Growth and Variablilty of Satete Indivdual Income An General Sales Taxes Richard

National Tax Association
GROWTH AND VARIABILITY OF STATE INDIVIDUAL INCOME AND GENERAL SALES TAXES
Author(s): RICHARD F. DYE and THERESE J. McGUIRE
Source: National Tax Journal, Vol. 44, No. 1 (March, 1991), pp. 55-66
Published by: National Tax Association
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GROWTH AND VARIABILITY OF STATE INDIVIDUAL INCOME
AND GENERAL SALES TAXES***
RICHARD F. DYE* AND THERESE J. McGUIRE**
ABSTRACT and variability of revenues are important

to policymakers at all levels of govern-
Two important characteristics of state
ment, the growth and cyclical character-
tax systems are the trend growth rate and
istics of taxes are of particular concern at
cyclical variability of tax revenues. We use
the state level, where balanced budgets
national aggregate time series data to es-
are virtually universally required, bor-
timate the trend rate of growth and the de-
rowing capacity is limited, entitlement
viation from trend for several components
programs are expanding, and, because of
of state general sales and individual in-
open state economies, economic cycles are
come tax bases. The results indicate great
essentially impervious to macroeconomic
variety in growth and variability charac-
policy.
teristics across tax base components. One
The growth and variability of taxes are
important finding is that growth and
not new tax policy concerns, nor have
variability are sometimes inversely re- been silent on the issues. An
economists
lated. Another interesting finding is that ,
extensive literature has developed that is
depending on structural design , income
concerned with estimating income elas-
taxes can be more stable than sales taxes.
ticities of different revenue sources and
designating revenue sources as relatively
I. Introduction stable or unstable depending on the size
of their estimated income elasticities. (See
Wilford, 1965, and Legier and Shapiro,
TRADITIONAL
of taxes of
andtaxes and tax employ
tax systems economicthree
systems employ evaluations three 1968, as examples.) This approach com-
criteria - equity, efficiency, and simplic- bines in one measure what to policymak-
ity. Two additional characteristics of ers are two concerns in the choice of rev-
taxes - long-run or trend rate of growth enue structure: the responsiveness or long-
in revenue and its variability over the run rate of growth of revenues and the
business cycle - are given only limited at- stability or variability of revenues over
tention in the applied public finance tra- the cycle. Other researchers (see Wil-
dition. These two characteristics are of liams et al., 1973; White, 1983; and Fox
great importance to policymakers who
and Campbell, 1984) have recognized and
must devise revenue systems that can both
estimated the differences between secular
support expenditure programs over the
and cyclical behavior of revenues. Most
long run and provide stable streamsresearchers
of conclude that "responsive-
revenue even as the underlying economy
ness is a double edged sword" (Ladd and
varies with the business cycle. Weist, 1991), in other words, that a trade-
The purposes of this paper are to define
off exists between higher growth (respon-
the growth and variability criteria, siveness)
to and higher cyclical variability.
evaluate the components of the two major
Studies that estimate income elastici-
sources of state tax revenues - the indi- ties for state individual income taxes and
vidual income tax and the general salesstate general sales taxes find that income
tax - using these criteria, and to interpret
taxes are more elastic, and thus less sta-
our results for policymakers. While growthble by the traditional interpretation, than
are sales taxes.1 Thus, if a state has a
*Lake Forest College, Lake Forest, IL 60045 and heavy reliance on the individual income
Institute of Government and Public Affairs, Univer-
tax, its tax structure is viewed as being
sity of Illinois, Chicago, IL 60607.
relatively
**University of Illinois at Chicago and Institute of
unstable.
Government and Public Affairs, University of Illi- On average the states derive approxi-
nois, Chicago, IL 60607. mately one-third of their tax revenues from
55
56 NATIONAL TAX JOURNAL [Vol. XLIV
each of the two major tax mate trend growth

