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State and Local Tax

State and Local Tax

Some people feel overwhelmed by the fact that they have to pay state and local taxes in addition to federal taxes. But did you know that state and local taxes are used to fund your local public school? They are also used to build highways that connect states and enable you to receive your Amazon order in a shorter time. What are the uses of state and local taxes? How do state and local governments receive these taxes, and do they help local economies? Keep reading to find out where the money you pay to the government for your state and local taxes goes!

State and Local Taxes in Macroeconomics

State and local taxes in macroeconomics account for a significant part of economic growth. Although most people think primarily about the federal government and federal spending regarding macroeconomics, state and local governments are also significant drivers of economic growth and commerce.

State and local taxes are taxes imposed by a state, county, or municipality to raise revenue to fund public services such as education, trash collection, etc.

State and local governments spend almost as much as the federal government each year. As of 2019, this amount was roughly $3.97 trillion!1 Much of this state and local spending was funded directly by state and local taxes. These state and local taxes amounted to about $4.07 trillion in revenue, with individual income taxes and general sales taxes making up the two most significant components, respectively.1

State and local taxes, sometimes assisted by federal grants, fund services administered and regulated at the state level.

The most significant expenditure funded primarily by state and local taxes is public education, which includes PK-12 public education, community colleges, and public universities.

Hospitals and health clinics are next, followed by roads and highways, law enforcement, the corrections field (which includes jails, prisons, and probation and parole services), various social services, and state and local courts.

Local taxes are the majority funding for PK-12 public education, fire protection, and law enforcement. State taxes fund hospital expenditures, road construction, and a strong majority of social welfare spending.

Both individuals and businesses are subject to various state and local taxes. The types of taxes can vary by state, with some states having income taxes and some not. Different states have different tax burdens, with liberal states tending to have higher tax burdens than conservative states.

Liberal states tend to have higher tax burdens to fund state and local government services more generously, such as funding for schools, unemployment benefits, and social services.

Altogether, the tax burden across the United States is relatively similar; otherwise, individuals and businesses would be incentivized to move to different locations to enjoy lower taxes.

State and Local Tax U.S. state and local government revenue sources in 2020 StudySmarterFig. 1 - U.S. state and local government revenue sources in 2020. Source: Bureau of Economic Analysis2

Figure 1 above shows U.S. state and local government revenue sources in 2020. It can be seen that the majority of revenue is generated by taxes (62.7%), followed by transfer receipts (33.0%), asset income (3.1%), and social insurance contributions (1.3%).

State and Local Tax Deductions

State and local tax deductions include income and property taxes, amongst others. Taxes paid to state and local governments are deductible - to some extent - when filing federal taxes each spring. There is a $10,000 cap on tax deductions for state and local taxes. The state and local tax (SALT) deduction applies to income and property taxes, requiring federal income tax filers to itemize these deductions by specific amounts. The SALT deduction has changed frequently, with different types of state and local taxes included or excluded with changing regulations. Federal tax legislation has halted proposals to increase the SALT deduction cap in recent years.

Examples of Local Taxes

Some examples of local taxes include property taxes, income taxes, and various fees for services.

Local governments are allowed to impose income taxes in seventeen states, most commonly associated with the federal government. Altogether, just under 5,000 municipalities in the United States impose some income tax. 3

Local income taxes, fortunately for taxpayers, are usually low, with the highest statewide average being 2.3 percent in Maryland.3 One hundred ninety counties across the country also have a county income tax, and about 950 school districts levy their income taxes3.

More common across the country is the use of sales and property taxes, which are virtually universal. Local sales taxes are usually added to the state “base” sales tax, with only a handful of states not having their own sales tax. States set a maximum local sales tax rate, meaning there is a combined full total sales tax (state rate and local rate).

The local sales tax rate can rise over time depending on the passage of incremental sales taxes to fund specific government projects, such as the construction of new roads or city facilities. The cumulative sales tax can be removed when these projects are completed and fully paid off.

Therefore, cities with faster growth rates and higher demands for new infrastructure are more likely to have higher sales taxes.

Several taxing entities within a county often levy local property taxes. A local appraisal district, run by the city or county, determines the value of each taxable property, typically houses and businesses. This value is then subject to a proportional property tax rate applied by each taxing entity.

Taxing entities usually include the county, city or town, school district, hospital district, and community college district. The total tax amount is generally collected annually by a single tax collection agency and then dispersed to the taxing entities. If a property is still under a mortgage, the tax bill is typically sent to the mortgage lender to be paid.

When it comes to property taxes, individuals and businesses can try to reduce their tax burden by protesting the appraisal district’s valuation of their taxable property. Sometimes, critics of appraisal districts feel that such communities intentionally overvalue properties to generate more tax revenue.

When protesting a suspected overvaluation of property, owners must be able to show evidence that the market value of the property is meaningfully less than the amount stated by the appraisal district.

Uses of State Taxes

One of the main uses of state sales taxes, property taxes, and income taxes is the funding of state agencies.

These typically include universities, state law enforcement agencies, state land management agencies, and social programs like unemployment benefits. Community colleges, PK-12 public education, and roads and highways are often funded by a combination of local taxes and state taxes. In some states, the state collects local tax revenues above a certain amount to disperse to other taxing districts to ensure a relatively uniform provision of services.

