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Is South Dakota's state revenue system "balanced and moderate."?

Tax discussions take up a great deal of time and energy. Governor Mickelson appointed two tax commissions (one that served for two years) to study tax reform. Taxes are often a major issue in the State Legislature, and are much discussed and debated by newspaper editors and people who write to them.

On November 3, South Dakotans will vote on a measure designed to change the state's tax structure. If passed, "The Property and Sales Tax Relief Act" would impose a personal income tax of 2 percent on the first $20,000 of South Dakotans' federal taxable income, 4 percent on the next $20,000, and 6 percent on federal taxable income above $40,000. It would also impose a corporation income tax on "net income," at the same rates and income brackets. Revenues would fund the exemption of food, utilities, and clothing from the sales tax, and a 20 percent property tax credit. Any remaining funds would be earmarked for school districts. The income tax and the sales tax exemptions would take effect at the beginning of 1993; the first property tax credits would apply to 1993 taxes payable in 1994. (Citizens for Property and Sales Tax Relief)

The one constant in tax reform discussions is disagreement. The protagonists disagree on what constitutes tax reform and even on what a good tax system looks like. Tax reform, like beauty, is in the eye of the beholder. If we can't agree on what a good tax system looks like, we aren't likely to agree on whether a new style is downright handsome, just plain ugly, or somewhere in between.

Because these are often deep-seated philosophical disagreements, the debate will never be definitively settled. Nevertheless, some light might be cast, and heat--not to mention hot air--avoided, if we could at least identify some reasonable, commonly-accepted criteria for judging tax structures. In this paper, we will try to add some order to the tax reform debate by comparing South Dakota's tax structure to criteria proposed by recognized authorities on the subject. We will begin with criteria proposed by two students of state and local taxation, then use relevant data to show how well South Dakota does or does not measure up to each criterion.

The criteria used here were proposed by Robert J. Kleine and John Shannon in an article entitled "Characteristics of a Balanced and Moderate State-Local Revenue System," published by the National Conference of State Legislatures. (Kleine and Shannon 1986) (Henceforth, Kleine and Shannon will be referred to as KS). KS say that

The ideal state-local revenue system places heavy emphasis on three values--balance (revenue diversification), tax fairness (shielding low-income households from the tax collector's reach), and moderation (tax rates and trends in revenue growth that do not deviate too far from the average). (KS 1986, 32)

KS propose "seven general guidelines" for testing the degree to which a state's revenue system satisfies these three values. We will now examine each guideline in turn.

"Revenue Diversification"

The state-local revenue system should be marked by revenue diversification--fairly equal reliance on the big three (income, property, and sales taxes), with user charges and 'all other' revenue sources rounding out this picture. (KS 1986, 33)

More specifically, KS say that each of the "big three" should account for 20 - 30 percent of state and local tax revenue. (KS 1986, 36, 39, 42) South Dakota does not meet this criterion. Property tax accounts for 40 percent of the state's total state and local tax revenue; general sales tax (state and local) accounts for 33 percent; corporation income tax on banking and financial institutions make up 3 percent, and all other taxes account for the remaining 24 percent. (U.S. Department of Commerce 1991, Table 29) (Unless otherwise noted, all tax data in this paper are for fiscal year 1989-90, the latest year for which comprehensive data are available.) South Dakota does not have an individual income tax or general corporation income tax. Only six states (including Montana, Nebraska, and Wyoming), get a larger share of their tax revenues from the property tax. (Ibid.)

If proponents' estimates of the effects of the Property and Sales Tax Relief Act are accurate, income taxes would account for about 20 percent of South Dakota state and local taxes, sales tax for about 25 percent, and property tax about 30 percent, after the changes had taken full effect. (These are extremely rough estimates, meant only to give a general idea of the proposal's effects. Using these estimates does not imply agreement with the proposal or the estimates.)

South Dakota's relatively heavy reliance on the property tax can be seen in another way. South Dakota's average effective property tax rate for farmland was .87 percent of market value in 1990, 13th highest in the nation and 12 percent above the national average. (U.S. Department of Agriculture, Economic Research Service.) This is down substantially from 1.41 percent in 1987, reflecting rising farmland values and the property tax freeze. The 1987 average effective property tax rate for single-family homes was 2.17 percent of market value, third in the nation and nearly twice the national average. (ACIR 1989, Table 33) This figure is unfortunately not available for later years, but has probably also fallen during that time. (This author knows of no consistent data for comparing effective property tax rates on commercial and industrial property.)

