Gary A. Wagner

English

Research Papers in Economics

Commentary
Gary A. Wagner
Before discussing the specifics of Professor
Fox’s article, I believe it is important to first address
an underlying issue that may provide additional
context to the concerns at hand. Namely, state and
local government revenue streams have become
more sensitive to economic downturns since World
War II. The implications are straightforward and
significant—subnational governments will experi-
ence more fiscal strain (at least on the revenue side)
from a 1 percent decline in economic activity today
than they would have from the same decline 30
years ago. This structural change for local govern-
ments may partly explain the growing reliance on,
or at least movement toward, nontraditional revenue
sources.
Although a detailed discussion of why state
and local revenue portfolios are becoming more
sensitive to downturns is beyond the scope of this
commentary, I believe we can look to two broad
culprits. First, as Tannenwald (2001) so carefully
documents, the U.S. economy has experienced a
well-documented shift away from goods toward
services in both production and consumption.
Combined with the increasing importance of
“knowledge-based” production, sales tax bases
are shrinking relative to the value of economic
activity. This is a serious concern for both state
and local policymakers, and several states have
attempted to broaden their sales tax bases to include
services.2
I
t is no surprise that the most recent eco-
nomic downturn, which some have called
the “Great Recession,” has had a substantial
impact on the fiscal health of state and local
governments. According to the National Governors
Association (NGA) biannual report, The Fiscal
Survey of States, state tax collections in fiscal year
(FY) 2010 were almost 12 percent below 2008
levels and are expected to remain near that level
for FY 2011.1 More than 40 states have responded
to the declining revenues by enacting midyear
budget cuts in both FY 2009 and 2010. This is
the first time widespread, back-to-back spending
reductions have been enacted since the NGA began
monitoring state fiscal conditions on a regular basis
in 1979.
In addition to prompting state and local govern-
ments to reduce expenditures, periods of fiscal
stress also provide the impetus for them to explore
opportunities to generate additional revenues
from both traditional and new sources. Professor
William F. Fox’s (2010) article provides a careful
analysis of some of the more recent trends and
issues involved in generating revenue from non-
traditional sources such as gambling and business
gross receipts taxes (GRTs). My comments, for the
most part, will complement and mirror Professor
Fox’s article by providing an overview of state and
local revenues, extending his analysis of GRTs,
and, finally, exploring the use of alcohol, tobacco,
and gambling taxes as revenue sources.
1 National Governors Association and National Association of State
Budget Officers (2010, executive summary, p. viii).
2 See Zodrow and Hendrix (2003) and Fox and Murray (1988) for an
overview of states’ attempts to broaden their sales tax bases to
include services.
Gary A. Wagner is a professor of economics at the University of Arkansas at Little Rock.
Federal Reserve Bank of St. Louis Regional Economic Development, 2010, 6(1), pp. 102-07.
© 2010, The Federal Reserve Bank of St. Louis. The views expressed in this article are those of the author(s) and do not necessarily reflect the
views of the Federal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. Articles may be reprinted, reproduced,
published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts,
synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.
102 VOLUME 6, NUMBER 1 2010 FEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENTFEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENT VOLUME 6, NUMBER 1 2010 103
Second, since World War II, state and local
revenue portfolios have become increasingly
dependent on revenue sources that vary more
over the business cycle. As Figure 1 shows, state
governments have become increasingly reliant on
individual income tax revenue and less reliant on
alcohol, tobacco, and motor fuel tax bases that are
significantly less volatile over the business cycle.
This trend is even more pronounced in figures
dating back to 1950.3 Moreover, a similar picture
