Property taxes, tax-cost illusion and desired education expenditures

The extensive tax-cost illusion found in the Marshall survey is interesting both in terms of its magnitude and the direction of its impact. Counter to the common view that tax illusion will result in higher expenditures, there appears to be at least one case where the overestimation of tax cost has the potential of leading to lower expenditure levels. The major factor leading to the systematic overstatement of cost appears to be that individuals do not consider the federal income tax deduction and the state income tax credit when assessing net property tax cost. However, even the differences between perceived costs and actual costs gross of the income tax breaks are large. Given that this is true for local education expenditures financed by an earmarked tax, one must question whether other government expenditures financed by far more complicated tax schemes might not be subject to much greater illusion. An implication of the current analysis is that tax illusion may not only result in a misallocation of resources between the public and private sectors but within the public sector as well. Such a case can result from the use of alternative taxes having differing degrees of illusion to finance different collective goods and services. Even though the degree of cost misperception in the Marshall survey is great, the apparent effect on citizens' desired education expenditure levels is not large as a result of the very small price elasticity of demand. Actually, one might argue that the degree of misperception observed is a result of this small elasticity; citizens not placing much importance on price as a determinant of demand would have little incentive to acquire accurate cost information. However, countering such an argument is the fact that such information is a joint product to the individual because the property tax is used to finance a number of locally provided goods and services. Some of these apparently have larger price elasticities, providing a greater incentive to acquire correct information and leading to greater differences in desired expenditures resulting from any misperception of cost. The current analysis focused on the misperceptions of citizens concerning the costs of property tax rate proposals rather than their misperceptions of the tax-prices of public education expenditures (i.e., the cost of increasing per pupil expenditures by one dollar). However, as seen in equation (8), the marginal tax-price, P i , depends upon both the cost to a citizen of an FR i ≡ the marginal federal income tax rate if one itemizes, zero otherwise; SR i ≡ the proportion of an additional dollar in property taxes that can be credited against state income tax liability; AV i ≡ the assessed value of property owned by the taxpayer; PUP ≡ the number of pupils in the school district; AV ≡ the total assessed value of property in the school district; Z ≡ the rate at which marginal changes in local tax revenues collected for public education are matched by state aid. increase in the property tax rate, α, and the property tax rate increase needed to finance a one dollar increase in per pupil expenditures, β. Even though the above empirical analysis does not consider citizens' perceptions of β, the observed misperceptions concerning α does bring into question whether citizens correctly calculate β. Many citizens' perceptions of α and β probably err in the same direction; the citizen who does not understand the impact of the income tax breaks on α most likely does not understand the impact of the matching state aid formula on β. A priori, one might think that misperceptions of β would be relatively larger than misperceptions of α, due to an information cost differential. While the annual filing of income and property tax returns provide information concerning the structure of and variable values in α, information concerning the structure of and variable values in β, being only available in public sources, are more costly to obtain. Citizens may never have seen a state aid formula, much less know how it changes from year to year. Intergovernmental grants can greatly affect citizens' tax-prices and, as a result, local expenditures. Of course, the latter effect depends upon the perceptions of citizens concerning the former effect. Questions concerning how citizens' perceptions of local spending tax-prices are affected by matching grants remains unanswered. Such questions deserve the attention of researchers. Similarly, the tax illusion found in Marshall underscores the need for more general research relating to the existence and impact of tax illusion. Finally, a number of current U.S. Personal Income Tax reform proposals include the elimination of the deduction for local taxes in the U.S tax code. An important question is how such a change would affect citizens' demands for local public services and local levels of public provision. The above analysis indicates that the resulting substantial changes in actual tax-prices may have less of an effect on expenditure levels than what one might otherwise think; if citizens do not understand how the current deduction affects their tax-prices, it is not clear why the elimination of the deduction should have an effect on their perceived prices. Copyright Martinus Nijhoff Publishers 1986