Referendum

Owings, W. A., & Kaplan, L. S. (2019). American Public School Finance (3rd ed.). Taylor & Francis. https://bookshelf.vitalsource.com/books/9781351013772

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Chapter 5 Taxation Issues

FOCUS QUESTIONS

1 Explain how taxes equalize resources and services for citizens.

2 Summarize the differences among proportional, regressive, and progressive taxes.

3 Describe how localities determine property tax rates.

4 Explain how states compare in rankings of per capita property tax, income tax, and sales tax revenue.

5 Identify revenue sources for states in addition to property, income, and sales taxes.

6 Define the indicators of a good tax.

7 Describe how you, as a school leader, will help the community understand the utility of paying taxes for public schools.

No one loves paying taxes, but everyone wants the services—such as high-quality public education and health care; well-trained and resourced police, firefighters, and military; and well-maintained roads and infrastructure—that taxes provide. This chapter explores taxation issues, explains the concept of equalization, and identifies the sources of state revenue for education. It also expresses in detail how school leaders can show stakeholders the benefits of their taxes for public education.

Clearly, education is an important investment in human capital, but taxpayers want lower taxes; and government agencies hold varying ideas on how to spend their limited funds. Yet as of 2015, 29 states were providing lower per pupil funds than in 2008, and 12 states had cut their general funding formula for education.1 Seven of these 12 states had enacted tax cuts, diverting millions from state treasuries rather than restore education funding.2 According to Education Week Research Center’s Quality Counts 2018 school finance report, the United States as a whole earned a nearly failing grade of D-minus on school spending in terms of per pupil spending and the proportion of taxable resources they dedicate to PK–12 education, despite increased spending on education.3 Policy makers and politicians struggle to find new revenue sources. Meanwhile, interest groups, such as advocates for parental choice, tuition tax credits, or school voucher programs, complicate educational funding decisions still further, potentially drawing money away from public schooling and its investment in every child.

Reluctance to finance public education is not a recent phenomenon, although it has become more pronounced since A Nation at Risk (1983) and the political climate it reflected. In all probability, the 1647 New England colonists resented paying taxes for their sons’ and servants’ education. The founding fathers, however, realized education’s importance to their new democratic republic better than many do today. Education is a state responsibility that requires public funds. With these public monies come public scrutiny and public comment. Therein lies the rub. Most people believe the correct taxation level is somewhat less than what they currently pay, and the level of service they want is somewhat higher than currently exists. In turn, many politicians attract voters with platforms based on tax reduction and education “reform.”

In the public service “business” of education, operating revenues come from the community mainly in the form of property taxes. As noted in Chapter 2, we no longer fund public schools by user fees or tuition. In fact, the courts have repeatedly stated that public education must be tuition free.4 Consumers do not buy education services based on economist-derived price points. As a state function, states are responsible for funding education. To this end, following the Massachusetts precedent begun in 1647, states rely on local property tax revenue as the major funding source to support public schools.

Increasingly, some U.S. taxpayers are rejecting using property taxes to pay for their schools. California offers a cautionary tale. In response to rising inflation and exploding property taxes, on June 6, 1978, Californians voted “Yes” on Proposition 13 to amend the state constitution, limiting local property tax rates, and making increasing other taxes more difficult. Initial estimates predicted a 57% decrease in overall California property taxes ($7 billion) and a 23% cut in local tax revenues (a $2.9 billion revenue shortfall).5 California’s per pupil spending went from about $400 above the national average in 1969–70 to more than $600 below the national average in 1999–2000,6 and its reputation for excellent public schools went with it. From 1978 to 2017, California slid from one of the nation’s highest performing public school systems to one of the worst-performing (ranking 42 of 50 with a D+ grade in PK–12 achievement and school finance,7 although the state’s increased per pupil spending moved its national ranking in financial support for education from 39th in 2017 to 32nd in 2018, earning a C grade).8

The spark had been lit. Within 5 years of Proposition 13’s passage, nearly half the states had legislated a similar straightjacket on politicians’ ability to raise taxes.9 Many homeowners resent property taxes—taxing a stock (rather than a flow) of wealth to fund state services. In fact, a national survey conducted one year after Proposition 13 was implemented showed a dramatic countrywide reduction in tax revenue at the state level.10 More than 40 years later, the trend continues. With the economic downturns following the 1995–2000 dot.com bubble, the 9/11 attacks, and the Great Recession (2007–09), this anti-tax mentality results in a lack of fiscal resources that strains the allocation of tax dollars for public services and undermines teaching and learning.

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UNDERSTANDING TAXES FOR EDUCATION: SOME BASIC CONCEPTS

Public education depends on tax dollars for funding. Public schools do not operate as for-profit companies designed to generate dividends and increase stock prices for shareholders, as do Amazon, General Electric, and Apple. Neither are public schools professional fee-for-service organizations as are dental practices or physicians’ offices. Taxpayer-supported schools are a unique public service provided on a scope and scale unlike anything else in our society—or in the world. The key question is, “What is the best way to generate political support and fiscal resources for our large and expensive public education service as an investment in our community’s and nation’s human capital and economic well-being?”

