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What the general fund does not measure

The General Fund of a town, county, or state is often viewed as a measure of fiscal health. Is it positive or negative? Large or small? Growing or shrinking? The balance, size, and trend of the General Fund are all good statistics to examine, but when considered alone, the General Fund is not an adequate measure of a government’s fiscal health.

Liquidity

The General Fund reflects short-term liquidity. The General Fund balance is like your checking account balance. There may be cash in your account, but this says nothing about your net worth, which is calculated as your total assets minus your total liabilities. How much have you saved for your child’s college education or for your retirement, and do you have equity in your house? These are your assets. Do you have liabilities such as a mortgage, a car loan, or credit card debt? Many of us have experienced having money in our bank accounts despite having high credit card debt, minimal home equity, or insufficient savings for college or retirement.

Solvency

The General Fund does not answer the question, “How fiscally secure or solvent is my town, county, or state?” because the General Fund does not capture long-term liabilities. The questions that the General Fund answers are, “Can my government pay its bills that are coming due in the short term?” and “Is there cash for a ‘rainy day’?”

If a state or local government is not fiscally secure, it must raise taxes, cut spending, issue debt, reduce contributions to its retirement obligations, or some combination of these options. These decisions will directly affect many constituents, including taxpayers, employees, vendors, bondholders, and public sector retirees, both current and future.

Unrestricted Net Position and Solvency

If the question is, “Is your state or local government fiscally secure enough such that your taxes are less likely to be raised to amortize your government’s liabilities?”, the answer lies in the Unrestricted Net Position. The Unrestricted Net Position is a balance that reflects whether the government has sufficient assets to meet all liabilities without resorting to liquidating building and land assets or dipping into special-purpose funds.

The General Fund is not correlated with Solvency

Not only is the General Fund balance not an indicator of fiscal health, but it is also not positively correlated with the Unrestricted Net Position balance. In fact, the statistical correlation between these two balances is negative 29%.(1)

Just how fiscally secure are state and local governments? Only 33% of all states, 33% of sampled counties, and 45% of sampled towns (cities) have a positive Unrestricted Net Position. Sixty-five percent of states, 65% of sampled counties, and 50% of sampled towns (cities) have a negative Unrestricted Net Position. The remaining states, counties, and towns have an Unrestricted Net Position of zero or near zero.

Unrestricted Net Position of Cities & Towns, Counties, and States, FY 2021.

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(1) Includes any government “rainy day fund” balance, which may be a distinct reporting category. If “rainy day funds” were excluded from the data used for the calculation, the statistical correlation would be more negative.

Source Pality.

Written by James Galasso.

Copyright 2023 Pality.

By |2024-03-21T12:23:59-04:00November 5, 2023|State and Local Finance|Comments Off on What the general fund does not measure
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Do small towns have better schools?

Keeping it Local

Small communities are characterized by taxpayers who are invested in their communities because they own real estate and demand accountability. Their taxes provide for tangible services with observable outcomes, such as the number of teachers and police officers, the condition of roads, and emergency response times. When taxes are collected and spent locally, as is the case with property taxes, a local government may feel a heightened sense of accountability.

If there is a greater sense of accountability in small towns and cities, then all else equal, locally provided services should perform better in smaller towns and cities. If this is the case, then schools in smaller towns should perform better than schools in larger towns and cities.

Measuring Performance

School performance is measured using 15 years of achievement testing data from 11th graders across more than 3,000 cities and towns in Connecticut, Massachusetts, and Pennsylvania. There is nearly 100% participation in the exam in all three states, and all use the same exam. To observe the impact of population size on scores, certain variables are controlled for, including household income, school size, student-teacher ratio, and testing year. As one might expect, household income is strongly positively correlated with performance. School enrollment size, which is distinct from the size of a town, is strongly negatively correlated with performance. Higher student-teacher ratios, meaning larger classroom sizes, are positively correlated with performance, which is a somewhat counterintuitive finding. The testing year has a highly statistically significant negative correlation and is an important control variable because test scores have declined over time.

Size Matters

For each 10,000-person increase in town population, there is up to a 2 percent drop in test scores. The impact of population size is greatest in Connecticut, with a 25-point decline in test score, which is about 2% of an average point score of 1,100, for every 10,000-person increase in population. The impact of a town’s population size in Massachusetts and Pennsylvania is smaller than it is in Connecticut, but for all three states, town size is highly statistically significant at the 99.9% significance level.

