 |
||
| BACK | NEXT | WEB BOOK |
An Introduction to State and Local Public Finance
Thomas A. Garrett and John C. Leatherman
| |
||
| BACK | NEXT | WEB BOOK |
Overview
Public finance is the field of economics that studies government activities and the various means of financing these activities. In general, public finance deals with any of the three levels of government: federal, state, and local. While the basic theories of public finance apply regardless of the level of government studied, state and local public finance has emerged as an important sub-field of public finance in recent years. An increased emphasis on state and local public finance is due to several factors. First, the past forty years have seen a dramatic rise in state and local government expenditures. State and local (city and county) government expenditures topped $1.1 trillion in 1996, a 500 percent increase in real dollars since 1960. In 1996, state and local government expenditures comprised over 16 percent of the Gross Domestic Product of the United States. Second, there are nearly 87,000 separate state and local governments in the United States, each having its own fiscal responsibilities and revenue sources. Unlike the federal government, changes in the taxing and expenditure behavior of one state or local government has impacts on surrounding localities as residents are mobile between state and local government jurisdictions. Third, the major services provided by state and local governments - education, public welfare, health care, and highway construction and maintenance - are those which most directly impact the daily lives of residents.
While the public sector is characterized by both revenues and the expenditure of these revenues on public goods and services, the focus of this chapter is on the revenue, or financing, side of government. The chapter is designed to provide the reader an understanding of the basic principles, theories and issues in state and local public finance. The chapter consists of two major parts each consisting of three sections. The first part includes three sections that provide an introduction to government growth, taxes, and tax theory, in addition to several important issues facing state and local governments. Selected applications in public finance are covered in sections four, five and six. While the chapter as a whole is written to provide a continuum between topic areas, each section may be read independently without a loss of understanding. The first two sections are written for the general reader and require only a minimal background in economics. Section three requires a background in undergraduate microeconomics, and a portion of the third section also requires a basic knowledge of differential calculus and econometric modeling. The fourth and sixth sections contain mathematical formulas and econometric models, but these formulas and econometric models can be skipped without loss of continuity. The fifth section is appropriate for the general reader and those having a background in basic microeconomics. For a further analysis of each section presented in this chapter, the reader is referred to several excellent texts on public finance. These include: State and Local Public Finance by Ronald C. Fisher, Public Finance by Harvey Rosen, and Public Finance: A Contemporary Application of Theory to Policy by David Hyman.
Section I provides numerical and graphical evidence on the growth of state and local governments in recent years. Several explanations for the dramatic increase in the size of state and local governments are also presented. The section then focuses on the major categories of state government expenditures and discusses the major historical trends for each expenditure category. Although this section contains a substantial amount of data for illustrative purposes, the reader should not focus on memorizing every bit of data, but rather concentrate on acquiring an overall understanding of the changes in state and local government over the past several decades.
Section II discusses the primary revenue sources for state and local governments. The section begins by providing background on the changing revenue sources for state and local government revenues. The revenue sources addressed include the sales tax, the property tax, the personal income tax, the corporate income tax and excise taxes. Attention is also given to the incidence of a tax in terms of the income distribution and revenue generation. States’ historical reliance on each tax as a source of revenue is discussed, along with critical issues and ideas surrounding each tax. Important issues surrounding sales tax revenues, such as cross border shopping and taxing electronic commerce, are also discussed within the section.
Section III provides an overview of tax theory. The distributional impacts of taxation and the effects of taxation on the efficiency of markets are discussed. Both issues should be considered by public officials when evaluating taxes in their state or community. A short background on efficiency is presented along with an analysis of the impact taxes have on the efficiency of market operations. Graphical analyses and differential calculus are used to derive expressions used to compute the efficiency costs of taxation. The section ends by presenting two popular models of optimal taxation - the Ramsey Rule and the Laffer curve.
Section IV provides a general background on revenue forecasting for state and local governments. The section begins by discussing the forecasting process. Further portions introduce the reader to the various forecasting methods available, differentiating between qualitative forecasting methods and quantitative forecasting methods. The benefits and drawbacks of each method are also discussed. Attention is given to the Box-Jenkins ARIMA model and the causal forecasting model.
Section V presents an overview of cost-benefit analysis, paying specific attention to evaluating the costs and benefits of public projects. The important concepts of present value, discount rates, and how to value costs and benefits are also included. The section concludes by addressing several pitfalls common to cost-benefit analysis.
Fiscal impact analysis is discussed in section VI. This sub-area of cost-benefit analysis is concerned with only the tangible effects of a policy or event on public sector costs. Several different planning approaches are presented, including methods for projecting public revenues and costs. Several econometric models often used in fiscal impact analysis are also discussed.