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a n e c o n o m ic re v ie w b y th e F e d e ra l R e s e r v e B a n k o f C h ica g o Paying for government spending Banking developments june 1973 Paying for government spending 3 The combined spending o f federal, state, and local govern ments totaled $382 billion in 1972. The sources that supply government revenues have changed dramatically over time as all governments have sought more efficient ways to shoulder their growing responsibilities. Banking developments 13 Subscriptions to Business Conditions are available to the public free of charge. For information concerning bulk mailings, address inquiries to Research Department, Federal Reserve Bank of Chicago, P. O. Box 834, Chicago, Illinois 60690. Articles may be reprinted provided source is credited. Please provide the bank’s Research Department with a copy of any material in which an article is reprinted. Business Conditions, June 1973 3 Paying for government spending The combined spending of all levels of government in the United States totaled $382 billion in 1972. This spending level equaled one-third of our gross national product, and was larger than the GNP of Japan, the second largest economy in the free world. All but $16 billion of the total spent was raised by taxes and other charges levied on individuals and businesses. Government spending and compara ble revenue collections on this large scale are modern phenomena. Total government spending in the late nineteenth century was about 8 percent of gross national product. This general level of spending persisted through the early part of the twentieth cen tury, except during World War I. In 1929, total government spending was just over $10 billion, 10 percent of gross national product, and was supported by $11 billion in revenue. But beginning with the Depres sion, the scope of government activities has broadened continuously. Both spending and revenue were about 30 times larger in 1972 than they were in 1929. Had the growth of govern ment spending merely kept pace with the growth of the economy, revenue require ments would have increased only one-third as much as they actually have. But the lion’s share of the growth has gone for ac tivities once considered outside the sphere of governments and for dramatic increases in the scope of activities traditionally as signed to governments. In 1972, the revenues collected for the social security program alone were nearly as large as the total revenues of all levels of government in 1946. The cost of operating state-supported colleges and uni versities last year was twice as large as the total revenues of all state governments in 1946. State transfers of funds to local gov ernments—over half for education—were four times the am ount local governments collected from all sources in 1946. Prior to the changes which began with the Depression, government spending meant largely local government spending, and taxes meant payments to local govern ment. In 1929, local governments ac counted for almost 60 percent of all gov ernment spending, the federal government for just over one-quarter of the total, and state governments for less than 15 percent. In 1972, state governments were still the smallest spenders, although their share had climbed slightly, to 17 percent. The big change was in the relative position of the federal and local governments. Federal spending was well over half the total, while the local share had dropped to about onequarter. The changes in the size of total spending were also accompanied by a dras tic revision in ways that revenues were raised. In 1929, when state and local rev enues dominated the scene, property taxes were the largest single source of all govern ment revenue by far, raising almost 42 per cent of the total. Corporate income taxes were in second place, closely followed by personal income taxes, each contributing about 12 percent of the total. In 1972, re flecting both the dominant position of the federal government and the changes that had occurred in the scope of government activities, the personal income tax was the number one source of revenues, contri buting nearly one-third of the total. Contri butions for social insurance, which had been number ten on the list in 1929, held second place, contributing about 20 per cent of the total. Property taxes had Federal Reserve Bank of Chicago 4 dropped to third place, contributing about 12 percent, and corporate income taxes had dropped to num ber four. In the February 1973 issue of Busi ness Conditions, the article “ Growth of government spending” traced the major patterns of government spending using the data in the National Income and Product Accounts. This article looks at the other side of the coin—the sources of the rev enues collected by governments to pay for their spending. The grand totals Revenues have been hard-pressed to keep pace with the growth in government spending that has occurred since 1929. When spending is growing, the nature of the legislative process virtually guarantees that enactment of new taxes will lag spend ing, keeping constant pressures on rev enues. Nevertheless, revenues have grown rapidly enough to pay for over 90 percent of total expenditures in the 44-year period. Only during World War II was there a mas sive shortfall. Although tax increases were very large compared to any previous experi ence, the expenditures needed for that war were so large that revenues only covered about half the total spending. The rapid and continuous growth of government revenues has meant that the most recent years have been the biggest contributors to the overall total. From 1929 to 