1 URBAN AND PUBLIC FINANCE EXAM: URPA 5324 STEVEN APELL/ 12th May 2005 1.

Property tax and local government autonomy in relation to financing education. An overview of the American Experience Brunori David (2003) examines how local governments are financed in view of current and future responsibilities of system governed by federalism 1. Brunoris hypothesis is a simple one: the future of local future of local governments that Americans are familiar with will be in jeopardy without significant change in the way local governments are financed. Brunori argues that without stable tax revenue, local government could be weakened to the point of irrelevance. To avoid this dire prophesy, government requires a tax system within their legal and political jurisdiction. Brunori further maintains that the revenue source capable of supporting local government finance is the property tax; however public and political pressure has eroded the taxs vitality for decades and the tax no longer dominates local government finance. The most serious threat to local government financial independency borne of the property tax, started with the school finance crisis. However lets first examine why Brunori favors the property tax, and then we shall constructively criticize his view from the perspective of Public School finance. Property is defined for legal purposes as the rights or control over economic goods. It is interpreted to refer to things or objects which may be the subjects of ownership; in most states , the basic point in determining property tax
1

Brunori David. (2003). Local Tax Policy, a Federalist Perspective .Urban Institute press .Washington Dc Brunori comes across as a strong advocate for localism and explores various issues on financing local government in hope of finding a system that ensures autonomy and survival of local governments.

2 base is all real and personal property both tangible property (Sexton Terri , 2003). However Brunoris book, property refers to land and any improvements thereof; hence property tax refers to the levy on real assets. Brunori supports localism because he believes local governments are the most efficient providers of public goods and through property tax. Localism increases control by the residents because they can elect local officials and hold them accountable for services they desire. Further more local governments try hard to satisfy their constituents cause if they dont, citizens will vote with their feet in accordance with Tiebouts hypothesis. Brunori supports the property tax because it has many qualities of a good tax; it is stable, easy to administer, visible and is based on an immobile tax base therefore even if residents move, they leave therefore property behind and cannot move with the base. Further more, as opposed to state sales taxes, property tax revenue is raised locally to support local public services, thus there is a strong connection between the source of revenue and its point of use. In sum, it promotes a sound tax policy based on the benefits principle of taxation rather than ability to pay and also is progressive and not redistributive (a quality which may force residents to flee). Brunori laments that not only has local control of property tax declined but also its dominance as the leading source of revenue for local governments. He points that local governments once raised 80% of their own source revenue, and 65% of that was from property alone (he does not tell us when) but today property tax accounts for less than 25% of local government revenue. This deterioration can be traced back to the general dislike of the tax by the public,

3 politicians and the loss of autonomy because of state financial support. So

whereas the local government bureaucrats favor property tax as their bulwark for autonomy, the people they are trying to serve do not like it and worse still the elected officials in public office dont have much regard for the tax. However there is a need for the local government to control its own finances so that they can justify and finance their existence. If they have

autonomy over finance, and they lack spending priorities with the authority to determine tax burdens, the election of local representatives serves little purpose, and they might as well not exist. Brunori nostalgically points that this tax has been around for along time and has always been used by the local government there fore we have more experience and familiarity with it , furthermore it is the epitome of a benefits tax and even some cases generates externalities when less affluent people benefit from using the facilities among the wealthier districts. Most of all his philosophy seems to be that the public should support this tax because truly puts power in the hands of the electorate. One area that has however undermined the local government control of the much favored property tax is the financing of public schools. The ongoing school finance crisis has drastically limited local government reliance on property taxes. Traditionally paying for elementary and secondary school education was primarily the responsibility of local governments; in meeting this obligation, local governments relied primarily on the property tax.2 One flaw with this method is that wealthier jurisdictions enjoy a much larger property tax base allowing them to develop human and capital resources more than the poorer districts.
2

