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MARCH 1972

BANKING STRUCTURE AND
PERFORMANCE: SOME
EVIDENCE FROM OHIO
R obert F. Ware
Numerous

studies

have

examined

the

relationship

between the structure o f banking markets and the pe rfo r­
mance o f banks in those markets. The assumption generally
made in these studies is th a t banks operating in com pet­
itive ly structured markets w ill produce greater o u tp u t at
lower prices. Nearly all o f the investigations employed
basically fo u r sets o f variables designed to measure (1) bank
performance, (2) banking m arket structure, (3) bank size
and efficiency, and (4) economic a c tiv ity in a banking

IN THIS ISSUE

market. Bank performance was usually measured as an
aggregate variable fo r all banks in a specified market. Such
measures as the average loan rate and the average service

Banking Structure and

charge on demand deposits were com m only used. The

Performance: Some

com petitive structure o f a banking m arket was generally

Evidence From O hio . . . 3

approxim ated in these studies by a concentration ratio,
w hich measures the percentage o f deposits held by the
largest banks in a market. In most cases, bank size and

The Structure o f
State Revenue .............. 15




efficiency were represented by deposits, costs, and loan
p o rtfo lio s; and economic a c tiv ity o f a market, by popu­
lation and income.
3

ECONOMIC REVIEW

The results o f the studies have been generally
mixed

because

of

differences

in

techniques,

One study th a t found an insignificant relation­
ship between bank structure and performance in

markets, and variable specifications. Five studies,

m etropolitan areas concluded th a t average bank

found a relationship between m arket structure and

size was the most im p o rta n t banking structure

performance, although in some cases the relation­

determ inant o f local loan rates.4 Moreover, results

ship appeared to be relatively small. Kaufman, fo r

indicated th a t the number o f banks in a m etro­

example, "fo u n d the market structure variable

politan area was an insignificant determ inant o f

consistently

significantly

various

the loan rates. In a recent study o f bank structure

measures

of

bank

directions

in Texas, the authors also found " th a t variations in

predicted

by

related

performance

economic

to
in
o

th e o ry.'

While

the

the level o f concentration appear to have little

relationship was statistically significant, however,

impact on

the effect o f structure on performance was not

perform ance."5 They concluded th a t the results

six

im p o rta n t measures o f banking

strong. Relatively large changes in structure were

lend support to the position th a t small shifts in the

associated w ith relatively small changes in per­

structure o f banking markets (such as through the

formance.

merger o f tw o com peting institu tio n s) do n o t have

Phillips also found a statistically significant and

an appreciable im pact on performance.
Differences in m arket areas and banking laws,

positive relationship between interest rates and
concentration
appeared

ratios, although the

to

be

relationship

"econom ically

sm all.”

He

however, make it d iffic u lt to apply the structureperformance results from one state to another.

concludes th a t "th e w eight o f the evidence is

This

th a t—w ith

structure-perform ance

region,

the effects o f loan size, bank size,

and

tim e

removed—concentration

is

study,

obtain

therefore,

examined

relationship

the
in

bank

Ohio. To

a homogeneous sample, the study was

positively associated w ith interest rates on business

lim ited to effects o f m arket structure on bank

loans charged by the banks in these 19 metroo

performance in counties th a t are n o t included in

politan areas."

Standard
SMSA).

1

Franklin R. Edwards, “ Concentration in Banking and Its

Effects

on

E cono m ics

Business
and

Loan

S ta tistics,

Rates,"
August

The

1964;

R eview

of

Franklin

R.

Edwards, "The Banking Com petition C ontroversy," The
N a tio n a l

B a n k in g

R eview ,

September

1 9 65;

George

Kaufm an, "B ank Market Structure and Performance: The

tions
fo r

M etropolitan Statistical
This

type

constant
a

more

Areas

(non-

o f sampling holds condi­

across

sensitive

markets
test

of

and
the

provides
structure-

performance relationship than some o f the other
studies.

This means, however, th a t the study

results cannot be generalized to other types o f

Evidence from Io w a," The S outh ern E c o n o m ic J o u rn a l,
A pril 19 66; Alm arin Phillips, "Evidence on Concentration
in Banking Markets and Interest Rates,” F ederal Reserve
B u lle tin , June 19 67; Charles T. Taylo r, "Average Interest
Charges, The

Paul A. Meyer, "Price Discrim ination, Regional

Loan

Rates, and the Structure of the Banking In d u s try," The
J o u rn a l o f Finance, March 19 6 7 , p. 48.

Loan M ix, and Measures of C om petition:

Sixth Federal Reserve District Experience," The J o u rn a l
o f Finance, December 1968.

2

4

5

Donald R. Fraser and Peter S. Rose, "M ore on Banking
Structure and Performance: The Evidence from Texas,"
Jo u rn a l o f F in a n c ia l a n d Q u a n tita tiv e A n a lysis, January

Kaufm an, op. c it., p. 438.

^Phillips, op. c it., p. 925.

4




1971, p . 611.
5

Counties in which no city has a population over 50 ,000 .

M ARCH 1972

th a t

operating performance concepts fo r these firm s are

changes in bank structure have little effect on

also d iffic u lt to measure. When a firm produces

overall bank performance.

one product, such as autom obiles or steel, p e rfo r­

markets.

Results

of

this

study

indicate

mance can be measured in terms o f sim ilar units

D E FIN IN G THE M ARKET AREA

produced. Banks, however, produce such diverse

A m ajor reason fo r restricting this study to
nonSMSA
defining

counties

relates to

a relevant

commercial

banks

bank
are

the

m arket

problem
area.

m u lti-p ro d u ct

services

as loans,

tru s t

services,

and demand

of

deposit accounts. Several performance measures

Since

must therefore be used to take account o f this

firm s,

it

becomes d iffic u lt, in some cases, to isolate a single

variety o f products.
In

this

study,

five

d iffe re n t

performance

geographic area th a t includes a large percentage of

measures (V j) were used to determine the effect o f

all the d iffe re n t products th a t are offered by a

banking structure on the performance o f banks

bank. For example, the relevant m arket area fo r

operating in 57 co u n ty markets in Ohio.

demand

deposits may be confined to a much

The firs t performance measure is the ratio of

narrower area than the market fo r commercial

total service charges on demand deposits to total

loans.