1972, governments collected over $4.5 trillion in revenues. Starting in 1929, it took 26 years to raise the first trillion dollars, but only eight years to collect the next trillion. The most recent trillion dol lars was collected in just three years. While inflation, increased population, and growth of the economy, both in com plexity and output, have contributed to in creasing government expenditures, hence to growing revenues, it is the increase in de mands on government th at has been the dominant factor in expenditure growth. By comparing the level of revenues with the size of the gross national product, which also includes the effects of inflation and population and output growth, it is pos sible to see the extent to which the in creased needs for government action has in fluenced the size of revenues. G o v ern m en t revenues grew from about 11 percent the size of GNP in 1929 to about 32 percent in 1972, with only minor deviations punctuating a steady up ward trend. Even during the early 1930s, when the dollar level of total revenues was declining, the level relative to GNP grew every year as output fell much more rapidly than tax collections. In fact, the year-to-year rise of revenues relative to GNP in 1932 over 1931 was the second largest in the 1929-72 period. The largest year-to-year increase occurred in 1943, when the impact of wartime tax rates was fully effective for the first time. Despite what were considered massive increases at the time—collections jumped from the pre war level of about 18 percent the size of GNP to just under 25 percent—the levels of Personal income taxes are entrenched as the number one revenue source Year Total revenues collected Personal income tax Contributions for social insurance Property taxes (b illio n d o lla rs ) ( p e r c e n t) (ra n k ) (p e r c e n t) (ra n k ) (p e r c e n t) (ran k) 1929 11 11.7 1950 69 26.5 1960 140 1972 366 3 2.2 1 10.0 31.8 1 32.4 1 Corporate income tax General sales tax Miscellaneous taxes (p e r c e n t) (ran k) (p e r c e n t) (ra n k ) (p e r c e n t) (rank 10 41.2 1 11.9 2 0.0 13 5.7 4 10.7 3 25.8 2 2.7 9 8.8 5 14.8 4 11.7 3 16.3 2 3.2 7 7.0 5 20.2 2 12.2 3 11.3 4 5.3 5 4.5 6 5 Business Conditions, June 1973 5 the 1942-46 period were low by today’s standards. Since 1949, revenues have taken a progressively larger share of GNP, and are now approaching one-third of the total. Sharing the pie The developments in government ac tivity that have occurred since 1929 com pletely transformed the historical American relationships between the federal govern ment and state and local governments. Be fore the Depression, education, health, wel fare, high ways, and a vast array of other services were provided by state and local governm ents, particularly local govern ments. These governments were the dom i nant factor not only in providing these ser vices but in collecting the revenues to pay for them. The primary function of the fed eral government was national defense, and the only federal function which touched the daily lives of all citizens was the postal service. In 1929, the U. S. armed services em ployed 255,000 men, a small number not only by today’s standards but also in com parison with the major powers of the time. The federal government’s share of total rev enues was less than one-third of the total collected that year. Moreover, federal rev enues were much more affected by the de cline in business activity during the early years of the Depression than were state and local government collections; by 1932 the federal share had dropped to 20 percent of the total. The advent of the New Deal inau gurated a major change in governmental re sponsibility. This change was the assump tion of the responsibility for public welfare by the federal government. At first, this was accomplished through emergency mea sures aimed at the specific problems of the Depression. But with the enactment of the social security program, income main tenance became a permanent responsibility of the federal government. Agricultural programs and federal funding of public works programs also date from this period. As a result of these new and shifted respon sibilities, federal revenue requirements were nearly 50 percent of the total on the eve of World War II. The increased responsibilities assumed by the federal government in the area of human resources during the 1930s laid the groundwork for the early 1970s, when these expenditures exceeded defense expenditures for the first time. Another change which significantly increased the revenue needs of the federal government was the nation’s altered de fense posture. With the outbreak of war in Europe in 1939, military expenditures in creased sharply, and taxes jumped. Actual U. S. involvement brought still sharper fed eral tax increases, so that the federal share of total revenue collections reached a peak of 80 percent in 1944. The federal share has been declining slowly but erratically from this abnormally high wartime level. By 1972, the federal share had been lowered to 62 percent of the total. This gradual swing back toward a f all governments Nontax revenue e r c e n t) (ran k) 8.7 4 Gasoline taxes Liquor taxes Estate and gift taxes Tobacco taxes M otor vehicle licenses Customs duties (p e r c e n t) (ra n k ) (p e r c e n t) (ra n k ) (p e r c e n t) (ra n k ) (p e r c e n t) (ra n k ) ( p e r c e n t) (ran k) (p e r c e n t) (ran k) 3.7 8 0.1 12 2.0 11 4.0 7 3.0 Year 9 5.3 6 1929 2.3 10 3.3 7 4.2 6 1.2 11 2.6 8 1.1 12 0.8 13 1950 2.7 9 4.1 6 2.8 8 1.6 11 2.1 10 1.1 12 0.8 13 1960 4.0 7 3.1 8 1.9 9 1.8 10 1.4 11 1.0 12 0.9 13 1972 Federal Reserve Bank of Chicago The federal share of