emerges on the local government front. While
local governments are far less diverse in their rev-
enue sources than state governments, a point noted
by Professor Fox, there has been movement away
from the highly stable property taxes toward the
more volatile user fees/charges (Figure 2).4
One of the more popular “alternative” tax
sources—and the focus of much of Professor Fox’s
article—is the use of business GRTs. In its purest
form, a GRT is a tax applied to all business income
with no deductions for any type of expenses, which
is equivalent to a tax on all business profits and
costs. Although Professor Fox devotes considerable
attention to explaining the (sometimes) subtle dis-
Wagner
0
5
10
15
20
25
30
35
40
45
50
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Percent of Own-Source General Revenue
Total Sales and Gross Receipts
Alcoholic Beverages
Motor Fuels
Tobacco
Individual Income
Corporate Income
Figure 1
State Own-Source Revenues (1977-2007)
SOURCE: Data from State & Local Government Finance Query System (www.taxpolicycenter.org/slf-dqs/pages.cfm); the Urban Institute–
Brookings Institution Tax Policy Center (www.taxpolicycenter.org/); U.S. Census Bureau, Annual Survey of State and Local Government
Finances (www.census.gov/econ/overview/go0400.html); Government Finances, Volume 4; and Census of Governments
(www.census.gov/econ/overview/go0100.html).
3 The corporate income tax (CIT) also receives attention as a factor
in the fiscal stress that states bear. While there is little doubt that
changes in business structure (limited liability corporations and so
on) and the growing use of business tax incentives have narrowed
the corporate tax base, CIT revenue has been a relatively modest
source of state revenue over the past 50 years. See Cornia et al. (2005)
for an overview of the issues surrounding state CITs.
4 Clearly, pressures on the expenditure side of state and local budgets
may also contribute to periods of fiscal strain. See Garrett and Wagner
(2004) for a more detailed analysis of state expenditure and revenue
trends since World War II.104 VOLUME 6, NUMBER 1 2010 FEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENT
tinctions among corporate income taxes (CITs),
value-added taxes, GRTs, and net receipts taxes, in
my opinion, this portion of his paper really centers
on the bigger issue of finding the appropriate
method to use to tax businesses. Hence, much of
my discussion focuses on the GRT in general and
some of the pros and cons of the GRT relative to
the CIT (currently the most common form of busi-
ness taxation).
Given that some form of business taxation is
necessary so that individuals cannot simply form
corporations and be exempt from taxes, the ideal
form of business tax would be one that generates a
“sufficient” amount of revenue, is relatively stable
and grows with the economy, adheres to established
principles of equity, and is as efficient as possible.
This is not a simple matter in practice because even
though a certain tax may perform well by one or
more measures, no form of business taxation per-
forms well on all measures. The obvious challenge
for policymakers is therefore to weigh the relative
performance of various taxes when making a deci-
sion, and, I believe, the challenge for public finance
economists is to provide the most accurate measures
possible in terms of efficiency, equity, and the like.
In addition to Professor Fox’s analysis, several
researchers, most recently Mikesell (2007) and
Chamberlain and Fleenor (2006), point out several
real advantages of a GRT relative to a CIT. Com  -
pared with other forms of business taxation, such as
value-added taxes and CITs, since a GRT is applied
to all (or most) business transactions, the tax base
can be larger than the total market value of pro-
duction (gross domestic product [GDP]). As an
illustration, Table 1 shows gross income, taxable
income, and nominal GDP figures for Washington
State, which has had a GRT for many years.
As the table shows, Washington estimates that
the ratio of the total (nominal) value of all transac-
tions to the state’s GDP averaged 1.81 over the
Wagner
0
10
20
30
40
50
60
70
Property Tax
Total Sales and Gross Receipts Tax
User Fees/Charges
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Percent of Own-Source General Revenue
Figure 2
Local Own-Source Revenues (1977-2007)