demand deposits (V ^ ). This ratio measures the

In this study, each o f the 57 nonSMSA counties

average price charged fo r a dollar o f demand

in Ohio was considered a single geographic market

deposits. The assumption was made th a t the more

fo r banking services. There are tw o reasons w hy

com petitive

these counties should approxim ate relevant market

market, the lower w ould be the average price fo r

the

environm ent

in

a

particular

areas. First, the banks in the nonSMSA counties

the demand deposits. The second performance

are, on average, smaller (less than $30 m illio n in

variable (X ^) is the ratio o f yearend average net

deposits) than banks in m etropolitan areas and

operating earnings to average total capital fo r the

generally derive fro m 80 to 90 percent o f all types

banks in each market. This ratio is one measure of

of deposit and loan business from th e ir respective

the average p ro fita b ility o f the banks in a market,

counties. Secondly, under Ohio banking laws, a

and it was assumed th a t a lower average p ro fit rate

bank cannot establish branch offices outside o f the

w ould

county in which the main office is located.7 This

com petitive environm ent.

aspect o f the law has a tendency to restrict the
influence o f a nonurban

bank to the county

be

found

The th ird

in

markets

w ith

a highly

performance measure (Vg) is the

ratio o f the total revenue received on loans fo r a
year to the average gross loans outstanding at the

market.

end o f the year. This ratio is intended to reflect

PERFORMANCE OF BANKS

the average loan price charged by the banks in a

Just as the geographic market areas fo r m u lti­

market,

and

it

was

assumed

th a t

the

more

product firm s are often d iffic u lt to define, the

com petitive the market environm ent, the lower

7 An

is

the rate w ould be. However, many problems are

headquartered in a city where the limits overlap into two

involved w ith an aggregate performance measure

exception

to

this

law

is

made

if

a

bank

or more counties. The bank may then branch into each of
the counties. This situation only existed in tw o of the 57
counties in this study.




such as this. First, aggregating all types o f loans fo r
the banks in a particular market may conceal the

5

ECONOMIC REVIEW

Bank Performance Variables

fo r the d iffe re n t customers o f a bank because o f
factors, such as compensating balances held by the

to tal service charges on demand deposits

V1 =

bank. This makes the real price o f a loan quite

total demand deposits

d iffe re n t fro m the average loan price th a t was used

net operating earnings

V2 =
V

3

in

total capital

most

studies.

While

sample

selection

can

p a rtia lly alleviate the firs t problem, the second

= total revenue on loans
-----------------------------------gross loans

problem can only be remedied by a very intensive

_ total interest paid on tim e and savings deposits

field survey. In this study, the use o f banks in
nonSMSA counties provided a sample o f a fa irly

total tim e and savings deposits

homogeneous group o f banks (i.e., banks less than
Vj- = average price spread (V ^ —V^)

$30 m illio n in deposits tend to have sim ilar loan
p o rtfo lio s ), which m inim ized the loan aggregation

Independent Variables

problem. The average loan price should, therefore,
total deposits o f tw o largest banks in county

be generally representative o f the m a jo rity o f

X1 =

total deposits o f banks in county

banks in the study.
= percent change in county population, 1 9 6 0 -1 9 7 0
y

_ percent change in county per capita personal income,
3
1 9 5 9 -1 9 6 9

The fo u rth performance variable (V ^) is the
ratio o f to ta l interest paid on tim e and savings
deposits to the to ta l am ount o f tim e and savings

= the per capita retail sales in county
v

_

deposits held by the banks. This ratio reflects the

m anufacturing covered em ploym ent

average price the banks had to pay in order to

total covered em ploym ent in the county

attract tim e and savings deposits. Presumably, if a
Xg = number o f savings and loan associations in county

market is highly com petitive, the average price

y

paid fo r the tim e and savings deposits w ould be

= total consumer loans
--------------------------------7
gross loans

higher. The fifth performance measure (Vg) was
derived by taking the difference between variables

Xg = average deposit size o f bank

Vg (average price charged by the banks fo r loans

to tal operating expenses
X9 =

they have made to various customers) and V ^

total assets

(average price the banks had to pay to a ttra ct the
raw materials in the fo rm o f tim e and savings
fact th a t loans have d iffe re n t prices and some

deposits

banks specialize in a particular type o f loan. Thus,

represents a measure o f the average price spread

to

make

the

loans). This difference

the average price o f a loan may n o t be represen­

between the so-called o u tp u t price (average loan

tative

effective

rate) and the average price paid fo r inputs (tim e

interest rate charged fo r similar type loans varies

and savings deposits). It was expected th a t the less

of

all

banks.8

Secondly,

the

com petitive
This problem may partially account fo r the fact th at the
results of some of the past studies were very inconclusive.
A discussion o f this problem appears in: Alm arin Phillips,
"Evidence

on

Concentration

in Banking Markets and

Interest Rates," Federal Reserve B u lle tin , June 1967.

6



market,

the

the

environm ent

larger

w ould

be

in

a

particular

the

difference

between V g and V ^ (i.e., the higher the price
charged on loans and the lower the price paid fo r
the tim e and savings deposits). Even though V ^ is

MARCH 1972

dependent upon Vg and V ^, it does perm it an

1960-1970 (X 2 ), (2) the percentage change in

observation o f the structure-performance question

county per capita personal income fro m 1959 to

in a slightly d iffe re n t manner.

1969

(X g), (3) the per capita retail sales in the

county (X ^) fo r 1969 and 1970, and (4) manufac­

DETERM INAN TS OF BANK
PERFORMANCE
The

operating

performance

tu r in g

em ploym ent

covered

by

the

State

unem ploym ent insurance as a percent o f total
of

banks

was

covered em ploym ent in the co u n ty (X ^). Variables

assumed to be a fu n ctio n o f banking structure as

X 2 and Xg serve as proxies fo r shifts in demand

well as other bank and market variables. In most

fo r banking services in a market, and X ^ is a p ro xy

structure-performance studies, the structure o f a

fo r the level o f demand. Variable Xg was used to

m arket was generally proxied by a concentration

control fo r differences in the level o f industrial

ratio, w hich indicates the percentage o f deposits

a c tivity among the markets. It was assumed th a t

held by the largest bank or banks in the m arket.9

the more highly industrialized markets w ould have

In this study, the tw o-bank concentration ratio, or

a higher level o f economic a ctivity.

the percentage o f deposits held by the tw o largest

A sixth m arket variable was also included to

banks in the market (X ^), was used to proxy

take account o f existing and potential com petition

banking structure. The tw o-bank ratio was used

provided by other financial in stitu tio n s in each

because it provided an accurate picture o f banking

market. The p ro xy used fo r this effect was the

structure in the nonSMSA county markets th a t

number o f savings and loan associations operating

were used in the study. The assumption was made

in

tha t the higher the concentration ratio in any

number

single m arket, the less com petitive w ould be the

operating in a particular market, there w ould be a

environm ent in th a t market.