total government revenues has declined from the World W ar II peak percent 100 90 state and local government 80 70 60 federal government 50 40 30 20 - 10 - assistance. From 1939 through 1957, grants-in-aid funded about 10 percent of state and local spending. Since then, they have contributed an ever-growing share, reaching 24 percent in 1972. If state and local governments had collected these taxes directly in 1972, and federal tax collections were reduced by an equivalent am ount, the state and local share of total revenue would have been 48 percent, rather than the actual level of 38 percent, very close to the 50-50 situation that existed immediately prior to World War II. The federal tax base 0 1929 '32 '35 4 0 45 '50 *55 '60 '65 '70 '72 larger share of revenues for state and local governments has resulted despite the fact that the defense establishment has been maintained at levels far above the preWorld War II norm. The postwar period has seen explosive growth in the needs for schools, highways, health facilities, and other government services supplied by state and local governments. Throughout the postwar period, and particularly in the past 15 years, spending by state and local gov ernments has risen much more rapidly than have the revenues they collected directly. The cost of this added spending has been met by funds collected by the federal government, but transferred to state and local treasuries through numerous special grants ranging from specific programs like the Interstate Highway System to the un restricted funds of the revenue sharing pro gram. These transfers of funds, known col lectively as grants-in-aid, have existed for a long time. They were relatively unim por tant prior to the Depression. During the New Deal, grants were used extensively to finance public works projects and direct Today, the federal govern ment relies on three tax sources for almost 90 percent of its toted rev enue. These are, in order of importance, the personal income tax, contributions for social insurance (mainly social security), and the corporate income tax. These three tax sources, combined, have formed the backbone of federal revenues ever since the major World War II tax increases became fully effective in 1943. The distribution of 1972 receipts by source was: Source Percent of total Percent of total adjusted for overwithholding’1 Personal income tax Social insurance Corporate income tax All other receipts 45.3 27.7 15.8 43.5 28.6 16.3 11.2 11.6 The personal income tax has been an im portant source of federal revenue during *1972 personal income tax receipts were about $7 billion higher than they would have been if taxpayers had taken full advantage of the right to adjust their withholding closer to their actual tax liabilities. These overpayments will be re funded in 1973, thereby reducing receipts. The ad justed percentages are derived by assuming that the extra withholding in 1972 had not been col lected. The adjusted shares show what can be ex pected from current tax laws in the future. 7 Business Conditions, June 1973 Three tax sou rces have accounted for over 80 percent of federal revenues for two decades percent I00 all other revenue corporate income tax contributions for social insurance personal income tax I929 '32 '35 4 0 '45 '50 '55 '60 '65 '70 '72 the entire 1929-72 period. The importance of the personal income tax fell sharply dur ing the Depression, not only because of the sharp drop in income, but also because the federal government turned to a host of new taxes during the New Deal period. World War II caused a dramatic turnaround. The personal income tax has been the largest single source of revenue for the federal government since 1943. Contributions to social insurance first b e c a m e im portant in 1937 with the introduction of social security and related payroll taxes. The impact of these new taxes on federal finances was dramatic. For f o u r years, 1937-40, they contributed about one-fourth of total revenues, and were the largest single contributors in the first three of those years. The imposition of w a r t i m e tax c h an g e s relegated contributions to third place. Beginning in 1 9 5 7 , changes in the social security p r o g r a m p r o g r e s s i v e l y increased the importance of revenue from this source. By 1966, it had grown to be the second largest source, and in 1972 supplied nearly 28 percent of total federal revenue. The corporate income tax, like the personal income tax, was a well-established major source of federal revenue in 1929. In that ye a r , it was the largest single source, supplying just over 31 per cent of the total. Its yield and im portance dropped during the 1930s, and then increased sharply with the advent of World War II. It was the s e c o n d la rg e st federal revenue source from 1943 until 1966. How ever, its relative importance has been declining steadily since the end of World War II, not only be cause of the yields of the social se curity system, but also because the long-term growth in corporate prof its has lagged the growth in the economy. The personal income tax Students of tax policy generally ap prove the personal income tax as a revenue measure because of its inherent tendency to relate the tax to the ability to pay and because it has less effect on resource alloca tion than other taxes. From the standpoint of the federal government, however, it has two advantages which have contributed to making it the most im portant revenue source. First, it rests on a very large taxable base. Second, the revenue which it can furnish can be changed by very large amounts through minor changes in the rate structure. The modern