Taxes Equalize Resources and Services

The purpose of a tax is to pay for a government function. In legal terms (see Chapter 3), a tax should be “equalized”—that is, the government should have a formal mechanism to calculate a lower cost for those who can least afford the service and a higher cost for those who can most afford the service. This equalization tends to make the most needed services more reasonably priced to those who are least able to pay. In essence, taxes have the effect of redistributing wealth at the local, state, or federal levels, with equalization leveling the playing field as we invest in the human capital of each succeeding generation.11

A major taxation tenet is that taxes should be spread out—redistributed—over as large a population as possible. In other words, the funding base for a service should be as large as the population it serves. Funding a federal service such as defense or Social Security should be stretched over the entire country. Paying for a state service such as parks or museums should be extended over the entire state. Supporting a local service, such as city or county police, firefighters, or garbage collections, should be distributed over the entire locality.

Likewise, each state has established a minimum “floor of educational services” which localities must provide. The key word in this floor level of services is minimum. In this way, the state assures that each student living within its boundaries has access to the most basic required set of courses and competencies needed to graduate from high school. No locality can offer less than that minimum. For the most part, that floor level of services is funded through a mixture of state and local dollars (91%) with a much smaller percentage of federal dollars (9%).

Wealthy localities may have no problem meeting these standards. Often these communities are already providing the extra courses and highly effective teachers, and almost all students pass their tests. Poorer localities, in contrast, face challenges in meeting the minimum standards, much less offering extra courses and recruiting highly effective teachers with attractive salaries and benefits.12 Within a state, therefore, not all localities have the same ability or capacity to prepare their students to meet the required levels of academic and skills

mastery. The state has a legal responsibility to help redistribute monies—or equalize funding—to help less wealthy localities meet these educational benchmarks.

Subsequent to A Nation at Risk in 1983, state and federal governments have been “ratcheting up” that floor level, increasing the number and intellectual rigor of courses that each student must complete successfully. Test-based accountability is here for the foreseeable future. The Every Student Succeeds Act (ESSA), passed in December 2015, requires students at certain grades to take and pass reading, math, and science assessments to demonstrate their proficiency and confirm their school’s accountability. But unlike its No Child Left Behind (NCLB) predecessor, ESSA gives states more control and flexibility in determining the standards and assessment targets to which students and teachers are held.

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Brief Review of Tax Funding for Public Schools

As discussed in Chapter 2, the history of financing U.S. public schools goes back to the country’s earliest days. The first public school finance law was the Massachusetts Law of 1647. Town elders used property owners’ taxes to hire a teacher in towns of 100 or more to educate the community’s sons and servants. Having to learn to read the Bible, the elders reasoned, would keep educated youth and adults from falling prey to Satan’s temptations.

Property was taxed because it was the means by which most people generated income. A farmer made his living by growing crops or raising animals on his land—his property. Selling the crops or livestock provided his income. Likewise, a merchant operated a store (above which she and her family usually lived) and derived her income from the profits of selling merchandise on her property. A furniture maker derived income from property—in the shop behind his house—selling handcrafted chairs or cabinets. Not all these transactions were cash sales. Individuals bartered or traded many items, using exchange of goods as a money substitute to secure the desired products or services.

It was logical, therefore, for government to tax property because that property was the basis for earning one’s income. At that time, property was a realistic proxy for income. Unfortunately, this is no longer the case. Today, very few of us derive our income from our property.13 Rather, we earn our income from our place of employment. For most of us, our homes represent more of a revenue drain than a revenue source: a stock—rather than a flow—of accumulated wealth. We do not realize any financial gain from our property until we sell it.

Flow of Production and Stock of Wealth

Taxes fall into two broad categories: taxes levied on the flow of production or services and taxes levied on a stock of wealth. Taxes may be based on a flow of production derived from purchases, such as income (your employer purchases your services), and sales. These taxes include personal income taxes, corporate income taxes, and retail sales taxes, to name a few. As money moves along the production or service process, it is taxed as it “flows” from one individual to another or from one company to another.

Alternatively, taxes may be based on a stock or accumulation of wealth. A stock of wealth has ceased to move in the flow of production. It does not involve building, making, selling, or servicing anything or anyone. Instead, it has become an individual’s or a company’s asset. Taxing property, as measured in our home or a business’s valuation is, therefore, taxing a stock or portion of wealth. This is known as an ad valorem (in proportion to the value) tax. Property taxes are considered ad valorem because a portion of the home’s or business’s assessed value (or a portion of the value) is taxed to support a service. In the same locality, the owner of a house valued at $200,000 pays twice the tax amount of the owner of a $100,000 home because the former home’s value is twice the latter’s. The tax rate is the same, however.

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In Rem and In Personam Taxes

Another tax classification includes in rem and in personam taxes. In rem taxes are those imposed on “things” such as machinery, cars, and houses. In some areas, these taxes are known as personal property taxes, and they are based on the value of the “item” being assessed. In rem taxes do not consider whether an individual owns the “item” free and clear or whether the “item” is bought entirely on credit. A disadvantage of in rem taxes is that individuals may pay taxes on items they do not really own, and they cannot claim their full and outright ownership as an asset. Although they “have” the taxable item, the item may not actually be theirs—the bank may hold the title and most of the item’s equity.