significant

M arket variables th a t could affect the p e rfo r­
mance o f banks can generally be put in to the

each

deposits

m arket
of

(X g).

savings
am ount

and

Presumably, if

and

certain

of

loan

com p e titio n
types

a large

associations

of

fo r

loans

in

are
tim e
the

markets.10

classification o f "econom ic a c tiv ity ” or "dem and”

Three bank variables were used to take account

variables. It can be expected that the comparative

o f bank operations th a t could alter bank p e rfo r­

performance o f banks in tw o separate markets

mance. One o f these variables is the percent of

w ould

levels o f

total loans held in the consumer loan category by

economic a ctivity, or demand fo r banking services,

the banks in each market (X y). Even though the

be

affected

by the d iffe rin g

even if the banking structure is the same. Four

banks in the sample are fa irly homogeneous, this

variables were used in this study as proxies fo r

variable was intended to help co n tro l fo r d iffe r­

economic a ctiv ity in the individual markets: (1)

ences in loan m ix th a t could have an effect upon

the percentage change in county population from
10
g

The same values fo r variables X 2 , X 3 , X 5 , and Xg were

used in both the 1969 and 1 9 70 regression equations.
The number o f banks in a m arket is sometimes used as a

structural

proxy.

However, both Fraser and Rose and

Kaufman

found that from

a statistical view point the

concentration ratio and the number of banks in a m arket
area were equally good proxies fo r the banking structure.




This should not hinder the analysis since these data do
not change significantly in one year. The number of
savings and loan associations was used in X q because data
were not available on the deposits o f savings and loan
associations by nonSMSA counties.

7

ECONOMIC REVIEW

the performance variables. Another bank variable,

a c tivity

average bank size (X g ), provided an additional

types o f banks operating in the m arket (X y —Xg).

control

Therefore,

fo r

d iffe rin g

bank

behavior

among

(X 2 —Xg) in the co u n ty as well as the

markets. Larger banks tend to behave d iffe re n tly
w ith respect to loan m ix and some prices. The

V jj = F (X ^ j,...,X g j) where i = performance measure
and j = m arket

ratio o f average to ta l operating expenses to average
total assets fo r the banks in each m arket (Xg)
presumably

measures, on a m arket level, how

e ffic ie n tly banks are managed.11 Some banks may

There are 57 separate markets or observations in

be operated more e ffic ie n tly than others, w hich

the study. The fo llo w in g sections discuss the study

w ould have an effect on market performance. In

results

order to isolate the effect of m arket structure

empirical findings; the actual statistical results are

upon performance, it is necessary, therefore, to

presented in the A ppendix.

con tro l fo r the effect th a t other variables, such as

in

detail.

The

Table

summarizes

the

Service Charge or Demand Deposits. Results

efficie ncy, may have on performance.

from

TECHNIQUES AND RESULTS

average service charge on demand deposits. The

this set o f equations fail to indicate th a t

bank concentration has an im p o rta n t effect on the
The structure-perform ance relationship among

relationship between service charges and concen­

banks headquartered in the 57 nonSMSA counties

tra tio n in the 57 nonSMSA counties is weak, w ith

in Ohio was investigated using m u ltip le regression

the degree o f association insignificant (at the 5

te c h n iq u e .

percent level) in both 1969 and 1970. On the

Cross-sectional

regressions

were

computed fo r tw o d iffe re n t years, 1969 and 1970,

other

to observe the structure-perform ance relationships

indicated by positive coefficients) may tend to

under d iffe re n t m onetary conditions.

increase the average service charge, b u t the size of

Data fo r

the banks in the 57 counties were taken fro m the

hand,

increases

in

concentration

(as

this increase w ould be relatively small.
Bank cost and bank size are significantly related

December 1969 and December 1970 "R eports o f
C o n d itio n " and "R eports o f Earnings and D ivi­

to

dends," as com piled by bank regulatory agencies.

variable fo r bank costs is significant (at the 0.1

service

charges

on

demand

deposits.

The

It was assumed th a t the performance variable

percent level) in both 1969 and 1970, and the

(V ), w hich is the average o f the values o f this

positive sign on the coefficients indicates th a t

variable fo r all o f the banks in a market, was a

banks w ith

fu n ctio n o f the concentration (X-|) and economic

asset ratios tend to charge more fo r th e ir demand

relatively high to ta l operating cost/

deposits. This result may sim ply im p ly th a t the
11

Under certain circumstances the bank cost ratio could

less e ffic ie n t banks must, and are able to , charge a

be viewed as a bank performance variable. However, in
this study the cost ratio is only assumed to be a proxy for
the differences in bank efficiency th at may have an effect
on bank performance.

13

The estimated change in the average service charge

brought about by an increase in the concentration ratio
can be com puted by taking the concentration coefficient

12

The year 19 69 was a relatively tight money period

while 1 9 70 was a period o f relative m onetary ease.

8



and m ultiplying

it by a representative change in the

concentration ratio.

Summary o f Results o f Structure-Performance Tests
fo r NonSMSA Counties in Ohio
Independent Variables

Performance
Variables
1969

Percent
C oncentration
Change in
Ratio
Population

Percent
Change in
Income
X3

Retail Sales
Per Capita
X4

Industrialization
Ratio

N um ber of
Savings and
Loan
Associations

Consumer Loans/ Average Bank
Gross Loans
Size
Cost Ratio

X5

X 6

X7

X 8

X9

V ^ —Average service charge
on demand deposits

insignificant

insignificant insignificant insignificant

insignificant

insignificant

insignificant

significant
positive

significant
positive

V j —P ro fit rate

insignificant

insignificant insignificant insignificant

insignificant

insignificant

significant
positive

insignificant

significant
negative

V g —Average loan rate

insignificant

insignificant insignificant

significant
negative

insignificant

significant
positive

insignificant

insignificant

significant
positive

V ^ —Average savings rate

insignificant

insignificant

significant
positive

insignificant

insignificant

significant
positive

insignificant

significant
positive

V ,-—Price spread

insignificant

insignificant insignificant

significant
negative

insignificant

insignificant

insignificant

insignificant

insignificant

insignificant

insignificant insignificant insignificant

insignificant

insignificant

insignificant

significant
positive

significant
positive

significant
negative

insignificant

significant
positive

significant
positive

significant
negative

X 1

X 2

significant
positive

1970
V ^ —Average service charge
on demand deposits

insignificant

significant
positive

V g —Average loan rate

insignificant

insignificant

significant
positive

insignificant

insignificant

significant
positive

insignificant

significant
positive

significant
positive

V ^ —Average savings rate

insignificant

insignificant

significant
positive

significant
positive

insignificant

insignificant

insignificant

significant
positive

significant
negative

insignificant

significant
positive

insignificant

significant
positive

insignificant

Pro fit rate

V g —Price spread

significant
positive

insignificant insignificant

insignificant insignificant insignificant

N O T E : Coefficients are significant at the 5 percent critical level. When significant,
the sign is indicated.
Source: Federal Reserve Bank o f Cleveland




ECONOMIC REVIEW

higher price fo r their demand deposits.