sources. How- rates as our measure
of growth
ever, there is great variety and use
in tax mixthe deviations from
across the states. Florida trend
raisesto calculate
60 per- a separate measure of
cent of its tax revenues fromvariability.
the general
sales tax and does not haveWilliams et al. (1973), White (1983), and
an individual
Ladd and Weist
income tax. Oregon is virtually the (1991)
re-also estimate trend
verse of Florida, raising 61 rates of growth
percent of and deviations from trend.
state
Unfortunately,
tax revenues from the individual income as Wilford (1975) has
pointed out,
tax and not imposing a general the results
sales tax.in Williams et al.
(1973) are seriously
Among the states that employ both aflawed because the
broadly-defined individual authors
income use revenue
tax anddata without con-
trolling
a general sales tax, there is for tax rate
also great va-changes. Additional
riety, with Arizona raising problems
46 percentwith revenue
from data include the
the sales tax and 23 percentdifficulty
from in controlling
the in- for statutory
dividual income tax and New changes in the rais-
York tax base and the lack of
ing 21 percent from the detailed sales tax reporting
andby 52 tax base compo-
nents.
percent from the individual income tax.
Several states, including California, Ladd and Weist (1991) use deviations
Idaho,
Kansas, Maine, Nebraska, Ohio, Rhode a measure of
from trend to construct
Island, and South Carolina, stability,
raise but approx-
instead of using their esti-
imately one-third of total matestaxof trend
revenuesgrowth rates, they esti-
from each of the two sources mate income(U.S. elasticities
De- to measure
partment of Commerce, June 1989). long-run responsiveness. The two mea-
Based on the elasticities that sures have
- trendbeenrate of growth and income
estimated for these two major elasticity
state- provide
rev- different pieces of in-
enue sources, a traditional formation analysis andwould
address different ques-
conclude that income tax reliant states tions. Income elasticity measures a link
such as New York and Oregon have po-between revenues and economic activity.
tentially unstable and responsive tax sys- Trend rate of growth is a simple measure
tems, sales tax reliant states like Arizona of revenue growth over time that policy-
and Florida have potentially stable and makers can easily compare to expendi-
unresponsive systems, and the tax sys- ture growth. Trend rate of growth also
tems of the states with revenue mixes ap- lends itself to easy evaluation and inter-
proximating the average mix display re-pretation of the growth potential of dif-
sponsiveness and stability characteristicsferent components of the tax bases re-
similar to one another. The results pre- gardless of the causes (income growth,
sented in this paper indicate that some of population growth, changes in income
these broad conclusions are not valid, and distribution, changes in industrial struc-
that the specific structures of the two taxesture, etc.) of the growth.
are important determinants of their trend Because we use national data sets to
growth and variability. In particular, we approximate the tax bases for all states,
find that a tax base component can be bothwe do not need to track statutory tax rate
faster growing and less variable. We alsoand tax base changes that have occurred
find, as anticipated by Fox and Campbellduring the period we analyze. The diffi-
(1984), that certain income tax structures culty of accounting for structural changes
can be more stable than certain sales taxwhen using actual revenue data has led
structures. most researchers to calculate elasticities
for only one or a few states. For example,
White's (1983) estimates are bound by the
II. Data and Methodology structure of only one state's tax system,
To analyze separately the individual which may limit the applicability of his
income tax and the general sales tax we results to other states. A major advantage
use national data sets that approximateof our approach is that we are able to in-
the underlying state tax bases. We esti- terpret our growth and variability results
No. 1] STATE INCOME AND SALES TAXES 57
for any state (with more a common or less

deflator confi-
for all components of
dence depending on theeach base, relative
match differencesthe
between in inflation
national data sets and the actual state tax rates among components are preserved in
bases). the data. The income tax base analysis is
The data for the sales tax are from the facilitated by the use of real values be-
National Income and Product Accounts. cause real income brakets, unlike nomi-
We have observations on total personal nal income brackets, provide a consistent
consumption expenditures and on various measure of the tax base components over
subcategories of the total. These subca- time. While it is true that most states do
tegories represent policy choices for notthe
index their personal income tax struc-
states - categories of sales that can be tures,
in- we consider this fact to be a reflec-
cluded in or exempted from the base.tion Byof conscious policy choices to raise real
combining various subcategories we taxare
rates and not a justification to shift
able to approximate most states' salesour taxfocus to nominal tax collections.
bases. For each tax base component (each cat-
The data for the personal income tax areegory of personal consumption expendi-
from the Current Population Survey. Fortures and each income bracket) we esti-
each year we calculate the amount of to- mate a regression using twenty annual
tal income attributable to each bracket of observations. We regress the natural log-
the income distribution. We treat the in- arithm of each tax base component on a
come amounts in the different brackets as constant and a linear time trend. The
components of a state's income tax base. coefficient obtained on the time trend is
This emphasis on the vertical distribu- our measure of the annual rate of growth.
Our measure of variability is the stan-
tion of the tax base is justified because the
salient differences in state individual in-dard deviation of the residuals from the
come tax systems (and in the policy choicesestimated trend equation - a summary of
available to states) are in their vertical the percentage deviations from trend
rate structures. As with the sales tax, wegrowth.
can approximate a state's income tax base One disadvantage of using national data
by combining, with appropriate weights,sets to describe the income and sales tax
the various taxable components of the in- bases of the states is that the growth,
come distribution. While these two na- variability, and composition of the na-
tional data sets are unlikely to approxi-
tionally-defined bases may be a poor ap-
mate closely any state's actual income or
proximation to a given state's actual tax
sales tax base, they do enable us to base.
doc-While this source of potential error
ument and evaluate important compo- may be large for some states, the differ-
nents of all state income and sales tax ences are likely to be small for many
bases. states. We recognize that the simplicity
We use real rather than nominal val- and general applicability we gain by us-
ues for the expenditure and income data.
ing our approach is at the expense of in-
Arguments can be made for either value.
creased precision obtained using other
Revenue directors work with nominal approaches.
dollars and are concerned about the growth
and variability of nominal revenues. But
III. Growth and Variability of the
ultimately the revenues are raised toGeneral
pay Sales Tax
for expenditure programs and goods and
services, which we value in real dollars. The growth and variability of a state
Furthermore, as Misiolek and Perdue sales tax depend on the composition of the
(1987) argue, inflation has different im-tax base. Since the tax base consists pri-
marily of retail purchases, the sales tax
pacts on different types of taxes. For our
purposes, the choice is not critical since
will be more or less stable and exhibit
we are interested in relative growth andfaster or slower growth as the retail pur-
chases included in the base are more or
variability across components of the bases
and across different bases. Because we use less stable and exhibit faster or slower
growth. Most states sales

