Taxes, Transfers, and Fees

State and local governments fund their operations from two major sources: federal (and, for local governments, state) transfers, and own-source taxes. But there is a third source of income: own-source non-tax revenues. These range from higher-ed tuition payments to sewerage fees to lottery proceeds. The graph below suggests an interesting story:

The sharp increase in state own-source revenue in the late 1960s is principally attributable to increased tax revenues (fueled, as I’ve argued here, by federal Great Society transfer payments.) Soon thereafter, taxes took a nosedive, largely due to the property tax revolt; by 1990, they had recovered a bit but flattened out at slightly under 10% of GDP.  Other revenues increased sufficiently first to prevent an own-source revenue collapse and then to allow growth. Over time, then, the proportion of non-tax revenues to total own-source revenue has increased quite substantially. Since 1990, however, non-tax revenues, too, have moved essentially sideways, leaving own-source revenues stuck at about 14% of GDP. The gap between that (purple) line and state and local expenditures (green) roughly represents federal transfer payments.

Is state and local governments’ increased reliance on non-tax own-source revenues a good or a bad thing? Impossible to say without a careful look. For example, the trend could signal an increased reliance on hidden taxation or a healthy migration to user-fee finance. (If states absolutely have to run elite universities like the University of Virginia, a high-tuition, high-need-based-assistance system makes more sense than tax-financed cross-subsidies for rich white kids from McLean.) What the chart supplies is an additional piece of evidence for a point made earlier: state and local governments aren’t going to tax their way out of fiscal trouble.