J.

OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 16(3), 413-423 FALL 2004

THE FISCAL IMPACT OF ECONOMIC GROWTH AND

DEVELOPMENT ON LOCAL GOVERNMENT REVENUE
CAPACITY
John D. Wong*

ABSTRACT. The focus of this article is to examine the relationship between

local economic growth and development and local government revenue
capacity. A model is established to determine the relationship between the
number of agricultural, manufacturing, service, and retail establishments per
capita and employees per capita on real local government property tax capacity
per capita. High property tax levies are highly negatively correlated with tax
capacity. Population density, the general price level, and the presence of local
retail sales taxes also play a role in determining tax capacity. New business
creation in the service industry does appear to have a positive impact on local
government tax capacity, while increases in agricultural, manufacturing, and
retail activity do not. Although increasing concentration in the number of
service establishments has a positive impact on tax capacity, increasing
concentration in the number of service workers alone does not seem to lead to
increases in tax capacity.

INTRODUCTION
The fiscal impact of growth and development on communities has
become a major issue because many areas across the U.S. experienced
substantial growth. Many growing communities have been faced with
the prospect of financing growth and development related infrastructure
such as off-site streets and waste-water treatment facilities. Concern
about the fiscal effect of growth is best evidenced by the rapidly
increasing trend to adopt impact fees. One lingering question is: Does
------------------
* John D. Wong, JD, Ph.D., is Associate Professor, Hugo Wall School of Urban
and Public Affairs, Wichita State University. His teaching and research interests
are in the areas of public sector and urban economics, local government
planning and economic development, and revenue forecasting and budgeting.

Copyright 2004 by PrAcademics Press

414 WONG

economic growth and development necessarily increase overall local

government revenue capacity? The focus of this paper is to examine the
relationship between local economic growth and development and local
government revenue capacity. Specifically, a model is established to
determine the relationship between the number and proportion of
agricultural, manufacturing, service, and retail establishments per capita
and employees per capita on real local government property tax capacity
per capita.
According to Burchell and Listokin (1992) the fiscal impact of
growth and development varies depending on the types of land use
involved. Land uses that impose an above average demand on local
government services such as education, public safety, recreation and
social services have a negative fiscal impact, while land uses that impose
a below average demand on local government services will have a
positive fiscal impact.
Differences in economic growth and development outcomes among
communities are reinforced by local political boundaries which are
seldom coterminous with economic demarcations. The economic status
of residents, labor force composition, and size and functions of local
government are reflected in governmental boundaries (Danielson &
Wolpert, 1992). Since local governments bundle differing packages of
public goods and services, some of which may be amenable to certain
economic activities and hostile toward others, economic growth and
development policies both explicitly and implicitly encourage certain
economic activities while discouraging others.

TRADITIONAL FISCAL IMPACT ANALYSIS

Traditional fiscal impact analyses focuses on determining the service
demands imposed on local governments by economic growth and
development and the assignment of costs to these demands. These
projected expenditures are usually determined with reference to a
standardized per unit parameter such as per household, per employee, or
per square foot. Likewise, revenue contributions are typically projected
by merely multiplying the estimated increase in the relevant revenue base
by the appropriate rate. Unfortunately, fiscal impact analyses seldom
measure the effects of growth and development by investigating actual
service demands imposed, the marginal costs of meeting those demands,
and the actual revenue contributions generated to meet those demands.
IMPACT OF ECONOMIC GROWTH AND DEVELOPMENT ON LOCAL GOVERNMENT REVENUE 415

Therefore, the validity of traditional fiscal impact analyses is heavily

dependent upon the validity of the initial underlying assumptions upon
which it was based.
Specifically, traditional fiscal impact analyses do not reflect
interactions among competing land uses as economic growth and
development occurs. For example, a residential development is usually
assumed to have a negative fiscal impact because of the increased
demand for public schools. However, this may be offset by increases in
business activity which may produce a positive fiscal impact via
increased sales tax collections and increased property tax collection
resulting from increased property values. On the other hand, a new
industrial development is usually rationalized as generating a positive
fiscal impact because of the increased tax base created. But this may be
offset by increased demand for local government services demanded by
the accompanying influx of new employees. As such, traditional fiscal
impact studies are not able to distinguish between whether growth and
development simply drives up the cost of public service provision or
whether it increases the revenue capacity per capita by increasing the per
capita tax base.