SOURCE: Data from State & Local Government Finance Data Query System; the Urban Institute–Brookings Institution Tax Policy Center;
U.S. Census Bureau, Annual Survey of State and Local Government Finances; Government Finances, Volume 4; and Census of Governments.Wagner
production chain are subject to higher effective tax
rates than products or services with fewer steps.
Washington State’s study,5 which Professor Fox
also cites, found cascading averaged 2.5 times the
statutory tax rate and ranged from 1.4 times all the
way up to 6.7 times the statutory tax rate.
In terms of cascading, there are several channels
for efficiency losses to occur. According to eco-
nomic theory, differential tax rates on products or
services will be as close to efficient as possible if
those rates are based on the product’s price elastic-
ities. A GRT applies differential rates based on the
number of stages of production, which is unrelated
to the product’s price elasticity. Moreover, as
Mikesell (2007) and Chamberlain and Fleenor
(2006) note, the cascading may provide an incen-
tive for firms to integrate to avoid the tax, encour-
age producers to move production chains out of
state, or prompt businesses to expand their reliance
on out-of-state suppliers. Finally, unlike CITs, GRTs
period from 1995 to 2008. Focusing on taxable
transactions (since some transactions such as gov-
ernment purchases are exempt), the ratio of taxable
transactions to GDP averaged 1.45. This means
that the GRT base in Washington is roughly 45
percent larger than GDP and potentially could be
as large as 81 percent of GDP!
So, while a GRT base would obviously include
all service sector transactions, which has proved
problematic for traditional sales taxes, the sheer
size of the tax base means that a relatively low tax
rate could generate considerable revenues. Further  -
more, since a pure GRT is applied to the broadest
possible tax base, which is a multiple of the state’s
GDP, in theory this type of tax should be far more
stable than other forms of business taxation over
the business cycle.
In a testament to the completeness of his article,
Professor Fox also addresses the major concerns
of cascading and integration with regard to GRTs.
Since the tax is applied to every transaction, prod-
ucts and/or services that require more steps in the
FEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENT VOLUME 6, NUMBER 1 2010 105
5 The 2002 Washington State Tax Structure Study Committee report.
Table 1
Washington State Business and Occupation Tax
Gross income  Taxable income  Nominal GDP  Gross income-  Taxable income- 
Year ($ millions) ($ millions) ($ millions) to-GDP ratio to-GDP ratio
1995 289,484 236,991 151,338 1.91 1.57
1996 311,486 253,317 161,760 1.93 1.57
1997 342,802 278,212 178,334 1.92 1.56
1998 351,049 290,606 195,794 1.79 1.48
1999 375,799 307,214 214,375 1.75 1.43
2000 401,638 326,770 221,961 1.81 1.47
2001 398,769 322,006 225,765 1.77 1.43
2002 385,593 312,178 231,463 1.67 1.35
2003 401,014 318,877 240,813 1.67 1.32
2004 444,585 348,867 253,247 1.76 1.38
2005 480,557 381,616 272,734 1.76 1.40
2006 535,121 420,215 289,070 1.85 1.45
2007 591,953 460,102 310,279 1.91 1.48
2008 603,744 464,684 322,778 1.87 1.44
Average (mean) 1.81 1.45
SOURCE: Nominal GDP figures from Bureau of Economic Analysis. Gross income and taxable income figures subject to Washington’s
business and occupation tax are from the Quarterly Business Review, Washington State Department of Revenue (calendar years 1995-2008).106 VOLUME 6, NUMBER 1 2010 FEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENT
Wagner
will move rapidly toward some form of a GRT
without a solid understanding of the consequences.
Finally, turning our attention to alcohol,
tobacco, and gambling taxes, state and local gov-
ernments have a long history of generating revenue
from these sources. However, as Table 2 and
Figure 2 show, for most states, the so-called sin
taxes simply do not generate a sizable enough por-
tion of state revenues to be viable, long-term solu-
tions to revenue problems. However, considering
that “sin tax” bases tend to range from acyclical to
somewhat countercyclical, the use of nontraditional
revenue sources can play a key role in balancing
state revenue portfolios by reducing short-term
variability. 
are completely independent of a company’s profit  -
ability and therefore unrelated to its ability to pay.