In personam taxes are imposed on people. The best example of in personam taxes are those imposed on people’s earned income—an income tax. In personam taxes account for equity in the value of the income derived. In other words, the size of one’s personal income determines the amount of tax to be paid. In rem taxes do not account for the equity in property; they assess the entire value of an “item” whether or not the individual owns the property or has a mortgage on it.

Each of these types of taxes generates funding for public services such as education. It is important for educators to know what types of taxes support their school’s funding and what taxes tend to be more popular with the public. Different types of taxes can have different effects on taxpayers and generate varying levels of acceptance. The effects of these taxes are discussed next.

Proportional, Regressive, and Progressive Taxes

Politicians often talk about the regressive nature of one tax versus the progressive nature of another tax. Very infrequently does the public hear discussion of proportional taxes. Informed educational leaders should be able to discuss the meaning, advantages, and disadvantages of each.

The sales tax is a proportional tax; each person pays the same percentage. For example, say a state has a 5% sales tax on purchased items that are not exempt from tax. Because everyone pays 5%, this is considered a proportional tax. Although a proportional tax initially seems fair, it taxes poorer persons more heavily than it does richer ones. Although the percentage taxed on any item is the same dollar amount for each person, this amount represents a larger share of the less well-off person’s financial resources.

For example, buying groceries for a family of four (two parents, two teenagers) might cost $200 each week. A sales tax of 5% on a grocery bill of $200 would amount to $10. Over a period of one year (assuming the cost of groceries remained constant), the sales tax on groceries alone would total $520. For a family with an income of $100,000 that represents .52% of their income—about one-half of 1%. For a similar family with the same eating habits earning an income of $50,000 per year, the sales tax on groceries as a percentage of their income represents 1.04% of their income—or about 1% of their gross income.

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Although a proportional tax may have a regressive effect on those with lower incomes, some argue that those who earn more tend to spend more, eventually paying more in sales tax. To make this kind of tax fairer, some states may not tax food, or tax it at a lower rate, and do not tax prescription drugs or patent drugs because these are essential, not discretionary, to good health.

A regressive tax allows individuals with higher incomes to pay a lower percentage of their income in taxes. Virtually no tax is designed intentionally to be regressive although some taxes have a regressive effect. The Social Security taxation system, more accurately known as the Federal Insurance Contributions Act, or FICA, is one such example.

As of 2018, employees pay 6.2% of their income in Social Security tax (OASDI)14 on the first $128,700 of income and 1.45% in Medicare tax on the first $200,000. Additionally, employees will pay 2.35% Medicare tax on all wages above $200,000 ($250,000 on joint returns). Given this, Individual A earning $128,400 would pay $9,822.60 in Social Security and Medicare taxes and Individual B making twice that amount—$256,800—would not be paying the 6.2% Social Security tax on the additional $128,400. Individual B would pay 2.35% Medicare tax on the amount over $200,000 (in this case $56,800 × 2.35% = $1,334.80) for a total of $12,195.60. Table 5.1 shows that Individual A pays 7.65% of his income in these taxes while

Individual B only pays 4.75%. While intended as a proportional tax, this has a regressive effect as the individual with lower income pays a higher percentage of income in taxes.

Finally, progressive taxes are those that increase as a percentage along with income. Federal income taxes are designed to be progressive.15 Currently, the lowest income wage earners (less than $3,700 for single taxpayer) are taxed at 0%. As income rises, the percentage of tax owed increases. The highest income earners are taxed at a rate of 37%.

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Table 5.2 illustrates the effects of progressive, regressive, and proportional tax rates on individuals with three income levels. Generally, “good” taxes are considered to be progressive whereas “bad” taxes are considered to be regressive. In the progressive scenario, the lower income individuals pay a lower percentage of their income in taxes than do upper income individuals. In other words, as income increases, so does the percentage of taxes paid. In the regressive tax structure, lower income individuals pay a greater percentage of their income in taxes than do upper income individuals. Under proportional taxation, each income group pays the same percentage rate of tax—in this case 10%.

Poorer people tend to spend a greater percentage of their income on basic living costs in contrast to those at the higher income levels. The spending habits of two families with incomes of $50,000 and $75,000 may not be significantly different. Life’s basic necessities—bread, milk, and butter, for example—differ little in quantity purchased by a family of four at these income levels. However, a family at the highest tax bracket level pays a lower percentage of their overall wealth in sales taxes related to these basic necessities of life. A proportional tax tends to have a regressive effect on lower income individuals.

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States have three major sources of tax revenue—property, income, and sales taxes. In this section, we discuss these major sources of tax revenue, some other minor tax sources, and an increasing tax source—lottery and gambling funds.

Property Taxes

As mentioned previously, property taxes are the primary revenue source for financing education. Property taxes are an ad valorem tax because it taxes a portion or a percentage of the property’s value. Property taxes are frequently expressed in “mills”—a unit of monetary value equal to $0.001 of a dollar—or one-tenth of one cent. The method for determining the tax rate is as follows:

If the locality needs to raise $5 million in taxes for services and the total assessed value of real estate in the locality is $500 million, the formula would look like this:

Today, for the most part, only tax professionals or doctoral students specializing in school finance calculate the millage rate. Most frequently, the tax rate is based on 100% of the home’s assessed value. This rate is usually expressed as a certain dollar figure per $100 of assessed value.16 Therefore, homeowners are most accustomed to seeing that the tax rate is, for example, $1.50 per each $100 of assessed value of the home. Table 5.3 depicts fixed and variable property tax rates based on fair market value.