DATA
Data were obtained for all 105 Kansas counties for the years 1981
through 1997. Data beyond 1997 were not used because the U.S. Bureau
of Economic Analysis Data ceased reporting some industry data on a
Standard Industrial Classification (SIC) basis and began reporting the
data on a North American Industry Classification System (NAICS) basis
making some of the data series not directly comparable. Data on tax
capacity and county property tax rates were obtained from the Statistical
Report of Property Assessment and Taxation compiled by the Kansas
Department of Revenue. Data on population were obtained from the
U.S. Census Bureau. Data on personal income were obtained from U.S.
Bureau of Economic Analysis. Data on county land area were obtained
from Geography of Kansas Syllabus and Atlas. Data on the number of
agricultural, manufacturing, service, and retail establishments and
employees were obtained from County Business Patterns. Data on city
and county local sales taxes were obtained from Kansas Department of
Revenue Annual Reports. Data on city classifications were obtained
from the Kansas Statistical Abstract.
416 WONG

MODELS
The focus of this model is to determine the relationship between the
number of per capita agricultural, manufacturing, service, and retail
establishments and employees, respectively, and real per capita local
government property tax capacity. Tax capacity is defined as:
TAX CAPACITY = ACTUAL TAX BASE * AVERAGE TAX RATE
In other words, property tax capacity represents the amount of property
tax that would be generated by a jurisdiction if it taxed at a rate equal to
the average property tax rate for all jurisdictions being compared
(Musgrave & Musgrave, 1989). Since business growth and development
increases the level of employment per capita, these variables should
serve as an indicator of the fiscal impact of growth and development on
local government tax capacity. The rationale for per capita comparisons
is that real tax capacity is highly dependent upon population. Because
diversity is the rule rather than the exception among local governments,
it is problematic at best to directly compare tax capacity levels of
different jurisdictions. Thus, it is helpful to standardize tax capacity data
from different jurisdictions because of differences in their sizes and
characteristics. One common method of standardization is to compare
the data on a per capita basis, for example, dividing tax capacity by the
local population. Although it would be expected that real tax capacity in
a highly populated jurisdiction would be greater than that of a thinly
populated jurisdiction, this should not be interpreted to mean that less
populated jurisdictions are necessarily poorer than more heavily
populated ones. Other factors that may distort inter-jurisdictional
comparisons include: (1) differing proportions of resources allocated to
the private versus public sectors, (2) differences in resource costs, (3)
differences in environmental factors, and (4) differences in the demand
for services. Despite employing per capita standardization, differences
in tax capacity can remain which do not reflect variations in the actual
ability to tax. For example, an areas economic base is defined as those
economic activities whose growth and development account for the
area's economic advancement. Other activities which sustain as opposed
to advance the local economy are referred to as non-basic. Basic
activities are those activities which generate output which is exported
from the area. The proportion the local economy dedicated to basic
activities determines the economic prosperity of the area. Differential
community growth in tax base, employment, and population are in part
accounted for by income differences (Danielson & Wolpert, 1992).
IMPACT OF ECONOMIC GROWTH AND DEVELOPMENT ON LOCAL GOVERNMENT REVENUE 417

