Local tax revenues play a crucial role in supporting local government services, with property taxes historically being the primary revenue source. However, states have explored additional revenue streams such as local income and sales taxes to diversify and reduce the burden on property taxes.
The landscape of local taxes reveals that local income taxes are authorized in 16 states and DC, while local sales taxes are imposed in 36 states and DC. Both taxes play a significant role in the revenue mix of different localities. However, the lack of uniformity in tax rates and the potential for tax hikes over time can lead to nonneutral tax systems and economic inefficiencies.
Local income taxes, which contribute a modest 5% to total local tax collections, can vary significantly from state to state. States like Maryland, Ohio, and Kentucky heavily rely on local income taxes, affecting up to 36% of their local tax collections. In contrast, local sales taxes, constituting more than 40% of local tax collections in states like Alabama, Arkansas, and Louisiana, are subject to similar variations in tax imposition.
While local income taxes have a broad tax base and are easily administered, they may increase the overall tax burden and negatively impact employment. On the other hand, local sales taxes provide revenue diversification and avoid double taxation, but they face challenges in the form of volatility, tax avoidance, and fiscal disparities.
Recent trends indicate a surge in average local income and sales tax rates across states, reflecting the evolving tax landscape. With economic nexus shaping remote sales tax compliance, local governments face new challenges in tax administration and revenue adequacy.
Ultimately, the choice between local income and sales taxes lies with state governments, who must weigh the benefits and drawbacks of each tax type. While both taxes can complement property taxes, attention to tax policy design is crucial to ensure an efficient and competitive tax system. States and localities must learn from the experiences of their peers to navigate the complexities of local tax revenue effectively.