14

Bank

The cost ratio is negatively related to the p ro fit

size and the average service charges on demand

rate, indicating th a t banks in markets w ith rela­

deposits

positively

tiv e ly higher average costs generally have lower

related fo r both 1969 and 1970. This means th a t

are

also

significantly

and

profits. The consumer loan/gross loan variable has

those banks located in counties w ith a relatively

a positive sign, indicating th a t the banks in the

high average deposit size tended to charge more

more pro fita b le markets had a larger percentage of

fo r th e ir demand deposits than banks in counties

consumer loans in th e ir p o rtfo lio . This result is

w ith a low average deposit size. This result may

consistent w ith

im p ly th a t relatively large banks in the study are

consumer loans tend to be more p ro fita b le fo r

located in less com petitive m arket areas. There­

banks than some other types o f loans.

fore, they were able to im plem ent higher service
charges on demand deposits.1 5

other

evidence

th a t

indicates

There is no significant im pact on bank p ro fit­
a b ility fro m the economic a c tiv ity variables fo r

The coefficients o f the savings and loan associ­

1969. For 1970, however, the population variable

ation variables and the fo u r variables fo r economic

and the industrialization variable are significantly

a ctivity

to

related to

the p ro fit rate.16 The sign on the

demand deposit service charges fo r either 1969 or

show

no

significant

relationship

population

variable

1970.

banks

Net Operating Earnings to Total Capital. The
performance variable

in this analysis measures

in

is positive, indicating th a t

markets th a t had large

increases in

population also had high p ro fit rates. The indus­
tria liza tio n

variable

has a c o e fficie n t

w ith

a

p ro fita b ility o f a bank related to its to ta l invested

negative sign, w hich implies th a t banks operating

capital. It was hypothesized that banks w ould be

in the more industrialized markets tended to have

less p rofitab le in a highly com petitive market. This

lower p ro fit rates. This may reflect the fa ct th a t

hypothesis was somewhat confirm ed by the test

these banks must compete w ith large c ity banks

results, b ut the findings are relatively insignificant.

fo r the more pro fita b le commercial and industrial

For 1969, the concentration variable is significant

loans th a t are available in these markets.
Bank p ro fita b ility in the 57 nonSMSA counties

at the 20 percent level, but is insignificant fo r
1970.

The

positive

sign

on

the

coefficients,

however, suggests th a t a high rate o f p ro fit is

does n o t appear to have been affected by compe­
titio n fro m savings and loan in stitutions.
Average

positively related to a high concentration ratio.
On the other hand, bank p ro fita b ility is s ig n ifi­

Loan

Rate.

The

conclusion

th a t

emerges fro m the analysis o f variables th a t affect

bank

loan rates o f the banks under study is th a t the

variables—costs and consumer loan/gross lo a n -

relationship between bank concentration and the

according to equations fo r both 1969 and 1970.

loan rate is weak, w hile the relationship between

cantly

14

affected

by

tw o

of

the

three

costs, income, and the number o f savings and loan
The simple correlation coefficients between bank costs

and concentration are —0 .1 8 and —0 .1 4 for 1969 and

tionship between concentration and average loan

1970, respectively.

15

This

point

is substantiated

associations is significant. S pecifically, the rela­

somewhat

by

positive

16

This result implies th at the economic activity variables

correlation coefficients between bank size and concen­

become more sensitive w ith respect to p ro fit rates during

tration o f 0 .2 2 and 0 .1 9 for 1969 and 19 70, respectively.

periods of m onetary ease.

10



M ARCH 1972

rates is weak fo r both 1969 and 1970, and the

markets th a t contain a relatively large number of

impact

savings and loan associations had a higher average

of

an

increase in

bank concentration

appears relatively small; i.e., an increase in the

loan rate. This may im p ly that, because savings

concentration ratio o f 20 percentage points w ould

and loan in stitu tio n s specialize in real estate loans,

have only increased the average loan rate in 1970

banks in markets w ith several such in stitu tio n s

by approxim ately 0.1 percent.17

tend to concentrate on selling other types o f loans,

The bank cost variable is highly significant fo r

possibly because the com p e titio n is less intense in

both years, and the positive sign on the coe fficie n t

these other areas.18 Since the rates on real estate

indicates th a t banks w ith relatively high costs also

loans

charged high average rates on th e ir loans. This

consumer and some other types o f loans, the

result is sim ilar to the one on average service

tendency o f holding fewer real estate loans in a

charges on demand deposits and suggests th a t the

p o rtfo lio w ould therefore result in a higher average

less e fficie n t banks in these markets are able to

loan

are

generally

rate fo r

lower

than

the commercial

the

rates on

banks in

those

markets. Thus, it appears th a t in markets where

charge higher rates fo r th e ir services.
Per capita retail sales and per capita income

there are a relatively large number o f saving and

were found to be significantly related to higher

loan associations, banks had a higher average loan

loan rates, although fo r d iffe re n t years. For 1969,

rate.
Average Time and Savings Rate. Bank concen­

the retail sales per capita variable implies th a t
counties w ith

high

retail

sales per capita had

tra tio n in nonSMSA county markets in Ohio does

relatively lower average loan rates. The level of

not appear to have had an im p o rta n t impact on

retail sales per capita was assumed to p ro xy the

the average savings rate paid by banks in those

intensity o f economic activity in a m arket; and,

markets. In both the 1969 and 1970 equations,

therefore, the lower average loan rate w ould be

the relationship between concentration and the

consistent w ith this assumption. For 1970, the per

rate paid on deposits is insignificant.

capita income variable indicates increasing demand
fo r

bank services; and, therefore, it w ould be

dire ctly related to the average loan rates.
Finally,

the

operation

o f savings and

loan

associations has a significant and positive re lation­

Bank costs, however, are highly significant in
both equations, and the sign on the coefficients
indicates a direct relationship between the average
1Q
This relationship

savings rate and the cost ratio.

implies th a t those banks operating in high average

ship w ith bank loan rates. Results o f equations fo r
1969 and 1970 indicate th a t banks operating in

18This result is supported by the correlation coefficients
between the number of savings and loan associations in a

17

The average loan rate may have been more precisely

measured fo r

1 9 70 than for 1969, which was a tight

money period w ith increasing loan rates. Since there are
usury ceilings in Ohio, the 1969 average loan rate may not
represent

the

effective

loan

rate.