If traditional notions of economic growth and development are

correct, increases in the per capita number of businesses and per capita
employment should have a positive impact on per capita tax capacity.
Typically, economic growth entails increases in existing economic
activity, while economic development involves a diversification of
economic activity. As such, there is likely to be a differential impact
depending on whether the increased activity is generated by agricultural,
manufacturing, service, or retail enterprises (Fik, Amey & Malecki,
1991).
Because the data set was comprised of time-series and cross-
sectional data, a pooled two-stage least squares (2SLS) with a serial
correlation correction approach was used. A simultaneous-equations
model is appropriate when the dependent variable in one equation is also
an explanatory variable in another equation. Endogenous variables are
jointly determined through interaction with other variables within the
system of related equations. Exogenous variables affect the result of the
endogenous variables, but their values are determined by factors outside
the model. There is one structural equation for each endogenous variable
in the system. 2SLS involves regressing each endogenous variable on all
the exogenous variables of the system then using the predicted values of
the endogenous variables to estimate the structural parameters of the
model. 2SLS estimation involves the application of ordinary least
squares (OLS) in two stages. In the first stage, each endogenous variable
is regressed on all the exogenous variables in the system. In the second
stage, the predicted values of the endogenous variables are used to
estimate the structural parameters of the model. The predicted values of
the endogenous variables are uncorrelated with the error terms, resulting
in consistent structural parameter estimates for the model (Judge et al.,
1985).
Because tax capacity is the product of the county tax base multiplied
by the average statewide tax rate, there is possibility of interdependence
between real per capita tax capacity and the average county property tax
rate. In the first stage, the property tax rate was estimated employing all
exogenous variables in the system. In the second stage, two-2SLS
equations were estimated using real per capita property tax capacity as
the dependent variable, one used the per capita number of establishments
in each industry, respectively, as explanatory variable; while the other
equation used the per capita number or employees in each industry,
respectively, as the explanatory variables.
418 WONG

The first model examines the influence of the property tax rate and
the number of agricultural establishments per capita, manufacturing
establishments per capita, service establishments per capita, and retail
establishments per capita, and a set of control variables on real per capita
tax capacity. All of the explanatory variables were estimated in double-
log form to minimize the potential effect of heteroscedasticity (Judge et
al., 1985). Because the coefficient on the property tax variable is
estimated in log-linear form, the coefficient may be interpreted as an
elasticity estimate, i.e., the percentage change in tax capacity resulting
from a one percent increase in the property tax rate.
Model 1:
ln(CAPACITY) = f[ln(RATE), ln(PAGEST), ln(PMGEST),
ln(PSVEST), ln(PRTEST), ln(POPDEN),
ln(INCOME), ln(PRICE),(COUNTY),(CITY),
(BORDER),(LARGE)]
Where:
ln(CAPACITY): Natural logarithm of real per capita tax capacity
ln(RATE): Natural logarithm of average county property tax rate
ln(AGEST): Natural logarithm of the number of agricultural establishments
per capita in county
ln(MGEST): Natural logarithm of the number of manufacturing
establishments per capita
ln(SVEST): Natural logarithm of the number of service establishments per
capita
ln(RTEST): Natural logarithm of the number of retail establishments per
capita
ln(POPDEN): Natural logarithm of county population density
ln(INCOME): Natural logarithm of county real per capita personal income
ln(PRICE): Natural logarithm of Implicit Price Deflator for Personal
Consumption Expenditures
COUNTY: Dummy variable indicating the presence of a county local option
retail sales tax
CITY: Dummy variable indicating the presence of a city local option retail
sales tax
BORDER: Dummy variable indicating the location of a county along the state
border
LARGE: Dummy variable indicating the presence of a large city within the
county.
The average county property tax rate would be expected to be
negatively related to tax capacity since the demand for taxable property
would be expected to decrease with higher tax rates. Population density
IMPACT OF ECONOMIC GROWTH AND DEVELOPMENT ON LOCAL GOVERNMENT REVENUE 419