Ibid 1

4 A case in point was in Texas, between Highland Park, the richest district in Dallas county, and Wilmer-Hutchings its poorest district: Highland Park taxed at $ 0.35 cents per 100 dollars of property tax valuation and spent $ 4,473.00 per student; while Wilmer-Hutchings taxed at $0.15 and only spent $ 3,513.00 per student (Mohler, 1988, P.191) this obvious disparity in the system obligated the Texas Supreme Court to take on the issues to ensure parity. However, the issue that brought the property tax to reform begun with the landmark ruling of Serrano vs. Priest (1971), when the California Supreme Court declared the states public school finance system illegal under the state constitution. This was followed by citizens voting for proposition 13 which decreased the relative importance of the property tax, and transformed it from a local tax to a state wide tax. Proposition 13 was also a contributing factor in the decrease in the overall burden of state and local taxes3. Similar rulings in Texas like, Edgewood II and IIA, Senate Bill 351, and the Robin Hood act all undermined the power of the property tax and the local autonomy by effectively transferring the school finance system to the state. By 2001, citizens had challenged the constitutionality of using property tax to finance education in 43 states. As of 2002, courts in 19 states had declared it illegal to use local property tax as the primary means for paying for schools and had voted control over to the state. From the beginning property tax as a preserve of local government was only a strong financier when America had not formed a Union and each state had absolute rights to its land. However when congress and the federal government
3

Proposition 13: Unintended Effects and Feasible Reforms. National Tax Journal.52:1

5 appropriated extra power to make all laws and override decisions of local governments, localism lost autonomy and independent oversight over revenue matters. So even the exclusive control they had until 1971 was only so because congress had not moved to claim its power over local governments; then the school finance issue came along. The Robin Hood act, Proposition 13 and other related acts turned the property tax from a benefits tax to ability-to-pay tax, meaning that the redistributive effect it created became unacceptable especially for the dominant middle class; because they reasoned that if the courts could dictate how their money from property tax should be spent, then local governments had no power. This meant that they in turn could not influence its use through the ballot, and further more the tax no longer exclusively benefited their neighborhoods so they turned over power of property tax (e.g. proposition 13 and other similar acts) to the state. Moreover most citizens linked the property tax they paid to the benefits accruing to them in their area and they expected to spend the money on schools where they children went and not to all schools in the state where they did not benefit anything. Fischel (1989) agrees that once the property tax was no longer a means for of financing education, local public support for the tax declined because many citizens reasoned that they no longer had control over the use of their tax through local vote moreover, benefits were now widely distributed hence creating free riders from less affluent districts. State centralization of school finance reduced reliance on property tax; and state funding of schools has made it difficult for local governments to raise that tax because of the cap instituted by more powerful

6 jurisdictions of government. Overall the local government no longer could project future incomes or exercise total control of appropriation and disbursement of funds from the property tax. Therefore, whereas Brunori maintains that the property tax is the only means of financing that local government has absolute control and autonomy, its is clear that this is far from the truth . The school finance crisis showed that the courts, the state and the electorate can at will hijack the property tax and dictate what should be done with it and the local government is totally vulnerable to the machinations of these three forces of public control. The amount of money local jurisdictions appropriate from property tax has been reduced and its control has been partly ceded to the state. Hence one can only speculate that if Brunori had meant that property tax put power in the hands of the people as manifested in local government, and then perhaps he has a valid argument; other wise property tax does not fortify localism. 2. Arguments, for and against the taxation of online transactions and e- commerce .Electronic commerce is the paperless exchange of business
information using electronic data interchange (EDI), e-mail, electronic bulletin boards, fax transmissions, and electronic funds transfer. It refers to Internet shopping, online stock and bond transactions, the downloading and selling of soft merchandise (software, documents, graphics, music, etc.), and business-to-business transactions. The concept of e-commerce is all about using the Internet to do business better and faster. It is about giving customers controlled access to your computer systems and letting people serve themselves. The Internets role in business can be compared to that of the telephone. It is a way for people to communicate with each other. It is also a way for a consumer to communicate with a companys computer systems without human intervention. In fact, the Internet is a communication medium like the many others we use in business every day4..