For the three states, the analysis was run with and without each state’s largest cities because these states are characterized by having mostly small and mid-sized towns and cities, plus just a few larger cities. No material impact was associated with the inclusion or exclusion of the largest cities. The impact of school regionalization was also observed, and all else equal, regional schools scored better than non-regional schools.

These results suggest that the accountability associated with smaller towns may help explain better school outcomes and, by extension, may also promote better performance in other town-provided public services. Other factors beyond accountability may contribute to the results, such as the larger presence schools may have in the social fabric of smaller towns. While regionalization is positively correlated with performance, the more numerous the cities and towns participating in a regional school district, the worse the outcome. With more cities and towns participating in one district, regional schools may not feel the same heightened sense of accountability for school performance. This finding is consistent with the finding that smaller cities and towns produce better school outcomes.

This analysis highlights a robust link between town size and school performance.

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Written by Joseph Cahill.

Copyright 2023 Pality.

By |2024-03-21T12:19:42-04:00November 4, 2023|Education|Comments Off on Do small towns have better schools?
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Tax fairness and free-ridership

Progressive or Regressive?

Tax fairness usually addresses whether tax burdens are progressive or regressive. With a progressive tax, the share of one’s income paid out as taxes rises as income rises, which is considered fair. With a regressive tax, the tax burden falls as income rises, which is considered unfair.

Generally, property tax is seen as progressive because high-income earners are more likely to own more expensive property and pay higher property taxes. Low-income earners are more likely to be renters, and depending on the strength of the rental market, landlords may not be able to pass through some of the property tax to their renters. Many cities and towns also have property tax exemptions for low-income households. Sales tax is thought to be the most regressive because not only does it tax the first dollar of spending, but it also burdens low-income earners disproportionally, who spend most of their income on basic needs. Income tax is progressive to the degree that the marginal tax rate rises with income, and the first dollars of income are tax-exempt.

Free-Ridership

Tax fairness also relates to who pays the taxes and who reaps the benefits of the services that the taxes fund. An imbalance between those who pay and those who benefit results in what is known as “free-ridership” or “free-riding.” Typically, this is a local taxation issue and is not identical to the concepts of redistribution or regressivity.

A city or town reliant on property taxes may have a free-ridership problem. Consider a city that has big box stores. These stores attract residents from surrounding communities who bring cars, which cause road wear and tear, as well as the need for traffic control, street lighting, garbage collection, police and ambulances, and other city services. But that city may be funded solely by the property taxes of the city’s residents. Although commercial establishments also pay property taxes, and their customers pay prices that capture the cost of taxation in turn, those taxes are not well aligned with the utilization of city-provided services. Further, not only do residents of larger cities and towns bear the tax burden, but they also absorb many negative externalities, such as noise pollution and reduced public safety from the transient population. Is it fair that residents of these cities pay for services used by “out-of-towners” who do not contribute to the cost?

Tax Burden and Population

Free-ridership may also be regressive. Not only do larger cities have more free-riders, but generally, tax burdens are also higher in larger cities. Using a broad sample of more than 100 cities with populations greater than 100,000, the correlation between the local tax burden, which is local taxes as a percent of income, and population size was observed to be 58%. So, unless there is a corrective cash redistribution from state funds to the local level, larger cities will continue to experience unfairness from free-ridership and potentially additional unfairness should their residents have fewer economic resources relative to out-of-towners.

Tax Burden and Population

Correlation coefficient = 58%.

Source: Pality.

Tax-Exempt Organizations

Tax-exempt property associated with non-profit institutions further compromises tax fairness. As an example, hospitals and universities, which are tax-exempt, invite free-ridership as they draw residents to utilize their services from well beyond the reach of a city’s taxing arm. Even when states provide relief through payments-in-lieu-of-taxes, these transfers rarely make the cities and towns whole from the foregone revenue associated with tax-exempt property. Yet again, the city’s residents must cover both direct costs, such as more traffic control, as well as indirect costs, such as noise pollution and reduced public safety. On top of this, they are shouldering the direct and indirect costs with fewer tax resources.

Can tax fairness be restored in cities and towns experiencing free-ridership?