In

19 70, however,

m onetary policy was less restrictive, and loan rates tended
to be lower. Therefore, the 1 9 70 average loan rate and the

m arket and the percentage of various types of loans held
by banks in those markets. There was a negative corre­
lation

between

the

number

of

savings

and

loan

associations and the percentage of consumer and comm er­
cial loans held by banks in these markets.
19

Part of the significance of this relationship is because of

effective loan rate would probably be approxim ately at

the fact that the total operating costs include the interest

the same level.

paid on tim e and savings deposits.




11

ECONOMIC REVIEW

cost markets paid a relatively high average savings

markets. However, the relationship is relatively

rate.

weak,

The

level

of

retail

as

evidenced

by

the

fa ct

th a t

a 20

sales per capita is also

percentage p o in t increase in the tw o-bank concen­

significant in both the 1969 and 1970 equations.

tra tio n ratio w ould have only increased the average

This result implies th a t a high level o f per capita

price spread by approxim ately

retail sales was associated w ith a high average tim e

1970.

.002 percent in

and savings deposit rate. Since retail sales per

The wide difference in the relationship between

capita was viewed as a proxy fo r the level of

the price spread and concentration fo r 1969 and

economic

1970

a c tiv ity

in

a market, this result is

is most like ly

a result o f the type of

consistent w ith a high average tim e and savings

monetary policy th a t was being pursued in both

rate.

years. In 1969, policy was restrictive and loan

F inally, there is little relationship between the

rates

and

deposit

rates

were

relatively

high.

number o f savings and loan associations and the

However, usury laws in Ohio kept some loans rates

rates paid on tim e and savings deposits, according

from increasing to th e ir natural level, and Regu­

to equations fo r 1969 and 1970. This result is a

lation Q prohibited the deposit rates fo r increasing

little surprising because it could be expected th a t

beyond th e ir stated ceilings, causing the spread

savings and

associations compete d ire ctly

between the rates to be distorted. In 1970, as the

banks fo r tim e and savings deposits and

supply o f credit expanded, both loan rates and

w ith

loan

w ould, therefore, drive up the average savings rate.

savings rates fell

somewhat fro m

th e ir ceiling

However, the relationship could be distorted by

levels. The demand and supply forces operating in

the rate ceilings imposed on both types o f in s titu ­

the

tions, which w ould lim it their com p e titio n w ith

produce a price spread th a t was essentially undis­

each othe r.20 This fa cto r could account fo r the

torte d . As a result, it can be expected th a t the

absence o f a relationship between the number o f

relationship

savings and

average price spread is measured more accurately

loan

associations

and the

banks'

m arket, therefore, were relatively

between

concentration

free to

and

the

fo r 1970 than fo r 1969.

average savings rate.
Average Price Spread. The relationship between
the average price spread and concentration

is

The number o f savings and loan associations in
the banking markets under study was found to

1970 equation, but is

exert some influence on price spread. The positive

insignificant in the 1969 equation. Both equations

sign on the savings and loan variable indicates th a t

show

highly significant in the

a

a relatively large number o f these in stitu tio n s in a

relatively large price spread is associated w ith a

m arket is associated w ith a large price spread fo r

high level o f concentration in the 57 banking

the banks in those markets. This is consistent w ith

a

positive

association,

im plying

th a t

the earlier findings on the average loan rate and
20

Savings and loan associations have higher ceiling rates

than commercial

banks. The

Federal

average savings rate equations. It could be h y p o th ­

Reserve System,

however, lifted some of the rate ceilings in 1 9 70 fo r large

esized th a t savings and loan associations do n o t

denom ination tim e deposits. This change would probably

o ffe r commercial banks as much direct com pe­

not have a great effect on the present findings since many
of the banks in this sample do not offer th at type o f tim e
deposit.

12



titio n fo r financial services as m ight be expected.
In fact, the presence o f a relatively large number

MARCH 1972

o f savings and loan associations in a m arket may

performance.

First,

banking

is

a

regulated

provide banks w ith an incentive to concentrate on

industry. Many o f the regulations tend to dim inish

providing financial services th a t are not offered by

the

savings and loan associations.

structure and bank performance since the market

The

relationship

between

price spread and

significance

of

the

relationship

between

is n o t entirely free to determine prices and o u tp u t

other variables examined—such as per capita retail

and

sales—is generally insignificant. The retail sales per

in e fficie n t perform er.21

to

reward

the

Secondly, the

capita variable is significant in the 1969 equation,

e ffic ie n t

results from

or

punish

the

this study may

but insignificant fo r 1970. The negative re lation­

im ply th a t the approach used to measure bank

ship between retail sales per capita and the price

performance was n o t su fficie n tly disaggregated to
isolate the structure-perform ance relationship as it

spread is consistent w ith earlier results.

exists

SUMMARY AND CONCLUSIONS
This

study

generally

concludes

fo r

banks

in

these

nonSMSA

county

markets. While the structure o f a m arket affects
th a t

the

some aspects o f bank performance, it may be very

structure o f markets (as represented by a two-bank

d iffic u lt to detect the extent o f the relationship

concentration ratio) is n o t strongly related to the

w ith aggregate performance variables. A d ditional

aggregate performance o f banks in the nonSMSA

research

markets in Ohio. The study differs somewhat from

performance (mortgage loan rates or business loan

other such studies in th a t it was lim ited specif­

rates instead o f average loan rates) is necessary to

ically to nonSMSA co u n ty markets in order to

measure precisely how great an impact market

obtain

structure has on bank performance.

a

more

homogenous

sample

fo r

the

using disaggregated variables o f bank

oo

This type o f

research must be com pleted fo r individual states

empirical tests.
The only specific variable th a t appeared to have

and fo r d iffe re n t markets w ith in states before any

had a consistent impact on bank performance is

generalized statements can be made w ith regard to

the bank cost ratio. This variable is significant in

th e

three o f the fo u r equations fo r both 1969 and

performance relationship.