income tax was intro duced in 1913. Prior to World War II, the revenue-raising potential of the personal in come tax went largely untapped. Most people were not touched by it because of the large personal exemptions relative to the income structure. The changes in the tax law necessitated by World War II con verted the personal income tax into the 8 broad-based levy it has remained ever since. As a result of this broad application, per sonal income tax revenues went from $1 billion in 1940 to about $16 billion in 1943. Once the revenue-raising capabilities of this tax were fully revealed, the federal government continued to use it not only as its primary source of revenue, but, through frequent adjustments of rates, as a tool for setting total revenue levels. Contributions for social insurance Unlike the personal income tax, which was a major revenue source before 1929, contributions for social insurance first became im portant in 1937, and in 1960 began a trend toward sharply in creased importance. Prior to 1937, the only specific elements in this category were pay ments for the federal employees retirem ent system and veterans life insurance. Unem p loym ent insurance revenues began in 1936, and social security and railroad re tirem ent programs began supplying rev enues in 1937. Since th at time, in addition to the gradual expansion of coverage of social security to more classes of wage earners and increases in the wage levels sub ject to tax, there have been major additions to the total program: railroad unem ploy ment insurance in 1939, coverage of selfemployed persons in 1952, and hospital and medical insurance in 1966. In 1972, contributions to social insurance made up nearly 28 percent of total federal revenue. Recent changes in the social security program which provide for increases in the taxable base income this year and again in 1974, and for further increases in the base in subsequent years, depending on the change in the consumer price index, will raise the share of federal revenue supplied by these contributions above the 30 per cent level in the next few years. It should be noted that benefits paid by the various programs in this category have been nearly as large as the revenue collected yearly, but Federal Reserve Bank of Chicago that the difference has contributed toward paying for other programs. The corporate income tax The corporate income tax has had much the same history as the personal in come tax. Both were imposed during the Civil War and then removed for many years. Tax theorists are far less unanimous about the desirability and economic impact of the corporate tax than they are about the consequences of the personal income tax. It is n ot at all clear whether this tax falls on the buyers of corporate goods and services through higher prices, on workers through lowered wages, or on owners through lower rates of return. Regardless of the actual economic impact of this tax, it has been a substantial contributor to federal revenues throughout the 1929-72 period. In 1929 and again in 1940 through 1942, it was the single largest source of federal revenue, and throughout most of the other years between 1929 and 1966 it was the second largest source of revenue. Nevertheless, its importance has declined steadily since 1965. The corporate tax rate structure is currently at the lowest level since the period immediately after World War II, but the failure of corporate profits to grow as rapidly as the general economy has been a major factor in the decline. When the temporary surcharge was decreased from the 1969 rate of 10 percent to the 1970 effective rate of 2 V2 percent, the share of total revenue contributed by the personal income tax actually rose slightly, while the share from corporate in come taxes fell. Other tax sources Tax sources other than the three major ones have contributed a small but steady share to federal revenue throughout the 1929-72 period. In some instances, these sources made major contributions 9 Business Conditions, June 1973 eral government relied on a wide spectrum during part of the period, particularly prior of tax sources. By 1972, all but three had to World War II. faded into relative unimportance, and a E sta te and gift taxes have con single source, the personal income tax, pro tributed about 2 percent of total federal vided nearly half of total federal revenues. revenues since 1929. Rates were raised In contrast, over 60 percent of all sharply during the New Deal period, and state and local government revenues in for a few years they contributed a much 1929 came from one source, the real estate larger share, reaching nearly 8 percent of tax. In 1972, the importance of the real the total in 1936. estate tax had shrunk to half its 1929 size, Customs duties have been a mainstay of federal revenues. Customs duties con and over two-thirds of state and local rev tributed 15 to 18 percent of total revenues enues came from a wide array of sources. in the 1929-32 period, but their impor Federal receipts from the personal income tance declined steadily thereaftei^-to less tax in 1972 were 100 times as large as they than 1 percent of the total in most years had been in 1929, but state and local re between 1943 and 1964. ceipts from real estate taxes rose only ten Liquor taxes became an im portant times in the same period. revenue source with the repeal of prohibi The growth of state and local rev tion. In 1935, they furnished nearly 12 per enues that occurred between 1929 and 1972 was much slower in gathering mo cent of total revenues. However, neither consumption nor rates have increased sig mentum than was the growth in federal rev enues. During