base taxes
to services, are
not to more based
business pur-
chasespersonal
on the sale of tangible of tangible property, thus the po-
property.
tential
Few states explicitly tax interest in this category
retail purchases from a
policy perspective
of services. One purpose of this is small. paper
Because of is
these reasons
to document and explore the our analysis and results ap-
implications
for state sales taxes ply
oftothe consumer purchases only,
apparent which
shift
from goods to servicesrepresent
in most,
the buteconomy.
not all, of the total
If
sales tax
retail purchases consist base in all and
more states. more of
services rather than goods,
In Table state
1 we display salesand
the estimates
calculations of our measures
taxes, as currently structured, of growth and
are failing
to capture this shift.variability for several components
Moreover, if goods of po-
tential or actual stategrowth
and services have different sales tax bases. The
and
three columns
variability characteristics, thenof figures
statesdisplaycan
esti-
effect different degrees
mated trend of growth
rates of and
real annual growth,
standard deviations
variability by extending the of the residualstax
sales from to
services. Finally, anthe estimated growth equations,
investigation of andthea
measure characteristics
growth and variability of the relative importance of of the
different types of component
services to thecanoverallinform
base (average
states' decisions as topercentage
which contribution
typesto of the total).
ser- The
vices to include in a broader sales tax base.
first row presents the results for total per-
Using annual observations on real personal consumption expenditures, while
sonal consumption expenditures from 1968 each subsequent row represents a subset
through 1987 from the National Incomeof the total.
and Product Accounts (U.S. Department Not surprisingly, we find that total per-
of Commerce, July 1986, September 1986, sonal consumption expenditures are rel-
July 1989), we calculate growth and vari- atively stable. The variability is 1.97 per-
ability measures for several actual and cent, a lower value than for any of the
potential components of state sales tax subcategories presented. The annual
bases. In particular, we estimate trend growth rate for the total is 2.93 percent,
growth rates and deviations from trendfaster than some subcategories and slower
for the following: total personal consump- than others. Total personal consumption
tion expenditures, a representative nar- expenditures are not a good approxima-
row tax base, a representative broad taxtion of any state's sales tax base. The to-
base, and several important categories -tal includes many important items not
both goods and services - actually taxedtaxed by any state, such as medical care,
by some states. We also analyze personaleducation, and housing expenditures. We
business services, an important categorypresent the total for purposes of compar-
currently not taxed by most states and onlyison only.
partially taxed by a few states. In the second and third rows of Table
We do not include the taxation of busi- 1, we present statistics for two bases that
ness purchases of goods and services in our are reasonably close to actual state sales
analysis. While in some states business tax bases. The representative broad base
purchases comprise a significant share of includes all items delineated in our data
the total sales tax base (see Ring, 1989), that any state taxes, such as food for home
most states attempt to exempt businessconsumption, personal and repair ser-
purchases in an effort to capture final re-vices, admissions, and motor vehicle fuels.
tail sales only and thus to mitigate theThe narrow base includes only items taxed
problem of tax pyramiding. We ignoreby most states, such as purchases of meals
business purchases for two reasons: first, away from home, alcohol and tobacco
we have not found a data source for busi- products, home furnishings, and other re-
ness purchases that approximates the tail items. Our first, somewhat surpris-
subset of total business purchases oftening, finding is that the representative
subject to taxation; and second, recent broad base displays a growth rate very
policy initiatives consider extension of the similar to the estimated growth rate of the
TABLE 1
GROWTH AND VARIABILITY OF PERSONAL CONSUMPTION EXPENDITURE
COMPONENTS (1968-1987)
Category Growth Standard Share of