Sometimes, the public resents paying property taxes. In a classic 1973 work, The Property Tax: Reform or Relief?, John Shannon cites two reasons for this unpopularity.17 First, people consider property taxes as a threat to the American dream of home ownership. It makes the cost of buying a home more expensive, discouraging many families from home ownership. Second, taxing a home’s value is taxing unrealized profits—the owner would have to sell the home to get the assessed monetary value as compared to the price originally paid for the house. Until its sale, the home’s value is only a paper profit. Yet, the taxes are based on its current value. For instance, many of us have grandparents who must sell their homes because they are living on a fixed income. The value of their home has increased so much that they can no longer afford to pay their property taxes. In a different scenario, when people buy their homes during a housing “bubble,” they pay a very high price in a rising housing market. After the “bubble” bursts and home prices drop steeply, the home owners may still owe more on their mortgage than the amount for which they could sell their home. If we can picture ourselves in these predicaments, we can see how the idea of property taxes generates such dislike.

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Additionally, property taxes are difficult and costly to administer. Fair market value is sometimes arbitrary, and the cost of administering property tax programs can be expensive. Furthermore, property tax bills usually arrive once a year—making payment difficult for those who have not budgeted ahead.

Consider the many municipal departments and employees a locality needs to manage property taxes. First, the municipality needs a system to inventory and organize all the locality’s property and improvements on that property. Second, specialized personnel must be hired and

trained to make periodic physical assessments of the property. States vary on how often they must make these physical assessments. Third, an appeals system must be available for homeowners contesting their homes’ valuation. Fourth, tax bills must be sent out and collected (an accounts payable and receivable system), requiring additional staff. Fifth, a system must be established to collect delinquent taxes, and the list goes on.

Furthermore, a home’s fair market value is sometimes difficult to calculate. Realtors use a comprehensive market analysis (CMA) to determine a home’s correct selling price. A three-bedroom, two-bath brick rancher on a half-acre lot on one side of town may have a greater value than the same house across town, and subjectivity often comes into play. As a result, comparing real estate tax assessments generally confuses and angers homeowners. Why does one house’s assessment increase by 15% while another goes up only 3%? Moreover, although people want their home’s value (and their personal wealth) to increase, they do not want to pay the resulting higher taxes on that unrealized position. Because property taxes are primarily the revenue source for schools, it is logical for taxpayers to associate and voice frustration with the schools over their real estate tax bills.

Jared Walczak, Senior Policy Analyst at the Tax Foundation, has set up an interesting way to examine effective tax rates—by the average amount of residential property tax actually paid as a percentage of home value. Table 5.4 shows Walczak’s figures along with the amount of property tax collected by local and state sources on a per capita basis for the year 2014 (latest data available), including relative state rankings. Income taxes are the states’ second major source of tax income, and as mentioned earlier, personal income may be a better measure of wealth today than is property. The federal government and most states collect income taxes.

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TABLE 5.4 Per Capita Property Taxes by State (Ranking in Parentheses)

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Income Taxes

For more than a century, the United States has been taxing income. The first federal taxes came after the Civil War to pay for war debts. Although this tax was repealed 10 years later, Congress revived it in the late 1800s to aid in antimonopoly and antitrust reform efforts. In 1894, Congress passed a flat 2% personal and corporate income tax, but in 1895, the U.S. Supreme Court found the tax unconstitutional.18 Levying a federal income tax required a Constitutional amendment—the Sixteenth Amendment, ratified in 1913—to allow the federal government to collect taxes on income. It states:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census of enumeration.

When federal taxation was challenged again at the U.S. Supreme Court level, the Sixteenth Amendment allowed the federal income tax to be judged constitutional.19

At the state level, until the early 20th century, property taxes provided the most reliable source of revenue. Because raising crops and cattle requires lots of acreage, farmers paid

proportionally higher taxes than businesses or wealthy individuals. Attempts at raising monies through state income taxes failed initially because people lied about their income, and income was hard to verify (as compared to property). Moreover, politicians hesitated to anger voters by enforcing income tax laws. In 1911, Wisconsin passed a rather progressive state income tax that appointed, rather than elected, tax commissioners; made the tax rate progressive; and ensured that the localities received most of the collected revenues. The tax proved to be rather lucrative for the state. It was so well devised and administered that it served as the basis for other states’ income tax model.20 Today, every state except for Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming has a state income tax.21

Table 5.5 shows the per capita personal income by state for the year 2014 (latest data available). These data show personal income relative to population and serve as a measure of each state’s wealth. In fact, these data are so well suited to measure wealth that the federal government uses this gauge to determine the percentage it pays for each state’s Medicaid costs.

Table 5.5 also shows the per capita revenue each state receives from income tax proceeds. Connecticut ranks #1 in both categories while Mississippi, ranks 50th in personal income and ranks 40th in state revenue derived from income taxes. Seven states have no income tax revenue. Tennessee, the state with the lowest revenue from income taxes ($46), has relatively high corporate income tax revenue and sales tax revenue to offset what the state does not collect from other sources. The seven states with no income tax must use other revenue sources to fund government operations.

