Elastic Tax

State tax systems produce the revenue in a state for providing public services such as municipal services, state services, and, of course, revenue for public education. State tax systems are evaluated so that shifts in taxing policy may be implemented to provide different revenue streams or combinations. Economists use several qualities to assess tax systems. Of major importance to state legislatures and budget developers is an adequate amount of revenue for the provision of public services. Adequacy means that sufficient revenues are available to meet a taxing authority's responsibilities as determined by law. Stability and elasticity are required to offer adequacy in funding. Stability refers to the ability of tax revenue to avoid great fluctuations from budget year to budget year, to provide the revenue anticipated for expenditures.

Elasticity is an important characteristic that must be assessed so that political policy can be set or changed. Elasticity refers to the ability of a tax to produce revenue at a pace faster than personal income growth over time. Elastic revenues are those that are highly responsive to change in the economy or inflation. As the economic base expands or inflation increases, elastic revenues rise in greater proportional rates than expansion or inflation. As the economy contracts, or during periods of low inflation, elastic revenues may decrease substantially. The volatility of this revenue source can put budgets and programs at risk.

For example, if government revenues increase faster, percentagewise, than do the personal incomes of a state's taxpayers, that state is deemed to have an “elastic” tax system. Conversely, if tax revenue rises slower than does personal income, then the state's tax structure, by definition, is inelastic.

In considering school finance reform, a state system that relies heavily on inelastic taxes (i.e., whose revenue grows more slowly than personal income) is likely to be less desirable than one that increases its use of elastic taxes. This would be the premise for some analysts' admonitions for greater reliance on [Page 330]state income taxes and, in some cases, implementation of local income taxes to support public schooling. The downside, however, is that elastic taxes may prove to be less stable over time; in times of economic decline, revenue can drop off precipitously, and support for long-term programs, change, or contracted increased expenditures cannot be met. Income and general sales taxes are regarded as having high elasticity, and the income tax is considered to have the greatest elasticity. Property taxes are the least elastic and, for school systems, the most stable of revenue sources. Property taxes are, in fact, the only tax that has the potential for accurate prediction at the start of a fiscal year. If jobs are lost and state and local income bases are reduced, the revenue from the source is also reduced (until legislatures intervene and increase tax rates). Stephen Gold was considered a front-runner in examining elasticity and its relation to increases and decreases in government spending. His work focused on the difference in state tax structures and the possible significance of “elasticity”—the ratio of new or incremental tax revenues in a state to the new or incremental personal income of state residents. In economics, a ratio exceeding 1 is termed elastic and a ratio less than 1 is termed inelastic.

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