(percent) Deviation Total
(percent) Expenditures
(percent)
Total Personal 2.93 1.97 100.0

Consumption Expenditures
Representative Broad Base 2.26 2.43 64.2
Representative Narrow 2.22 4.32 31.4

Base
Food for Home Consumption 1.31 2.21 12.5
Motor Vehicle Fuels 2.84 15.82 3.7
Household Utilities 4.69 6.29 4.3
Telephone Services 2.85 5.26 1.6
Personal Consumer 1 . 58 4.39 4.6

Services
Personal Business 4.82 5.73 5.6

Services
Recreation Services 3.23 2.04 1.1
The data are from the U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business. July
1986 and July 1989, and the National Income and Product Accounts. 1929-82. September 1986, Table 2.4. The figures
have been deflated using the personal consumption expenditure deflator with 1987 as the base year. All lines
mentioned in the following definitions refer to line numbers from Table 2.4 of the NIPA.
Total personal consuaption expenditures is line 1 of Table 2.4 of the NIPA data. It includes food, personal
care, housing, medical care, transportation, private education and several other expenditure categories.
The representative broad base is line 1 minus lines 5, 6, 23, 44, 55, 63, 98, 102, and 103, plus lines 27, 45,
65, 66, 67, 68, 69, and 70. This broad base includes food, most personal consumer services, and motor vehicle fuel.
Items not taxed by any (or most) states such as housing, medical care, and personal business expenditures are not
included in this base.
The representative narrow base is line 1 minus lines 3, 5, 6, 7, 17, 19, 22, 23, 36, 41, 42, 43, 44, 55, 63, 82,
98, 102, and 103, plus lines 9, 27, 65, 66, 67, 68, 83, 85, 86 and 87. This narrow base includes most goods taxed
by most states. It does not include food for home consumption, most services, or motor vehicle fuels.
Food for hoae consumption is line 3 minus line 9, which does not include alcoholic beverages.
Motor vehicle fuels is line 70, which includes gasoline and oil.
Household utilities is line 36, which includes electricity, gas, water and other sanitary services, and fuel oil
and coal.
Telephone services is line 41, which is defined as telephone and telegraph services.
Personal consuner services is the sum of lines 17, 19, 22, 42, 43, 69, and 88. This includes cleaning, storage
and repair of clothing and shoes, barbershops and beauty parlors, domestic household services, repair, greasing,
washing, parking, storage and rental of motor vehicles, and radio and television repair.
Personal business services is line 55. This includes brokerage charges and investment counseling, bank service
charges, and legal services.
Recreation services is the sum of lines 90, 94, and 95. This includes admissions to specified spectator
amusements, clubs and fraternal organizations, commercial participant amusements, but does not include net receipts
of lotteries, cable TV, nor film processing.
representative narrow base. The two rep- It is also of interest to see that the narrow
resentative bases differ greatly, however,base is about half as large as the broad
base.
in terms of their variability, with the nar-
row base being almost twice as variable The remainder of the table presents
as the broad base. This occurs because the
statistics on several components of per-
pooling of additional components in sonal
the consumption expenditures. None of
these components is included in the rep-
broad base involves offsetting variations.
resentative narrow base,