In Texas, this is done with public school funding. School districts that collect property tax revenue above a certain amount must forfeit the extra funds to the state, which then allocates those funds to lower-income school districts.

Spending by states varies based on how government services are broken down between state and local authorities.

Geographically larger states in the West may have larger state spending on conservation and land management, while more urbanized states have more spending done by city governments.

Smaller rural communities may rely more on statewide agencies, such as law enforcement, while larger towns and cities have their own distinct agencies.

Some countries and cities have lower income revenue due to low-income receivers, making it harder to support schools and infrastructure. State spending may also be necessary to help the government services of these rural counties.

States also have some taxes that local governments do not, such as fuel taxes (which the federal government levies) and state lotteries. These state taxes tend to fund specific projects, with fuel taxes going primarily toward road construction and maintenance. State lottery revenue tends toward specific funds like education, veterans’ benefits, and road construction.

State Tax Returns

State tax returns are a type of documentation that one files with a state tax authority where income, expenses, and other financial information are included.

When filing tax returns each spring, most people automatically consider filing their federal income tax with the Internal Revenue Service (IRS). However, most states also require the filing of state income tax. All states have some tax forms that either individuals, businesses, or both, must file.

Fortunately, most tax filing services, such as the online TurboTax service, simultaneously allow for the timely filing of federal and state income taxes. The IRS free-file program for those with an income of less than $73,000 per year also allows for some free state tax return filing.4

Like federal tax returns, state tax returns include the same primary sections: a statement of income, a statement of deductions, and a statement of tax credits. States with income tax typically allow similar deductions to those the IRS allows on federal income tax, including medical expenses, mortgage interest, and job-related expenses.

Many states also have tax credits similar to those offered by the federal government, including an earned income tax credit meant to boost the income of low-wage earners. For businesses, states often provide tax credits for investing in things desirable for society, such as green energy projects, employing workers in low-income areas, and using sustainable resources.

State and Local Tax - Key takeaways

  • State and local taxes are taxes imposed by a state, county, or municipality to raise revenue to fund public services such as education, trash collection, etc.
  • Taxes paid to state and local governments are deductible - to some extent - when filing federal taxes each spring.
  • State sales taxes, property taxes, and income taxes are used to fund state agencies.
  • Spending by states varies based on how government services are broken down between state and local authorities.

References

  1. Census Bureau, Census Bureau Releases 2019 State and Local Government Finance Table, https://www.census.gov/newsroom/press-releases/2021/state-local-government-finance-table.html
  2. Bureau of Economic Analysis, Table 3.3 https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey
  3. Tax foundation, Local Income Taxes in 2019, https://taxfoundation.org/local-income-taxes-2019/#:~:text=Municipalities%20account%20for%203%2C816%20of,are%20in%20Ohio%20and%20Pennsylvania.
  4. IRS, IRS Free File Online Options, https://apps.irs.gov/app/freeFile

Frequently Asked Questions about State and Local Tax

Local and state taxes are not the same. Local taxes are paid to the local government and state taxes are paid to the state government.

State and local taxes are taxes imposed by a state, county, or municipality to raise revenue to fund public services such as education, trash collection, etc.

By supporting local businesses and local people.

State and local taxes are progressive.

Yes. They help fund local and state economies.

Final State and Local Tax Quiz

Question

What are state and local taxes?

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Answer

State and local taxes are taxes imposed by a state, county, or municipality to raise revenue to fund public services such as education, trash collection, etc.

Show question

Question

State and local taxes, sometimes assisted by federal grants, fund services administered and regulated at ________ level. 

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Answer

the state 

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Question

What is the most significant expenditure funded primarily by state and local taxes?

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Answer

The most significant expenditure funded primarily by state and local taxes is public education, which includes PK-12 public schools, community colleges, and public universities. 

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Question

____ taxes fund hospital expenditures, road construction, and a strong majority of social welfare spending.

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Answer

State

Show question

Question

____ taxes are the majority funding for PK-12 public education, fire protection, and law enforcement.

Show answer

Answer

Local

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Question

The tax burden across the United States is relatively similar; otherwise, individuals and businesses would be incentivized to move to different locations to enjoy lower taxes.   

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Answer

True

Show question

Question

Are taxes paid to local and state government deductible?

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Answer

Yes

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Question

What are some of the taxes local governments impose?

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Answer

Local governments impose sales taxes, property taxes, income taxes, and various fees for services.

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Question

Which cities are more likely to have higher sales taxes?

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Answer

Cities with faster growth rates and higher demands for new infrastructure are more likely to have higher sales taxes

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Question

Why fast growing cities are likely to have higher taxes?

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Answer

To fund specific government projects, such as the construction of new roads or city facilities.

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Question

What's the use of state and local taxes?

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Answer

State sales taxes, property taxes, and income taxes are used to fund state agencies

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Question

Why does the spending by states vary?

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Answer

Spending by states varies based on how government services are broken down between state and local authorities. 

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Question

State spending may also be necessary to provide government services in rural counties and cities with low-income tax bases, as their revenues may be insufficient to support schools and infrastructure.


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Answer

True

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Question

Give an example of state taxes that local governments do not have.

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Answer

Fuel taxes

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Question

Many states also have tax credits similar to those offered by the federal government, including an earned income tax credit meant to boost the income of low-wage earners.

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Answer

True

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