The Advisory Commission on Intergovernmental Relations (ACIR) provides yet another measure of a state's relative dependence on particular taxes. "Tax capacity" is the revenue a state would collect if it used a tax at the same rate as do all 50 states. South Dakota's property tax capacity, for example, is the amount of taxes South Dakota local governments would collect if the statewide average property tax rate equalled the average property tax rate levied by state and local governments in all 50 states. South Dakota's per capita property tax capacity was 77 percent of the national average in 1988 (latest year for which tax capacity data are available), showing the state's property tax base to be relatively low.

"Tax effort" gives actual state and local tax revenues as a percent of tax capacity. A state whose tax rate equals the national average would have a tax effort of 100. South Dakota's 1988 property tax effort was 129 percent of its tax capacity, showing that the state depends on property taxes much more than do most states. (ACIR 1990, 56)

South Dakota's 4 percent state sales tax rate is relatively low compared to rates in other states. As of October 1991, 33 states had rates above 4 percent, the highest being 7 percent, and three states had lower rates. Five have no general sales tax. (ACIR 1992, Table 31) However, South Dakota's dependence on the sales tax is heavier than its rate alone indicates, because of its very broad sales tax base (discussed in detail under the second general guideline) and use by local governments.

Local governments depend on the sales tax more heavily in South Dakota than in most states. The sales tax accounts for 16 percent of South Dakota local governments' tax revenues, but only 11 percent of tax revenues of local governments in all states taken together. (U.S. Department of Commerce 1991, Table 29) (For this paper, "all states" or "50 states" includes the District of Columbia.) South Dakota's "combined state and local sales tax rate" is estimated to have been 5.16 percent in 1987, compared to a national average of 5.89 percent. (Joulfaian and Mackie 1992, 90)

Tax capacity and effort provide a comprehensive single measure of the overall sales tax burden, since they include the effects of rate differences, local use of the sales tax, and the more comprehensive tax base. South Dakota's sales tax capacity per capita is 87 percent of the national average; its sales tax effort is 127 percent of sales tax capacity.

KS recognize one exception to their revenue diversification principle:

Only those states that have an above-average ability to export their taxes to nonresidents are in a position to ignore this revenue diversification prescription. (KS 1986, p. 33)

Taxes are exported when someone living outside the state bears the burden. For example, if a firm can pass a tax on to customers by raising its prices, the tax is exported to the extent customers live outside the state (e.g., tourists or purchasers of manufactured goods shipped out-of-state). If a firm cannot raise prices (for example, because of competition from out-of-state sellers), the owners may bear the burden as lower profits. In that case, the tax on a locally-owned firm is not exported, but the tax on a widely-held corporation is exported to stockholders around the nation (or world). Thus, taxes on widely-held corporations selling in a multi-state market will be exported to a greater degree than will taxes on locally-owned businesses selling locally.

State and local taxes are exported to the federal government when they reduce federal corporate or individual income tax liability. An individual taxpayer who itemizes deductions and is in a 28 percent tax bracket reduces his/her federal tax liability by $280 for every $1,000 in property or income (but not sales) tax. Businesses (corporate and non-corporate) deduct state and local taxes as a business expense, reducing their federal liability.

Only about 29 percent of individual income taxpayers itemize deductions nationally (15 percent in South Dakota), and individuals can no longer itemize sales taxes. (U.S. Department of the Treasury, 1992, 86, 107) However, businesses deduct all taxes as business expenses. Thus, business taxes account for proportionately more of the federal offset than do taxes on individuals.

Tax exporting depends on states' economic endowments, over which they often have limited control. States export a larger share of their taxes if they have many out-of-state tourists, large amounts of energy-related minerals (since regulators let utilities pass severance taxes along to customers), and/or many large corporations.

As Table 1 indicates, most states with no individual income tax have some special characteristic giving them "an above-average ability to export their taxes to nonresidents," thus fitting KS's exception. Nevada and Florida export to tourists; Alaska, Texas, and Wyoming rely heavily on energy mineral taxes. Washington and South Dakota, however, do not enjoy such special opportunities for tax exporting.