the Depression, it was vir nificantly and they contributed just over 2 tually impossible for state and local govern percent of the total in 1972. ments to increase their revenues, and yields Excise taxes on a wide variety of from existing sources declined appreciably. other products and services have been used To economize, many state and local ser from time to time throughout this 44-year period. During the New Deal, a whole spectrum of excise taxes was Real e state taxes provide a i n t r o d u c e d and later dropped. shrinking share of all sta te These miscellaneous taxes, which and local revenues made up less than 3 percent of fed eral revenues in 1929, swelled to percent 100 nearly 30 percent of the total in 1934 and then faded away. In 1972, the sum of all these other all other revenue taxes still on the books amounted to less than 4 percent of total fed gas and eral revenues. vehicle tax personal in come tax State and local taxes— a broad-based approach The tax structure of state and local governments has developed on lines almost opposite those fol lowed by the federal tax structure during the 1929-72 period. In the early years of the period, the fed general sales tax real estate tax 1929 '32 '35 40 '45 '50 '55 '60 '65 7 0 '72 10 vices were cut back. The federal govern ment picked up the responsibility for pro viding relief to individuals and for public works projects that would have been paid for with local revenues in earlier times. World War II, following on the heels of the Depression, further deterred expan sion of state and local government activi ties. Military needs absorbed both the fiscal and manpower resources which might otherwise have been devoted to expansion of services by state and local governments. But in the postwar period, the need for state and local government services bal looned. Not only was there a need to make up for the unfilled needs accumulated since 1929, but a host of new demands arose. To meet these needs, state and local govern ments have continuously raised tax rates and introduced new taxes to supply the necessary revenues. As a result, 1972 re ceipts were 12 times as large as those of 1945—a growth rate twice th at of federal government receipts. Despite this rapid growth, revenues would have fallen far short of requirements had not federal grants-in-aid provided a major supplement to funds raised by state and local govern ments from their own resources. It must be borne in mind th at aggre gate state and local revenues result from the independent taxing actions of thou sands of individual jurisdictions. The five states served by the Seventh Federal Re serve District contain over 15,000 taxing units. Thus, when a particular tax grows in importance, more taxing units may be using it, the tax rate may be increasing, or both may be occurring at once. Property taxes Property taxes were the basic source of state and local financing throughout the nation’s early history, and still remain the principal, frequently the only, source of revenue for smaller units of government. While most property tax laws cover a wide Federal Reserve Bank of Chicago scope of property types, difficulties in assessment and collection have resulted in real estate being the only property effec tively taxed in most jurisdictions, typically accounting for over 95 percent of property tax revenue. When the nation’s economy was primarily rural, the property tax was a rough substitute for an income tax. As the society was transformed into an urban in dustrial economy, the property tax has be come a use tax, particularly on the use of real estate. No lasting form of taxation has been criticized as severely as the property tax by students of taxation and taxpayers alike. Criticisms range from its inequity due to the problems of obtaining fair and uniform assessment to the fact that there is often no reasonable relationship between the tax paid and the government services received. Nevertheless, this tax has persisted. It is the only tax source available to many small jurisdictions—other sources have been pre empted by the larger units of government, or banned by state constitutional pro visions which are difficult to change. Also, local voters appear reluctant to abandon their direct control over the maximum allowable rates of this major tax. The property tax has largely been abandoned by state governments. State governments received 20 percent of their revenues from property taxes in 1929. By 1971, the most recent year th at compara ble data are available, property taxes sup plied only 2 percent of state collections. Local governments, which were deriving over 75 percent of their revenues from property taxes in 1929, still obtained over 55 percent from that source in 1971. Despite this decline in the importance of property taxes, real estate taxes remain the largest single revenue source for the aggre gate of all state and local governments. While the property tax as a share of total revenues collected has declined steadily from 61 percent in 1929 to 31 percent in 1972, the total dollar am ount collected Business Conditions, June 1973 under this tax has increased yearly since 1942. Growing revenue sources The second largest source of state and local revenues in 1972 was the general sales tax, providing 14.2 percent of the total, almost $20 billion. The general sales tax is relatively modem in origin, and has been used primarily by states, although local use is growing. It was first introduced in 1931, as other revenue sources shrank and state governments actively developed new ones. By 1936, its use was widespread, and by the end of World War II it supplied 7.5 percent