Taxes are an essential source of revenue for all levels of government. Like other parts of the revenue structure, tax revenue setting by municipalities is restricted by state governments. States are not uniform in their approach to allowing municipalities to utilize the three major sources of tax revenue - property, sales and income taxes - usually permitting some combination. In some states, municipalities receive revenue from two of these taxes, usually some combination of property and sales taxes. In addition some states assign a portion of state tax revenues to those municipalities with a substantial share of the state population (New York City, St. Louis, and Kansas City, for example). Municipalities in other states are reliant on one tax with only a limited degree of reliance on a second. And in other states, municipalities rely on only one revenue source, usually the property tax. Municipalities in this latter category are either heavily reliant on that one source (as in Connecticut), or that one source is a relatively low percentage of total general revenues (Idaho).
The property tax is the oldest tax levied in the United States and is the only major tax common to all fifty states. It is also a mainstay of municipal and county revenue structures, although fifteen states still levy the tax to garner state revenue.
This tax is levied on a property owner who pays a percentage of the value of his property. 'Property' is a broad category which includes real, personal, and state-assessed property. Real property is immobile and includes residential and commercial land, natural resources and fixed improvements to the land. Personal property is mobile and includes both tangible (i.e. vehicles and equipment) and intangible (stocks, bonds and bank accounts) items. State-assessed property includes public utilities and railroads, which span several local jurisdictions.
Assessing a property's value, generally defined as 'fair market value,' is an inexact science; the total value of a parcel of land plus the property on it is estimated using legally specified standards applied by a tax assessor. While assessors in most states are part of county government, New England states usually employ municipal assessors, and Maryland is unique in its use of state assessors. The assessed value remains until the property is exchanged on the market where its actual market value is determined, or until it is reappraised. Real property is reappraised periodically, but most states have no statutory requirements requiring their frequency. For the states that require regular appraisal, the frequencies range from every two years to every ten.
According to the Tax Foundation, property taxes on owner-occupied housing as a percentage of median home value range from 0.14 percent in Louisiana to 1.76 percent in Texas. As a percent of own-source revenue (revenue generated by local sources only), property tax revenue fell from 78 percent of total municipal tax revenue in 1942 to 29 percent in 2002.
A local sales tax is a percentage of the transaction price of a broad range of goods and services levied at the point of sale. The vendor collects the tax on behalf of the taxing jurisdiction, which may be a local or county government. The sales tax base is larger than the property tax base, since it includes nonresident shoppers and tourists.
A local sales tax must be authorized by the state government, as it is in 33 states. Municipalities in some states rely on their home-rule powers to levy the tax, as in Colorado, Illinois and North Dakota, while others derive their authority from business licensing powers, as in Alabama and Arizona. Some states allow additional forms of local government to levy the tax, including counties, school districts and transit authorities. In all, nearly 6,500 cities levy this tax. State law dictates the types of transactions that are taxable.
For the states that authorize their municipalities to collect sales taxes, most allow the municipalities to choose from a range of tax rates. Then the state limits the combined overlapping rate of all local governments. According to the Tax Foundation, combined state and local sales tax rates range from 0 percent in Montana, New Hampshire and Oregon to 9.41 percent in Tennessee. As a percentage of municipal own-source revenue, sales taxes generated 4 percent of total revenues in 1942, increasing to more than 17 percent in 2002.
The case of California provides a good illustration of how a sales tax divides the proceeds among interested parties. The sales tax in California is 7.25 percent. A $10 item will generate a $0.73 sales tax, from which the state general fund claims $0.50, county and city operations take $0.10, local public safety takes $0.05, the local revenue fund takes $0.05 and county transportation takes $0.03. Oftentimes additional sales tax increments are added on to the overall sales tax rate to fund specific purposes, such as transportation, either by the state government or, where authorized by state law, the local governments themselves. As a result, the overall sales tax rate may vary by jurisdiction.
The income tax is a flat-rate or sliding scale tax on earned income (including wages, salaries, tips and commissions) from individuals residing in the city, earned income from those who work in the city (sometimes referred to as a "commuter tax") and net profits from unincorporated businesses. According to the Tax Foundation, income tax rates range from 0 percent in South Carolina to 11 percent in Hawai'i and Oregon.
Some states require state authorization for municipalities to collect the income tax. Adoption of an income tax is more likely in cities than in counties, and some municipalities elect not to levy the tax even when their state authorizes them to do so, as is the case in Arkansas and Georgia. Only Maryland requires income tax adoption by all its municipalities.
Tax rate changes at the local level most frequently occur through legislative initiatives at the state government level. States may set limits on rates, on assessment increases, on the amount the taxes may increase from year to year and on the total revenues collected during the year. Each type of tax has specific procedures in state law for fee and rate adoption.
Occasionally, tax rates may be modified by direct citizen intervention. Efforts to reduce the property tax over the last 3-4 decades are one example. In California, voters imposed a property tax limitation in 1978 called Proposition 13, and a similar event occurred with Massachusetts' Proposition 2 1/2 in 1980. In 1992, voters in Colorado adopted the Taxpayer Bill of Rights (TABOR) which provided that any new state or local tax, any increase in an existing tax or any state or local spending increase that exceeded a certain limit would require specific voter approval. Several national groups promote versions of Colorado's TABOR plan in approximately twenty states, but voters in Maine and Washington and legislatures in Florida and Missouri suppressed its adoption.
Local taxation autonomy may also be significantly constrained through voter- or state-imposed (constitutional or statutory) tax and expenditure limitations (TELs). There are two types of TELs - those that constrain the property tax and, less commonly, those that constrain overall revenue spending increases. Thirty-three of 50 states have potentially binding limits in place for municipalities, indicating a prevalence of TELs among municipal governments across the country.