would be expected to be negatively related to tax capacity since more

densely populated urban areas tend to have a disproportionate share of
low value properties. Real per capita personal income would be
expected to be positively related to tax capacity since the demand for
taxable property would be expected to increase with income. The
general price level would be expected to be negatively related to tax
capacity since the demand for taxable property would be expected to
decrease with increases in the price level. The presence of county or city
local option sales taxes would be expected to be negatively related to tax
capacity since the presence of sales taxes would be expected to decrease
the demand for purchases in the jurisdiction and, hence, reduce the
demand for taxable properties. The location of a county on a state border
would be expected to be positively related to tax capacity to the extent
that the bordering state has higher property tax rates since the demand for
taxable property would be expected to increase with the tax differential.
Finally, the presence of a large city in the county would be expected to
be positively related to tax capacity since large cities are more likely
have high-value properties.
Likewise, the second model examines the influence of the property
tax rate and the number of agricultural employees per capita,
manufacturing employees per capita, service employees per capita, and
retail employees per capita, and a set of control variables on real per
capita tax capacity. Model 2 differs from Model 1 in that per capita
levels of employment in the specific industries are used instead of the
number of establishments as explanatory variables.
Model 2:
ln(CAPACITY) = f[ln(RATE), ln(PAGEMP), ln(PMGEMP),
ln(PSVEMP), ln(PRTEMP), ln(POPDEN),
ln(INCOME), ln(PRICE),(COUNTY),(CITY),
(BORDER),(LARGE)]
Where:
ln(CAPACITY): Natural logarithm of real per capita tax capacity
ln(RATE): Natural logarithm of average county property tax rate
ln(AGEMP): Natural logarithm of the number of agricultural employees per
capita in county
ln(MGEMP): Natural logarithm of the number of manufacturing employees
per capita
ln(SVEMP): Natural logarithm of the number of service employees per capita
ln(RTEMP): Natural logarithm of the number of retail employees per capita
420 WONG

ln(POPDEN): Natural logarithm of county population density

ln(INCOME): Natural logarithm of county real per capita personal income
ln(PRICE): Natural logarithm of Implicit Price Deflator for Personal
Consumption Expenditures
COUNTY: Dummy variable indicating the presence of a county local option
retail sales tax
CITY: Dummy variable indicating the presence of a city local option retail
sales tax
BORDER: Dummy variable indicating the location of a county along the state
border
LARGE: Dummy variable indicating the presence of a large city within the
county.

RESULTS
Parameter estimates, standard errors, t-statistics, and P-values can be
found in Tables 1 and 2. In both equations, the coefficient for the
property tax rate is negative and significant as predicted. Also the
coefficient estimates for the control variables of population density, per
capita personal income level, and general price level all possess the
postulated signs and are statistically significant or nearly significant. The
coefficient estimates for the dummy variables indicating the presence of
a county and/or city retail sales tax, location along the state border, and
the presence of a large city also possess the postulated signs and are
statistically significant or nearly significant.
In Table 1, the coefficients for per capita service establishments and
per capita retail establishments are positive, while the coefficients for per
capita agricultural establishments and manufacturing establishments are
negative. This indicates that higher concentrations of service and retail
establishments tend to increase tax capacity, while higher concentrations
of agricultural and manufacturing establishments tend to decrease tax
capacity. However, only the parameter estimate for the number of
service establishments per capita is statistically significant. This
indicates that only service establishments have a positive impact on the
local tax base. This is not entirely surprising given the increasing
importance of the service industry to most economies. The fact that the
parameter estimate for manufacturing establishments per capita is not
statistically significant indicates that the increased presence of
manufacturing establishments does not increase local tax capacity. This
finding may be related to the common practice of many local
IMPACT OF ECONOMIC GROWTH AND DEVELOPMENT ON LOCAL GOVERNMENT REVENUE 421

TABLE 1
Dependent Variable: ln(TAXCAP)
Estimated
Variable Coefficient
Standard t-statistic P-value
Error
Constant 15.3149 0.8126 18.8468 [0.000]
ln(RATE) -2.4978 0.1313 -19.0254 [0.000]
ln(AGEST) -0.0022 0.0033 -0.6447 [0.519]
ln(MGEST) -0.0009 0.0043 -0.2116 [0.832]
ln(SVEST) 0.1610 0.0612 2.6304 [0.009]
ln(RTEST) 0.0231 0.0572 0.4045 [0.686]
ln(POPDEN) -0.1691 0.0237 -7.1465 [0.000]
ln(INCOME) 0.1888 0.1008 1.8728 [0.061]
ln(PRICE) 0.9150 0.1468 6.2345 [0.000]
COUNTY -0.1171 0.0347 -3.3769 [0.001]
CITY -0.0449 0.0381 -1.1803 [0.238]
BORDER 0.0632 0.0368 1.7188 [0.086]
LARGE 0.0911 0.0663 1.3738 [0.170]
R-squared = 0.721580, Adjusted R-squared = 0.719692