Of the states with no sales tax, Alaska and Montana rely heavily on severance taxes. Delaware is the home of many corporations, and taxes them heavily. New Hampshire and Oregon do not seem to fit KS's exception.

Among these states, South Dakota truly stands out. Its economic structure does not provide special tax exporting opportunities. By eschewing individual and corporate income taxes, it passes up its best opportunities for tax exporting. Only one state exports a smaller share of its taxes onto non-residents and only two export a smaller share onto the federal government. Taking these together, South Dakota is last (and less than half the U.S. average) in tax exporting. Only one other state (West Virginia) has an exporting rate below 10 percent.

Tax exporting rates have no doubt changed since 1980, but this author knows of no estimates more recent than these. Economic conditions and tax structures have changed in the last ten years, but probably not enough to dramatically change exporting onto citizens of other states. It is even less likely to have dramatically affected relative exporting rates among states. Lower federal marginal income tax rates (both corporate and individual) probably reduced the federal offset more for higher income states than for lower income states. Removing the individual itemized deduction for TABULAR DATA OMITTED sales tax reduced the federal offset more for states that depend more heavily on the sales tax. It is impossible to know which of these factors dominated, but it seems safe to presume that relative tax exporting rates probably did not change substantially; if South Dakota's exporting rate is not still 50th, it is surely still relatively low.

"Revenue Stability and Moderation"

To stabilize revenue flows, it is necessary to go beyond revenue diversification. For many states, there is also the need to broaden both sales and income tax bases and to scale down tax rates. (KS 1986, 34)

South Dakota's sales tax base is one of the broadest in the nation. South Dakota taxes food and consumer utility bills, each of which is exempted by 25 of the 45 states with sales taxes. Of surrounding states, only Wyoming taxes food; Nebraska and Wyoming tax consumer utilities. Montana has no state sales tax. (ACIR 1992, Table 29)

South Dakota is one of three states with "general" taxation of services other than utilities, the broadest category; Iowa has "broad" taxation of services, Minnesota and Wyoming "substantial;" other adjoining states tax few if any services. (Mikesell 1991, 45) In a ranking based on the 1986 sales tax base as a percent of gross state product, South Dakota ranked sixth nationally. (Mikesell 1992, 51) In a ranking based on the number of services taxed by each state, South Dakota ranked fifth. (Graeser 1990, 7, 9) Both rankings placed South Dakota first in the region.

South Dakota taxes more business inputs than do many states. It is one of the 21 states (of 45 with sales taxes) that do not exempt machinery and equipment. Of adjoining states, only Iowa exempts machinery and equipment. (Mikesell 1992, 51) South Dakota is one of 30 states to exempt only ingredients physically incorporated in a new product being manufactured; 14 states (including Minnesota) exempt not only ingredients, but also other inputs used directly in manufacturing. (ACIR 1992, Table 29)

The chances of achieving a tolerable degree of revenue stability are greatly improved if state-local revenues increase at about the same clip as the economy of a state. (KS 1986, 34)

South Dakota personal income is probably the best available measure of changes in the state's economy. As Table 2 shows, South Dakota personal income (not adjusted for inflation) grew at an 8.2 percent average annual rate between 1963 and 1980, 6.2 percent between 1980 and 1990. During the same times, state and local own-source revenue (taxes plus charges, fees, and miscellaneous income such as interest receipts) grew faster than personal income. State and local taxes together, however, grew more slowly than personal income in 1963-80, slightly more rapidly in 1980-90. The earlier period saw more rapid growth in state taxes (dominated by the sales tax), slower growth in local taxes (dominated by the property tax). During the latter period, state taxes and local taxes grew at about the same rate.


All these changes include the effects of higher tax rates, base broadening (such as adding many services to the sales tax base in 1979), and economic growth. If the sales tax rate had not doubled (one percentage point increases in 1965 and 1969) and excise tax rates also increased several times, taxes (and thus own-source revenues) would have grown much more slowly. As Table 2 shows, taxable sales (which includes the effects of base broadening and economic growth, but not of higher tax rates) grew less rapidly than did personal income in all periods shown.

Heavy reliance on the property tax is a major factor in slow growth in local taxes; property taxes grew by only 5.8 percent per year between 1963 and 1990. Rapid increases in local sales taxes helped support local tax growth, in large part because many municipalities adopted local sales taxes, especially during the 1980's.