The CIT is not without problems, but it is easily
plausible that a low–production chain, high–profit
margin firm (such as an information technology
firm) could face a substantially lower tax rate than
a high–production chain, low–profit margin firm.
I want to be clear that I am not arguing against
GRTs per se, nor am I advocating for them. My
primary concern is this: Given that GRTs are not
widespread, in my opinion we have an incomplete
understanding of the efficiency losses of such a
business tax system relative to the CIT. Combine
this with the political appeal associated with a low-
rate, broad-base tax, and I fear that policymakers
Table 2
Gambling Shares of Revenue: Top 10 and Bottom 10 States
Top 10 Percent of revenue Bottom 10 Percent of revenue
Nevada 13.60 Utah 0.0
West Virginia 9.2 Hawaii 0.0
Rhode Island 7.7 Alaska 0.0
South Dakota 6.3 Wyoming 0.0
Delaware 6.1 Alabama 0.0
Indiana 5.5 Arkansas 0.1
Oregon 5.3 Montana 0.2
Missouri 4.5 North Dakota 0.3
Louisiana 4.4 Minnesota 0.4
Illinois 4.2 Nebraska 0.5
SOURCE: Dayayan and Ward (2009).REFERENCES
Chamberlain, Andrew and Fleenor, Patrick. “Tax Pyramiding: The Economic Consequences of Gross Receipts
Taxes.” Tax Foundation Special Report No. 147, December 2006; www.taxfoundation.org/files/sr147.pdf.
Cornia, Gary; Edmiston, Kelly D.; Sjoquist, David L. and Wallace, Sally. “The Disappearing State Corporate Income
Tax.” National Tax Journal, March 2005, 58(1), pp. 115-38.
Dayayan, Lucy and Ward, Robert B. “For the First Time, a Smaller Jackpot: Trends in State Revenues from
Gambling.” Nelson A. Rockefeller Institute of Government Fiscal Studies, September 2009;
www.rockinst.org/pdf/government_finance/2009-09-21-No_More_Jackpot.pdf.
Fox, William F. “Can State and Local Governments Rely on Alternative Tax Sources?” Federal Reserve Bank of St.
Louis Regional Economic Development, October 2010, 6(1), pp. 88-101. 
Fox, William F. and Murray, Matthew. “Economic Aspects of Taxing Services.” National Tax Journal, March 1988,
41(1), pp. 19-36.
Garrett, Thomas A. and Wagner, Gary A. “State Government Finances: World War II to the Current Crises.”
Federal Reserve Bank of St. Louis Review, March/April 2004, 86(2), pp. 9-25; 
http://research.stlouisfed.org/publications/review/04/03/Garrett.pdf.
Mikesell, John L. “Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance.”
Tax Foundation Background Paper No. 53, January 2007; www.taxfoundation.org/research/show/2180.html.
National Governors Association and National Association of State Budget Officers (NASBO). The Fiscal Survey of
the States. Washington, DC: NASBO, June 2010; www.nga.org/Files/pdf/FSS1006.PDF.
Tannenwald, Robert. “Are State and Local Revenue Systems Becoming Obsolete?” Federal Reserve Bank of Boston
New England Economic Review, 2001, Issue 4, pp. 27-43; www.bos.frb.org/economic/neer/neer2001/neer401b.pdf.
Washington State Tax Structure Study Committee. “Tax Alternatives for Washington State: A Report to the
Legislature.” Volume 1. November 2002; www.mrsc.org/GovDocs/W3taxalts1.pdf.
Zodrow, George R. and Hendrix, Michele E. “Sales Taxation of Services: An Economic Analysis.” Florida State
Law Review, 2003, 30(3), pp. 411-33.
Wagner
FEDERAL RESERVE BANK OF ST. LOUIS REGIONAL ECONOMIC DEVELOPMENT VOLUME 6, NUMBER 1 2010 107

Are State and Local Revenue Systems Becoming Obsolete?” Federal Reserve Bank of Boston New England Economic Review,

Association and National Association of State Budget Officers (NASBO). The Fiscal Survey of the States.

For the First Time, a Smaller Jackpot: Trends in State Revenues from Gambling.” Nelson A. Rockefeller Institute of Government Fiscal Studies,

Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance.” Tax Foundation Background Paper No.

Sales Taxation of Services: An Economic Analysis.” Florida State Law Review,

State Government Finances: World War II to the Current Crises.” Federal Reserve Bank of St. Louis Review, March/April

Tax Pyramiding: The Economic Consequences of Gross Receipts Taxes.” Tax Foundation

Tax Structure Study Committee. “Tax Alternatives for Washington State: A Report to the Legislature.”

Commentary on "can state and local governments rely on alternative tax sources?"

http://research.stlouisfed.org/publications/red/2010/01/Wagner.pdf

Commentary on "can state and local governments rely on alternative tax sources?"

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics