PFM Final

Why move from traditional 3-factor to single sales factor?

- Because it encourages property and employment in the state - incentivizes them to move into the state and stay there - Corporations pay property taxes and sales taxes - way of generating economic activity in the region

Value added tax (VAT)

- A tax on household consumption that is collected at each stage of the production/distribution flow on the value added at that stage. VA by a business = Sales by the Business - Purchases from other businesses - The darling of the tax policy community - used by reforms in Europe - Hated by the Wall Street Journal and other conservative observers because their concern is that the VAT will be such a revenue producer that will allow for an expansion of government. They are worried about the stealth aspect of it (tax is included in the ticket price of the good you see on the shelf) leading to larger government - A marvelous revenue producer (possible a money machine) - Any country hoping to enter the EU must levy a VAT, minimum rate of 15% and subject to the standards of the Sixth Directive - VAT is what drives that OECD countries rely more on consumption tax than US and that US relies more on income tax than they do

Proprietary funds

- Account for a government's business-type activities - Enterprise funds, internal service funds - Examples: Austin Water, municipal utilities, airports (these are entities that can pay for themselves)

Governmental Funds

- Account for a government's operating and financing activities - General fund, specific revenue funds, debt service funds, capital project funds, permanent funds - Examples: Day to day activities, personnel costs, etc.

Fiduciary Funds

- Account for resources held by government but that will benefit parties other than government - Trust funds, agency funds - Examples: pensions

Restricted fund balance

- Amounts constrained for specific purposes as required by legal mandate from others outside government (e.g. bond holders require contingency fund) - Doesn't give ability to absorb financial shock in the future

Committed fund balance

- Amounts constrained for specific purposes unless highest level of decision-making authority in the government decides not to commit resources for said purpose (e.g. rainy day fund) - Does give you some ability to absorb downturns in economy, but requires approval from legislature and governor

Nonspendable fund balance

- Amounts not available to be spent in the next fiscal year (e.g. legal settlements) - Does not provide financial cushion

Assigned fund balance

- Amounts not restricted or committed but which the government intends to use for a specific purpose - authority for assignment does not have to be highest level of decision-making authority in government (e.g. can be finance committee or an official, e.g. internal rainy day fund) - Provides some financial cushion

Types of basis of accounting

- Basis of accounting determines when transactions and events are recognized - Measurement focus determines what is being reported on - which assets and liabilities will be given accounting recognition - cash basis, accrual basis, modified accrual basis

Collection cost (administrative and compliance) - tax principle

- Collection cost is deadweight cost - done because of revenue production and not because of direct value of the service - Objective is not lowest possible cost, but lowest cost subject to the achievement of the desired level and distribution of non-payment - Compliance cost: cost to taxpayer to comply with code - Administrative cost: cost to government agencies of collecting the tax - Data on Collection Costs -- U.S. Income Tax ---- Administrative costs: 40 cents per $100 ---- Compliance: 8-10% of collections (burden is heavy on individual) ---- Most revenue from voluntary compliance --Real Property Tax ---- Administrative costs: around 5% of collections ---- Compliance: approximately zero (some people do challenge their property tax) ---- Collections from direct enforcement: 100%

Credit ratings - rating agencies, users and importance

- Credit quality is very important to local government - Governments are typically rated by Standard and Poor's, Moody's, and Fitch's - Better credit ratings lead to lower interest rates --- Illinois example - they are paying close to 1 billion more in interest because of their credit rating decline after the 2007/8 financial crisis - Debt burden very general rules of thumb - debt should not exceed: --- 10% of assessed value - 15% per capital personal income --- 20% over previous year - 90% authorized by state law - Other important factors in credit quality include: --- Budgetary soundness - tax debt and burden --- Overall economic conditions - flow of funds structure --- Covenants - the government - Municipal bond defaults occur when a city makes known that they simply cannot pay their debt. Drives the credit rating down and the interest rates up and generally makes it much more difficult for a government to borrow money

Municipal bankruptcy possible impacts

- Credit rating downgrade resulting in higher borrowing costs for municipality - May result in higher borrowing costs for state ("contagion effect") - Reputational damage to the community that can impact businesses and family locational decisions - reduces tax base - Workers may see reduced benefits or lose their jobs - Creditors may receive a haircut on their investments - Residents may see higher taxes and reduced services - Expenses - high fees to lawyers, consultants, emergency manager salary, etc. - Empirical research is limited, because not many have happened and those that have are often not generalizable - Credit rating agencies should be tracking financial health before bankruptcy (so how much further would the municipality go down - in theory not much because they would already have a low credit rating) - People don't want to live in a bankrupt city, businesses don't want to be there - Creditors (bond holders, counter-parties on interest rate swaps) will see haircuts on investments - Very expensive to go through the process - especially Detroit ($70 million in costs to go through process) - Credit rating agencies look at the plan to get out of bankruptcy - and that is key to increasing credit rating after the process. Ex. Detroit, they created a good plan that credit rating agencies approved of and as a result, their rating increased

Tax credits

- E.g. earned income, child care, education - A tax credit directly reduces taxes owed - Benefit lower income taxpayers (progressive) - A tax credit typically favors low-income earners - To increase equity, provide tax credits over deductions