of state and local revenues. Sales tax rate increases raised its impor tance to 10 percent of the total in 1948, a level which remained relatively constant until the early 1960s. Since 1963, as a re sult of the introduction of local sales taxes as well as some increases in state rates, the sales tax yield has steadily increased. A nother growing revenue source for state and local governments is the personal income tax. Like the sales tax, this tax has been primarily a state tax, but use by local government has been increasing. Only two or three states used the income tax in 1929, and in the aggregate its importance was small. By 1972, 44 states and hundreds of municipalities were using some form of personal income tax, and it contributed 11 percent of total revenues—the third most im portant tax source to state and local governments. Contributions for social insurance are another revenue source that has grown steadily over the 1929-72 period. For state and local governments, these contributions do not have the broad base of the federal programs. They are the payments govern ment employees make to retirement and re lated insurance plans. However, receipts for these programs, which provided less than 2 percent of 1929 revenues, supplied nearly 8 percent in 1972. 11 The old reliables The variety of special use, license, ex cise, and related taxes used by state and local governments to raise revenues is al most endless. Most of these taxes have grown steadily in dollar amounts from 1929 to 1972, but have either just held their own or lost importance as a share of total revenue over the period. The automobile has created irresis tible demands for expenditures for streets and highways, but, at the same time, has provided substantial revenue from licenses and gasoline taxes. In 1929, vehicle license fees supplied 4.5 percent and gasoline taxes 5.5 percent of total revenue. Their com bined contribution peaked at about 14 per cent in 1949-50. In 1972, the two taxes together supplied about 8 percent of state and local revenues. C orporate income taxes generally were used by state and local governments before personal income taxes. Corporate taxes made their largest contribution to total revenues, 4.7 percent of the total, right after World War II, then slowly de clined in importance until the early 1960s. Since then, state after state has either raised rates or introduced this tax for the first time. In 1972, it contributed just under 4 percent of total revenue. Liquor, tobacco, death, and gift taxes are all widely used by state and local gov e r n m e n ts . S m all but steady revenue sources, each has accounted for 1 to 2 per cent of revenues since 1929. Of the four, only the tobacco tax has not declined in importance over the last ten years. Miscellaneous license fees, entertain ment taxes, resource severance taxes, and pari-mutuel taxes are a few examples of other taxes which are widely employed. In dividually, none of these taxes has contrib uted more than a pittance toward aggregate state and local government revenues, but taken together they supplied nearly 9 per cent of the total, about $12 billion, in 1972. 12 State and local governments also rely on nontax charges for a wide variety of ser vices they provide directly to the public. These range from tuition at public colleges and universities to net income from pub licly-owned utilities and liquor stores. The sum of these revenues has been a major contributor to total revenue throughout the 1929-72 period. Their total was second only to real property taxes in 1929, when they provided over 12 percent of the total revenue. They remained stagnant in abso lute dollar levels and declined as a share of the total through 1947. Then the flood of veterans into colleges and universities set in motion an expansion of state-supported higher education that is still in progress. Not only did enrollment boom, but tuition and other fees have been steadily raised. This increase in revenue from education has been paralleled by increases in charges for a multitude of other services. As a result, nontax revenues supplied nearly 10 percent of the total in 1972. The contrasting trends The difference between the modern revenue patterns of the federal government and of state and local governments is strik ing. The federal government appears to be moving in the direction of reliance on three tax sources for the lion’s share of its rev enue. The personal income tax seems locked in at about 45 percent, and contri butions for social insurance seem headed for the 30 percent level. These, together with the corporate income tax, have ac counted for nearly 90 percent of federal receipts for the last decade. State and local governments seem headed in the opposite direction. Once completely tied to the real property tax, Federal Reserve Bank of Chicago they have consistently increased the im por tance of old revenue sources, and expanded their tax base to new sources. Today, the three largest sources combined, property taxes, personal income taxes, and general sales taxes, provide only 57 percent of state and local revenues, less than the property tax alone supplied in 1929. G rants-in-aid, particularly revenue sharing, and tax increases of the last few years produced a large aggregate surplus for s ta te and local governments in 1972. Furthermore, projections by such groups as the Tax Foundation Inc. suggest that these surpluses will continue for several years. Nevertheless, many individual units of government are facing severe problems in trying to raise adequate revenues. Re ceipts from their old standby, the real estate tax, are not growing rapidly enough. These