"Tax Fairness"

Although state officials should avoid highly progressive (Robin Hood-type) tax policies, they should not close their eyes to the need to shield subsistence income from the reach of state and local tax collectors. They can do this by

(a) tax circuit-breaker plans, (b) credits...or exemption from the sales tax for the purchase of food, and (c) making sure that families below the poverty line are not required to pay a state income tax. (KS 1986, 34)

"Circuit-breakers"--now existing in about 35 states--are designed to reduce the property tax burden on lower-income taxpayers. The income limits vary by state. South Dakota's sliding scale circuit-breaker (i.e., the amount of tax refund is lower for homeowners with higher incomes) is limited to single homeowners with incomes below $9,000 and multi-member households with incomes below $12.000. For comparison, the 1991 federal poverty line was about $6,500 for single persons 65 years and over, $8,200 for two-member families with an aged head, and $13,900 for a four-member family. (A program enacted in 1992 would have provided a credit of approximately 3.7 percent of all property tax bills up to $3,000, with no income restrictions. The South Dakota Supreme Court recently declared it unconstitutional. |South Dakota Codified Laws 10-13-11 to 10-13-19; Woster 1992, 1A~)

About 20 states (including Montana) limit circuit breakers to elderly homeowners and renters. Another ten (including Iowa, South Dakota, North Dakota, and Wyoming) include disabled homeowners and renters, as well as the elderly. Seven states (including Minnesota)include homeowners and renters of all ages. (ACIR 1992, Table 40)

South Dakota taxes food but provides a sales tax refund for elderly or disabled persons, with the same age and income restrictions as for the circuit breaker. (ACIR 1992, Table 41. Descriptions here generally refer to 1991 laws.)

"From an equity standpoint, relief should be based on income, not age." (KS 1986, 45) If the goal is "to shield subsistence income from the reach of state and local tax collectors," there is little reason to exclude younger poor persons. An estimated 21,127 South Dakota families had incomes below federal poverty levels in 1989. (U.S. Department of Commerce 1992, Table 9) This figure does not include individuals living alone, so it is only a partial measure of poverty in South Dakota. In fiscal year 1989, 4,232 circuit breaker or sales tax refunds were paid. With more lenient guidelines, the number of refunds rose to 6,869 in FY 1991. (South Dakota Department of Revenue 1991, 35)

For fiscal year 1991, the average refund was $145.58, about 94 percent of which were sales tax refunds. (ACIR 1992, Table 41) With a state sales tax rate of 4 percent, this is equivalent to $3,640 in taxed purchases. By contrast, people with incomes below $10,000 averaged roughly $5,170 in 1988-89 for purchases subject to South Dakota's sales tax. (National average, calculated by the author from U.S. Department of Labor 1991, Table 28.)

KS suggest that states should also exempt medicine and utilities from the sales tax and should "tax most services." (KS 1986, 40) South Dakota exempts prescription drugs, as do all but two other states, but taxes household utilities and most services. "One weakness of an across-the-board exemption is that high-income as well as low-income persons receive the benefit, making it very expensive." (Ibid.) Exempting food would cut South Dakota's sales tax base by about 11 percent; exempting residential utilities would probably take around 4 percent. (Governor's Advisory Commission on Taxation 1988, 433, 435) In fiscal year 1991, such a 15 percent cut would have meant about $40 million less state government revenue.

Several studies show that South Dakota does not "shield subsistence income from the reach of state and local tax collectors." In a comprehensive study of all 50 states, Phares found South Dakota's overall tax structure (i.e., state and local taxes) to be relatively regressive. Compared to other states, South Dakota ranked 23rd to 45th (ranking from most progressive to most regressive), depending on the index used. (1986, 81; 1980, 143) A more recent study of South Dakota and the six surrounding states that used generally the same methodology as Phares used, found South Dakota's tax structure in 1985 to be the most regressive in the region and significantly more regressive than a composite of all 50 states. (For discussion of this study, see Governor's Commission on Tax Fairness and Government Cost Effectiveness 1989, Chapter 6. The comparison to other states was presented to the Commission, but is not in the report.)