Per capita income varies widely across our country. Connecticut has the highest per capita income at $68,704. Mississippi has the lowest at $34,771. The range is $33,933 for every man, woman, and child in the state—a wealth disparity which is increasing (by about $15,000 since the first edition of this text in 2006). With such wealth differences across the nation, the ways and the extents to which states and the federal government tax income affects all public service sectors—especially schools.

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TABLE 5.5 Per Capita Personal Income and Per Capita State Revenue from Income Taxes and Rankings

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Sales Taxes

Table 5.6 shows general state sales tax revenues (does not include special sales taxes such as those on alcohol, gasoline, or tobacco) generated more than $347 billion in the United States in 2014 (latest data available and up from the $291 billion collected in 1999). Some states have no direct sales taxes on purchases; however, states do tax gasoline, utilities, telephone and 911 services, and other items that qualify as a sales tax. Sales tax revenue provides income for states to fund educational and other public services. The major impact of sales tax revenue comes from visitors and tourists—important parts of many state and local budgets—as well as from state and local residents.

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State and local sales taxes generate a great deal of funding for education. It is interesting to note how per capita income (see Table 5.5) and the state and local sales taxes

vary. Connecticut has the highest per capita income level, but it ranks 20th in state and local sales tax as a percentage of personal income. Mississippi, on the other hand, has the lowest per capita income level and the 21st highest level of state and local sales taxes as a percentage of personal income. States attempt to secure resources to fund public services from those assets available that can pass political muster.

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Lotteries and Gambling (Voluntary Taxes)

Revenue from legally sanctioned gambling plays a relatively small but important role in state budgets. Most states collect revenue from some form of gambling—lotteries, casinos, racinos (a blend of racetracks and casinos), pari-mutuel wagering, Native American casinos, and other less common gambling activities. States obtain the majority of gambling revenues from three sources—lotteries, casinos, and racinos. Table 5.7 shows the net revenue to states from those three sources (with casinos and racinos combined).

In the wake of the Great Recession, many states authorized new gambling options to generate additional revenue. With the increased competition for limited gambling dollars, individual states’ revenue has declined somewhat. However, in fiscal 2015, local and state governments collected approximately $18.2 billion net revenue from lotteries alone. In this form of revenue collection, the government sells chances to win some prize. A government-sponsored lottery may be considered a voluntary tax. When a lottery winner claims the prize (paid by voluntary contributions), the state and federal governments then collect income taxes on what cost them virtually nothing. For our purposes, we will not consider gambling’s moral issues but only its function as revenue sources for education.22

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Severance Taxes

The term “severance taxes” may be new to some. The Department of Commerce defines these as “taxes imposed distinctively on removal (severance) of natural resources (e.g., oil, gas, coal, other minerals, timber, fish, etc.) from land or water and measured by value or quantity of products removed or sold.”23 In FY2017, U.S. collected severance taxes totaled more than $8.86 billion. Although this tax is quite lucrative for some states, overall it accounts for less than 1% of all state revenues. Some states collect no revenue from severance sources, and others collect a substantial amount. Table 5.8 shows severance tax collection for selected states that report revenue through this means.

Alaska generated significant revenue from severance taxes—most notably from the oil pipeline—but in 2015 experienced a substantial income loss due to changes in how taxes are calculated. Lower fuel prices and lower production have serious consequences for these taxes. Nineteen states reported no revenue from severance taxes in this period.

Corporate Income Taxes

In 1909, Congress levied the first federal corporate income tax when it enacted an excise tax for the privilege of doing corporate business in the United States. At the state level, the corporate income tax can be traced to Wisconsin in 1911, the same year Wisconsin passed its first-in-the-nation individual income tax.24 Corporate income taxes once generated approximately one-fourth of all federal revenue. Today, sales tax revenue brings in almost six times more revenue.25

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Corporate income taxes are calculated on sales revenue less production costs, interest or rent payments, depreciation on capital equipment and facilities, as well as any state or local taxes paid. This tax impacts the price of many stocks and pension plans. As such, the ramifications of corporate income taxes are rather widespread. Generally, they are popular with the public at large and unpopular with business owners and executives.

Corporate income taxes do have many critics, however. To some it is seen as a “double taxation” system. Others view corporate income taxes as increasing the final cost of goods and services to the end consumer. Still others perceive these taxes as taking money from investors in the form of dividends or stock appreciation, which impacts John and Mary Babyboomer’s retirement portfolio (that includes stocks). The couple may feel better positioned for retirement with lower corporate income taxes, which could result in a higher yield on their investments.

The corporate tax issue is complicated and beyond the scope of this text to explain more fully. Suffice it to say that where thriving businesses exist, people are employed and paying income taxes, purchasing and maintaining homes that generate property taxes, and buying goods and services that generate sales taxes. This is a healthy cycle for a local economy, and funding education appropriately keeps that healthy cycle turning.

TABLE 5.9 Per Capita State Corporate Net Income Tax Revenue, 2015 (Rank in Parentheses)

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Sumptuary Taxes

Governments impose sumptuary (“sin”) taxes on alcohol and tobacco, for example, to help regulate or limit activities seen to be not in the public’s best interest. Legislatures attempt to regulate these “bad” behaviors by taxing them at varying rates above and beyond the sales tax. “Sin tax”26 revenues generated by alcohol sales attempt to regulate alcohol use by increasing its price (and making it less affordable). Lawmakers reason that if a product’s sale and use are not in the public interest, the additional tax should be used to benefit various other state functions or help remedy the problems the products may have caused.