Tax deductions

- E.g. student loan interest, medical expenses, mortgage interest - A tax deduction reduces amount of taxable income - May help improve horizontal equity - Benefits higher income earners more (regressive). (ie. the benefit of a deduction is more valuable when it is shielding income that is taxed at a higher rate as is the case for higher income earners)

Evaluate financial condition based on other factors beyond indicator ratios

- Financial numbers in CAFR do not tell the whole story as it relates to a government's financial condition - Demographic factors - Economic conditions - Political and leadership qualities - Social considerations - Expected future population changes - Quality of financial documents (budget and financial statements)

Importance of accounting principles

- Financial statements present what happened to an entity in the past - Different accountants could describe these events differently - Accounting principles: cash basis, accrual, modified accrual (focused on short-term) ---- Can get different results by using each principle - Argument for not using accounting principles - just want the data. Users of financial statements may be indifferent to the way the data is presented as long as they are given adequate information - Accounting principles often have economic consequences ---- The way you present information has consequences about whether fiscal stress is being revealed

Tax increment financing

- Freeze property tax of an area and any property tax increases are put into a special fund - Overarching point is to encourage development in blighted areas - it's an economic development tool - Freezes assessed valuation in a TIF district for a set time period. The frozen assessed value continues to accrue to existing taxing bodies - Increases in assessed value due to economic development go to pay for infrastructure improvements, developer subsidies or repayment of debt to fund infrastructure development - Chicago uses TIFs basically across the entire city - State legislation sets how long TIF can be in existence - Concerns: it can lead to gentrification (a community develops, property taxes increase, and then those low-income families get priced out); it's not transparent (often viewed as a slush fund for mayors. Mayors determine where they will provide development incentives and allows them to drive development where they want); growth is not guaranteed (don't know if development will/will not occur, lots of sensitivities and there isn't a cushion); siphoning off money from schools, library systems, and the city and it's going into a fund for development (those institutions aren't getting the full benefit from property taxes and if the fund works as it is designed to, then would expect to see population increases that would lead to increase spending needs for these same institutions); would this development have occurred but for the incentives (what would have happened if TIF hadn't been put in place, TIF is based on the premise that this development would not have occurred but for the TIF being put in place and it's difficult/nearly impossible to prove that - so you might be giving money to developers that would have developed there anyways); don't have to vote in it, it is technically a revenue bond (this is a way for governments to access debt finance outside of normal public approval process)

General obligation bonds

- Full faith in taxing power of the government - can pull from multiple sources. As an investor you have a claim on all of the resources eligible for debt repayment - Often there are no limitations on the funds that have to be raised to pay for these bonds - Subject to constitutional/statutory limits - Normally require voter approval - GOBs have lower interest rates, except for in Chicago - Appropriate for capital projects benefiting community as a whole

Fund balances

- Fund balance is arguably the most identified number in government accounting. General fund balance (surplus or deficit) - Taxpayers understand that if the government's assets are larger than their liabilities, the government is living within its means - Policymakers understand that if you end a fiscal year with a fund balance, you have more to spend next year - This leads to a fundamental question: Is a government's fund balance too small, too large or just the right size? How do you answer this? --- Rainy day funds: usually 5% of total revenues. If it's too big there is an opportunity cost (you could deploy it for other purposes) --- From the perspective of an investment, the bigger the fund balance the better --- From the perspective of a taxpayer, large fund balance means government isn't spending money on taxpayers --- Balances are invested in short-term securities because government's needs liquidity, but investing in short-term securities mean government gets less return

Statement of Net position - purpose of government-wide financial statement

- Has the government's overall financial position improved or deteriorated. Would determine this by looking at the net assets - How much has it invested in its infrastructure and other capital assets. Determine by looking at value of capital assets - Were its current year revenues sufficient to cover full cost of current year services --- Were the revenues raised in this given year enough to pay for activities/program in the year - How much does it depend on user fees and other exchange like revenues compared to general tax revenues - How does its financial position compare to other similar governments --- Compare to previous year and other governments

Overarching focuses of government-wide financial statements

- Illuminate operational accountability --- OA refers to how efficiently and effectively an organization used its financial resource to advance its mission --- Budget counterpart is program budget - Focus on economic resources --- Long-term resources and long-term commitments (or liabilities)

Economic neutrality (avoid distortion) - tax principle

- Interfere with economic choices emerging from normal market forces as little as possible. Markets are smarter than lawmakers and administrators at resource allocation - Minimize loss of consumer/producer surplus - Taxes distort by creating tax wedges - difference between price as seen by the buyer and price as seen by the seller - Marginal tax rate -- Your incremental decisions are going to be based on the tax rate on that last dollar, which is why we look at MTR for this - What do taxes distort? -- Timing of events: marriage, realization of capital gains, births, deaths, profit repatriations, etc. ----- Capital gains tax increase for 1987,capital gains were realized the year before ----- Preferential treatment for profit repatriation (incentivize people to bring monies back to the US) ----- Births: heavier in last few days of old year than first few days of new year - want tax credit/exemption for child (get it for the whole year even if they are born in the last few days of December) ----- Few marriages in IV quarter relative to I quarter - due to marriage penalty for many couples. Higher taxes paid for being married ----- Deaths: when estate tax rates have changed, death patterns change in ways that reduce the tax -- The most sensitive behavioral response to taxes is not the economic development incentives, it's the timing of things. There is a strong behavioral response in terms of trying to avoid taxes due to tax changes -- How to quantify distortion: deadweight loss

