Government Finance

The United States has a lower tax burden and a smaller public sector (meaning less government spending) than any other advanced industrial democracy.  In general southern states spend less than northern states. In 2018, Texas state and local government spending was lower than that of most states: Texas ranked 45th among states in state government spending, and 48th in combined state and local government spending (

State and local government spending is a problem because governments must bring in money–revenue–in order to provide public services. There are four general ways to finance governmental activity:
*taxes:  people and organizations must pay taxes; they are compulsory
*charges, user fees:  primarily those who use a governmental service or facility are the ones who pay for them (e.g., swimming pools, parks)
*intergovernmental transfers, grants:  grants of money from higher levels of government.
*borrowing: loans must be paid back.

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Taxation:  Most governmental revenue comes from taxes.  Taxation is the traditional but unpopular way to raise governmental revenue.  Tax capacity refers to the ability of a state’s people to pay taxes (basically, state income).  Tax effort is the measure of taxes paid relative to tax capacity.

There are some general guidelines for a “good” tax:
*the distribution of the tax burden should be equitable; that is, people in the same general situation should pay the same amount.
*taxes should interfere as little as possible with private economic decisions or consumer behavior
*taxes should be transparent and understandable to those taxed
*the costs of collecting taxes should be as low as possible
Obviously, governments face challenges in meeting these guidelines.

As you will read in the Local Government lecture the three levels of American government rely primarily on three different types of taxes:
*federal government:  income tax (although the payroll tax is another part of the federal tax system)
*states: sales taxes: 43 states also have an income tax. Several states, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not have a state income tax. As a result, they generally rely on higher sales taxes.
*local governments:  property taxes.  Local governments are limited by state laws on both how they can raise revenue and how much they can tax. Property taxes provide most of the local financial support for municipal governments, county governments, and school districts.

Generally income taxes are more progressive. Progressive taxes are those that take a larger percent of income from those better able to pay; i.e. those with higher incomes or more valuable property. .Property taxes are generally fairly progressive, but property taxes may be regressive for low-income and retired homeowners since these people may own their homes but have current lower incomes.

Regressive tax systems are those that take a larger percent of income from lower-income individuals in that all income groups must pay the same tax rate. Sales taxes are the most regressive taxes.  Most states allow local governments to attach a local sales tax to any others imposed by state government, making it a “hidden tax” that makes it difficult for people to assess their services relative to the cost of these services.  One way many states have made sales taxes less regressive is by exempting essential items such as groceries and medicines.

Other types of taxes that do not target so many people include the excise taxes or “sin taxes” which are taxes on alcohol, tobacco, and similar items.  These are designed to both to increase revenue and to discourage use.  Estate taxes, or “death taxes,” are taxes put on a person’s estate or other holdings after that person’s death.

The Texas constitution prohibits the imposition of an income tax, and its property and sales taxes are relatively high. Texas relies heavily on state sales taxes and local property taxes. Therefore, Texas has a more regressive tax system than most states.

All states except Vermont cannot run deficits because their state constitutions forbid doing so; that is, they must have balanced budgets. Nevertheless, state governments have to maintain at least basic functions, such as public safety, and the national government is giving less money to the states for certain purposes. 

The budget process:  In most states, the state budget is created annually. Texas has a two-year budget cycle. For a description of a typical state (Idaho) budget process, see Figure 4-1).

Governments are required to provide entitlements, or services that laws require expenditures regardless of cost to the state.   Other expenditures are discretionary spending.

Terms and Ideas

4 ways to raise governmental revenue
*charges, user fees
*intergovernmental revenues
*property taxes
*income taxes
*excise, or “sin taxes”
*estate taxes
Tax capacity
Tax effort
Guidelines for a “good” tax system
Primary sources of revenue for the 3 levels of government
Progressive taxes
Regressive taxes
Texas budget cycle
Entitlement spending
Discretionary spending
Balanced budget
Texas reliance on sales taxes and property taxes

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