Chapter 5 Taxation Issues

Chapter 5 Taxation Issues

Education is a State Responsibility Requiring Public Funds (TAXES)

• Taxes are a means to redistribute wealth

• Shift $$$ from wealthier to poorer communities

• Promote equity of educational opportunities

• Spread financial burden over as large a group as possible

• Prevent poverty, ignorance, & civil unrest

Taxes Share Financial Burden of Supporting Education

Dispersing education’s tax burden over the entire state allows smaller, remote, or economically disadvantaged localities with little internal capacity to pay for quality education to provide one.

Taxes for Schools Benefit the Entire State

The entire state benefits economically from an educated population:Higher income tax revenues Higher discretionary spendingHigher charitable contributions Lower public assistance costs Lower incarceration rates

T axes H e lp Loca litiesIf a loca l econom ic dow n tu rn occu rs, the bu rden can be spread over the en tire s ta te ; no t bo rne on ly in a re la tive ly sm a ll a rea . Fo r exam p le , if a loca lity ’s la rgest em p loye r, a tex tile p lan t, c loses , loca l ch ild ren can s till rece ive a s trong educa tion .

T a x e s f o r E d u c a t i o n

I t s e e m s l o g i c a l , t h e r e f o r e , t h a t a l l i n t h e s t a t e c o n t r i b u t e t o w a r d s e d u c a t i o n , n o t j u s t t h e p e o p l e i n a l o c a l i t y .

Education Funding Invites Critics

In spite of these facts, education funding issues always invite strong advocates and critics with competing agendas.

Competition for Education Dollars

• Taxpayers want lower taxes

• Agencies’ agendas

• Parental choice• Tuition tax credits• School vouchers

Public $$$ Public Scrutiny Most people believe

that the correct taxation level is somewhat less than what they currently pay, & the level of service they want is somewhat higher than currently exists.

The More You Understand About School Finance…

The better you can explain to your parents & community WHY they need to support public education with their tax dollars.

Schools & Finance• Schools do not

operate as a “for-profit” company designed to generate dividends & increase stock prices for shareholders, such as IBM

• They are not a professional “fee for service” organization like a dentist’s practice

Schools Are a Public Service

Schools are a public service on a scope & scale unlike anything else in our society.

Paying for Education

Public schools are no longer funded by user fees or tuition

In fact, the United States Supreme Court has repeatedly indicated that public education must be free of tuition

Education services are not sold to consumers based on price points derived by economists.

A Tax Primer The purpose of a tax is to pay for a

government function A tax should be equalized –

The government should have a formal mechanism to calculate a lower cost to those who can least afford the service & have a higher cost to those who can most afford the service.

Taxes = Operating Revenue In a public service ‘company’ like

education, taxes are the operating revenue.

School Finance Issues

Understanding school finance vocabulary & concepts is the first step in understanding school finance issues.

Understanding Tax Terms That Underlie School Funding

Issues • Tax Equalization• “Floor of

Services”• Property Taxes

– Historical View

•Tax Categories –

–Stock of Wealth–Flow of Production

•Capacity & Effort•Equity v. Equality

Understanding Tax Terms That Underlie School Funding

Issues, cont.

Stock of Wealth

Flow ofProduction

In Rem

Ad Valorum

TAXES ON:

In Personam

Ad ValorumTax Structures: Proportional Regressive Progressive

Understanding Tax Terms That Underlie School Funding

Issues, cont.Tax Revenue Sources:

– Property– Income– Sales– Lotteries– Severance– Corporate– Sumptuary

Tax Equalization Tax equalization tends

to make the most needed services more affordable to those who are least able to pay

Taxes have the effect of redistributing wealth – at the local, state, or federal levels.

This equalization tends to level the playing field as we invest in human capital

Taxes Should be Spread Out As Much As Possible

• A federal service -- defense -- should be spread out over the entire country

• A state service-- education -- should be extended over the entire state

• A local service -- a city or county park -- should be distributed over the entire locality

Legal & Moral Reasons Require Equalization of Funds Dispersing education’s tax bill over the

entire state allows smaller, remote, or economically-disadvantaged localities with little local wealth to provide a quality education for its citizens.