As such, many states received millions of dollars from the 1998 federal court settlements against the tobacco industry. Some states elected to use most of their tobacco settlement monies to fund schools. Other states used the tobacco settlement monies to balance their state budgets by placing these dollars in the state’s general fund.

“Sin taxes” present a conundrum for educators. Table 5.10 shows how much we receive from the sale of some substances we teach our students are harmful to them. Without this extra money, however, our already low funding would be even further reduced. At what point do these taxes have a substantial negative impact on tobacco farmers and vineyards and ultimately on state revenue? The revenue is not insignificant as total state tax revenues from alcohol ($6.431B) and tobacco ($17.742B) taxes totaled $24,172,538,000 in 2015.27

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All citizens are concerned about the tax structure’s impact. The public often hears elected officials’ voicing conflicting rhetoric on the subject. The divide between lawmakers favoring tax cuts and those wanting to raise taxes to support more government services is becoming wider. Our public school students may be the ones who feel this schism most severely.

Education funding should be a national priority, viewed as an investment in our country’s human capital, economy, and national security. Moreover, the tax impact to fund education needs to be equitable. In a climate of high-stakes testing, high levels of accountability for educators, and our students’ future capacity to compete successfully for employment in a global

marketplace, our classrooms need substantial resources. Likewise, our teachers need competitive salaries and ongoing professional development to enable them to help every student meet or exceed state academic standards. Politicians and legislators must recognize that educating all students well requires adequate funding—for recruiting, improving, and retaining effective teachers (especially in high-needs urban schools), providing extra time to support student learning, affording professional learning, and acquiring appropriate instructional supplies. Failure to recognize that excellent and equitable education for every student takes fiscal and other resources—and act on this belief—will make it much more difficult for public schools to fulfill their mission.

Educational leadership students must assess the tax impact of education on their local and state constituencies and couple this with positive school outcomes. If local and state school boards ask that more public funds enter the education stream, then educators must and will be held accountable for results, including higher levels of student performance, increased community satisfaction with the public school system, and creating welcoming places for pupils, parents, and the community.

MARGINAL UTILITY

Economists discuss a concept called diminishing marginal utility (see Figure 5.1). This means as a person increases consumption of a product (while keeping consumption of other products constant), the level of satisfaction (marginal utility) that a person gets from using each additional unit of that product declines (although the total utility increases). The basic idea is that consumers try to maximize their satisfaction (or utility) through their income by purchasing desired goods and services.

This is best explained with an example. When one of the authors was growing up in Baltimore with its hot and humid summers, his parents’ home did not have air conditioning. As a teenager, when he started to work, he experienced great satisfaction (or utility) by purchasing a window air conditioner for his bedroom. He hated those hot and muggy Baltimore nights, and loved the new room air conditioner. Not long afterwards, his parents bought a window unit for the living room and then one for their bedroom. That first air conditioner was novel and brought great relief (and satisfaction) on hot days and nights. Going from no air conditioning to air conditioning had great utility for him. The second unit brought utility to the main living area of the house—nice, but not as important to him. The third window unit brought utility to his parents’ bedroom—which had no utility for him (but probably much for them). Other areas of the house could have been air conditioned, but the rooms were used less often, and the expense would have brought diminishing utility to everyone in the house. As you can see from Figure 5.1, the utility does not decrease to zero. Purchasing more window units would have taken away from available dollars to purchase other wanted or needed items that would have brought higher utility.

Taxes, too, can have diminishing marginal utility. To some point, people see the utility in paying taxes. They drive smoothly over the new roads, appreciating their easier commute. They

look appreciatively at their new schools, feeling proud of their school district’s accomplishments. They realize that their children are learning more in school and acknowledge how their schools district’s reputation is attracting thriving businesses (as employers and taxpayers) to locate there.

As taxes rise and consume a larger percentage of income, however, the utility or satisfaction with paying taxes tends to decrease unless citizens understand that the cost brings them meaningful benefits. Educational leadership students need to remember that people are only willing to pay taxes for schools as long as they see it has utility for them. Educational leaders can help promote the success of all students by understanding, responding to, and influencing the public and economic contexts of taxes to ensure that the tax-paying public perceives this educational utility in a relevant, personal way that makes sense to them.

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Indicators of a Good Tax

Balancing this idea of diminishing marginal utility is the idea of a good tax. When tax structures are too complicated to understand or when loopholes allow individuals or companies with high capacity to pay little or nothing in taxes, people become frustrated and cynical about all taxes. The following concepts are generally agreed-upon principles of a good tax system, discussed in alphabetical order.28

Accountability to Taxpayers

Taxpayers must be able to access and see information on tax laws and their development, modification, and purpose.

Adequacy of Yield

The cost of administering a tax should not exceed the revenue generated by that tax. In other words, if the state builds a bridge and installs a booth to collect tolls from users to repay for the bridge and the means to collect the tolls (personnel, management, audits, and so forth), the monies collected should be high enough to cover the costs (and then some) necessary to collect them.

