Policy Option: Allow Local Income Taxes

Estimated Revenue

Revenue per capita differs widely across towns; per capita revenue ranges from $40 to $1,773 for the AGI Tax, and from $31 to $1,874 for the Income Surtax. These are substantial ranges. If we don’t consider the 5 percent of towns with the highest revenue per capita and the 5 percent with the lowest per capita revenue, we find that for 90 percent of the towns per capita revenue ranges from $120 to $639 for AGI Tax, and from $90 to $705 for the Income Surtax. For most towns the revenue from the tax on AGI is similar to the revenue from the tax on tax liability.

Per capita revenue for the Payroll Tax ranges from $22 to $872. The per capita revenue for the Payroll Tax is positively related to AGI Tax revenue per capita, but the correlation is small, 0.27. The reason is that AGI is based on the income of the residents of a town, while the payroll tax is based on the earned income of those working in the town.

Per capita revenues for the Split Earnings Tax ranges from $97 to $760. For towns with low values of per capita Payroll Tax revenue, the per capita revenue for the Split Earning Tax is greater than the Payroll Tax revenue per capita. Towns with small Payroll Tax bases are likely to be residential communities so that resident earned income is likely to be larger than payroll earned income. The opposite is the case for towns with large Payroll Tax revenue per capita.

One possible objective for adopting a local income tax is to reduce property taxes. In the aggregate, a local income taxes in Connecticut would generate sufficient revenue to reduce total property taxes, including school property taxes, by about 11.5 percent. But there are substantial difference between towns in the possible reduction in property taxes, and furthermore the possible reduction for a town differs by tax.

Given the data that were available errors in estimated revenue are likely. A limitation with the data is that they do not include earnings of Connecticut residents who work out-of-state; we are unable to adjust for this. Thus, it needs to be stressed that the estimates by town are reasonable indications of local income tax revenue for informing state tax policy, but not for local government budget making.

Economic Effects

In considering whether to recommend allowing local governments to use local income taxes, the following factors are relevant.

• 
  Effect on Employment
  

It is expected that a local income tax will have a small, negative effect on hours worked. To the extent the local income tax rates differ across towns, for example, if not all towns adopted a local income tax, it is expected that the tax differential will cause migration of the tax base from the towns with the higher income tax rates to those towns with lower tax rates, but with the tax rates proposed, the effect will be small. Much of the research on the effect of local income taxes on tax base mobility has focused on Philadelphia, for which differential income tax rates have been shown to result in migration of workers across the Philadelphia region.

• 
  Effect on Tax Competition
  

The adoption of an income tax will change the incentives for local government competition for tax base. Currently, towns compete for property tax base, with commercial and industrial property being more desirable since there are less associated public service costs than for residential property. Adopting an income tax provides an incentive for towns to compete more strongly for high wage households or high wage jobs, and somewhat less for property.

• 
  Effect on Equity
  

The distribution of the tax payments across households from the AGI Tax will be proportional, assuming that income is measured by AGI. The distribution for the Income Surtax will be the same as the distribution of the state income tax liability. Local earned income taxes are slightly regressive since not all income sources are taxed and the excluded income (largely returns to capital) are associated with higher income households. Any of the local income taxes will be less regressive than either property taxes or sales taxes.

• 
  Effect on Fiscal Disparities
  

Income tax revenue per capita is generally larger for towns with better fiscal health, as measured by the index of fiscal disparities created by the New England Public Policy Center at the Federal Reserve Bank of Boston (Zhao and Weiner 2015). This is particularly true for the AGI Tax, the Income Surtax, and the Split Earnings Tax. Thus, the adoption of local income taxes will not offset existing fiscal disparities. The results are the same if we consider property tax base (i.e., Grand List) per capita rather than the index of fiscal disparities.

• 
  Other Issues
  

The cost of administration and compliance, assuming state administration, would be small for a local income tax that is based on state AGI or state tax liability. The administrative cost for an earned income tax administrated by each town will be large relative to the tax revenue generated, and would require significant administrative capabilities, although regional administration would likely reduce the total cost of administration. Given the size of many of the towns in Connecticut, we suspect that administrating such a tax for many towns would be a challenge. If the tax is based on payroll, the tax would generate tax revenue from commuters, and thus offset some of the service costs associated with commuters and visitors.

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