Other studies have produced the same general results. One ranks South Dakota and Wyoming in the ten "states with the highest taxes on poor and middle-income families compared to taxes on the richest one percent." It also finds South Dakota (with Nebraska) among the ten "states with the highest taxes on the poor" and (with Wyoming) among the ten "states with the lowest taxes on the rich." (McIntyre, et. al. 1991, 3, 5)

Every study of this sort suffers from shortcomings, especially the absence of data and other information needed for the best conceivable study. Critics also can object to particular assumptions upon which a study is based. Findings are not precise and must be treated with caution. Studies based on "ideal" (but, alas, unavailable) data might find less regressivity. However, relative distributions found under ideal conditions would probably be similar to what is found with available data. Sales and property taxes are almost certain to be more regressive than an individual income tax that specifically and directly exempts poor people through standard deductions and personal exemptions. Choosing to rely heavily on more regressive taxes and eschew a tax that can target its relief precisely at people with lower incomes can only result in a more regressive tax system.

"State Fiscal Equalization"

The state should be the senior partner in the state-local fiscal system. More specifically, the state should assume (a) at least 50 percent of the cost of 'spillover' programs such as education, health, and hospitals, and (b) complete financial responsibility for the nonfederal share of public welfare. If the state prefers a more decentralized fiscal approach, it can share, unconditionally, a substantial part of its revenues with its localities on an equalizing basis. (KS 1986, 34)

For the 50 states together, in 1988-89 state governments provided 48 percent of elementary and secondary schools' revenues, local sources accounted for 46 percent, and the federal government provided 6 percent. In South Dakota, state sources accounted for 25 percent of elementary and secondary education, far below KS's 50 percent criterion. Local school districts provided 63 percent and the federal government provided the remaining 12 percent. Only two state governments, including Nebraska's, provide a smaller share of support for local schools. (U.S. Department of Education 1991, 148)

South Dakota state government increased its share of local school funding from 9 percent in 1959-60 to 27 percent in 1986-87. (ACIR 1991, 244) The state's share probably rose again after 1988-89, due to the property tax freeze.

Considering only the amounts provided by state and local governments (i.e., non-federal sources), state government provided about 29 percent in South Dakota, but state governments provided about 51 percent in all the states together. All adjoining states, except Nebraska, provided over half of non-federal revenues to local schools. (U.S. Department of Education 1991, 148)

South Dakota state government exceeds KS's 50 percent goal for health and hospitals, accounting for 80 percent of total state and local spending for this function. Nationally, state governments account for 48 percent of health and hospital spending. (U.S. Department of Commerce 1991, Table 29) South Dakota state government provides nearly all funding for public welfare, but requires counties to provide medical care for indigents.

KS advocate the state's "senior partner" status "to guard against a local property tax overload." (KS 1986, 34) As discussed above, South Dakota's effective property tax rates are higher than rates in most other states, and only six states rely more heavily on the property tax. It appears that South Dakota state government's failure to assume greater responsibility for local school funding contributes to this situation, since local schools account for the lion's share of local property taxes. South Dakota school districts levied 64 percent of total local property taxes; among the 50 states, school districts accounted for 43 percent of local property taxes. (U.S. Department of Commerce 1991, Table 29)

Compared to other states, South Dakota provides relatively little state aid to its local governments. State aid (of all kinds) to local governments accounted for 20 percent of South Dakota state government direct general spending; nationally, it accounted for 52 percent of state spending. From the recipient's perspective, state aid provided 23 percent of South Dakota's local governments' general revenue; nationally, it provided 34 percent of local governments' general revenue. (Ibid.)

"Political Accountability"

To ensure that tax increases are the product of overt legislative action and not the hidden consequence of inflation, state personal income taxes should be indexed for inflation....

By the same token, a "truth-in-property-taxation" safeguard is also necessary to make sure that political responsibility for a property tax increase is focused squarely on the local legislative body and not on the assessor..."

The first part of this guideline does not apply to South Dakota. "Truth-in-property-taxation" laws establish a "baseline" property tax rate, usually the rate that would produce the same amount of property tax revenue as was collected the previous year. Thus, the baseline takes account of any changes in property assessments. Before the local legislative body (city council, county commission, school board) can exceed the baseline, it must hold a public, widely advertised hearing, then pass a special ordinance or resolution to exceed the baseline.

