This series will breakdown two major factors to consider when evaluating taxes in your community: (1) revenue adequacy and (2) equity.  Each of these factors will be discussed in separate posts. An appreciation of these factors can help local government decision makers better understand what tax structure is most prudent for a given community.

Revenue Adequacy

Revenue Adequacy considers the growth potential of a given tax and its ability to support general government function. Taxes differ in their growth potential. Some tax revenues are more prone to economic conditions than others, thus making revenues derived from these taxes more volatile. Many taxes have a limited tax base or have a rate that’s capped by law that reduce a tax’s ability to raise revenues.

The two predominant taxes local governments levy in PA are the property tax and the earned income tax. In terms of revenue adequacy, earned income taxes have a greater potentially for growth with job gains and wage growth during economic booms and are prone to rapid decline in recessions. In contrast, property tax revenues have less growth potential as property values remain relatively stable and do not change as drastically due to economic cycles.

The realty transfer tax is an example of tax that has revenue adequacy limitations due to a limited tax base and rate that’s capped by statute. The realty transfer tax base is effectively the value of properties sold in your municipality. While this number may change due to real estate market conditions, administrators cannot plan on market conditions and sale volume being consistently favorable. In addition, the realty transfer tax rate is capped by statute at 1 percent and subject to sharing with your school district. This limited base and restricted rate affect the revenue adequacy of the realty transfer tax.

A key to assembling a responsible revenue plan to support your municipal operations is akin to investing for retirement: diversification. It’s a good idea to have a mix of taxes—covering different tax bases, some more prone to economic cycles with higher growth potential, and others more stable and steady—to mitigate overall risk to municipal revenue flows.