governments will have to move toward heavier reliance on more flexible tax sources, such as income taxes, or else exercise ingenuity in devising new revenue sources if they are to meet their growing expenditures. Much of the 1929-72 period can be viewed as an abnormality in the nation’s tax and spending history. Both the Depres sion and World War II were events that hopefully will not be repeated. The post war period has witnessed a slow, steady trend toward renewed importance for state and local government expenditures. Today, most taxpayers view the federal govern ment as the primary collector of taxes. However, if current trends continue, and if grants-in-aid are viewed as revenues of state and local governments, the smaller units of government will have first claim on the tax payer’s attention in the years to come. Morton B. Millenson Business Conditions, June 1973 13 Banking developments Interest rates on loans Except for the “ prim e” rate charged by major commercial banks on loans to their most creditworthy customers, information about the level and structure of loan inter est rates is very limited. This is in contrast to the large volume of interest rate sta tistics for marketable debt instruments such as U. S. Government securities or high-grade corporate bonds. Such evidence as is available on lending rates indicates that there is a rather wide variation in rates charged on different types of loans and in rates charged on the same type of loans by different lenders. All interest rates are influenced by the same basic factors. The most im portant variable at any given time is the degree of risk—whether the borrower will be able to meet interest and principal payments in ac cord with the loan contract. Other factors are loan (or borrower) size, maturity, type of collateral, if any, location (partly re flecting competitive conditions), and the relationship between borrower and lender. Most of these factors are related to risk. The major reason why so little information is available on lending rates to local busi nesses and individuals is the difficulty in classifying loans into groups with the same degree of risk and related characteristics and thus in arriving at a meaningful mea sure of either the rate level at a particular time or trends over time applicable to a standardized type of loan. Most loans to smaller businesses are made at rates higher than the prime be cause of the risk premium. The spread tends to widen when the general trend of interest rates is downward and to narrow when it is upward. Rates on loans to indi viduals generally are scaled upward from home mortgages, on which collateral nor mally is the critical variable, to credit card debt, on which both risk and administrative costs are relatively high. Evidence on the structure of lending rates is currently available from two sur veys. The Federal Reserve’s survey of con tract rates on business loans made at major U. S. banks during several days out of each quarter provides data on interest rates by size of loan. In early May, this survey showed that, at district respondents, con tract rates on new short-term logins over $1 million averaged 7.48 percent, compared with 8.13 percent on loans under $10,000. (The prime rate at the majority of the na tio n ’s major banks was changed from 6 3/4 percent to 7 percent during the survey pe riod.) The inverse relationship between loan size and contract rate reflects mainly the creditworthiness of the borrower and, to a lesser extent, the lower per dollar ad ministrative costs for big loans. Moreover, the ability of large borrowers to substitute sales of commercial paper for bank loans tends to maintain a close link between bank interest charges on big loans and money market rates. From February to May, the rise in the average was 113 basis points on the largest loans and only 34 points on the smallest loans. Past surveys have shown geographic d if f e r e n tia ls in these rate averages— especially between banks in New York City and those elsewhere. But these differences probably reflect the greater proportion of loans made to large top-credit-rated firms at the New York banks. Moreover, the con tract rates do not accurately measure ef fective rates paid because contract rates are not adjusted to reflect non-rate require- 14 Federal Reserve Bank of Chicago ments, such as com p e n s a tin g balances, Interest rates on loans of w h ic h also d if f e r Seventh D istrict banks1 a m o n g b a n k s an d among loans. Range o f: N u m b e r o f lo a n s "M o st c o m m o n " A t m o st L o a n s c lo s e d d u r in g t h e A second and re R e p o r t e d ra te s ra te s c o m m o n ra te T o ta l w e e k e n d e d A p r il 7 , 1 9 7 3 latively new source of (p e r c e n t) ( p e r c e n t o f t o t a l ) ( a c tu a l n u m b e r ) information on lending S m a ll , s h o r t - t e r m , 4 0 .4 n o n in s t a lm e n t b u s in e s s 6 .0 0 - 1 2 .0 0 6 .5 0 1 0 .5 0 879 rates is data obtained F e e d e r c a t t le o p e r a t io n s 6 .7 5 - 8 .5 0 6 .7 5 - 8 .5 0 7 8 .0 50 fo r the use of the O t h e r f a r m p r o d u c t io n 7 .0 0 - 9 .3 1 7 .5 0 - 9 .3 1 6 8 .1 47 Committee on Interest C o n s u m e r i n s t a lm e n t : and Dividends on small N e w a u t o m o b ile s ( 3 6 m o s .) 6 .5 9 - 1 4 .5 4 8 .4 0 - 1 2 .8 3 6 3 .8 2 ,4 3 5 M o b ile h o m e s ( 8 4 m o s .) 9 .3 7 - 1 4 .6 8 9 .3 7 - 1 4 .6 8 8 4 .6 78 business loans, farm O t h e r c o n s u m e r g o o d s ( 2 4 m o s .) 8 .4 1 1 8 .1 6 8 .4 1 - 1 6 .4 0 7 5 .5 485 lo a n s, and various O t h e r p e rs o n a l e x p e n d it u r e s (1 2 m o s .) 9 . 