People Don’t Want to Give $$$$ Away, but…

Our country holds a moral & legislative imperative that wealth must be redistributed, in part, to promote equity of educational opportunity and democratic citizenship.

Without this ResourceReallocation, poverty & ignorance would spiral downward, reaching a critical mass that would ultimately restructure our society to a lower standard of living & general well-being, increase deprivation, & foment civil unrest.

Taxation Supports U.S. Freedoms & Lifestyles

Taxation perpetuates our democratic government, permits our comfortable lifestyles to continue, & allows all educated individuals – regardless of race, ethnicity, gender, age, or creed – to participate in

“the good life.”

Paying for the “Floor of Services”

• The tax burden must be spread over as large a group as possible

• Each state has established a minimum “floor of educational services” that localities must provide

• With the No Child Left Behind Legislation of 2001, the federal government is “ratcheting up” the floor level of services

Equalizing Wealth Lets All Meet the Standard

• Wealthy localities may have no problem meeting these standards

• Poor localities may be unable to meet the required levels of increasing progress

• The state, therefore, has a legal responsibility to help redistribute monies – or equalize funding – to help less wealthy localities meet these educational benchmarks

Property TaxesIn the U.S., states rely primarily on property tax revenues for the majority of their income to operate schools.

Brief History of Property Taxes Funding Public Schools Massachusetts Law

of 1647, “Ye Olde Deluder, Satan Act”

Property owners’ taxes were used to hire a teacher in towns of 100

The community’s sons & servants could be educated

Property was Taxed Because It was How Most People Earned Their Living

• A farmer made his living from the land • A merchant earned money from goods sold on his

property• A carpenter sold furniture made in a workshop on his

property

Not All These Transactions Were Cash Sales

Many items were bartered or tradedas a money substitute.

Property Taxes Were a Realistic Proxy for Measuring

Income

It was logical, then, for government to tax property because that property was the basis for making one’s income.

Today’s Property is NOT a Source of Wealth

Today, for many of us, our homes represent more of a revenue drain than a revenue source …

a stock – rather than a flow – of accumulated wealth.  

Two Tax Categories Taxes levied on the

flow of production or services, i.e.

Personal income taxes Corporate income

taxes Retail sales taxes

Taxes levied on the stock of wealth:

This wealth has ceased to move in the flow of production

It has become an asset of the individual or the company

Taxes Levied on the Stock of Wealth

Property, as measured in our home valuation, is therefore a stock of wealth.

Taxing property is taxing an individual’s or company’s portion of wealth.

Ad Valorum Tax

“Ad Valorum” means a portion of the value.

Property taxes are known today as an ad valorum tax because a portion of the assessed value of the home is taxed to support a service.

In Rem Taxes• In rem taxes

include those that are imposed on “things” such as machinery, cars, and houses

• These taxes are based on the value of the “thing” being assessed

• In rem taxes do not consider whether an individual owns the “thing” free & clear or whether the “thing” is bought entirely on credit

In Rem Taxes - DISadvantage• Individuals may pay

taxes on items they do not really own & cannot claim as an asset

• While they “have” the taxable item, the item may not actually be theirs – the bank may hold the title

• .

In Personam Taxes are Imposed on People

• The best example of in personam taxes are those imposed on people’s earned income

• Personal income determines the amount of tax to be paid

If you have

$100,000 salary, you are WORTH $100,000 of tangible value ---

In Rem vs. In Personam TaxesIn Rem Taxes –• $100,000 house• 0 (zero) assets• $100,000 liability• 0 (zero) net

worth• This is NOT a

realistic indicators of your wealth

In Personam Taxes –

• $100,000 income

• $100,000 net worth

• This is a better indicator of your wealth

Funding Education Each of these types of taxes is used to generate funding for public services such as education. It is important for educators to know what types of taxes support their funding & what taxes are more generally favored by the public. The different types of taxes can have different effects on taxpayers.