3. Currently, items sold over the internet are not subject to state sales tax unless the seller has a physical nexus in the state in which the purchaser resides. Physical Nexus means a seller must have a physical presence in a state5 Donald and William (2001) estimated that by 1993 losses of sales tax would be up to 24 billion dollars. These decisions were made by the
4 5

www.businesstown.com/internet/ecomm-definition-asp
Public Finance and Management, 4:2

7 Supreme Court proceeding from two cases; National Bella Hess (1965) and Quill (1992); where the court held that; the states enforcement of the use tax against Quill places an unconstitutional burden on interstate commerce. Only congress has the power to regulate commerce among states and thus may authorize state actions to burden interstate commerce. Even if the courts were to be in favor of having states tax e-commerce, there is still a big problem with the complexity of variable tax structures over all states. There are currently about 7,600 sales and use tax jurisdictions in the United States; Sparks Ryan et-al (2004) argues that congress is unlikely to require businesses to files up 7,600 tax returns monthly and will instead require the states to reduce filing requirements if they want to harvest tax from internet sales. The states in turn have started the Streamline Sales Tax Project in 1994 to simplify and modernize sales and use tax collection and administration. Briefly, the goals of the project is specified under seven objectives; i) to have uniform definition within tax laws; ii) rate simplification; iii) instituting state level tax administration and local sales and use tax; iv) uniform sourcing codes ; v) simplified exemption and administration for use and entity based exemptions, vi), uniform audit procedures: and vii) State funding of the system. Further more, the project will provide sellers the opportunity to use one of their three technology models to report sale tax; Model 1 where a certified service provider compensated by states will perform the sellers sales tax functions; Model 2 a certified automated system, to perform only the tax calculation functions, finally Model 3 for large sellers that have developed their own systems. The states believe that through this project they will be able to collect all dues. There have

8 been strong arguments for and against taxing internet sales. However let us first examine the arguments supporting taxation: The first argument is that leaving internet sales untaxed, causes massive losses of revenue to states form uncollected dues. Beth Cox (2001) revealed that a government report in 2001 showed that state and local revenue losses would approach $440 billion in losses between 2001 and 2011 as a result of remote sellers failing to collect sales and use taxes. Some have argued that for some states facing budget deficits the harvest of taxes will be a boon to their economies. In a later article , ( 02/05/2003) the same Beth Cox claimed that a New York based research and consulting firm , Jupiter Research, argued that a sales tax on e-commerce would have no impact at all, so there was no need too be afraid of reduced business over the net as a result over the tax. Further more they pointed that most online shoppers are either unaware of the fact that sales tax can be avoided or do not see it as a cause to choose one retailer over another 6. If anything, one wonders just how much price plays a part on the decision to shop on line; online shopping is more convenience or search for rare items. Statistics from the Jupiter research report found that only 9% of the shoppers make purchase decision based on sales tax*7. This means that a new sales tax if put at an inconspicuous amount may not be noticed. According to Osten (National Conference of State Legislatures), small businesses with a certain amount of revenue say less than $5 million, could be exempt from collecting taxes from

www.internetnews.com/ec-news/article.php/10793_1581061_2. Retrieved 05/10/2005. This web site has a series of excellent articles by Beth Cox on opinions of the private sector on the proposed internet tax.
7

9 states where they have no physical presence. Therefore they need not worry about costs of hiring accountants and filing tax returns. Further more; there are already companies like Barnes & Noble that are collecting taxes from online sales, so this project has support from the private sector as well who have shown that it is possible to collect taxes remotely. Additional support came from unlikely quarters like e-bay; the spokesman for the company (Kevin Pursglove) said that e-bay believes that current tax laws and introduction of tax would not be a problem because most of their sellers on line were already including sales tax8 in their transactions, and no body seems to mind. Most brick-and-mortar stores complain that not taxing the online traders constitutes unfair competition, and coming from the private sector these are the voices that also put pressure on the government to tax online sales to level the playing field. In light of such complaints the Federal government feels obligated to deal with accusations of unfair competition by instituting a tax. E-commerce going untaxed constitutes the biggest opportunity to free ride in the history of American commerce. Though I do not have the backing of empirical economic and statistics models, I believe that in some way the on-line traders cause inefficiency in the market by not compensating for the externalities of internet trade, whatever they maybe9. The online business have alternatively claimed that they do not have an advantage over brick and mortar stores, because they also spend a lot of money
8 9

Ibid 6 How will the government net the tax dues from other continents like Europe and Asia? I did not get the figures of international sales but with globalization, many companies may relocate online businesses to tax havens in Cayman Islands.