1 0 - 3 6 .0 0 7 2 .4 1 0 .8 6 - 1 7 .9 0 1 ,4 4 8 types of consumer in C r e d it c a r d p la n s 1 2 .0 0 - 1 8 .0 0 n o t a p p lic a b le 1 2 .0 0 - 1 8 .0 0 stalment credit at a 1Based on a sample of 46 banks ranging in deposit size from less than $50 m illion to more than $5 billion. sample of commercial Consum er credit rates are annual percentage rates reported on a truth-in-lending basis. b an k s an d fin an ce co m p an ies. The ac companying tables illustrate: (1) the gen finance companies reflect greater homoge eral structure of rates on consumer loans at neity of collateral and less risk associated banks and finance companies, based on re with the collateral compared with other cent national summaries, and (2) differ types of consumer financing. Finance com ences in the “most com m on” rates charged pany rates are higher for all types of loans. and in the proportion of loans made at the Bank loans tend to be lower-risk loans— most common rate, as evidenced from the with borrowers often deposit customers. district bank sample in April. Data for the two types of lenders are not Relatively low rates on new car loans strictly comparable, however. and mobile home loans at both banks and Variability of “ most com m on” rates within loan categories was greatest for noninstalment business loans of Consumer instalment credit rates $10,000 to $25,000 maturing in March 1973 one year or less, where the “ most ____ Banks common rate” ranged from 6.50 Average of Finance companies percent to 10.50 percent and only "most common" Specified Average Average ______ rate maturity rate maturity 40 percent of the loans were closed (p e r c e n t) (m o n th s ) (p e r c e n t) (m o n th s at rates within that range. Consumer credit for: At most of the survey banks, New autos 10.04 36 11.85 35.1 Mobile homes 84 10.67 12.54 113.9 the contract interest rate applies to Other consumer goods 24 12.48 18.95 21.1 outstanding business loan balances, Other personal expenditures 12.71 12 20.75 33.2 Credit card plans 17.19 but about one-fifth of the banks use th e d is c o u n t m eth o d of Note: Rates are Annual Percentage Rates (APRs) as specified in the Truthcharging interest. About one-fourth in-Lending Regulation, but are not comparable between institutions due to dif ferences in maturities and calculation of the average rate. Bank loan rates are of the respondents required com simple unweighted averages of the APRs on the largest volume of loans of the specified maturity in the particular category at each bank in the sample. Finance pensating balances in conjunction company rates are weighted average APRs on contracts purchased by finance companies in the sample, except that rates on loans for "other personal expendi with business and farm loans—the tures" apply to loans made directly. Finance company loans for "other consumer goods" exclude recreational vehicles, boats, and aircraft. typical balance requirement being 10 to 20 percent of the loan. II Business Conditions, June 1973 15 Real estate loans Real e sta te loans at Seventh D istrict insured commercial banks—volume and percent change in 1972, by SM SA SM SA1 Real estate loans outstanding December 31, 1972 Percent change, December 31,,1971 to December 31, 1972 Total Farm Residential All other 10.6 24.5 23.4 -46.5 49.0 11.5 (m illio n d o lla rs) Illinois Bloom ington 35.9 Champaign 57.2 22.5 22.0 3,707.6 67.2 15.6 22.6 -63.2 16.3 18.4 23.5 26.6 17.8 18.8 11.4 Chicago Decatur Peoria Quad Cities Rockford Springfield 18.7 15.3 18.9 100.5 12.0 20.4 5.3 31.1 13.0 26.7 129.6 21.1 20.7 14.2 145.0 193.1 12.1 43.1 Indiana Anderson 39.9 19.5 10.0 18.3 24.9 Fo rt W ayne Gary-Hammond 188.1 264.9 21.4 19.2 14.6 38.2 16.6 18.2 30.0 19.8 Indianapolis 632.0 76.4 22.8 Lafayette 27.3 48.7 24.0 19.4 20.5 16.4 Muncie South Bend 45.8 14.2 188.2 20.3 -23.5 12.4 17.6 17.4 25.6 Terre Haute 62.2 15.6 24.9 12.6 18.7 19.9 19.3 Iowa Cedar Rapids 54.3 6.9 11.3 2.7 11.2 Des Moines Dubuque 149.9 58.5 16.1 12.9 16.4 18.8 18.4 7.6 11.7 25.0 Sioux C ity 42.8 19.2 10.4 25.4 14.6 W aterloo 31.6 14.1 17.4 24.1 5.0 Michigan Ann A rbor Battle Creek 153.1 19.7 6.4 24.7 3.2 22.2 27.2 3.9 65.4 10.0 17.0 62.3 12.9 211.2 20.9 3,843.7 13.6 -52.2 15.1 9.4 Flin t 388.2 14.2 - 0.5 7.3 126.0 Grand Rapids 373.6 16.1 17.7 17.2 12.6 77.7 16.7 13.1 20.4 205.3 12.4 7.0 21.9 1.6 - 2.2 583.1 2.3 14.8 1.6 2.9 86.7 12.1 13.7 9.1 127.4 12.2 15.9 - 9.4 11.6 28.3 230.3 154.9 14.4 26.4 14.4 11.1 24.1 32.9 16.2 36.6 60.1 13.8 63.3 16.5 5.6 197.1 4.5 53.5 36.2 21.5 21.3 32.3 B a y C ity Detroit Jackson Kalamazoo Lansing Muskegon Saginaw Wisconsin Appleton Green Bay Kenosha Madison M ilwaukee 889.2 24.0 24.2 Racine 102.9 19.7 i District S M S As as of December 31, 1972. 16.8 28.6 29.6 All except three of 38 district SMSAs reported 1972 gains in real estate loans th a t exceeded the r e l a t i v e l y h ig h g r o w th ra te s of 1971. At all U. S. com m ercial banks, o u ts ta n d in g s rose about 20 percent, compared to 13 per cent in 1971. Total mortgage d e b t held by all le n d e rs increased about $65 billion, or 14 percent, in 1 9 7 2 . Commercial banks accounted for one-fourth of the d o lla r g ain , inc re a s in g the share held by banks to 17.5 percent. Loans s e c u re d by re si d e n tia l properties a cc o u n t for more than 60 percent of b a n k s ’ real estate loan portfolios. In 1 9 7 2 , b o th resi d e n tia l and non farm, nonresidential 1o ans increased at th e same rate—21 percent—while loans secured by farmland rose 13 percent. In 13 district SMSAs, r e s id e n tia l lo a n s w ere th e fastest g ro w in g category, and in 11 SMSAs gains exceeded the national average. ■
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