Administration Costs

The cost of administering and collecting the tax should be low for both the government and taxpayers. Collecting income taxes is more efficient than collecting property taxes: your employer deducts your taxes directly from your income and sends it to the proper authority whereas a property tax requires a much more personnel-intensive operation to collect revenue.

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Appropriate Government Revenues

Tax systems should have appropriate levels of predictability, stability, and reliability to allow the government to determine the timing and amount of tax collections.

Certainty

The tax rules should clearly spell out how the amount of payment is determined, when the tax payment should occur, and how to make the payment.

Convenience of Payment

A good tax is convenient in time and manner for the citizen to pay. If a tax can be paid through the mail or electronically, it should be done for the taxpayers’ convenience.

Economic Growth and Efficiency

The tax system should not unduly impede or reduce the economy’s productive capacity. The tax system should promote economic growth and not distort taxpayer behavior by imposing high marginal tax rates on labor, savings, or other activities.

Economic Neutrality

Ideally, taxes should leave individuals in the same relative position after taxes as before paying taxes. Economic neutrality is much more easily said than done. One way that we approach neutrality is through diversification of taxes. As taxes are diversified through income, property, sales, lottery, sumptuary, and the like, we lessen the impact of any one tax.

Everyone Pays Something

All citizens enjoy the benefits of government. Police protect. Teachers teach. Firefighters fight fires. Soldiers defend. Roads transport. And so it goes. In a good tax system, all citizens contribute something to the common good and gain by having these services to make their lives easier.

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Fairness and Equity of the Tax System

Fairness and equity are sometimes judged in the eye of the beholder. Basically, a fair and equitable tax structure has a greater burden on the rich than on the poor, accounting for individuals’ different capacities to bear the taxation burden. Some politicians and economists argue that a tax is not fair and equitable unless it is progressive. Others argue about the relative merits of a proportional tax. Virtually all agree that a regressive tax system is unfair and inequitable.

Information Security

Tax administration must protect taxpayer information from all types of unintended and improper disclosure. Ensuring taxpayer privacy is an essential and continuing challenge in today’s internet-connected environment; and government offices are obligated to keep up with technological changes (and additional costs) that ensure it.

Simplicity

Taxpayers should be able to understand the tax law rules and comply with them correctly and in a cost-efficient manner. The compliance burden—record-keeping, planning, preparing returns, and responding to audits—should also be simple.

Transparency and Visibility of Benefit

Taxpayers should know that a tax exists and how and when it is imposed on them and others. Many of us see signs during road construction saying something like “Your tax dollars at work.” When a new school opens, the public has a visible anchor of utility on how their tax dollars were spent. Each time the school is used for a community benefit and the school is well maintained, the community experiences the school’s benefit.

These taxation principles are both old and contemporary, some developed by Adam Smith in 1776’s The Wealth of Nations and others more recent, used by governments, economists, tax advisers, in this country and internationally. Countries need a dynamic and flexible tax system—able to meet current revenue needs as well as adapt to changing needs and to technological and commercial developments. Especially in the face of taxpayer

resistance, federal, state, and local officials must review tax systems regularly to ensure they support the jurisdiction’s goals and can generate appropriate revenues to keep public services—including schools—functioning well and in accord with the principles of good tax policy.

CONCLUSION

It is important for educators to know what types of taxes support their school’s funding and what taxes tend to be more popular with the public. Different types of taxes can have different effects on taxpayers and generate varying levels of support.

CASE STUDY

The recent state government elections have changed the political makeup of education funding. The new governor ran on a pro-public education platform. Your state’s spending on education in the past has historically been low. Salaries, buildings, and curricula had been deemed “good enough.” The public polling indicates that residents see a need to increase funding, but their understanding of how the state funding works is low. With a lack of knowledge, residents are reluctant to increase taxes to fund some new initiatives such as increasing salaries, modernizing facilities, and implementing curricular changes.

The governor has selected you to design a four-page (front and back) brochure that will be mailed to all state residents explaining how your state funds education. Your directions are to make the brochure understandable to someone reading on the 9th-grade level.

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You are to include the following information:

• Sources of major tax revenue to the state;

• The major expenditure categories and why education ranks as such a large state expenditure;

• How the state equalizes funding so localities with greater capacity receive fewer state dollars and localities with less capacity receive more state dollars;

• The reason for any special programs initiated by the governor and how they relate to student achievement and economic growth;

• The role of the local, state, and federal governments in funding education; and

• Any other information you deem relevant to the explanation that may be relevant to your state.

Include graphs and charts to make your illustrations clear to the public.

CHAPTER QUESTIONS/ASSIGNMENTS

1. Explain the relative fiscal capacity of your state to fund education. Show this in terms of state per capita income, property values, and sales tax revenues compared with surrounding states. Based on that capacity, how much effort (per pupil expenditure) does your state put into education?

2. Describe the differences among proportional, regressive, and progressive taxes. What efforts has your state made to make the tax structure as progressive as possible? What tax structures appear to have a regressive impact on citizens?

3. Discuss how a proportional tax could have a regressive impact. Cite examples from your state. How would you recommend that these taxes be improved?

4. Describe how you as a school leader will help show your community that there is utility in paying taxes for the public schools.