argued thewhile alla change
merits of such but basedone
of the componentson - personal
equity business
and efficiency considerations. As
examplesin
services - are included see Fox
theand Murray (1988) and
represen-
tative broad base. Food for home con- Ladd and Weist (1991). We find that per-
sumption, which represents more thansonal
ten consumer services exhibit slow
growth
percent of total expenditures, is the slow- (slower growth than all compo-
est growing component of total expendi-nents examined except food) and high
variability. Thus, while extension of the
tures and it displays much less variabil-
base to include personal consumer ser-
ity than the representative narrow base.
vices would increase the size of the base
Motor vehicle fuels is extremely variable
considerably, it would result in a slower
and displays somewhat faster growth than
the representative narrow base. growing sales tax base. The overall vari-
The remaining five components are ability
dif- of the expanded base would de-
ferent types of services. Two of these pend - on the covariances of the compo-
household utilities and telephone ser- nents.
In contrast to personal consumer ser-
vices - are treated separately because most
vices, recreation services are faster grow-
states explicitly tax or exempt these spe-
ing and less variable than the represen-
cific services. Relative to the representa-
tive narrow base, household utilitiestative
and narrow base. To be precise,
telephone services are faster growing recreation
and services grow half again as fast
as the representative narrow base and
more variable. The 6.29 percent variabil-
ity for household utilities makes itdisplay
the less than half as much variabil-
least stable of the services examined. ity.
Finally, we examine the growth and The results for personal consumer ser-
vices and recreation services illustrate that
variability characteristics of three rela-
tively broad categories of services - per- higher growth and variability, as we have
sonal consumer services (repairs, clean-defined them, are not always two sides of
ing, grooming, etc.), personal businessthe same coin. We have seen that a rel-
services (financial and legal), and recre- atively fast-growing component - recrea-
ation services (admissions). (See the notes tion services - can also be relatively sta-
to Table 1 for further details on the com- ble and that a relatively slow-growing
ponents of these categories). The fastest component - personal consumer ser-
growing of these service categories is per- vices - can be somewhat variable. These
sonal business services at a growth rate distinctions have not been uncovered in
of 4.82 percent. This is more than twice the previous literature either because the
as fast as the growth of the representa- authors used the traditional methodology
tive narrow base. Personal business ser- of calculating income elasticities to deter-
mine the stability and responsiveness of
vices is a large component (equal to al-
revenue sources, or because the authors
most one-fifth of the representative narrow
were limited by the tax collections data
base) and is characterized by high vari-
provided by one or a few states. Research-
ability. Thus, while the personal business
ers limited to the data of a few states are
services category provides the greatest
growth potential and the largest boost tounlikely to find distinctions between
growth and variability because most states
the size of the base of the three categories
of services, it also represents a highly have average rather than extreme tax
variable component.2 Because of admin- structures, data obtained from states is
istrative and policy considerations, verytypically not detailed by components of the
few states tax any of the services cate- bases, and actual tax structures may not
gorized as personal business services. vary much across states in a given small
In recent years, several states havesample of states.
considered the possibility of extendingOf the forty-five states with general
their sales tax bases to cover personalsales taxes, eighteen states include food
consumer services. Previous authors have for home consumption in their general
rate, thethese
sales tax bases.3 All else equal, important differences across
states
have relatively slow-growing states werebut captured by our examination
stable
tax bases. Ten states include of the components
purchases of the
oftax base. But
motor vehicle fuels in their state income
general tax rules differ in both the
sales
tax bases, thus adding an definition
element of the taxof
base in-
and in the ver-
tical
stability and above average growth to their rate structure. We judge the differ-
bases. Four states (Colorado, ences in tax rate structures to be the more
Maryland,
Nevada, and Rhode Island) have rela- important source of variation and thus
tively narrow bases. Based on the results examine the distribution of income to
in Table 1, these states can expect their identify cross state variations in the char-
relatively volatile bases to display real acteristics of individual income taxes.
growth of approximately two percent per While data on the distribution of income
year. would not be sufficient if our goal were to
Twelve states have relatively broad provide detailed simulation results, for our
bases. Hawaii taxes both food and motor purpose, which is to analyze representa-
vehicle fuels and has very broad coveragetive state income taxes, the vertical rate
of personal consumer services, recreationstructure is the salient feature and in-
come distribution data are sufficient.
services, and personal business services.
(See Federation of Tax Administrators, Using annual data on the size distri-
1990, for a thorough discussion of statebution of real household money income for
sales taxation of services.) Hawaii ex-
1968 through 1987 from the Current Pop-
ulation
empts gas and electricity from the tax, but Survey (U.S. Department of Com-
includes telephone services. Very few merce, February 1989) we calculate growth
states have broad coverage of personaland variability measures for different
ranges of income. The Current Popula-
business services. The service categories
tion Survey data have the advantage of
of greater interest because of their actual
being a consistently defined time series of
and potential taxability are personal con-
sumer services and recreation services. the size distribution of income with real
As we have seen, the variability andincome brackets. A disadvantage is that
"money income" differs from income sub-
growth characteristics of personal con-
sumer services differ greatly from theject to tax in most states (see the notes to
characteristics of recreation services. In Table 2).
addition to Hawaii, sixteen other states Table 2 presents the growth and vari-
have broad coverage of personal con- ability results for eleven different income
sumer services or recreation services or groups. The growth rate is around two
both. The states that have broad coverage percent per year for most of the groups,
of personal consumer services have intro- rises to 2.70 percent for the $35,000 to
duced an element of slightly above aver- $50,000 group, and jumps to 4.08 percent
age variability and an element of slow for the $50,000 and over group. This find-
growth to their bases. The states with ing of faster growth at the highest income
broad coverage of recreation services have levels in recent decades has been docu-
introduced an element of fast growth and mented and discussed elsewhere (see, for
of low variability to their bases. example, Pechman, 1990). The variability
measure is well below two percent in the
lowest income groups and increases
IV. Growth and Variability of the
Individual Income Tax
sharply to twelve percent for the top
bracket. Examining growth and variabil-
The other major state revenue source ity together,
is there is no systematic rela-
the individual income tax. As was the case tionship for the lower income groups, but
for the sales tax, alternative income tax from $20,000 on up there is a clear pat-
structures will differ in their growth and tern-the more a state seeks to tax high
variability characteristics. For the sales incomes, the more it trades off cyclical
tax, since each state has only one flat taxvariability for higher trend revenue
growth. Unlike our findings treme are statesfor

