recent trend of Congress pushing more responsibilities to state and local governments will place additional burdens on the current state-local tax structure.

If these two trends were to continue, federal grants-in-aid support to state and local governments would remain at modest levels for some time, and burdens would increase as well. That prospect increases the importance to state and local leaders of maintaining a state-local tax structure that will continue to generate adequate revenues with which to support valuable public services. The continued effectiveness of the tax structure is essential to maintain the autonomy of state and local governments. State and local leaders concerned with the independence and responsiveness of their governments should be sensitive to the stability of the state-local tax structure. The major vulnerability of the current state-local tax structure is its inability to adapt to increased mobility.

The current tax structure was built decades ago when the industrial economy produced tangible goods. The shift to the new service economy is the best-documented challenge to the current tax structure, but other social, demographic, and technological trends pose difficult challenges as well and could jeopardize the future viability of the current state-local tax structure. Each of these trends has important tax implications.

Exhibit 1 EMPLOYMENT GROWTH (in millions) 1979 1992 2005 Projected Manufacturing 21.0 18.4 17.5 Services 16.8 28.4 41.8 Source: Monthly Labor Review (November 1993), Bureau of Labor Statistics Economic Transformation

The magnitude of the shift over the last half-century from an economy based on manufacturing goods to one dominated by knowledge-based and personal services is often not well understood, but it poses several challenges to current tax policies. In 1959, services constituted...