If a state provides direct transfers of revenue from state-levied income and sales taxes to cities and towns experiencing free-ridership, fairness can be restored. However, if the state levies new taxes to fund these transfers, unintended consequences may arise, such as economic distortions and tax avoidance schemes. Further, once a tax is established, it is difficult to remove or reduce it. Finally, even if it is neutralized at the onset with a lower local property tax, the overall tax burden may creep up over time.

Written by Joseph Cahill.

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Copyright 2023 Pality.

By |2024-03-21T12:20:47-04:00November 3, 2023|Taxation|Comments Off on Tax fairness and free-ridership
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Just how diversified are taxes?

What is Tax Diversification

Within the context of public finance, a government that is tax-diversified is one that levies a wide array of tax types. Tax diversification is a policy goal of many governments, as a lack of diversification may disproportionately burden certain groups of taxpayers or expose a government to economic shocks.

Facts versus Headlines

Governments, particularly state governments, are far more diversified than headline statistics suggest. Take New Hampshire, which has neither a sales tax nor a personal earned income tax. Is New Hampshire undiversified? The state government’s largest source of revenue is fees collected and revenue earned from governmental and business-type activities. These fees and revenue comprise 35% of total revenue, surpassing total tax revenue, which makes up only 27% of total revenue.

Now consider Florida, Texas, and South Dakota, three states with no personal income tax. Each state’s sales taxes comprise more than 80% of total tax revenue. When viewed alone, this might suggest that these states are undiversified, but in fact, tax revenue comprises less than one-third of their total revenue, like New Hampshire. All US state governments have not only a mixture of tax types but also a blend of additional revenue from business-type and component unit activities, as well as grants and transfers from federal and local governments.

Local governments are also more diversified than headline statistics suggest. Even a local government whose only source of tax revenue is property tax will collect fees and earn revenue from business-type and component unit activities, and may also receive transfers from the state, all of which are revenue diversifiers.

Tax Revenue Diversification

On average, a state’s income and sales taxes constitute 83% of total tax revenue. In counties, 66% of tax revenue comes from property taxes, 24% comes from sales taxes, 8% comes from other taxes, and income taxes contribute 2% to tax revenue. In cities and towns, 63% of tax revenue comes from property taxes, nearly 23% comes from sales taxes, and the remainder comes from income taxes and other taxes at 6% and 7%, respectively.

Source: Pality

Revenue Diversification

While each jurisdiction type has one or two predominant tax types, for all jurisdiction types, tax revenue comprises less than half of total revenue. In a typical state, tax revenue makes up 34% of total revenue. In a typical county, tax revenue comprises 46% of total revenue, and in a city or town, it makes up 44% of total revenue.

State governments, on average, earn a variety of fees and revenue from business-type and component unit activities. Together, these sources comprise 37% of total revenue, which is greater than the revenue that taxes contribute to total revenue. Transfers and grants, net of outflows to and inflows from cities, counties, and the federal government, make up the balance of about 28% of total revenue.

County governments earn a variety of fees and revenue from business-type and component unit activities as well, which together comprise 39% of total revenue on average. Transfers and grants, net of outflows and inflows, amount to 16% of total revenue.

The average revenue composition in cities and towns is like the revenue composition in counties, with a variety of government fees and revenue from business-type and component unit activities comprising 39% of total revenue and net transfers and grants comprising 17%.

Source: Pality

Tax Diversification for the Taxpayer

Even if a state or local government’s tax revenue composition is not well-diversified, a taxpayer’s tax burden is well-diversified when viewed in the aggregate. Excluding federal government taxes, the composition of the combined state and local tax burden on taxpayers is quite balanced on average, with sales taxes comprising 35%, property taxes comprising 32%, income taxes comprising 26%, and other taxes comprising 7% of total taxes paid.

If federal taxes are considered, income taxes play an even bigger role. Income taxes comprise 60% of all taxes collected by federal, state, and local governments, excluding payroll taxes. Combined across all jurisdictions, sales taxes comprise 19% of total tax revenue, property taxes comprise 17%, and other taxes account for 4%.

Share of Total Tax Revenue by Type of Tax

Source: Pality

Discussions surrounding tax diversification should address total revenue in addition to tax revenue and focus on diversifying the Tax & Fee Burden on taxpayers.

Written by James Galasso.

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Copyright 2023 Pality.

By |2024-03-21T12:18:26-04:00October 13, 2023|State and Local Finance, Taxation|Comments Off on Just how diversified are taxes?
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