Thirteen states have such provisions. Most require recorded, roll call votes, so voters can readily identify the elected officials who voted to exceed the baseline rate. Many also set precise instructions on the size, composition, and location of meeting notices (e.g., they cannot be in the classified advertising or legal notices section of the newspaper). (Fisher 1988, 124)

Taxpayers worry that their property taxes will rise if assessments rise. That need not occur, however, if local officials reduce tax rates proportionately. Truth-in-taxation provisions "direct political responsibility for any property tax increase to the local governing body...and away from either the local assessor or state officials." (Advisory Commission on Intergovernmental Relations 1977, 14) At the same time, these provisions leave local elected officials free to raise property taxes if they are convinced their constituents want the added spending. In short, they provide accountability and flexibility--both characteristics of a good federal system.

"Property Tax Equity"

The central objective of state property tax policy should be to create an administrative and professional environment that will promote a fairly high degree of assessment uniformity, both within and between local assessment jurisdictions. The closer the state can push local assessment levels to full value, the more equitable the tax system. (KS 1986, 35)

KS say that "property should be assessed on average at no less than 80 percent of full market value (100 percent is the ideal)." (KS 1986, 45) South Dakota's assessments of non-agricultural property statewide averaged 75-80 percent of market value in 1988-91; average assessments of agricultural land exceeded 80 percent of market value in 1987 and 1988, but were just below 70 percent in 1989-91. Based on 1990-91 sales, the agricultural land assessment ratio was 67.6 percent and the non-agricultural ratio was 77.6 percent. Countywide averages in 1991 ranged from 77 percent to 115 perecent for non-agricultural property and 46 percent to 97 percent for agricultural land. (South Dakota Department of Revenue, South Dakota Assessment and Sales Information, various years.)

KS believe that "the property tax will not likely be viewed as fair if there is a wide variation in assessment ratios among classes of property and if the tax is riddled with exemptions." South Dakota Department of Revenue's studies show lower assessment ratios for agricultural land than for residential property in almost every county. (Ibid.) This relationship has endured for many years, except in 1987-88, when farmland values fell more rapidly than assessments. The relationship between residential and commercial properties is less clear and requires more study, but cursory examination indicates that commercial property may be assessed higher relative to market value than is residential property.

The coefficient of dispersion is the standard statistical measure of "variation in assessment ratios." "The larger this number, the less uniform the assessment system." (KS 1986, 47) According to South Dakota's annual report on property assessment, "there seems to be some general acceptance of the notion, when all properties in a jurisdiction are concerned, that 20 percent is the absolutely outside tolerable figure; that 15 percent can be achieved if there is a genuine excellence in the assessment product." (U.S. Department of Revenue, South Dakota Assessment and Sales Information, 1992, 9-10.) However, countywide figures show very few cases where the coefficient of dispersion falls below even the more lenient guideline.

South Dakota law, under provisions adopted in 1989 and 1990, requires counties to assess property at 85 - 100 percent of true value and to have coefficients of dispersion of 30 percent or less. Beginning in 1993, a county that violates either of these rules for two successive years will have half its personal property tax replacement placed in escrow. If the county fails to correct the violation the next year, it will lose the escrowed funds. Beginning in 1994, the criteria are tightened to 90 - 100 percent assessment ratios and 25 percent coefficients of dispersion. (South Dakota Codified Laws, 10-6-33.8 to 10-6-33.10) If these efforts succeed, South Dakota's assessment quality should improve dramatically during the next year or two.

"Tax Competitivenes"

"...a bad business climate is...marked by the appearance of several features--a relatively heavy tax burden; highly progressive tax policies; no provision for property tax exemptions for inventories, machinery, and equipment; no sales tax exemption for industrial machinery; the use of worldwide apportionment; a classified property tax and above-average rates for unemployment insurance and workers compensation." (KS 1986, 35)

Many of these features were discussed above and only require brief review and comment. South Dakota's overall tax burden, depending on the measure used, is relatively low to about average for the 50 states. South Dakota state and local taxes per capita in 1990 were 72 percent of the 50-state average, ranking the state 47th. Taxes as a percent of personal income were 87 percent of the 50-state average, ranking the state 43rd. (U.S. Department of Commerce 1991, 105, 101) The state's overall tax capacity per capita was 78 percent of the national average in 1988; its tax effort was 95 percent of tax capacity. (ACIR 1990, 32) Comparing South Dakota and the six surrounding states, it ranks last in taxes per capita, taxes relative to personal income, and tax capacity per capita, and 5th in tax effort. (Same sources as above.)