Tax Structures

• Under the proportional taxes, each income group has the same percentage rate of tax to pay – 10%

• In the regressive tax structure, the lower income individuals pay a greater percentage of their income in taxes than do the upper income individuals

• In the progressive scenario, the lower income individuals pay a lower percentage of their income than do the upper income. As income increases, so does the percentage of taxes paid

Proportional Taxes A proportional

tax requires the same percentage from each person’s income

A sales tax is an example

This tax affects the less wealthy persons more heavily than it does the richer ones

The amount taxed on any item is the same dollar amount for each, but it represents a larger share of the less well-off person’s financial resources 4.5%

Sales Tax

Proportional Sales Taxes can be Regressive on Individuals

Poorer people tend to spend a greater %age of their income on basic living cost items –– Food, Clothing– Shelter, Transportation…

in contrast to those at the higher income levels.

Proportional Sales Taxes, cont.

The spending habits of two families with incomes of $50,000 and $75,000 may differ significantly.The basic necessities of life – bread, milk, and butter, for example – differ little in quantity purchased by a family of four at these income levels.

Example: Proportional Tax -- Regressive Effect

• Groceries for a family of 4 (2 teenagers) might cost $200/week • A sales tax of 4.5% would be $9/wk• Over 1 year, the sales tax on groceries

would total $468• For a family with an income of

$100,000/yr. = .468% of income • For the same family (same eating

habits) earning $50,000/yr., sales tax on groceries = .936% of income

Proportional Sales Taxes Tax the Wealthier, Less

The family with the higher income level spends a lower percentage on the sales tax related to these items.

But Proportional Sales Taxes Tax The Less Wealthy, More

The family with the lower income level spends a higher percentage on the sales tax related to these items.

Regressive Taxes

A regressive tax requires those with higher incomes pay lower percentages of their income.

Social security taxation system

At the beginning income levels all individuals pay 7.65% of their income in FICA tax

FICA taxes are not collected after one’s income reaches $68,400

Regressive Taxes, cont. FICA* is a

regressive tax. An individual earning

$68,400 would pay $5,232.60 each year in FICA taxes.

An individual earning twice that rate, or $136,800, would pay the same FICA tax amount or 3.825% -

1/2 the % of income that the $68,400 earner would pay!!

*FICA - Federal Insurance Contributions Act

Progressive Taxes

Progressive taxes are those that increase as a percentage along with income

Federal income taxes are designed to be progressive

Tax Brackets – 2002 Taxable Income

$0–$12,000 $0–$6,000 10.0%

12,000–46,700 6,000–27,950 15.0

46,700–112,850 27,950–67,700 27.0

112,850–171,950 67,700–141,250 30.0

171,950–307,050 141,250–307,050 35.0

307,050 and up 307,050 and up 38.6

Joint Return Single Taxpayer Rate

Individual Taxes Paid Taxes as a Income % of Income

Proportional Taxes1 $10,000 $1,000 10%2 $50,000 $5,000 10%3 $100,000 $10,000 10%

Regressive Taxes1 $10,000 $500 5%2 $50,000 $2,000 4%3 $100,000 $3,000 3%

Progressive Taxes1 $10,000 $300 3%2 $50,000 $2,000 4%3 $100,000 $5,000 5%

Illustration: Proportional, Regressive, & Progressive Taxes

Examples of the 3 Tax Classifications

“Good” taxes

are generally considered to be

progressive

while “Bad” taxes

are considered to be

regressive.

Property Taxes

• Property taxes are the primary source of revenue for financing education

• This tax would be referred to as an ad valorum tax because it taxes a portion or a percentage of the property’s value

• “Mills” are the tax rate on a certain portion of the assessed value of a home

Property Taxes, cont.