communities granting tax concessions as inducements for manufacturing

establishments to locate in the area. If this is the case, then an increasing
concentration of manufacturing establishments may not signal an
expected increase in tax capacity.
In Table 2, the coefficients for per capita manufacturing employment
and per capita retail employment are positive, while the coefficients for
per capita agricultural employment and service employment are negative.
This indicates that higher concentrations of manufacturing and retail
workers tend to increase tax capacity, while higher concentrations of
agricultural and service workers tend to decrease tax capacity. However,
none of the parameter estimates are statistically significant. This
indicates that increasing employment concentration in these sectors does
not have a positive impact on the local tax base.
While the results from Models 1 and 2 are consistent with the
general economic trend for economic activity to be concentrated in the
service sectors, this runs counter to the temptation for many communities
to attempt to attract large manufacturing establishments and the
accompanying jobs.
422 WONG

TABLE 2
Dependent Variable: LTAXCAP
Estimated
Variable Coefficient Standard t-statistic P-value
Error
C 13.4484 0.6543 20.5553 [0.000]
ln(RATE) -2.4903 0.1367 -18.2202 [0.000]
ln(AGEMP) -0.0015 0.0031 -0.4831 [0.629]
ln(MGEMP) 0.0001 0.0039 0.0294 [0.977]
ln(SVEMP) -0.0219 0.0354 -0.6174 [0.537]
ln(RTEMP) 0.0019 0.0402 0.0464 [0.963]
ln(POPDEN) -0.1777 0.0236 -7.5351 [0.000]
ln(INCOME) 0.2539 0.0984 2.5803 [0.010]
ln(PRICE) 1.0771 0.1472 7.3193 [0.000]
COUNTY -0.1120 0.0352 -3.1808 [0.001]
CITY -0.0580 0.0389 -1.4933 [0.135]
BORDER 0.0660 0.0379 1.7407 [0.082]
LARGE 0.1272 0.0684 1.8616 [0.063]
R-squared = 0.7221, Adjusted R-squared = 0.7202

CONCLUSIONS
The most important factor affecting local government tax capacity in
Kansas is discretionary. Specifically, high property tax levies are highly
negatively correlated with tax capacity. Population density and the
general price level also play a role in determining tax capacity.
Interestingly, population density is negatively related to tax capacity,
while the general price level is positively related.
In Kansas, counties with high tax capacities tend to have a high
number of service establishments. From this it may be concluded that
economic growth and development do in fact produce an increase in
local government revenue capacity. However, the impact is not generic
across business and employment sectors. New business creation in the
service sector does appear to have a positive impact on local government
tax capacity, while increases in agricultural, manufacturing, and retail
activity do not. Based on these findings it appears that communities are
not well served in offering large manufacturing concerns financial
incentives to locate a facility in the area. Although increases in service
industry activity have a positive impact on tax capacity, increasingly
IMPACT OF ECONOMIC GROWTH AND DEVELOPMENT ON LOCAL GOVERNMENT REVENUE 423

large concentrations of economic activity in the service sectors do not

necessarily lead to increases in tax capacity.

REFERENCES
Burchell, R. W., & Listokin, D. (1992). Fiscal Impact Procedures State
of the Art. New Brunswick, NJ: Center for Urban Policy Research,
Rutgers-the State University.
Danielson, M. N., & Wolpert, J. (1992). "Rapid Metropolitan Growth
and Community Disparities." Growth and Change, 23 (4): 494-515.
Fik, T. J., Amey, R.G., & Malecki, E.J. (1991). "Changing Employment
Profiles and Growth: An Economic Base Study of Florida Counties
(1982-1987). Growth and Change, 22 (3): 86-104.
Judge, G. G., Griffiths, W.E., Hill, Carter, R., Lutkepohl, H., & Lee, T-
C. (1985). Theory and Practice of Econometrics (2nd ed.). New
York: John Wiley and Sons.
Musgrave, R. A., & Musgrave, P. B. (1989). Public Finance in Theory
and Practice (5th ed.). New York, McGraw-Hill.