Tax pyramiding

- It is in effect a tax on a tax. Results in a higher effective tax rate on items. - Can be seen in businesses. In the production of goods, businesses are taxed and then when the good is sold the consumer is taxed. In an ideal scenario, the business is not taxed so that the effective tax rate can remain lower. - Incentivizes vertical integration on the part of businesses - a way for them to avoid the tax - Violates transparency because tax on the good advertised to the consumer is lower than the actual tax the consumer is paying

Deadweight loss due to taxation

- It's easier to put a number to this than equity. Have to decide social welfare function (tradeoff between efficiency and equity) - we all have different preferences for right level of redistribution in society. - It is a function of the amount of the tax and the elasticity of demand - Larger taxes have more deadweight loss - Higher elasticity of demand, more deadweight loss ---- Elasticity of demand - the more elastic the demand, the more the price will shift ---- If taxes are placed on elastic goods, it will distort behavior - Ramsey's Rule

Purpose and impact of federal tax exemption on municipal bonds

- Municipal bonds generally not subject to federal income taxation - Primary effect is that interest rates are lower for state and local bonds compared to similar taxable bonds - Tax exemption lowers interest costs because interest that investor gets is not subject to taxation, so they are willing to accept lower rate - Providing the tax exemption lowers interest rate, so cost of projects is less, so you can do more projects. Government providing state and local governments an indirect subsidy (this is a cost to the federal government, but does not mean that state and local governments incur any costs) -- Ex. ---- Marginal tax bracket = 25% ---- Taxable bond = 8% ---- Municipal bond tax exempt = 6% ---- Tax exempt equivalent yield = taxable rate (1-marginal tax bracket)

Strength and weaknesses of financial indicator ratios

- No hard rules of thumb on ratios - Government categorize activities differently which also complicates analysis between entities --- In Chicago public school system is not part of the general government - they are a separate legal entity with separate budgets --- In NY public schools are a part of the general budget --- Therefore, cannot compare the two cities directly - Preference for high or low ratios often are in the eye of the beholder - Level of development of a municipality may necessitate higher or low ratios --- Growing city may have more debt vs. not growing city and have to take that into account when looking at and comparing ratios - Trend and comparative analysis is very important but it is not definitive - it merely often demands further inquiry on the part of the analysis if there are dramatic differences or changes over time

Types of fund balances

- Nonspendable fund balance - Restricted fund balance - Committed fund balance - Assigned fund balance - Unassigned fund balance

VO key fundamental budgeting question

- On what basis do we determine to allocate x dollars to Activity A instead of Activity B? - Is there a framework we can use? Is it political? - Cost benefit analysis, cost effective analysis, etc. try to answer these questions - What is the proper way to allocate resources is the base question

User charges

- Prices charged for voluntary purchased but publicly provided services (e.g. toll roads) - Send price signal to government to determine what to fund - offers conclusive test of demand for service - citizens who do not want service don't have to pay for it - Prevents non-residents from free riding on government service (e.g. toll roads - non-residents contribute to pay for repairs, etc. not just residents) - Creates efficiency as agencies must respond to client demand or agency goes away - Makes people and firms respond to true social cost of action (e.g. toll roads, aware of social cost of driving on them)

Pros of property taxation

- Property wealth is indicator of capacity to bear cost of government that may not be easily captured in other indicators - Provides benefit basis for support of many local government services - you pay the tax and you know the services you are getting for the tax - Source for local fiscal independence - immobile base, administratively feasible for local governments, susceptible of fine rate variation - Not easily evaded or avoided -- Can't avoid it because you own the land and if you avoid it the government will put a lean on the property that you have to pay when you sell it -- Collection cost for government is very low - Closes gaps of affluence accumulations that haven't been taxed by income tax -- Ex. trust fund kid who inherited their wealth - may not have been able to tax income because there wasn't any but can tax property - Visible tax

Payroll taxes

- Taxes on wages and salaries only - Tax revenues earmarked for social insurance programs - Payroll taxes are regressive -- Effective tax rate decreases as the size of the tax base increases -- Marginal tax rate is lower than the effective rate

Ramsey's Rule

- Ramsey formulated the problem of optimal taxation from an efficiency perspective by asking how we can raise a given amount of revenue with the least amount of distortion - Elasticity: The most efficient taxes are placed on goods with least elastic demand (or supply) - so tax necessities - Base: Better to tax a wide variety of goods at a lower rate because deadweight loss increases with the square of the tax rate - Want a tax with a wide base and low rate - Means we shouldn't tax: luxury goods (but this violates ability to pay principle). Can see tradeoff between efficiency and equity - We don't abide by this in many ways (ie. some states don't tax food and others have very small taxes on food)

Evaluate financial condition of a government through calculated indicator ratios

- Ratios mean nothing in isolation - have to compare - Compare to the government itself over time (trend analysis) - Compare to another peer government at one point in time (benchmarking analysis) - Compare to another peer government over time (trend and benchmarking analysis)

Deferrals in fundamental accounting equation

- Recognition of revenues and expenses and they are related to a future period - With 'deferrals', recognition of revenues or expenses are being deferred to a future period to which the inflows and outflows are related

Proportional, progressive, and regressive tax systems

- Regressive: effective tax rate falls as income is higher - Proportional: effective tax rate is constant - Progressive: effective tax rate rises as income is higher

Unassigned fund balance

- Residual amounts not included in other categories - Full financial flexibility

Accrual basis presentation of government activities

- Revenues are recognized when they are earned - Expenses are recognized when liability is incurred

Cash basis presentation of government activities

- Revenues are recognized when they are received - Expenses are recognized when they are paid

Public monopoly

- Revenues received from government from sale of a private or toll good - Primarily utilities, liquor stores, state/local gambling - Justification for utilities •Price setting (to eliminate price gauging) •Subsidize general activities of government (to the extent that you can move monies around) - Justification for liquor stores •Subsidize general activities of government •Control alcohol consumption - Justification for gambling •Voluntary (people chose to gamble, if you don't want to pay the tax then don't gamble) •Social/moral norms allow it to be taxed highly (it's a sin tax) •Limitations of gambling oRelatively modest revenue yield oRevenue expensive to produce - high administration cost oVolatile revenue source year to year oAlthough voluntary it seems spending on gambling represents a regressive burden Ex. slot machines, but may not be as regressive for high value card games where large fund is needed to enter the game oShould government be in the business of promoting suspect values/activities? oLottery revenues are fungible Texas - lottery revenues and education spending No real incremental benefit overtime

User fees

- Sale of licenses that allow the user to engage in some activity (e.g. home construction permit fees, pushcart food vendor fees) - Often more a requirement than a choice - Does not necessarily directly purchase any government services, purchasing right to do something - Reduces burden on general fund but creates silos - these amounts will have to go into a separate fund that can only be used for specific purposes

Municipal bankruptcy facts

- Section 9 governs municipal bankruptcy - Provides court protection from creditors to give governments space and time to work out financial challenges - Courts do not have authority to make policy decisions on spending and revenue - courts approve the plan municipalities create - Happens rarely - less than 700 since 1937 (many of the 700 are small/special taxing districts). But rose to prominence after the financial crisis. Meredith Whitney went on 60 minutes in 2011 and predicted mass defaults of debt of municipalities as result of financial crisis. That never materialized, there were some bankruptcies but not nearly as widespread as predicted

Calculate coefficient of dispersion

- Step 1: calculate assessment ratio = assessed value/market value - Step 2: calculate absolute dispersion = median assessment ratio - assessment ratio - Step 3: sum up absolute values of absolute dispersion - Step 4: divide by the number of properties to obtain average absolute deviation - Step 5: divide by the median assessment ratio to get the CoD - Whether or not the assessment is good is based on the type of community, for an older community can be over 10% but less than 20% and for a newer community with homogeneity want less than 10%

Cons of property taxation

- Tax on stock, not flow - not linked to current income - problems for elderly, farmers on urban fringe - Horizontal equity - poor administration in many jurisdictions and differing preferences for property ownership - Generally low income elasticity of base - needs rate increases to keep up with demand for services (but stable in recessions) -- Because property values aren't always increasing, so have to increase tax in order to keep on having the same revenues - Property tax reduces after tax return for economic development/refurbishment of buildings - particular problem in urban areas where more people are renting and there isn't an incentive to maintain property - Disparity in local government property tax bases - implications for quality of local government services -- Burden is higher on lower income area than higher income area because higher income areas have larger base and can be taxed at a lower ate - Politics: no politician lost an election by running against the property tax - Viewed by some politicians and people as regressive, but among economists it is uncertain if it is regressive

Tax expenditures

- Tax preferences are exclusions, exemptions, and deductions - Expenditures are losses in tax revenues attributable to tax preferences --- Tax expenditures are an alternative to government-financed programs --- Biggest tax expenditures: tax exclusion for employer sponsored health insurance (ie. insurance UT provides to employees is not taxed). It is a loss of ~172.8B --- Other large ones: mortgage interest deductions, state and local tax deductions, credits for kids & other dependents

Excise taxation

- Taxes on narrow class of goods or services - Alcohol, tobacco, motor fuel - Revenues are often earmarked for particular uses, e.g. motor fuels for highway operation and maintenance - Politicians like excises on things that are presumed bad for use - "sin taxes"

Revenue bonds

- Tied to a certain revenue stream associated with a project. Not backed by the full faith and credit of the jurisdiction - Secured revenues of a given project - Credit quality depends on strength of underlying project - Credit quality is normally lower than for GOBs due to limited revenue streams - Usually not limited by constitutional/statutory limits - Usually do not require voter approval - Appropriate when a specific, reliable, predictable, and sufficient revenue stream can be garnered from a project or financing mechanism (ie. parking garages, water systems, airport terminals) Political aspect - Favor revenue bonds because they don't require voter approval - 65-70% of issuances are usually revenue issuances

Benefits of VAT over retail sales tax (RST)

- VAT reduces likelihood of tax evasion - Provides for more exclusion of business purchases from taxation --- Reduces tax pyramiding - which is a tax on a tax (so that price would just keep growing) - Tax evasion at retail stage reduces government revenues only by the tax on the value added at that stage rather than a loss of all tax revenues when taxes are evaded in the RST

Problems with user fees & charges

- Very regressive (related to benefit principle but not ability to pay) - Can be expensive to collect - Can be volatile funding source (low yield) - Creates silo mentality - Not appropriate for many core public services like police and fire protection - often these fees are not legally allowed to fund anything but the service related to the fee --- Ways around it: pay some games (move money around); employees providing the service in the fund create an indirect cost to the whole government for the work done by employees in the fund and so government does a charge back to compensate government for indirect cost (extract resources via charge back so that money can go into the general fund)

Statement of Activities - purpose of government-wide financial statement

- Where does the government's money come from, where it went, and whether its core activities pay for themselves - Whether revenues were enough to pay expenses - Why did net assets change

Excise taxes & the 5 principles of taxation

- Yield - small base, potential revenue is not that big. Sensitivity to changes in economy (revenues have been low on gas tax because people aren't driving as much and there are more fuel efficient cars, electric cars are becoming more popular, and people are driving less). - Equity - they are very regressive (more consumed by lower income people) - Economic neutrality - localities and jurisdictions play against one another (one will raise taxes on the product and the other won't, so people will cross the state border in order to purchase it in the state where the tax is lower). Black markets are also a part of that distortion (when there is too high of a tax, a black market develops and yield is reduced and purchasing and distribution of the product changes) - Collection costs - not large administrative costs, but more than regular consumption cost because have to make sure stores are complying and regulate black market. Compliance cost for consumer is low - Transparency - people don't fully know what the tax is, but still have visibility and open adoption in government

Horizontal equity

- equal treatment of equally situation taxpayers. people who have the same ability to bear the cost of government should have same tax burden - If the quality of the tax assessment is good, then property taxes would be supported by this

Summation or Cost Approach - property assessment

- land and improvements valued separately, improvement value based on cost of reproduction or replacement. Land value based on comparison so similar lots, etc. - Flaws: incentivized to underestimate value of replacement cost, because that will make property value less. Some properties have very unique features to them and coming up with the replacement cost is extremely difficult - if the house went away, could you even replace it?

Accrual basis accounting

- measurement focus all economic resources - Revenues are recognized when they are earned - Expenses are recognized when a liability is incurred - when it receives a good/service - Government-wide financial statements use this basis

Cash basis accounting

- measurement focus cash receipts and disbursements - Revenues are recognized when they are received - Expenses are recognized when they are paid

Modified accrual basis accounting

- measurement focus short-term assets/liabilities - Revenues are recognized when they are earned only if they are collectible soon enough to pay the liability during the current accounting period; otherwise they are recognized when received - Expenses are recognized when payment is due - Fund financial statements use this basis

Vertical equity

- people who have a greater ability to bear the cost of government should pay more - Progressive: effective tax rate rises as income is higher wealthy people consume more services (which aren't taxed), whereas goods are taxed

Income Approach - property assessment

- value as capital asset, discounted flow of return from ownership - Property viewed as capital asset. If this property were to be rented over the next 30 years, how much would you get on a net basis (PV of future cash flows) - Flaws: difficult to calculate

Sales Comparison Approach - property assessment

- value of comparable property that has recently sold (does include the location of the home) - Flaws: for unique houses, there is no comparison house. This approach is market-based, so impacted by financial crisis where values go down. If you live in an area with foreclosures around you, benefits property owner but bad for government because it is valued lower. You may not be able to use this approach - do you truly have a comparison or not

5 tax princples

- yield - equity - economic neutrality - collection cost - transparency

Capital budgeting process

1. Calculate revenue with interest/inflation rate 2. Calculate Fixed and Variable Annual Costs (Capital, O&M) 3. Calculate Annual Net Benefits (Revenue - Costs) 4. PV Benefits (Annual Net Benefits)/(1+discount rate)^yr

Corporate tax apportionment strategies

3- factor formula (average of all three percentages) double weighted (double weight sales and divide by 4) single sales (just whatever the sales is)

Yield - tax principle

Absolute revenue potential and its distribution. Can it produce significant revenues - Rate / revenue cure: accounting and economic relationships - Property tax - wide base Revenue growth - how sensitive is the tax to changes in economy and tax rate - Buoyancy - Elasticity - Ex. cigarette tax (base is small so doesn't do well on yield principle, but are not sensitive to changes because people who smoke now are addicted and not effected by tax changes) - Property tax is not sensitive to changes in the economy - Income tax is more sensitive than sales tax and is especially sensitive Cyclical Response (dealing with revenue instability) - Cyclical stabilization (rainy day) funds - help absorb cyclical changes - Secular stabilization funds - where states have exposure to natural resources (like Texas and Alaska)

Pros & cons of excise taxation

Advantages - Revenue but modest - May correct market for negative externalities, inadequate information in market prices - compensate for damage done that isn't reflected in the price - Quasi-price (benefit basis) - know that motor fuel tax goes to highway - Easy money without major political hassles, tool for shifting burden to non-residents Disadvantages - Modest revenue - Economic distortion - Relatively high collection costs - Equity issues - horizontal and vertical --- Vertical - higher burden on lower income people --- Horizontal - people with the same means, one person buys the item and the other doesn't, there is a different tax burden based on difference in tastes and preferences

Transparency - tax principle

Aspects of Transparency - Important for democratic governance - how can you have a democracy if the public doesn't know how much government services cost and who is paying for them? - Unpopular with most lawmakers - Hidden taxes create the illusion that government services are costless - problem for efficient allocation of resources Dimensions of Transparency - Adoption: open legislative process, political accountability, no automatic increases - Administration: payment on objective and impersonal criteria, not subject to negotiation with tax administration, open and fair appeals process - Can't bribe people - Compliance: tax calculation should not be a mystery - Problem in terms of income tax bc it is complicated - Visibility: amount of tax should not be hidden from the taxpayer

Uses and challenges of financial reporting

Assess financial condition - Assessing financial health of organization Compare actual results of assessment with the budget Determine compliance with appropriate laws, regulations and restrictions on the use of funds -- How do we know what we appropriated actually happened - have to look at financial statements Evaluate efficiency and effectiveness -- Program budget concerned with effectiveness -- Performance budget concerned with efficiency -- Financial statements will allow us to look at budgets and assess them Users of government financial reports -- Governing boards, investors and creditors, taxpayers and citizens, regulatory and oversight agencies, employees and other constituents

Benefit tax principle vs. ability to pay principle

Benefit tax principle: equity standard based on taxpayers' benefits from or usage of the public service Ability to pay: equity standard based on taxpayers' capabilities to bear the burden - Measure through: income, consumption, wealth, current or permanent income - Comprehensive measure looks at net wealth as well because both income and wealth figure into an individual's affluence Approach is based on philosophical and pragmatic ideals. Individuals will pay for a public service if and only if they benefit from it, and those who receive more benefits will pay more than those who benefit less.

Challenges to the corporate income tax

Don't really know who bears the burden of it Tax fairness -- Double taxation - corporate level and income level when dividends is taxed Corporate income tax effect on savings/investment -- Double taxation of dividends reduces rate of savings Corporate income tax effect on capital structure -- In financing a firm, executives are incentivized to use debt in their capital structure because you can deduct interest expense from corporation taxable income -- This is a problem because with loans and debt, if you default you get sued, whereas with equity you just don't pay dividends if you don't have it -- This increases risk to firm, potential to overleverage yourself and make finances more fragile -- Example of economic distortion - corporations changing what they do because of corporate income tax

Property tax relief mechanisms

Exemptions or Credits for Owner-Types (e.g., elderly homeowner, if it is your primary residence) - It reduces the tax bill for the person and it shifts the burden to businesses and people who own properties that they don't reside at Rate classification - Different rates depending on residential vs. commercial - Commercial properties have a higher rate than residential properties, because we want to move tax burden away from residents and onto businesses Controls on Assessment, Rates, Levies - Property tax cap - in Texas 3.5% cap on levy (the tax revenue) - Can control the growth in assessments (assessed value can only grow by a certain amount) and can control the growth in rates (property tax rates can only grow by a certain amount per year), levies (the total property tax revenues in a city cannot grow by more than a certain percentage per year) - Assessment cap is not effective because you could just raise rates - Cap on rates, can just get more aggressive on assessments - Texas was smart by focusing on a cap on levies Circuit Breakers - To protect lower income people that have high property tax bills relative to their income. It reduces property tax bill to make it less burdensome Deferrals - Defer the amount that the individual can't pay until they are able to pay it or until they sell the house. Alternative option to foreclosure, allows person to hold onto the property and defer the property tax payment into the future All of these are just ways to reduce someone's property tax bill - does not eliminate it

Debt purposes and uses

Federal and state and local governments use debt for different purposes -- Federal - covering operating deficits. Revenues that feds can realize each year have been lower than expenditures. Sell treasury securities to cover that gap. That is the main type of debt for federal government -- Municipal - much of the purpose is to finance capital projects. Use municipal securities. Cover operating deficits (mainly federal but sometimes state/local) Finance capital projects (state/local) Cover short term cash flow deficiencies within a given fiscal year (federal, state and local) -- Because revenues come in around march, April, May period. But service continuity has to be provided throughout the year. Use debt to cover that period until revenue from tax sources come in

Calculate gross receipts tax (GRT)

First line for cost of business inputs is 0. Each line after that = sales price to next firm + GRT Value added - information is given Sales price to the next firm = cost of business inputs + value added Gross receipts tax = % of sales price ETR = sum of GTR / sum of value added

Calculate value added tax (VAT)

First line of cost of business inputs is 0. Each line after that it is sales price to the next firm amount Value added - information is given Sales price to the next firm = cost of business inputs + value added Value added tax = % of sales price to the next firm VAT remitted to government = % of value added VAT retained and reimbursed to firm = value added tax - VAT remitted to government ETR = sum of VAT remitted to government / sum of value added