10 on shipping and handling costs which customers only pay a fraction; so the question of unfair competition does not arise . This though is a weak argument in favor of not taxing internet sales because it is quite clear that online traders make profit from shipping and handling and the cost is passed on to customers anyway. Secondly, there is a general argument that taxing e-commerce may discourage its use and growth; the White House has commented that whereas it supported the tax, the administration believes that government should be promoting internet usage and availability, not discouraging it with excess taxes and discriminatory taxes.10 This is a view that is further reflected by the on line business owners who echo that the tax will discourage the use of the internet and undermine access and use of internet by less affluent society; hence the tax may cause a dead weight loss. Anti-tax protagonists like Ted Laliotis (1997) claims that by allowing ecommerce to thrive, every one will benefit because of the strong economic growth that it will produce: Jobs will be created, income taxes will grow, consumers will benefit, and local economies will be fueled, thus boosting the well known benefits of stronger real estate prices, and higher sales tax revenues. If electronic commerce is burdened by excessive government regulation and taxation, it could very well be that the opposite result will be achieved. E-commerce companies have for long argued that collecting taxes from thousands of states and local jurisdictions would put an undue hardship on their nascent businesses; furthermore the smaller enterprises claim that even if the Stream Line project takes off, they can barely afford to finance and meet the requirements of collecting sales tax remotely, so they are still not in support of
10

Ibid 6

11 the taxes. On the technical side of it, some have pointed that no software is yet available to help with the project. However this is also a weak argument that can be solved by any software engineers contracted by government. Nevertheless the anti-tax lobby still argues that with all the instruments of the stream lines project in place, the process will still be too complicated and unworkable that no one should even bother with it. Kesarev (1998), makes the argument that e-commerce should be free because where as you can tax physical commodities, it is infeasible to implement viable tax collecting schemes on intellectual property rights like software and music. 11 Kesarev points that it is very easy to smuggle intellectual property using encryption technology ,as a result, customs officials and tax collecting agencies have no possibility of monitoring intellectual property( e.g. consultancies) being traded over the internet. Further more there is the issue of telecommuting and tele-working ; many jobs are carried out over the internet from countries like India, how will taxing jurisdictions handle virtual labor?, it is a known fact so much of the traffic on the internet is more information than physical items. Kesarevs proposal is one that has to be considered seriously and indicates an area of e-commerce that may never be touched. Finally its been said that the internet is still growing , no body knows exactly how far and how complex it will get , so regulating it with sales tax will only discourage innovation as more creative minds are reluctant to explore more use because of perceived declines in profits. In a letter sent to White House advisor Ira Magaziner, the Internet
11

Kiril Kesarev 1998. Tax free internet: Department of Science and Engineering. Helsinki University of Technology. This opinion expounds the problems of internet taxation as well as possible solutions to internet taxation. The discussion is on a general level and does not go into details of jurisdictions internationally.

12 Society, a leading international organization for the technical, economic, and policy development of the Internet, wrote that taxing businesses conducted on the Internet should not be done at this time because it could constrict an industry in its early stages of development. Martin Burack, executive director of the Internet Society wrote: "Governments appear to view electronic commerce on the Internet as a golden goose that will
yield many eggs. We urge all to give the gosling the opportunity to grow to puberty before being asked to give up any gold".

Electronic commerce is at the infancy stage of an explosive growth potential. It is at the infancy stage because industry standards for electronic payment systems, privacy, and security are still in the process of being developed. This is the right time for industry and government to work together towards a situation in accommodating the needs of the industry besides hands off policy on taxation.12 References Bruce Donald & Fox William, 2001 E-commerce in the context of declining state sales tax bases: National Tax Journal. LIII No 4, Part 3 Brunori David. (2003). Local Tax Policy, A Federalist Perspective .Urban Institute Press Washington Dc Kiril Kesarev 1998. Tax free internet, Department of Science and Engineering. Helsinki University of Technology www.tml.hut.fi/studies/Tik-10.300/1998/newtech/taxfree_internet_1.html Sexton Terri, Sheffrin S, & Osullivan A. 1999 Proposition 13: Unintended Effects and Feasible Reforms. National Tax Journal.52:1 Ted Laliotis.1997, www.laliotis.org/cc97.htm. Retrieved 05/11/2005 www.businesstown.com/internet/ecomm-definition-asp Retrieved 05/11/2005
12

www.laliotis.org/cc97.htm

13

www.internetnews.com/ec-news/article.php/10793_1581061_2.Retrieved 05/10/2005 Sparks Ryan, McCoskey, Melanie & Alvis John, 2004 Can Internet Sales Be Taxed? Public Finance and Management, 4:2.