As discussed under "Tax Fairness," South Dakota's tax policies are regressive, not "highly progressive."

South Dakota exempts all personal property from the property tax. Since inventories and much machinery and equipment are personal property, they are not subject to property taxation. Some machinery and equipment are classified as real property and thus subject to taxation. However, counties or municipalities can allow full or partial property tax exemptions for up to five years to "new industrial or commercial structures, or additions to existing structures" with a value of at least $30,000. (South Dakota Codified Laws, 10-6-35.1 to 10-6-35.4)

As discussed under "Revenue Stability and Moderation," South Dakota's sales tax is one of the most comprehensive in the nation. It includes manufacturing equipment, other equipment, and many other business inputs exempted by many other states. "Worldwide apportionment" applies to state corporate income taxes, so it is not an issue for South Dakota.

South Dakota has relatively few property tax classifications. Agricultural land is assessed according to its use, rather than market value, and is subject to lower school district tax rates. Agricultural structures are also given preferential treatment. (South Dakota Codified Laws, 10-6-33.1, 10-4-13.1) As mentioned above, new commercial or industrial property can be given favorable treatment for five years.

As promoters of economic development like to point out, South Dakota has relatively low rates for unemployment insurance and workers compensation. In 1990, it was one of five states with the lowest statewide average unemployment insurance tax as a percent of all wages. That rate (0.3 percent) was less than half the 50-state average. (U.S. Congress, House, 1991, 476-77) For workers compensation, the average weekly premium cost per worker was $6.60 in South Dakota, well below the median rate of $7.93. (Thompson 1992, 25)

Summary and Conclusions

This paper examines South Dakota's tax structure in terms of seven proposed "Characteristics of a Balanced and Moderate State-Local Revenue System." Like all states, South Dakota meets some criteria more closely than others.

Absence of a state personal income tax and a general corporation income tax is a very significant--perhaps the most significant--characteristic of South Dakota's tax system, one with several ramifications. Without these revenue sources, which provide 26 percent of state and local taxes for the 50 states taken together, South Dakota state and local governments must spend less than do governments in most other states, or rely more heavily on other revenue sources. They do both.

State and local spending per capita was 84 percent of the 50-state average in 1990. Of major spending functions, South Dakota government spending per capita was above national averages only for transportation. (U.S. Department of Commerce 1991, Table 30)

South Dakota's average effective property tax rates (by various measures) are among the nation's highest. While the state sales tax rate is relatively low, the tax base is one of the most comprehensive. Comprehensive base plus wide use by municipalities equals heavy dependence on the sales tax. In comparing what the state actually collects to what it would collect if it used each tax to the same degree as do all 50 states, we find that South Dakota's property and sales tax burdens are over 25 percent higher than national averages. Property and sales taxes each account for over 30 percent of total state and local taxes. In sum, South Dakota's tax structure does not satisfy KS's "Revenue Diversification" criterion.

The state's broad sales tax and relatively low rate meets the "Revenue Stability and Moderation" criterion. KS also prefer that tax revenues grow at about the same rate as the state's economy. Because property and sales tax bases tend to grow less rapidly than a state's economy, governments that use them must either accept spending that grows less rapidly than the economy, or periodically raise tax rates, broaden bases, or find new sources (such as gambling revenue). South Dakota's state and local taxes grew more slowly than personal income during the 1960s and 1970s and slightly faster than personal income during the 1980s. Local taxes lagged during the earlier period, but slightly outpaced the economy in the 1980s, at least partially because of wider use of local sales taxes. State taxes grew much faster than personal income during the 1960s and 1970s (when the sales tax rate doubled), slightly faster than personal income in the 1980s (when several excise tax rates were raised). The sales tax base lagged behind economic growth in both periods, despite base broadening.

The state's revenue structure also fails the "Tax Fairness" test. Because sales and property taxes are generally more regressive than personal income taxes, South Dakota has one of the nation's more regressive tax structures. South Dakota's property tax circuit breaker and sales tax credit direct tax relief to lower income elderly and disabled persons, but not to other poor persons. Average refunds are relatively low and reach a small proportion of the state's poor. More generous programs with only income restrictions could probably "shield subsistence income from the reach of state and local tax collectors."