Equity - tax principle

Fundamental Principle - Benefits received: pay for what you value or pay for what you receive ---- ie. pay for a toll, get a benefit from it; property tax (get police, fire, education, and infrastructure) - Ability: pay for what you can afford or a person's tax bill should be in relation to their ability to bear the cost of government Questions for Ability to Pay - Measuring Ability: income, consumption, wealth, current or permanent income - Distributional Patterns: horizontal, vertical - Identifying burden: who pays? --- Impact (or legal incidence) may not be same as economic incidence --- Legal burden (statutory incidence) v. economic burden (economic incidence) ------- Example where they can differ: corporate income tax (incidence of the tax - it can be borne by four entities: shareholders, producers/suppliers, laborers, consumers) --- Impact -> shifting -> incidence ------- Corporate income tax (incidence of the tax - it can be borne by four entities: shareholders, producers/suppliers, laborers, consumers) --- Incidence on persons in their role as ------ Consumers ------ Producers (entrepreneurs) ------ Factor suppliers (land, labor, capital, natural resources)

Types of debt

General obligation -- Full faith in taxing power of the government - can pull from multiple sources. As an investor you have a claim on all of the resources eligible for debt repayment -- GOBs have lower interest rates, except for in Chicago Revenue -- Tied to a certain revenue stream associated with a project

Deferred outflow of resources example

Government pays property insurance on its buildings for the current fiscal year in the amount of $1 million, impact on net position is: - -$1M + $0 - $0 - $0 = -$1M in revenue Government pays property insurance that is for the next fiscal year but makes $1 million in payment in the current fiscal year (ie. it pre-pays its insurance), impact on net position is: - -$1M + $1M - $0 - $0 = $0 in revenue When the next fiscal year begins, the impact on net position is: - $0 - $1M - $0 + $0 = -$1M in revenue

Deferred inflow of resources example

Government receives property tax payments for the current fiscal in the amount of $1 million, impact on net position is: - Assets + deferred outflows - liabilities - deferred inflows = net position - $1M + $0 - $0 = $1M in revenue - No deferred inflows or outflows Government send out property tax bills that are for the next fiscal year but receive $1 million in payments in the current fiscal year, impact on net position is: - $1M + $0 - $0 - $1M = $0 in revenue - If we didn't do this, we would be skewing our financial position because that million is for services in the future and not right now when the payment is received When the next fiscal year begins, the impact on net position is: - $0 + $0 - $0 + $1M = $1M in revenue - Recognize that 1 million in revenue because we are in the next fiscal year

VAT versus gross receipts tax (GRT)

Gross receipts tax - Tax gets levied and firms don't reimburse themselves, they just levy it to the next buyer by selling it at a higher rate - Government can realize more revenue through this tax - The effective tax rate is much higher - Problem: consumer is still paying for the majority of the tax, but now it's higher; transparency issue (ETR is higher than stated tax rate); regressivity with it being a consumption tax; yield is high; economic distortion (this tax incentivizes people to keep everything in house - vertical integration, so that they don't have to buy from outside the firm and therefore don't have to pay the tax. This results in small businesses closing. Also incentives people to purchase inputs from states that do not have this tax structure)

Benefits to moving from an income tax system to a consumption tax system

Increase economic growth: the switch will reduce the difference between pre and post-tax return to saving that encourages taxpayers to consume rather than to save, so saving will be encouraged by the change and the growth path of the economy may move upward. Future consumption (or saving) is not penalized in comparison with current consumption Improve fundamental equity: Consumption is a more fundamentally equitable way for sharing the cost of government than annual income. Each individual measures their own tax capacity when they decide on what they will purchase. Therefore, a tax based on consumption rates each individual's spending capacity according to their own yardstick. Can use value added tax (VAT) or retail sales tax (RST) to collect consumption tax Large potential yield Extract tax revenues from people who have evaded income taxes or who have inherited wealth Sales taxes can take into account negative externalities/act as charges for government services - ex. vice taxes (cigarette and alcohol tax - negative externalities associated with those products, so tax product to change behavior or fund programs that address them) Satisfies notion that you should be taxed on what you extract from economy (consumption) rather than what you add to the economy (income) Encourages savings visa vie an income tax - Savings is important because the more savings we have the more loanable funds we have and larger supply means interest rates will be lower - Having capital sourced by savings is important

Granof financial ratios

Indicator 1: total revenues / by population (enrollment) -- High ratios are favorable. Suggests the entity has adequate annual resources Indicator 2: total general fund revenues from own sources / total general fund revenues -- High ratios are favorable. Suggests the entity is not reliant on external governmental organizations Indicator 3: general fund sources from other funds / total general fund sources -- Low ratios are favorable. Suggests the entity does not have to rely on operating transfers to finance general government operations Indicator 4: operating expenditures / total expenditures -- Low ratios are favorable. Suggests the infrastructure is being maintained adequately Indicator 5: total revenues / total expenditures -- High ratios are favorable. Suggests the city experienced a positive interperiod equity Indicator 6: unreserved general fund balance / total general fund revenues -- High ratios are favorable. Suggests the presence of resources that can be used to overcome a temporary revenues shortfall Indicator 7: total general fund cash & investments / total general fund liabilities -- High ratios are favorable. Suggest sufficient cash by which to pay short-term obligations Indicator 8: total general fund liabilities / total general fund revenues -- Low ratios are favorable. Suggests short-term obligations can be easily serviced by the normal flow of annual revenues Indicator 9: direct long-term debt / population (enrollment) -- Low ratios are favorable. Suggests the entity has the ability to repay its general long-term debt Indicator 10: debt service / total revenues -- Low ratios are favorable. Suggests the entity is able to pay its debt service requirements when due