• Property taxes are supposed to be proportional

• but have the effect of being regressive

Property is Taxed in Mills• Property taxes are

frequently expressed in terms of mills

• A mill is 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:

Rate = Amount of Tax Revenue to be Raised Tax Base or Property Value

Taxing in Mills  According to this formula, if there is a

total value of $500,000,000 of real estate in a locality and $5,000,000 in taxes needed to be raised for services, the formula would look like this:

$5,000,000 $500,000,000 = 1.0 % or 10 mills

Mills Are the Tax Rate on a Portion of a Home’s Value

Most frequently, the tax rate is expressed as a dollar figure based on 100% of the assessed home’s value

For example, the tax rate may be $1.50 per each $100 of home’s assessed value

Property Taxes Have a Down Side

1. Property taxes are seen as a threat to the American Dream of home ownership

2. Taxing a home’s value is taxing unrealized profits – the owner would have to sell the home to get the assessed monetary value versus the price that was paid. It is a “paper profit” until the home is sold

Property Taxes are Costly to Administer

• 1st, locality needs a system to inventory all the locality’s property

• 2nd, personnel must make periodic physical assessments of the property

• 3rd, locality needs a system of appeals for contesting valuation

• 4th, tax bills must be sent out & collected

• 5th, locality needs a system to collect delinquent taxes

Fair Market Value is Difficult to Calculate

• Realtors use a comprehensive market analysis to determine a home’s correct selling price

• A 3 bedroom, 2 bath brick rancher on a 1/2 acre lot on one side of town may have a greater value than the same house on another side of town or in another neighborhood

• Comparing assessments generally brings confusion & anger

Property Taxes Per Capita, 2002, Selected States

State Property Tax RankPer Capita

Alabama $ 273 50California $ 767 31Virginia $ 838 24Illinois $1,163 10New York $1,361 4New Jersey $1,761 1

Property Taxes Incite Public Interest

• Since the majority of property taxes support schools, it is logical for the taxpayers to voice their frustration over tax bills with the schools

Tax “Capacity” - Introduction• “Capacity” is the ability to pay for goods and services• There are approximately 15,000 school systems in the United States • The variance in each community’s wealth is great • The wealth or tax base behind each of these

school systems to finance the educational program is known as fiscal capacity

Personal Income is a Better Measure of Wealth

For example, an income of $100,000 per year is a better measure of wealth than a home of the same value

The home may or may not have a mortgage. In some cases, individuals finance 100% of their home through a mortgage

They have accumulated no net worth in their home – it is an unrealized asset – a paper profit not to be realized until it is sold

“Capacity”: Contributors to an Area’s Wealth

Personal income Real estate taxes Sales taxes Corporate income

taxes Lotteries & other gambling Other revenues

“Capacity”: Contributors to an Area’s Wealth, cont.

Capacity & cost of living vary from locality to locality, state to state, region to region & nation to nation.

Fiscal “Effort” – Introduction• Fiscal “effort”

means putting your money where you say your priorities are

• A state or locality can have a great deal of capacity to fund education and may elect not to do so

• On the other hand, a state or locality can have limited capacity and apportion a great deal of effort into funding education

Factors Influencing “Effort” Many factors

determine the level of fiscal effort the public is willing to provide for education

History of effort, attitudes toward taxes

The overall taxation structure The percentage of students

attending public versus private schools in the area

The percentage of the population with school-aged children or grandchildren in the area

“Effort”• “Effort” may be

defined as the level to which a governmental entity uses its capacity to support public education.

• A simple formula for determining fiscal effort is:

Fiscal Effort =

Revenue Collected for Education Overall Tax Base

(Capacity)

“Effort” Equalizes for Capacity When Comparing Expenses

• It would be unfair to compare a locality, state, or nation with others by education expenditures, alone & draw conclusions except how wealthy a locality, state or nation is • Effort is a vehicle to determine how much of a priority education is within some jurisdiction

Equity – An Introduction• Equity has been at

the core of school finance reform efforts & court decisions since 1976’s Serrano v. Priest decision from the California Supreme Court

• Basically, the court found that while California’s system for financing education did tend to equalize funding among the school districts, the system also generated revenue proportional to the wealth of the school and the school district. Such funding violated the idea of equity.

