earnings
In recent years, state and local govern-ments have begun extending their wage and personal income taxes to nonres-ident professional athletes. These so-called jock taxes occur because athletes earn a pro rata share of their income when they play in the taxing jurisdiction.
Philadelphia, for example, extends its nonresident wage tax of 3.8801 percent to football, basketball, baseball, and hockey players for the portion of time they work in one of the city’s stadiums or arenas. Players have a taxable nexus for the time they are playing and earning income in the city. At least a half dozen cities now impose their income tax on athletes, and twenty states extend their state income tax to professional athletes.
Several intergovernmental issues arise because of the jock tax, which is usually extended to other high-dollar wage earners, including musicians and actors.
Not all states or local governments give a credit for taxes already paid on that income, which creates a double tax on those earnings. The jock tax also imposes significant compliance expenses on nonresident athletes, who must com-plete a tax return for each city and state in which they play. And it gives rise to the potential for discriminatory taxation. For example, Alberta, Canada, imposes an extra 2.5 percent income tax on top of its 10 percent tax on all resident players of its two hockey teams, but it does not tax visiting players.
Source: Most of this information is from David K. Hoffman and Scott A. Hodge, “Nonresident State and Local Income Taxes in the United States: The Continuing Spread of ‘Jock Taxes,’”
Tax Foundation Special Report no. 130 (July 2004), taxfoundation.org/sites/taxfoundation .org/files/docs/fe9737a23595921c41616df11dc3cd48.pdf.
The significance of the income tax in a local government’s revenue structure depends on the breadth of the tax base (Figure 4–5). For example, local governments in Indiana, Maryland, and Michigan tax the personal income (earned and unearned) of individuals and the net profits of unincorporated businesses. In general, these governments expe-rience more rapid growth in income tax revenue than do those with more narrowly based earned income taxes, such as in Ohio and Pennsylvania. This is primarily because components of the tax base change in value at different rates, and data from the Internal Revenue Service (IRS) indicate that the greatest rate of growth occurs with unearned income (interest, dividends, and realized capital gains).
Personal income Although an income tax limited to earned income is less costly to collect and enforce, modern techniques of tax administration, especially the sharing of tax information between state and local revenue departments and the IRS, now make taxation of personal income administratively feasible. Consequently, states that have ad-opted the income tax somewhat recently—most notably, Maryland—define the tax base more broadly to include both earned and unearned income. Since higher-income indi-viduals receive a greater portion of their income from unearned sources, excluding this income places a greater portion of the tax burden on wage earners in the lower- and middle-income brackets. A broad-based tax on personal income distributes the tax bur-den more evenly across all income categories and is more equitable on the ability-to-pay basis. All versions of the income tax, other than payroll taxes, include the net profits of unincorporated businesses in their tax bases (Figure 4–5).
Gross income Local income taxes differ from their state and federal counterparts in still another way: most are levied on gross income with no exemptions, deductions, or credits, which facilitates local collection and enforcement of the tax. Including ad-justments to gross income increases the complexity and cost of administering the tax, especially if locally administered. On the other hand, itemized deductions for certain expenses and exemptions for dependents generally increase the tax’s progressivity by reducing the tax burden on lower- and middle-income households.
Personal Business
Earned (EI) Wages Salaries Tips
Commissions Unearned (UI) Interest Dividents Capital gains Rent Royalties Inheritances Giftsb
Proprietarya Net profits (NP) Gross income Corporate (CI) Net income
a Unincorporated businesses and professions.
b Normally taxed separately and not included in the income tax base.
Figure 4–4 Types of income
Piggybacking the local tax onto the state’s income tax is a cost-effective approach to integrating such adjustments into the local tax. For example, the Maryland Department of Revenue collects the counties’ taxes along with the state liability. The local share is remitted to the taxpayers’ counties of residence. This approach reduces taxpayer com-pliance costs because only one tax return is filed. It also increases the equity of the local tax because local adjustments to gross income are the same as the state’s. On the down side, state administration makes the state tax liability appear larger because taxpayers may not distinguish between the state portion and the local portion.
Payroll taxes Interest in payroll taxes has resurfaced as a result of Nevada’s 2003 adoption of the tax, which is currently at 0.65 percent. Several local governments have levied such a tax for a number of years, but Nevada is the first state to do so. The most widespread use of the payroll tax is in Alabama, where twenty cities levy a municipal occupation tax ranging from 0.50 to 2.0 percent of an employer’s payroll. Generally, liability for payroll taxes falls on the employer.
Because they usually have no deductions or other adjustments, payroll taxes can be particularly onerous on smaller businesses that have narrow profit margins, operate in a highly competitive environment, and depend on highly skilled labor—for example, computer software developers. To accommodate such entrepreneurs, some local govern-ments exempt a portion of the payroll from taxation.
While employers are generally liable for the payroll tax, the tax burden is likely shifted to employees as lower wages, particularly in industries employing lower-skilled workers. However, this may not be true in businesses where the demand for workers is more competitive. In general, the tax does not rate well on horizontal or vertical equity, and it likely has a negative impact on economic growth in the long term, particularly in sectors that rely on highly skilled, higher-cost employees, such as those in engineering and technology development.
Local government dependence on the income tax
Of paramount interest to local government leaders is the revenue potential of a new tax or fee. Revenue yields from local income taxes have shown modest increases for municipalities (Table 4–1) but have held steady for counties. In those few states where counties do levy the tax, however, it represents a substantial portion of their revenue. For example, income tax revenues for Maryland counties in 2007 amounted to 32 percent of their general revenues and 41 percent of their tax revenues, only slightly less than the revenue yield from the property tax.47
The income elasticity of the tax poses a serious problem for local government budgets. For example, a 10 percent decline in personal income in the local economy may result in a 15 percent decline in income tax revenues. The more dependent a local
Narrowest tax base Broadest tax base
Earned only Earned and proprietary
Personal and proprietary
Earned, proprietary, and corporate
Personal, proprietary, and corporate
Alabama Ohio
Pennsylvania Indiana
Maryland Philadelphia
Ohio Michigan
New York City Figure 4–5 Income tax bases used by local governments
Figure 4–4 Types of income
government is on the revenue from the income tax, the more vulnerable it is to mid-year revenue shortfalls and budget instability. For this reason and others discussed in the following sections, local governments should avoid overdependence on the income tax.
Budgetary issues and the local income tax
The greatest source of controversy related to a proposed income tax concerns its po-tential effects on business and household locational decisions. The common assumption