like California,
different Idaho,
components of the sales New Mexico,
tax and North Dakota,
base, for the which
$20,000 and up ranges have much
of more progressive structures
income, the -
growth and variability with measures
generous zero tax amounts
move for to-
those
gether. with low incomes (the combined effect of
Our results indicate that the growth and standard deductions, personal exemp-
variability of state income tax structures tions, low income credits, or other fea-
will depend, in large part, on the propor- tures) and increasingly higher rates for
tion of tax revenues raised from the higher those with higher incomes.
income groups.4 At one extreme are states For any actual or hypothetical state rate
like Illinois and Indiana, which have one structure, trend growth can be calculated
flat rate for all incomes with virtually no from Table 2 by using weights that adjust
exclusions or deductions and only a $1,000 for different tax rates and also for the
personal exemption.5 At the other ex- share of income in each bracket. Vari-
TABLE 2
GROWTH AND VARIABILITY OF INCOME RANGES (1968-1987)
Income Growth Standard Share of

Range (percent) Deviation Aggregate
(1987 $) (percent) Income
(percent)
0- 2,500 2.05 1.25 8.2
2,500- 5,000 2.05 1.45 8.0
5,000- 7,500 2.03 1.52 7.5
7,500-10,000 1.99 1.37 7.0
10,000-12,500 1.94 1.33 6.6

12,500-15,000 1.88 1.42 6.1
15,000-20,000 1.82 1.70 10.9
20,000-25,000 1.80 2.41 9.2
25,000-35,000 2.03 3.75 13.8
35,000-50,000 2.70 5.87 11.8
50,000 up 4.08 11.99 10.9
All Incomes 2.28 3.04 100.0
The data are from U.S. Department of Commerce

and Persons in the Uni ted States: 1987 (February 1989) Table 2.
"Money Income" includes money income from wages and salaries, net self -employment income, social security,
Supplemental Security Income, welfare, interest, dividends, net rent, veterans' payments, unemployment
insurance, workers* compensation, pensions, alimony, child support, and other periodic income. Compared to
an inclusive measure of what is taxable under state personal income tax rules, money income does no£ include
capital gains but does include cash transfers, child support, all pensions, and all of social security.
There are also definitional or response differences which lead to the understatement, or even overstatement,
of certain sources of income in the CPS compared to independently derived estimates.
The census table presents data on the total number of households, the percent of households in each income
bracket, and the mean income for all households. The dependent variables are calculations of the aggregate
number of dollars in each income bracket. Income for each group was allocated across any lower brackets.
The bracket midpoint was assigned as the mean income level for each closed-ended income group with the
residual allocated to the open-ended $50,000 and up group.
ability, however, is not

