Future shock for tax systems.

Is the New Global Economy Leaving State Local Tax Structures Behind? by Thomas W. Bonnett, the National League of Cities, the National Conference of State Legislatures and the National Governor's Association, 1998, 80 pages.

Talk about irony. Now that states are enjoying their strongest economies and fiscal conditions in nearly a decade, it turns out that technological growth and development have the potential to undermine state and local finances in the long haul. This new study, sponsored by NCSL, the National Governors' Association and the National League of Cities, examines how current trends in the national and global economies are threatening almost every assumption about how to pay for state and local government services. This shouldn't be written off as more of the normal grumbling and foreboding of fiscal analysts, always a gloomy lot. State and local governments are in an unprecedented situation, due to changing economic, demographic and political climates.

The situation springs from the remarkable transformation of the national and global economies, the aging of the industrial world's population and the communications revolution. Consider how many significant changes are occurring simultaneously in our world and how they can affect public finances:

* The transformation to a service economy Although manufacturing output continues to grow in the United States, production of services grows much faster. The share of manufacturing jobs in the United States dropped from 35 percent in 1946 to 16 percent in 1996, while service jobs jumped from 11 percent to 28 percent of payroll employment. Production of services now accounts for about two-thirds of American gross domestic product. As consumption of services outstrips that of goods, state and local sales tax bases suffer, since services are largely exempt. Equally significant is in the way that goods-producing industries bear a relatively heavier burden of property taxes than service industries because the manufacturers' investments in plant and inventory represent so much more of their assets.

* Electronic commerce The Internet provides the potential for retail sales to shift away from local merchants to electronic commerce, further undermining sales tax bases. Mail order has long been recognized as a threat to sales tax because of the restrictions on states' power to require out-of-state vendors to collect sales or use taxes. Electronic commerce makes interstate or international sales easier, and tax collection even harder.

* Mobility of businesses Electronic communications and improved transportation, the mobility of capital and the focus on services make it increasingly possible for firms to locate wherever they find favorable tax treatment. The notion of location of a business is increasingly vague as firms contract for goods and services around the world. This raises a two-pronged threat - jobs can disappear overnight, and governments are tempted to adopt whatever tax policies may induce businesses to come to them.

* Deregulation of the telecommunications and electric industries Increased competition in these businesses will force revision of state and local tax policy as industry-specific taxes become impractical. Tax liabilities will shift, and some local governments are likely to face especially difficult financial adjustments.

* An older population The aging of the American population raises a number of public finance issues besides the well-known ones of Social Security and Medicare finance. The tax advantages most states give people over 65 will become more expensive as a larger proportion of the population receives them, accentuating issues of generational equity. Consumption patterns among the elderly tend to shift toward services, away from taxed goods, increasing the problems that will afflict sales tax collections.

* Federal tax reform A national sales tax or a flat national income tax would force substantial change and conformity on state taxes. A national sales tax would crowd out state taxes and force states to abandon income taxes as we know them. A lack of federal income tax reporting would make administration of existing state personal and corporate income taxes difficult or impossible.

Individually, any of these items would be cause for concern. Coming at states together, they pose significant issues, whose impact is hidden for the time being by the remarkable performance of the national economy. State and local tax bases remain attuned to the American economy of a generation ago. Despite its growth, it was far more stable than the current economy, whose rapid changes will force policymakers to be far more innovative than ever before in trying to maintain the revenue base for the services necessary to a modern economy.

For more information call NCSL's Scott Mackey, [phone]; NLC's Frank Shafroth [phone]; or NGA's Tim Masanz, [phone]. For a copy of the book, call NLC's publication sales office, [phone].