1970, im plying th a t bank efficiency may be an
im po rtant determ inant o f the

performance o f

banks in the nonSMSA county markets. There
may be at least tw o reasons w hy most studies o f
this type have n o t consistently shown a strong
relationship between market structure and bank




b a n k in g

industry

and

the

structure-

21

For a discussion o f this point see: Alm arin Phillips,
"C om petition , Confusion, and Commercial Banking," The
Jo u rn a l o f Finance, March 1964.

22

For example see: Donald Jacobs, Business L o a n Costs

an d B ank M a rk e t S tru c tu re (New Y o rk: National Bureau
of Economic Research, 19 71).

13

APPENDIX TABLE
Statistical Results of Structure-Performance Relationship Tests
for NonSMSA Counties in Ohio

Performance
Variables

Intercept

1969

Concentration
Ratio

Percent
Change in
Population

Percent
Change in
Income

Retail Sales
Per Capita

Industrialization
Ratio

Number of
Savings and
Loan
Associations

Consumer Loans/
Gross Loans

Average Bank
Size

Cost Ratio

R2

X1

x2

X3

X4

X5

X6

X7

X8

X9

V j —Average service charge -.29112 X 10~2
on demand deposits

.94213 X 10- 3
(.78239)

.26268 X 10- 4
(.81942)

-.56828 X 10- 6
(-.70743)

.73054 X 10- 3
(-1.14822)

.29635 X 10~5
(.19977)

.16071 X 10- 3
(1.18134)

.28650 X 10- 3
(.13477)

.66004 X 10- 7 *
(2.11502)

.17510t
(3.61064)

51.4

V 2—Profit rate

.13929

.36004 X 10- 1
(1.49472)

.34542 X 10~3
(.53865)

-.33158 X 1 0 - 5
(-.20634)

.15612 X 10 ~ 1 -.6 054 5 X 10- 4
(1.22672)
(-.20590)

.18304 X 10- 2
(.67260)

—1.72600*
(-1.77914)

26.1

V^—Average loan rate

.44813 X 10—1

.66914 X 10~3
(.22360)

.11717 X 10~3
(1.47080)

.46376 X 10~6
(.23230)

-.28203 X 10- 2 *
(-1.78375)

V^—Average savings rate

.16587 X 10-1

.22414 X 10- 3 .12226 X 10- 3 *
(2.00654)
(.97930 X 10 ~ 1)

.14487 X 10~5
(.94884)

.20935 X 1 0 _2# -.3 564 5 X 10- 4 -.7 163 4 X 10- 4 -.8 8 7 1 5 X 10 2 * -.1 979 6 X 10 7
(-.33373)
(-.27703)
(2.19566)
(-1.27582)
(1.73115)

Vg—Price spread

.28226 X 1CT1

.44500 X 10- 3
(.14438)

V^—Average service charge -.2 466 6 X 10- 2
on demand deposits

.91616 X 10- 3
(.70129)

.39042 X 10~4
(1.15806)

V j —Profit rate

.27117

.26421 X 10~1
(1.16675)

.11794 X 10- 2 *
(2.01821)

.15707 X 10~5 -.3 102 5 X 10- 2 --.55160 X 10- 3 * .20936 X 10~2
(-2.00705)
(.79767)
(-.35520)
(.10351)

Vg—Average loan rate

.42282 X 10-1

.56482 X 10- 2
(1.48064)

.11218 X 10- 3
(1.13958)

.45742 X 1 0 " 5* -.19429 X 10- 3 -.49444 X 10—4 .100088 X 10_2#
(-1.06799)
(2.28170)
(-.13205)
(1.78961)

V4 ~Average savings rate

.24809 X 10“ 1 -.2 947 2 X 10~2
(-1.24553)

.66502 X 10~4
(1.08903)

.35315 X 10~5* .17197 X 10- 2 * -.23025 X 10~4 -.20095 X 10- 3 -.40452 X 10- 2
(-.87745)
(-.73270)
(1.88431)
(-.80178)
(2.22741)

Vg—Price spread

.17472 X 10 ~ 1

.85955 X 10~2 *
(2.41178)

.45683 X 10- 4
(.49670)

-.50878 X 10~5 .98500 X 10- 6
(-.47906)
(-.62007 X 10~1)

-.4 913 8 X 10_ 2 t
(-3.01747)

.14805 X 10- 4
(.40529)

.50450 X 10- 4
(1.34095)

.93011 X 10_ 1 * -.4 794 5 X 10- 6
(2.18729)
(-.76802)

.58994 X 10_3# -.1 3 8 4 9 X 1 0 3 -.3 2 5 9 2 X 10 8
(1.74493)
I[-.26216 X 10—1) (-.42024 X 10- 1 )

.66157 X 10- 3
(1.34095)

.87330 X 10- 2
(1.60506)

.16536 X 10~7
(.20702)

.48180t
(3.99762)
.50038t
(5.42831)

43.2
60.6

-.18575 X 10“ 1 32.8
(-.14964)

1970

NOTE: Figures in parentheses are t-values.
* Significant at the 5 percent level,
t Significant at the 1 percent level.
Source: Federal Reserve Bank of Cleveland




-.27094 X 10- 6 -.6 916 5 X 10- 3
(-1.37266)
(-.30953)

.10427 X 10- 5
(.43664)

.53850 X 10- 6
.23438 X 10- 3
(.33964 X 10~1)
(1.54791)

-.19140 X 10“ 2 -.2 641 8 X 10- 4
(-1.39242)
(-.61078)

.12097 X 10- 2 t
(2.92872)

-.54663 X 10- 3
(-.21476)

.61106 X I Q ' 7 *
(2.05432)

.15238t
(3.33138)

48.6

.11881 +
(2.69298)

.28658 X 10- 6
(.55581)

—3.64484t
(-4.59683)

44.7

.43478t
(3.25515)

41.8

.34851 X 10” 7
(.64686)

.33504t
(4.04385)

49.2

-.29231 X 10- 7
(-.36021)

.99741 X 10-1
(.79929)

35.8

.56205 X 10- 8
.56415 X 10- 2
(.75906)
(.64710 X 10 1)

.96868 X 10- 2
(1.39505)

