A Summer’s Swim through the Unexpectedly Murky Waters of Local Government Finance

Camping, bicycling, catching up on reading, Netflix, and HBO’s Game of Thrones. These are the ways a normal person my age spends their summers. I spent my summer at the Platte Institute slogging through the last eight years’ worth of Nebraska’s county budgets in search of insight about why Nebraska finds itself on a list of only six states that still tax inheritances.

In my summer’s voyage through the unexpectedly murky waters of local government, I learned two lessons, the first of which surprised me.

Lesson One: So Much for Transparency in Local Government

For two months, I spent the better portion of my 40 hour weeks incessantly copying entry after entry of information on county taxes into Excel spreadsheets. The data I sought was not particularly obscure: In each county I was basically looking for the total tax revenue, total revenue from just the inheritance tax, and how much of this inheritance tax money they spend every year.

In most counties, the first figure was unavailable in any straightforward manner. Although a few counties presented their total tax revenue conveniently in one of the first pages of their annual budgets, most counties in most years apparently did not deem how much total they collected in taxes an important enough figure to even calculate anywhere in the budget. Instead, I rummaged through each page marked “revenue,” looking for lines that said “tax” in them, and added them up manually to determine that year’s total tax revenue.

If I were a normal person, as I am clearly not, I would likely have just given up at the point that my county treasurer told me over the phone (as several did) that the meticulous process of looking through long, often non-searchable PDFs for four to six entries and adding them together was the best way to figure out how much my county collected in taxes.

Relatively speaking, the other evidence I needed was easy to find. Easy in that I could usually find the relevant information in predictable places on the budgets. They were still in long, non-searchable PDFs, and in seven counties, the information just wasn’t there in at least one year.

While local government transparency wasn’t what I set out to investigate, the inconsistent, counterintuitive way Nebraska’s counties present their budgets was hard to miss. As it turns out, Nebraska is one of the few states that doesn’t require its local governments to conform to generally accepted accounting principles (also known as GAAP) in their financial reporting. If Nebraskans want transparency in county government, the Legislature needs to take action to ensure counties use GAAP in financial statements – the first lesson, and the one I didn’t expect, from my foray into county accounts.

Lesson Two: The Inheritance Tax’s Unintended Consequences

It is true that inheritance taxes generate revenue. However, after its use proliferated in the late nineteenth and early twentieth century, many economists became skeptical of how effective the inheritance tax really was in collecting revenue. Because it is dependent upon the random timing of death, inheritance taxes cannot provide a consistent, predictable stream of revenue. Governments need to have both consistency and predictability in their revenue sources in order to meet regular obligations.

True to the predictions, Nebraska’s inheritance tax revenue varied by 74 percent in the average county. That means if a county gets an average of $500,000 in inheritance tax revenue annually, they can expect anywhere between $100,000 and $900,000. That level of unpredictability makes it difficult for county governments to spend in a consistent, responsible way. Instead, the random spurts of revenue are saved in inheritance tax funds and disbursed all at once on special projects. According to my conversations with Nebraska county treasurers, the majority of the expenditures from the inheritance tax funds cover shortages in roads funding, but if counties require more roads funding, the inheritance tax’s unreliability makes it a less attractive option for revenue.

Out-migration and falling entrepreneurship are also unintended consequences of the tax. All taxes change incentives. We know this because when we want to punish a behavior, like smoking, without banning it, we tax it heavily. With the inheritance tax, the goal isn’t to change the behavior of retirees to encourage them to move elsewhere or avoid moving to Nebraska, but that is nonetheless a consequence of inheritance taxes.

Retirees may take their wealth and demand for local goods and services to other states. All of Nebraska’s neighbors but Iowa have no inheritance tax, and Iowa’s is lower and has more forgiving brackets. Moving to Iowa isn’t a tough decision for retirees anyway, as its cities frequently rank among the best for retirees, but with Nebraska’s senior citizens goes wealth and demand for local goods and services that employ many Nebraskans.

Similarly, a study from the U.S. Treasury indicated that inheritances frequently provide an important source of cash for young entrepreneurs. By taxing inheritances, Nebraska may adversely affect entrepreneurship in the state.

Incentivizing senior citizens to leave and take their consumption spending and liquidity for young entrepreneurs with them seems like a high price to pay for the questionable budgetary benefits of the inheritance tax. My upcoming study of the inheritance tax will include a number of reform options, but the most attractive one may be to devolve the question to counties themselves. If counties feel they need the revenue, the local officials can make the case to their voters, and the voters can take the issue to the ballot. Alternatively, efforts to phase the inheritance tax out over a period of many years and broaden other tax bases will replace an unreliable form of revenue with more consistent ones.

Although it at times felt futile, my dive into the swamp of local government finance yielded both experience and data that will help Nebraska and its counties rethink how they handle their funds. For more transparent local governments, the Unicameral needs to adopt GAAP standards for financial reporting. For better funded local governments and a more growth-friendly economy, Nebraska should turn the reins over to counties on the inheritance tax.

Posted by: Albert Gustafson

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