South Dakota state government assumes a very large share of funding for health, hospitals, and welfare programs. It leaves funding of elementary and secondary education (the single largest component of state and local government spending) to local revenue sources to a much greater degree than do most other states. Compared to other states, South Dakota state aid (of all kinds) to local governments is quite small--as a share of state spending and as a share of local revenue.

Given South Dakota's heavy reliance on the property tax, it is no surprise that property tax administration receives considerable attention. State average assessments relative to market values are close to KS's minimum criterion, although the average masks considerable variation across the state. As recently-passed laws take effect, assessment quality should improve. Adopting a truth-in-property-taxation provision might help hold down property taxes, or at least hold local governing bodies more accountable.

Of all criteria examined, South Dakota perhaps comes closest to "Tax Competitiveness." The overall tax burden is quite low, and not highly progressive--in fact quite the opposite. Inventories are exempt from property taxation, and unemployment insurance and worker's compensation rates are low. Some machinery and equipment are exempt from the property tax, but all are subject to sales tax. Precisely how all these factors affect business competitiveness is not clear. Do low overall taxes mean low business taxes? Do high property taxes and few sales tax exemptions mean that businesses pay more property and sales taxes in South Dakota than in other states? If so, are these more than offset by low worker's compensation and unemployment insurance and the absence of income taxes? The "bottom line" on these questions awaits further study.

Would adopting personal and/or corporation income taxes move the state toward KS's "balanced and moderate system"? Personal income taxes tend to grow at least as rapidly as a state's economy, often more rapidly, helping tax responsiveness. Personal exemptions and standard deductions direct tax relief more precisely at lower income persons, shielding subsistence incomes. More state revenue could mean more state aid and less dependence on local funds, making the state more of a "senior partner," and evening out reliance on the major taxes. It might also fund sales tax exemptions for machinery and equipment, and for food and utilities, adding to competitiveness and fairness.

South Dakotans will continue to debate tax questions with vigor, emotion, and sometimes bias. We also need information and as much objectivity as possible. We will never resolve--finally and conclusively--what a good tax system looks like, but whatever we decide will affect us all well into the next century.


Advisory Commission on Intergovernmental Relations. 1977. State Limitations on Local Taxes and Expenditures. Washington, D.C.: GPO.

Advisory Commission on Intergovernmental Relations. 1989. Significant Features of Fiscal Federalism, 1989, Volume 1. Washington, D.C.: GPO.

Advisory Commission on Intergovernmental Relations. 1990. 1988 State Fiscal Capacity. Washington, D.C.: GPO.

Advisory Commission on Intergovernmental Relations. 1991. Significant Features of Fiscal Federalism, 1991, Volume 2. Washington, D.C.: GPO.

Advisory Commission on Intergovernmental Relations. 1992. Significant Features of Fiscal Federalism, 1992, Volume 1. Washington, D.C.: GPO.

Citizens for Property and Sales Tax Relief. 1992. Initiative Petition and miscellaneous information.

Fisher, Ronald C. 1988. State and Local Public Finance. Glenview, Illinois: Scott, Foresman and Company.

Governor's Advisory Commission on Taxation. 1988. South Dakota Taxation and Expenditure Structures. Pierre: Executive Office.

Governor's Commission on Tax Fairness and Government Cost Effectiveness. 1989. Tax Reform Plan--Part 1. Pierre: Executive Office.

Graeser, Laird. 1990. Sales Taxation of Services: A Taxonomy and Ranking of the States. Washington, D.C.: Federation of Tax Administrators. Photocopied.

Joulfaian, David and Mackie, James. 1992. Sales taxes, investment, and the Tax Reform Act of 1986. National Tax Journal XLV (March): 89-105.

Kleine, Robert J. and Shannon, John. 1986. Characteristics of a balanced and moderate state-local revenue system. In Reforming State Tax Systems, ed. Steven D. Gold, 31-54. Denver, Colorado: National Conference of State Legislatures.

McIntyre, Robert S., et. al. 1991. A Far Cry from Fair. Washington, D.C.: Citizens for Tax Justice.

Mikesell, John L. 1991. Sales tax coverage for services--policy for a changing economy. Journal of State Taxation IX (Spring): 31-50.

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Author:Ring, J. Raymond
Publication:South Dakota Business Review
Date:Sep 1, 1992
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