Equity v. Equality• Equity can be defined as a fairness

issue both for students and for taxpayers

• Equity should not be confused with equality

• Equity is providing for what students need while equality is providing the same for all students

An Equity Scenario• Two relatively similar

school systems have roughly the same level of capacity to fund education & the same number of students, about 10,000

• Both receive about the same funding from the locality and the state

• Both school systems draw from upper middle class neighborhoods

School System A

School System B

An Equity Scenario, cont.School System B

School System A

10% of its students identified as eligible to receive special education services.

20% of its students eligible to receive special education services .

Equality – OK financing to meet needs of these 2 schools systemsEquity – NOT OK. School System B’s students’ needs are greater than School System A’s. School System B must spend more funds to meet the identified special education population’s needs than does School System A.

Income Taxes – 2nd Major Source of State Income

State Per Capita Rank Personal Income, 2000

Mississippi $ 20,856 50S.Carolina $ 23,952 40Vermont $ 26,904 30Illinois $ 31,842 10California $ 32,225 8New York $ 34,502 4Connecticut $ 40,870 1

U.S. Income Taxes – Single Taxpayer

If Taxpayer Income is: Tax Rate is:Between But Not More Than$ 0. $6000. 10%$ 6000. $26,250. 15%$ 26,250. $63,550. 27%$ 63,550. $132,600. 30%$132,600. $288,350. 35%$288,350. ------ 38.6%

U.S. Income Taxes – Joint/Married Taxpayer

If Taxpayer Income is: Tax Rate is:Between But Not More Than$ 0. $12,000. 10%$ 12,000. $43,850. 15%$ 43,850. $105,950. 27%$105,950. $161,450. 30%$161,450. $288,350. 35%$288,350. ------ 38.6%

Sales Taxes Sales tax revenues (from all sources,

not just retail sales) generated approximately $290,993,000,000 in the United States in 1999 Gasoline Utilities Telephone 911 services Other

Lotteries & Legal Gambling Government-

sponsored lotteries are a legal form of gambling

Sells chances to win a prize

When a government sponsors a lottery, it may be considered a voluntary tax

Lotteries & Gambling: Revenue Sources for Education

When a lottery winner claims the prize, the state and federal governments collect income taxes

Lotteries & Legal Gambling• Legal gambling in the United States

grossed more than $50 billion in 2000 • That amounts to $180 for every man,

woman, & child in the country

Legal Gambling Revenue by State, 2000

State Gross Revenue $ Per Capita Rank(in millions) Revenue

Oklahoma $ 62 $ 18 40Rhode Island $ 298 $ 285 30California $ 2,629 $ 78 6Illinois $ 2,680 $ 216 5New York $ 2,739 $ 144 3New Jersey $ 5,451 $ 648 2Nevada $ 9,632 $ 4820 1

Severance Taxes• The Department of

Commerce defines it as “taxes imposed distinctively on removal of natural products – e.g. oil, gas, other minerals, timber, fish, etc. – from land or water and measured by value or quantity of products removed or sold”.

Severance Taxes, cont.• This tax is quite lucrative

for some states, but overall, accounts for less than 1% of all states’ revenue

• Some states collect no revenue from severance sources while others collect a substantial amount of taxes

Per Capita Severance Tax Revenue for Selected States

State Per Capita Revenue RankAlaska $ 856.33 1Wyoming $ 604.76 2New Mexico$ 244.71 3

Indiana $ .09 48Illinois $ .02 49Missouri $ .01 50

Corporate Taxes• The corporate income tax began at the

federal level in 1909• Congress levied it as an excise tax for

the privilege of doing corporate business

• Corporate income taxes once generated approximately 1/4th of all federal revenue. Today, it accounts for less than 10% of federal revenue

Corporate Taxes, cont. Corporate

income taxes are calculated on:

Sales revenue less production costs, interest or rent payments

Depreciation on capital equipment and facilities

Any state or local taxes paid

Corporate Taxes:A Double Taxation?

