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Chapter 4 Demise of the State Sales Tax At the dawn of the twenty-Arst century slightly more than one-third of all economic activity in the United States passed through the public sector. In round numbers, the federal, state, and local governments collected about $3.5 trillion in revenues out of a $10 trillion U.S. economy . The federal government collected just more than one-half of these revenues, state governments collected slightly more than onefourth , and local governments took in slightly more than one-Afth. The relative sizes of the public and private sectors in the United States remained fairly stable for much of the second half of the twentieth century. This is certainly the case when compared to the pre– World War II period. As a benchmark for comparison, in 1900 the public sector accounted for less than 7 percent of the economic activity in the United States. Similarly, and again by long-run historical standards, the relative sizes of the federal, state, and local governments during the postwar period remained fairly stable.1 Beneath these signs of post–World War II stability a revolution occurred in state Ascal policy, particularly with respect to the structure of state taxes. State Revenue Sources Funds to Anance the activities of American state governments come from three principal sources: tax revenues (43 percent), intergovernmental revenues (22 percent), and insurance trust revenues (20 percent ). Regarding tax revenues states rely largely on three instruments : general and selective sales taxes, individual (or personal) income taxes, and corporation net income taxes. These three instruments generate about 90 percent of state tax revenues. In addition, state lawmakers have direct statutory authority to determine these three revenue sources. For these reasons, revenue policy deliberations in America’s state capitols center most often on the appropriate level and mix of the sales tax, the individual income tax, and the corporation income tax. 50 This chapter focuses on these three major tax instruments, Arst examining the variation among states and the evolution of state tax structures over time. It then provides new measures of marginal tax rates and the progressivity or regressivity of sales and individual income taxes for each state. These critical indicators of the state tax burden lay the groundwork for the analysis in chapter 5 of the impact of alternative tax instruments on state economic performance. The Composition of State Tax Revenues In the late twentieth century, a remarkable change occurred in the composition of state tax revenues. In 1969 sales taxes reigned as the instrument of choice, accounting for almost 80 percent of tax revenues in the median state. In that year, in the median state sales tax revenues exceeded individual income tax revenues by a factor of 4 and exceeded corporation income tax revenues by a factor of 11.This overwhelming dominance of sales tax revenues fell dramatically in the three decades that followed (see Ag. 4.1).2 In 1998 (the most recently available data) sales tax revenues remained the largest tax revenue source, although its share of total tax revenues declined to 53 percent in the median state, down from its 80 percent share just 30 years earlier. Near the end of the century, sales tax revenues exceeded personal income tax revenues only by a factor of 1.3 and exceeded corporation net income taxes by a factor of 8 in the median state. A simple linear projection of these revenue composition trends indicates that by about 2004 states will rely almost evenly on sales taxes and personal income taxes (about 46 percent each), with only a slight decline in the corporation income tax as a revenue source (projected to remain at about 8 percent). The linear trend line projections indicate that by about 2005 state individual income tax revenues will exceed sales tax revenues and by 2010 will comprise 50 percent of all state tax revenues. Table 4.1 shows the composition of taxes for the individual states. This table shows the share of all tax revenues raised from the three major tax instruments in 1998 and how much these shares changed between 1969 and 1998. Consistent with the general trends already described , in 1969 individual income tax revenues exceeded sales tax revenues in only 5 states; by 1998 income tax revenues exceeded sales tax revenues in 12 states, or in almost 25 percent of the states. Between 1969 and 1998 individual income tax revenues as a share of total taxes increased in 84 percent of the states and the...

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