pend onjust a weighted
the relative reliance on the two
average since it will taxes,
also thedepend on theof the
breadth and composition
covariation across the different income sales tax base, the structure of income tax
rates, and the covariation of the sales and
groups. Table 3 presents the results for two
very different hypothetical tax struc-
income tax bases.
tures. The "Illinois-like" extreme with a
As examples, Kansas, Kentucky, Rhode
flat rate after a low zero tax amount is Island, and Utah each get roughly an equal
modeled by combining all incomes over proportion of their tax revenues from
$2,500 and applying a constant rate. The general sales taxes and individual income
regression results suggest that states with
taxes. But these states represent quite
different combinations of sales and in-
a flat tax structure will experience reve-
nue growth of 2.30 percent per year with come tax structures. Utah has a broad
variability of 3.31 percent around that
sales tax base and, by virtue of a rather
trend. low top income tax bracket amount (the
As an example of the other, "Califor-
level of gross income at which a taxpayer
nia-like," extreme we specify a hypothet-enters the top marginal tax bracket), gives
ical progressive rate structure with a zero
little extra weight to the higher income
tax amount of $10,000, a 2 percent tax rate
groups in its income tax. Kentucky has a
on income from $10,000 to $20,000, afairly
6 narrow sales tax base and a rather
percent tax rate on income from $20,000low top bracket amount. Kansas has a
to $50,000, and a 10 percent tax rate on
broad sales tax base and a relatively high
income above $50,000. The revenue growthtop bracket amount. Rhode Island has a
from this progressive rate structure would
narrow sales tax base and a relatively high
be 2.72 percent per year and the vari- top bracket amount. None of these states
ability would be 5.95 percent. Compared represents the pure extremes for both the
to the "Illinois-like" case of a flat rate af-
sales and income taxes, but they do rep-
ter a low zero tax amount, states with resent a range of choices which would re-
progressive rate structures would get sult in differences in the growth and vari-
somewhat higher growth at the cost of al- ability of the combined income and sales
most twice the variability. tax systems.
To identify the potential range of vari-
V. Combined Effects of Sales and ation in growth and instability for states
Income Taxes with equal reliance on sales and income
taxes, we examine four pairs of hypothet-
Most states have a mix of both sales and ical tax structures representing the ex-
income taxes. We have looked separately tremes for each of the two types of tax.
at the growth and variability character-The "narrow" and "broad" sales tax bases
istics of actual and potential componentsare as defined in Table 1. The two income
of a sales tax base and the vertical seg-tax regimes are described above (and dis-
ments of the income distribution. The played in Table 3) as the "flat" or "Illi-
growth and variability of combined nois-like"
tax structure and the "progressive"
revenues for a particular state will de- or "California-like" structure. Table 4
TABLE 3
GROWTH AND VARIABILITY FOR HYPOTHETICAL
INCOME TAX STRUCTURES
Income Tax Growth Standard

Type (percent) Deviation
(percent)
Flat 2.30 3.31
Progress ive 2.72 5.95
presents the growth andof variability

measures long-term growth andre-vari-
sults for these combined structures. The
ability - for major components of state
general sales and individual income tax
trend growth rates all fall in the narrow
range of 2.26 to 2.49 percent. Because the
bases. We find great variety in the growth
and variability characteristics of the dif-
growth rates of the narrow and broad sales
tax bases are virtually identical, the ferent
dif- components. To our surprise, we find
ferences in system growth rates are driven
that growth and variability are not posi-
by the growth characteristics of thetively
in- related for all components of the tax
come tax structures. bases. For example, personal consumer
There is a much greater range for the are both slower growing and more
services
variability measure - from 2.73 percent variable
for than recreation services. Also, in
the broad sales tax and flat income tax to
comparing possible sales tax structures to
possible income tax structures, we find
5.01 percent for the combination of a nar-
that a narrow sales tax base can be both
row sales tax and a progressive income tax.
The covariation of the two taxes affects slower growing and more variable than a
flat income tax.
the combined variability (White, 1983).
There appears to be a small amount of When the underlying growth and vari-
stability gained from diversification across
ability characteristics of the components
of the two tax bases are compared to ac-
taxes, since in all four cases the deviation
tual sales and income tax structures em-
from trend is slightly lower than the sim-
ple average of the separate variability es-
ployed by states, we infer much variety in
timates. the actual growth and variability of state
It is interesting to note that the vari-tax revenues. States that include a rela-
ability of the narrow sales tax base at 4.32tively broad spectrum of consumer expen-
percent (see Table 1) is greater than theditures under the sales tax can expect
variability of the flat individual incomegrowth similar to the growth of sales tax
tax at 3.31 percent (see Table 3). This re-revenues for states with narrowly-defined
sult, which contradicts the conventionalbases; the narrow base, however, exhibits
view of income taxes as being less stablemuch more variability than the broad base.
than sales taxes, clearly illustrates our States with virtually flat individual in-
primary point - that tax structure is ancome tax structures should experience
important determinant of the growth andslower growth and less variability than
variability of state taxes. states with progressive individual income
tax structures. Given these differences in
VI. Conclusions and Policy the growth and variability characteristics