MARCH 1972

THE STRUCTURE OF STATE REVENUE
Warren E. Farb

INTRO DUCTION

level. (Services provided at the state government

State governments have been faced w ith both
increased

operational

costs

and

co n tin u a lly

level in some states may be provided by counties
or m unicipalities in other states.)1

growing demands fo r public services. As a result,
the states have found it necessary to increase tax

TA X STRUCTURE

institute new taxes. They have also

The am ount o f revenue th a t a taxing a u th o rity

turned to the Federal Government fo r financial

is able to raise is necessarily lim ited by the size o f

aid. In the past. Federal aid has been in the form

the relevant tax bases. The principal bases are

o f grants fo r specific programs; but in the future,

income, sales, and wealth (property tax), although

some funds may be distributed through a form o f

other measurable concepts could be used. A range

revenue sharing fo r use largely at the discretion o f

in possible rates as well as numerous com binations

the

fo r

o f taxes leads to greatly d iffe rin g tax structures

revenue sharing th a t are currently being considered

and, consequently, variations in tax e ffo rt among

rates and

recipient

government.

The

proposals

are based on factors such as population, per capita

the states. The d iffe re n t tax structures make it

income, and tax e ffo rt o f the individual govern­

v irtu a lly impossible to develop a clear-cut measure

m ent u nit.

o f e ffo rt. For example, one state may be making a

This article discusses the variation in state tax

strong e ffo rt in terms o f the wealth base, b u t its

structure and tax e ffo rt and d iffe re n t aspects o f

e ffo rt may appear weak when compared to the

the

income base.

principal

taxes

now

used

by the states,

particularly those states in the Fourth D istrict.

The measure o f tax e ffo rt discussed in this

The possible impacts o f a revenue sharing program

article is revenue per $1,000 o f personal income,

and state funding o f local schools on the state

which tends to remove the effects o f differences in

revenue structures are also examined. The dis­

income levels among states stemming from either

cussion and data relate o nly to taxation at the
state level (thus excluding taxes imposed by cities,
counties, and school districts) and do not account
fo r differences in services provided at the state



1
For a more complete study, see:

"State and

Local

Revenues and E xpenditures," E c o n o m ic R eview, Federal
Reserve Bank of Cleveland, November 1970.

15

ECONOMIC REVIEW
T A B LE I
Rank o f States' Revenue Per $1,000 o f Personal Incom e*
Selected Revenue Sources
1970
Per Capita
Personal Income
Connecticut
Alaska
3 Nevada
4 New Y o rk
5 California

$ 4 ,5 9 5
4 ,4 6 0
4 ,4 5 8
4 ,4 4 2
4 ,2 9 0

1

2

46 South Carolina
47 West Virginia
48 Alabama
49 Arkansas
50 Mississippi

General Sales or
Gross Receipts

Total
T ax Revenue

2,6 07
2 ,6 0 3
2 ,5 8 2
2 ,4 8 8
2 ,2 1 8

Hawaii
New Mexico
V erm o nt
Mississippi
Delaware

8 8 .2 1

Hawaii
Mississippi
Washington
West Virginia
Arizona

5 1 .0 3
4 9 .9 6
4 3 .9 5
42.41
3 8 .07

New Y o rk
Oklahoma
V erm o nt
New Jersey
Massachusetts

$ 1 1 1 .2 6
9 4 .9 9
9 4 .8 0
92.81

Missouri
Nebraska
New Jersey
Ohio
New Hampshire

Individual
Income Tax

$ 5 3 .1 7
4 3 .5 5
4 1 .7 2
38 .38
3 0 .4 3
12.44
11.99
11.97
11 .7 3
7.41

Hawaii
Wisconsin
Delaware
New Y o rk
Verm ont

$ 3 4 .3 2
3 1 .8 6
3 0 .8 8
3 0 .8 0
3 0 .62

Louisiana
New Hampshire
Tennessee
New Jersey
Connecticut

4.61
1.39
1.08
0 .5 8
0 .3 6

* Personal income data are U. S. D epartm ent o f Commerce estimates for calendar
year 1969.
Source: U. S. Departm ent o f Commerce

d iffe re n t

populations

or

levels

of

per

capita

income.2 A lthough this measure ignores "w e a lth "
and

of

a ctiv ity ,

most

relatively high per capita incomes do not

necessarily have the lowest tax efforts. O f the five

recognize income as the major source o f tax revenue.

states w ith the highest revenue per $1,000 o f

Tax e ffo rt—as measured by revenue per $1,000

personal income, all b u t New Mexico are among

personal

economic

w ith

states

of

levels

weak negative correlation, suggesting th a t states

incom e—varies greatly among the

the five to p states in either income or sales tax

states because o f variations in income o r d iffe r­

efforts. S im ilarly, those states having the lowest

ences in tax structure (see Table I). The average

overall tax e ffo rt either do n o t use one o f the tw o

state

personal

m ajor types o f state taxation or use them to o n ly a

income in 1970, and ranged fro m $38 in New

lim ited extent. Ohio, w hich did not have a state

Hampshire to $111 in Hawaii. O f the five states

income tax in 1970, and New Hampshire, which

that ranked highest in per capita personal income

does n o t have a sales tax, are examples o f the

in 1970, none was among the to p five in tax
e ffo rt; on the other hand, o f the lowest ranked

form er, and New Jersey is an example o f the
o
latter. The sources and relative d is trib u tio n o f tax

states in per capita income, one state (Mississippi)

revenue fo r the five states th a t rank as the highest

tax

was

$67

per

$1,000

of

ranked among the to p five in revenues collected.

in overall tax e ffo rt and the five states th a t rank

In general, tax e ffo rt and per capita income show a
o

the lowest are shown in Table II. Tables I and II

widely

per $1,000 o f income between the five to p ranked

Tax e ffo rt measured by tax per $ 1 ,0 0 0 o f income is a

used defin ition , but it does have many short­

comings and is by no means the only measure o f tax
e ffo rt found in economic literature. For a more detailed
discussion o f measures o f tax effo rt and tax capacity see:
Allen

D.

Manvel, “ Differences in

Fiscal Capacity and

E ffo rt: Their Significance for a Federal Revenue Sharing
System ," N a tio n a l Tax J o u rn a l, V ol. X X IV , No. 2 (1 9 7 1 ).

16



both illustrate the large disparity in revenues raised

states

and

the

five

lowest ranked states.

On

average, revenues raised by the five leading states
3

Pennsylvania instituted a state income tax in 19 71; and
Ohio began levying an income tax in 1972.

