The voices of Tax Policy Center's researchers and staff
Whenever the federal government goes completely nuts, it can be comforting to remember the United States is a highly decentralized country. Fifty states and more than 90,000 cities, counties, school districts, and other special purpose governments (such as water or transit authorities) are paying their employees, keeping their parks open, and picking up the trash at a time when much of the federal government remains shut down.
But the state and local public sector is more than that fifty labs of democracy we were taught about in high school civics class. If you are looking to get up to speed on what states and localities actually do, have no fear. My Tax Policy Center colleagues and I have updated the relevant entries in our ever-popular Briefing Book.
Here’s a cheat sheet:
The US state and local public sector is big. States collected nearly $2 trillion in general revenue in 2016 (the latest year for which comprehensive financial information is available) and localities collected $1.6 trillion. But don’t sum those two amounts! A lot of what states do is give money to local governments.
Localities received almost a third of their budgets from states in 2016, and another four percent directly from the feds. The federal government used to give a lot more direct aid to cities but that changed in the 1980s. Now the federal government targets grants to states that in turn give money (both federal and state) to localities.
Federal money isn’t a bailout; it’s a quid pro quo. The federal government recognizes that state and local governments have certain advantages when it comes to tailoring programs to their populations, geographies, and costs. That’s why it has long distributed grants and had state and local governments provide services though these funds, almost always with strings attached.
The federal government also helps states and localities through the tax code – by allowing federal taxpayers to deduct state and local taxes on real or personal property and on income or sales (up to a $10,000 limit after the Tax Cut and Jobs Act or TCJA). And the feds exclude state and local municipal bond interest payments from individual taxable income.
Federal aid can be helpful in a recession. For example, it propped up state revenues in 2011 and 2012. But rules intended to limit gaming may prevent federal grants from truly equalizing differences in state resources or responding to economic swings.
“Taxes” are a four-letter word, but “fees” are not (go figure). Both states and localities have increased fees and user charges since the late 1970s. For states, this is mostly college tuition while it’s water, sewerage, and parking meter fees for local governments.
For example, states that use federal taxable income as a starting point for their own systems will have to decide whether to conform to the TCJA’s new federal deduction for income earned by sole proprietorships, partnerships, and other “pass-through” entities. This decision is important because both state and federal revenue from taxes on corporations known as “c-corps” is way down.
Sales taxes, meanwhile, remain the states’ main source of tax revenue even as the US economy shifts from a goods- to a service-based one. The result: over time sales taxes are generating less revenue and are less progressive.
Institutions matter. It’s a truism to say states, unlike the federal government, can’t borrow to finance deficits. In truth, state budget institutions vary a lot in structure and outcomes. The devil is in the details when it comes to Tax and Expenditure Limits and Rainy Day Funds (RDFs), for example. States do a lot to save for recessions, but they could do more by getting rid of arbitrary RDF caps.
States get a lot of press for being on the front lines of major policy issues such as whether to expand Medicaid, how to pay for roads, and or whether to raise the minimum wage. But they are not little mini-feds showing the way for frustrated policy mavens in Washington, DC. There’s a lot more to states than meets the eye, and we hope you will enjoy digging into our updated Briefing Book and other resources.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.