• This tax has an impact on the price of many stocks and pension plans

• The higher the corporate taxes, the lower the stock dividends or stock appreciation to investors or the higher the retail price of their goods and services to end consumers

Corporate Taxes & Education Funding

Where there are thriving businesses: People are employed paying income taxes More purchasing and maintaining homes

that generate property taxes More buying goods and services that

generate sales taxes This is a healthy cycle for a local economy

that will have greater capacity to fund public education

Sumptuary Taxes• Sumptuary taxes are those imposed by

a government to help regulate or control activities that are seen not to be in the best interest of the public

• They are sometimes referred to as “sin taxes”

Sumptuary Taxes, cont. Smoking and drinking

are deemed not to be in the public interest

Governments then regulate their activity by taxing them at varying rates above and beyond the sales tax

A Conundrum for Educators • We receive some of our school

operating revenue from the sale of substances that we teach our students are harmful to them

• Without this revenue, however, our funding (already too low) would be further reduced

Measuring Tax Impact Funding for education should be a

national priority The tax impact to fund education

needs to be equitable In a climate of high stakes testing &

high levels of accountability for educators & students, resources are sorely needed in our classrooms

Urgent Need for More Resources

The No Child Left Behind (NCLB) legislation with required Adequate Yearly Progress (AYP) goes into full effect in 2014

Making AYP for all students will require additional funding for professional development, supplies, remediation for students – especially in poor urban schools

Securing More Taxes to Support Public Schools

• Taxpayers must see their extra tax dollars’ impact with positive results in the schools

• Educators must & will be held accountable for results

Results include:• Higher student

achievement levels • Increased public

satisfaction with their school system

• Customer friendly schools for students & the community

Diminishing Marginal Utility Utility means “satisfaction” Consumers try to maximize their

satisfaction when using their income to buy goods & services

Buying ONE unit of a novel & desired item brings HIGH satisfaction

Buying MORE units brings LESS satisfaction

Diminishing Marginal Utility, cont.

Buying ONE unit of a novel & desired item brings HIGH satisfaction

Buying MORE units brings increasingly LESS satisfaction

Diminishing Marginal Utility, cont.

U2

U1

1 2 3 4 5

U4U3

U5

Quantity

Uti lit

y

Marginal Utility & Taxes Citizens are proud

of the new roads, new schools, & accomplishments of the school district

As taxes rise, however, and consume a larger %age of income, the utility or satisfaction with paying taxes tends to decrease unless citizens see that the cost brings utility for them in some way

Marginal Utility & Taxes, cont.People will only be willing to pay taxes

for schools as long as they see it has utility for them

It is the job of all educators to make certain that the tax-paying public sees educational utility in a personal way that makes sense to them

Indicators of a GOOD Tax Good taxes have utility & make sense. • Fairness of the Tax System • Everyone pays something • Economic Neutrality • Adequacy of Yield • Administration Costs• Convenience of Payment • Visibility of Benefit

Fairness of the Tax System • A fair tax structure has

a greater burden on the rich than on the poor

• Virtually all agree that a regressive tax system is unfair

“Fairness” is often in the eye of the beholder

Everyone Pays Something All citizens enjoy the benefits of government

• Police protect • Teachers teach • Fire fighters fight fires • Soldiers defend • Roads transport

All citizens contribute something to the common good

Economic Neutrality • Ideally, taxes should

leave individuals in the same relative position after taxes as before paying taxes

• Everyone’s relative position is maintained in spite of taxes

• As taxes are diversified through income, property, sales, lottery, sumptuary, & the like, we lessen the non-neutral impact of any one tax

Adequacy of Yield • The cost of

administering a tax should not exceed the revenue generated by that tax

• If a bridge were built and a toll placed on the bridge to pay for the construction, the toll should pay for the bridge & the means of toll collection

Administration Costs The cost of administering &

collecting the tax should be low The income tax is collected with much

greater efficiency than is the property tax Your company deducts your income tax &

sends it to the proper state authority. Minimum personnel are involved.

Property taxes, on the other hand, require a much more personnel-intensive collection operation

Convenience of Payment A good tax is one that is convenient

for the citizen to pay• If the public must stand in line for hours,

shuffle from one office to another, & face arrogant, rude government workers, tax utility is lost

Visibility of Benefit People need to SEE the obvious value their tax dollars bring.

YOUR TAX $$$$’sAt Work