5. Examine the taxes that support education, and discuss whether they meet the criteria for good taxes. How could they be improved? How could we as educational leaders advocate for reform in these areas? If you were to become your state’s superintendent of schools, governor, or president one day, how would you campaign to restructure education funding in a more fair and equitable manner using the principles of good taxes? On what platforms are national, state, and local candidates campaigning?

NOTES

1 U.S. Census Bureau (2017). Public education finances: 2015. Washington, DC: U.S. Government Printing Office. Retrieved from www.census.gov/content/dam/Census/library/publications/2017/econ/g15-aspef.pdf 2 Leachman, M., Masterson, K., & Figueroa, E. (2017). A punishing decade for school funding. Washington, DC: Center on Budget and Policy Priorities. Retrieved from www.cbpp.org/research/state-budget-and-tax/a-punishing-decade-for-school-funding 3 Burnette II, D. (2018, June 6). States squeezed by fiscal pressures, political rifts in financing education. Quality Counts 2018: Finance, Education Week, 37 (34), 23. 4 Randolph County Board of Education v. Adams, Supreme Court of Appeals of West Virginia, 467 S.E.2d 150 (1995); Cardiff v. Bismarck Public School District, 263 N.W.2d 105

(1978); Hartzell v. Connell, Supreme Court of California, In Bank 35 Cal. 3d 899, 201 Cal. Rptr. 601, 679 P.2d 35 (1984). 5 Oakland, W.H. (1979, June). Proposition 13—Genesis and consequences. National Tax Journal, 32 (2), 387–409. Supplement: Proceedings of a Conference on Tax and Expenditure Limitations. Retrieved from www-jstor-org.proxy.lib.odu.edu/stable/pdf/41863190.pdf

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6 Carroll, S.J., Krop, C., Arkes, J., Morrison, P.A., & Flanagan, A. (2005). California’s K-12 public schools. How are they doing? Santa Monica, CA: Rand Education. Retrieved from www.rand.org/content/dam/rand/pubs/monographs/2004/RAND_MG186.sum.pdf 7 Education Week (2016, December 30). Quality counts 2017: State report cards map. Retrieved from www.edweek.org/ew/qc/2017/2017-state-education-grades-map.html 8 Quality Counts Finance: 2018 (2018, June 6). State snapshots from this year’s analysis. Education Week, 37 (34), 21. 9 Moore, S. (1998, July 30). Proposition 13 then, now and forever. Commentary. Washington, DC: CATO Institute. Retrieved from www.cato.org/publications/commentary/proposition-13-then-now-forever 10 The Editor’s Page (1979). The spirit of 13 continues to sweep the country. Phi Delta Kappan, 61 (2), 84. 11 In truth, perfect equalization does not exist. Inequities exist despite the aspirational goal. 12 As a result of litigation, some poorer districts spend more per pupil than wealthier localities as in, for example, New Jersey, with their “Abbot” districts.

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13 Unless one has extensive Gro-lux lights in the basement. 14 Old Age, Survivors, and Disability Insurance. 15 The thought of federal income taxes as progressive here excludes IRS loopholes that may have the potential for making these taxes regressive if higher income individuals use options to reduce their tax liability significantly. 16 It is important to compare assessments at 100% of fair market value of properties. A tax rate of 75 cents would appear low compared to $1.50 until we knew that the 75-cent assessed rate was based on each $25 of assessed value, making the tax rate twice what it would be at $1.50 per $100 of assessed value. 17 Shannon, J. (1973). The property tax: Reform or relief? In G.E. Peterson (Ed.), Property tax reform (pp. 26–27). Washington, DC: Urban Institute. 18 Pollock v. Farmers’ Loan and Trust Co., 157 U.S. 429 and 158 U.S. 601 (1895). 19 Brushhaber v. Union Pacific R.R. Co., 240 U.S. 1 (1916). 20 Stark, John O. (1987). The establishment of Wisconsin’s income tax. Wisconsin Magazine of History, 71 (1), 27–45.

21 For dates when each state established an income tax, see: Drenkard, S. & Borean, R. (2014, June 10). When did your state adopt its income tax? Washington, DC: Tax Foundation. Retrieved from https://taxfoundation.org/when-did-your-state-adopt-its-income-tax/ 22 One of the authors’ great grandmother was a “bookie” practicing illegal gambling in Baltimore City. 23 United States Department of Commerce (2011). Federal, state, and local governments. Government finance and employment classification manual. Description of tax categories. Washington, DC: Author. Retrieved from www.census.gov/govs/www/class_ch7_tax.html#t53 24 See Alexander, K. & Salmon, R. (1995). Public school finance (pp. 104–105). Needham Heights, MA: Allyn & Bacon. 25 Morgan, K. & Morgan, S. (2017). State rankings 2017: A statistical view of America. Thousand Oaks, CA: CQ Press, Sage. National per-capita income from corporate income tax was $153 compared to a national per-capita general sales tax revenue of $892. 26 With all apologies to grammarians. 27 Morgan & Morgan (2017), pp. 344, 348. This is an interesting topic for class discussion. 28 American Institute of Certified Public Accountants [aicpa.org] (2017, January). Guiding principles of good tax policy: A framework for evaluating tax proposals. Tax Policy Concept Statement 1. New York, NY: Author. Retrieved from www.aicpa.org/ADVOCACY/TAX/downloadabledocuments/tax-policy-concept-statement-no-1-gl obal.pdf; and others.