Implications across tax structures, it is clear that states
with identical revenue shares for the two
In this paper, we estimate trend ratestaxes can experience differences in growth
of growth and deviations from trend - ourand variability of their tax system reve-
TABLE 4
GROWTH AND VARIABILITY OF COMBINED TAX SYSTEMS WITH
EQUAL- YIELD SALES AND INCOME TAXES
Sales Tax Income Tax Growth Standard
Type Type (percent) Deviation
(percent)
Broad Flat 2.28 2.73
Narrow Flat 2.26 3.71
Broad Progressive 2.49 3.94
Narrow Progressive 2.47 5.01
5Details on state income

nues simply because of structural tax structures
differ- can be found
ences in tax base rules. in Commerce Clearing House (1991) and ACIR (1990).
Growth and variability of state reve-
nues are important characteristics to state
policymakers, who must insure that rev- REFERENCES
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and ever-changing expenditure programs.
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Due, John F. and John L. Mikesell, Sales Taxation,
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Journal, 37:2 June 1984, pp. 201-212.
Fox, William F. and Matthew Murray, Economic As-
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ENDNOTES March 1988, pp. 19-36.
Federation of Tax Administrators, Sales Taxation of
***The authors are grateful to Bill Fox, Dana Services, Washington, D.C.: Author, 1990.
Weist,
three anonymous referees, and the editor Ladd, Helen
of this and Dana Weist, "General Sales Taxes,"
jour-
nal for useful comments and suggestions. in Therese J. McGuire and Dana Wolfe Naimark
It is not, in fact, easy to find paired estimates (eds.), Stateofand Local Finance for the 1990s: A Case
income elasticities for both state individual income Study of Arizona, Arizona State University, Tempe,
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literature is the lower response to income growth . . National
. Tax Journal, 21:1 March 1968, pp. 46-56.
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(Mikesell, 1977), we have found only two publishedTax Base Components," Quarterly Review of Eco-
papers that empirically estimate income elasticities nomics and Business, 17:1 Spring 1977, pp. 83-94.
for both tax sources. Williams et al. (1973) estimate Misiolek, Walter S. and D. Grady Perdue, "The Port-
the long-run elasticities of the individual income tax folio Approach to State and Local Tax Structures,"
to be 2.08 and the general sales tax to be 1.37. These National Tax Journal, 40:1 March 1987, pp. Ill-
estimates have been called into doubt by Wilford (1975)114.
Pechman, Joseph A., "The Future of the Income Tax,"
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provides estimates for Louisiana of an individual in- American Economic Review, 80:1 March 1990, pp.
come tax elasticity of 1.71 and a general sales tax 1-20.
elasticity of 0.66. Ring, Raymond J., Jr., "The Proportion of Consumers'
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able base does not necessarily result in an increase National Tax Journal, 42:2 June 1989, pp. 167-179.
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variability of the expanded base depends on the co- lations, Significant Features of Fiscal Federalism,
variance of the original base and the addition to the Washington, D.C.: Author, December 1987 and
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a pro-cyclical fashion, while the original base varies U.S. Department of Commerce, Bureau of the Census,
in a counter-cyclical fashion, then the measured vari-Money Income of Households, Families, and Per-
ability of the expanded base would be less than thesons in the United States: 1987, Series P-60, No. 162,
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Growth and Variablilty of Satete Indivdual Income An General Sales Taxes Richard

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Growth and Variablilty of Satete Indivdual Income An General Sales Taxes Richard

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National Tax Association

RICHARD F. DYE* AND THERESE J. McGUIRE**

ABSTRACT and variability of revenues are important

each of the two major tax mate trend growth

for any state (with more a common or less

growth. Most states sales

Category Growth Standard Share of

Total Personal 2.93 1.97 100.0

Representative Broad Base 2.26 2.43 64.2

Representative Narrow 2.22 4.32 31.4

Food for Home Consumption 1.31 2.21 12.5

Motor Vehicle Fuels 2.84 15.82 3.7

Household Utilities 4.69 6.29 4.3

Telephone Services 2.85 5.26 1.6

Personal Consumer 1 . 58 4.39 4.6

Personal Business 4.82 5.73 5.6

Recreation Services 3.23 2.04 1.1

resentative narrow base,

growth. Unlike our findings treme are statesfor

Income Growth Standard Share of

0- 2,500 2.05 1.25 8.2

2,500- 5,000 2.05 1.45 8.0

5,000- 7,500 2.03 1.52 7.5

7,500-10,000 1.99 1.37 7.0

10,000-12,500 1.94 1.33 6.6

15,000-20,000 1.82 1.70 10.9

20,000-25,000 1.80 2.41 9.2

25,000-35,000 2.03 3.75 13.8

35,000-50,000 2.70 5.87 11.8

50,000 up 4.08 11.99 10.9

All Incomes 2.28 3.04 100.0

The data are from U.S. Department of Commerce

ability, however, is not

Income Tax Growth Standard

Flat 2.30 3.31

Progress ive 2.72 5.95

presents the growth andof variability

VI. Conclusions and Policy the growth and variability characteristics

Broad Flat 2.28 2.73

Narrow Flat 2.26 3.71

Broad Progressive 2.49 3.94

Narrow Progressive 2.47 5.01

5Details on state income

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