Tax Revenue and Tax Structure

Abstract

This article examines the relationship between the selection of tax instruments Abstract and the size of the public budget. It develops and tests with data from 37 large cities a model that is an alternative to the commonly cited fiscal illusion model. The model is predicated upon the assumption that budget-maximizing governments prefer broad-based tax systems composed of inelastic taxes and not just many taxes. The empirical tests indicate that cities that rely on taxes with elastic bases tend toward lower per capita tax revenues and cities that rely on taxes with inelastic bases tend toward higher per capita tax revenues.

The Empirical Analysis of Fiscal Illusion

“…Studies by Wagner (1976), Pommerehne and Schneider (1978), Baker (1983) and Breeden and Hunter (1985) have sought to measure this effect. In terms of Figure 1 the increasing complexity of the revenue system, or a fall in its level of simplicity, should cause a move in the perceived price of the public good down the vertical axis.…”

“…In any event, the empirical analysis of fiscal illusion has either taken the form of what Oates (1988, p. 68) describes as ad hoc expenditure studies, like Wagner (1976), Breeden and Hunter (1985), Feenburg and Rosen (1987), Misiolek and Elder (1988), or work employing demand functions for public goods such as Bergstrom and Goodnam (1973), Wildasin (1989), Hayes (1989) and Crane (1990). In both the expenditure and demand approaches a measure of budgetary size or budgetary growth is regressed against various socio-economic variables aimed at capturing those determinants present in the absence of fiscal illusion.…”

“…Empirical tests of fiscal illusion aim to evaluate the significance of the area X, a&, , the excess budget/revenue/expenditure attributable to the illusion vector /IF.The first hypothesis is revenue-complexity where the misperception of the taxprice results from fragmentation of the revenue system. Studies by Wagner (1976), Pommerehne and Schneider (1978), Baker (1983) and Breeden and Hunter (1985) have sought to measure this effect. In terms of Figure 1 the increasing complexity of the revenue system, or a fall in its level of simplicity, should cause a move in the perceived price of the public good down the vertical axis.…”

The determinants of off-budget activity of state and local governments

“…A related hypothesis is that structure and complexity of tax systems is one way to create fiscal illusion. For studies of this hypothesis, see Wagner (1976), Pommerehne and Schneider (1978), Breeden and Hunter (1985), and Feenberg and Rosen (1987). 9.…”

Tax structure and the size of government: An empirical analysis of the fiscal illusion and fiscal stress arguments

“…This hypothesis may also be tied to the arguments of the Leviathan model of Brennan and Buchanan (1980), but their construction is broader in nature and concerns the existence of constraints on the revenue raising capabilities of the Leviathan. Breeden and Hunter (1985) explore another aspect of this model, testing whether broad based taxes on groups of commodities with inelastic demands will produce larger governments. Breeden and Hunter find some confirmation of this argument but note that the results must be interpreted carefully due to the possible endogeneity of (the breadth of) the tax structure.…”