Calculate present value of incremental revenues under TIF

Info needed: property tax base pre-TIF, growth in tax base, property tax rate pre-TIF, tax rate annual increase (for inflation), discount rate Line for year Line for tax base (year 1 already includes the initial growth in tax base. Each subsequent year is percentage growth based on the previous year) Line for frozen base = property tax base pre-TIF Line for property tax rate Line for total property taxes = tax base * property tax rate Line for total property taxes for frozen base = frozen base * property tax rate Line for incremental property taxes = total property taxes - total property taxes for frozen base Line for PV of incremental property taxes (using discount rate) Sum up the PV of incremental property taxes to get PV of incremental property tax revenues

Maximum bond size given a financial plan

Info needed: revenues & revenue growth rate, O&M cost and growth rate, debt service coverage factor, interest rate on bonds Line for years Line for revenues Line for O&M Line below for net revenues = revenues - O&M cost Line for revenues available for debt service = net revenues / debt service coverage factor Line for PAY-GO revenues = net revenues - revenues available for debt service Line for PV of revenues available for debt service (calculate PV using interest rate on bonds) Line for PV of PAY-GO revenues (calculate PV using interest rate on bonds) Maximum bond size = PV of revenues available for debt service Total PV of revenues = maximum bond size + PV of PAY-GO

Issues with consumption tax systems

Regressivity: percent of income spent on consumption declines as income is greater, so tax burden as percent of income falls as income is higher - If income is seen as the appropriate index of tax capacity, the tax is regressive - Pattern applies for both general consumption taxes and for most specific excises - It is very regressive for excise taxes (cigarette, alcohol, and gaming) - low income people purchase those products and engage in those activities at a much higher rate than high income people -- From a political marketing perspective, excise taxes are popular

Municipal bankruptcy issues

Which creditors get priority? - Bond holders or pensioners How much is the haircut for each creditor? - They are not going to be equal - Detroit - pensioners got priority, they got more than investors did Impact on access to capital markets after bankruptcy? - Detroit had a lot of capital needs, can you get money from lenders in the future? Post-bankruptcy plan? - Economic development plan? What to do in terms of services? - Can't just buy more time, have to have a good plan

Application of 5 tax principles to a specific tax: Warren Wealth Tax

Yield Principle - ability to produce stable revenue & significant amount of revenue - Concern is that revenue will be less than anticipated (European countries tried it and ended tax) - Net worth can fluctuate - some sensitivities with value of assets (ie. valuation of smaller businesses) - Estimated amount of revenues $200B over 10 years (federal budget is $4 trillion) - which is a relatively small amount - Potential is also limited because it will impact 70,000 people Equity Principle - Vertical equity - relatively strong (taxing people that can afford it). Will make tax code more progressive - Horizontal equity - may not be supported (people can game the system with assets that are harder to value) - Double taxation - taxing assets that are already taxed - Tax incidence - wealthy people will deploy less of their capital (business might grow less quickly, job growth might not grow as quickly). Economic burden might not only fall on the wealthy individuals, others might be impacted - In sum, biggest gold star is on equity. - Social welfare function - tradeoff of equity and efficiency. Does really well when priority is equity Economic Impact - Distorts economic decision making and behavior - could reduce entrepreneurship (b/c of economic burden issue in equity principle) Collection & Administration Cost - Tax accountants - costs to allow us to comply with tax code (no new products, no advancements made in economy). More problematic here because wealthy people will rely more on tax accountants - Will make compliance costs increase because wealthy people will have to value everything - Administrative costs will increase - will have to hire to agents to make sure people are actually complying - All of these costs are deadweight costs Transparency - open legislative process, accountability, tax calculation isn't a mystery - Pretty transparent - We have an open legislative process, IRS for administration and they are objective, tax calculation will be challenging but not a mystery, amount of tax will not be hidden from taxpayer Strong on equity and transparency Yield, economic impacts, and collection costs are where there are more issues

Ab

assessed value of property in higher class rate - often commerical

Aa

assessed value of property in lowest rate class - often residential

Appraised value - property tax

market value of property

Assessed value

market value of property multiple by assessment ratio

Wb

multiple of lowest class rate that higher class rate will bear

Assessment ratio - property tax

percentage of market value that is assessed for property tax purposes

E

planned government expenditure

T

planned non-property tax revenue

Economic tax incidence

refers to who actually bears the burden of a tax in terms of paying higher prices or receiving lower prices

Statutory (legal) tax incidence

refers to who is legally obligated to pay the tax

Effective property tax rate

statutory tax rate adjusted for assessment ratio

Rb

statutory tax rate for property facing higher tax rate - often commercial

Ra

statutory tax rate for property facing lowest rate - usually residential

Statutory property tax rate

tax rate applied to property to determine tax liability

Tax wedge

the difference between what consumers pay and what producers receive from a transaction in broad terms, the tax wedge is any difference between pre and post-tax returns to an activity caused by taxes

Property assessment approaches

valuation is done on mass appraisal basis but uses techniques similar to single property appraisal three approaches to valuation: summation or cost approach, income approach, and sales comparison Appeals are necessary - Property assessment is an administrative opinion - Need open and unbiased process for appeal, because people have different opinions - Requires transparent basis for assessment, clear standard for evaluation of the fairness of the assessment, open procedure for challenging the assessment