MARCH 1972
TA B LE II
Percent D istrib u tio n o f State Tax Revenue
1970
National
R ank*
1
2
3
4
5

General Sales
and Gross
Receipts Tax

Individual
I ncome Tax

Hawaii
New Mexico
V erm ont
Mississippi
Delaware

30.9%
13.1
32 .3
9.1
35 .0

M EAN
4 6 Missouri
47 Nebraska
48 New Jersey
49 Ohio
50 New Hampshire

Corporation
Income Tax

47.8%
3 1 .3

All
O th e rt

46 .9
- 0-

4.3%
3 .0
4 .3
4.1
6.9

17.1%
52.7
50.8
39.9
58.1

1 9 .2$

2 9 .5 $

9 .1 $

4 2 .2 $

15.8
17.0
1.3
- 03.7

4 2 .0
28.7
26.7
38.7
- 0-

2 .6

3 9 .6
51.1
59.3
6 1 .3
9 6 .4

1 2 .6

3 .3
12.7
- 0- 0-

* Rank of state based on total 1970 tax revenue per $ 1 ,0 0 0 of personal income,
t Other includes selective sales and gross receipts taxes on alcohol, m otor fuel,
tobacco, etc., property tax, death and gift taxes, and docum ent and stock
transfer taxes.
| Adjusted to include only those states imposing the specified tax.
Source: U. S. D epartm ent o f Commerce

were at least tw ice as large as revenues raised per

rapid rise in revenues fro m state income and sales

$1,000 o f income fo r the five lowest ranked states.

taxes. Because these taxes have a broad base, it is

For all

f if t y

states, the sales tax averaged

possible to raise large amounts o f tax revenue

$19.12 per $1,000 o f personal income in 1970, or

through relatively small increases in the tax rates.

about 30 percent o f the average to ta l tax revenue

Because the d ollar volume o f sales and income are

(Table

highly correlated, the fact th a t the measure o f tax

III).

A n other

$12.40

per

$1,000

of

personal income, or 19 percent o f the average total

e ffo rt used here does n o t e x p lic itly allow fo r the

tax revenue, was derived from state income taxes.4

sales tax base is n o t lik e ly to seriously bias the

N ot only are these tw o taxes the most im p o rta n t

expressed relationships.

sources o f revenue, b u t they have also been the

Sales Tax. The retail sales tax was used by 45

fastest growing in terms o f actual revenue raised.

states in

1970.5 Am ong these states, however,

During the post-World War II period, many states

there are many differences in the application o f

instituted these taxes to meet expanding needs fo r

the tax. Actual sales tax rates range from 2 percent

funds.

incomes, upward

in Indiana and Oklahoma to 6 percent in Pennsyl­

revisions in tax rates, and continuous grow th in

vania, and the items th a t are subject to the tax

retail sales also contributed im p o rta n tly to the

vary considerably. The most com m only exempted

The

rapid

grow th

in

item is barber and beauty parlor services, w hich is
4 The sales and income taxes average $ 2 2 .6 3 and $ 1 4 .6 9 ,
respectively, per $ 1 , 0 0 0 if only those states levying these
taxes are considered.




5

States th at did not have a retail sales tax in 1 9 70 are:

Alaska, Delaware, Montana, New Hampshire, and Oregon.

17

ECONOMIC REVIEW
TA B LE III
Sources and D istrib u tio n o f Revenue Per $1,000 o f Personal Incom e*
Average, A ll States
1Q70
Per $ 1 ,0 0 0
of Income

Source
Total general revenue
Intergovernm ental revenue
from Federal government
Total tax revenue
General sales tax
Individual income tax
Other taxest
Other revenue^

Percent of
Total Revenue

$ 1 0 4 .9 5

1 0 0 .0

2 5 .9 9
6 4 .7 3
19 .12
12 .40
33.21
14 .23

2 4 .8
61.7

Percent of
Total Tax Revenue

%

1 0 0 .0

%

29 .5
19.2
5 1 .3
13.5

* Personal income data are U. S. Departm ent o f Commerce estimates fo r calendar
year 1969.
tO th e r taxes include "o th e r" as defined in Table II plus comparable income taxes
and property taxes.
t Consists o f revenue received from local governments in the form of shared
revenues and grants-in-aid, as reimbursed fo r services, or in lieu of taxes.
Source: U. S. Departm ent o f Commerce

taxed by o n ly seven states. U tilitie s, especially

arises, and

local transportation, are also exempted fro m the

government u nits.7

retail sales tax by many states. Other exemptions
range from food and clothing to repair services.
In addition to exem pting entire classes o f goods

is adaptable to sharing w ith other

Income Tax. A state personal income tax is
more com plicated to adm inister than the sales tax,
b u t most states th a t use the income tax tr y to

sales taxation, some states allow

keep it as simple as possible. In comparison w ith

special taxes and tax rates on specific items. For

the Federal income tax, these e ffo rts have been

example,

successful.

from

general

C onnecticut

and

some

other

states

exem pt admission charges from the general sales

O f the 44 states th a t used a personal income

tax, b ut impose a separate admission tax. Tw enty-

tax in 1970, V erm ont and Alaska opted fo r the

five states allow co u n ty and m unicipal govern­

simplest o f all methods—a fixed percentage tax

ments to impose a sales tax levy in addition to the

levy on individual Federal income tax lia b ility . For

state sales tax. In most states, the additional tax

the other states, com plications are introduced at

rate is lim ited to either 0.5 or 1 percent; however,

tw o levels: (1) in calculating the tax base and (2)

Alaska allows m unicipalities to tax at a rate up to

in determ ining the applicable tax rate.

5 percent, and Colorado and New Y o rk allow up
to 3 percent.

In some states, the d e fin itio n o f income fo r tax
purposes is related to one o f the several income

Regardless o f its form , however, the sales tax is

concepts used in the Federal income tax return,

relatively simple to understand and administer. It

w hile in other states the tax base is independent o f

can also be used to obtain large amounts o f

the Federal income tax. States may or may not

revenues, is relatively easy to increase if the need
0

a llo w

standard

or

itemized

deductions

or

For a com plete list of exemptions by state see, S tate a n d

7 O f the 2 5 states th at perm it a local sales tax levy in

L o c a l Sales Taxes, (N ew Y o rk : Tax Foundation, Inc.,

addition to the state sales ta x, 19 administer the entire

1 9 70).

tax at the state level.

18



MARCH 1972

deductions fo r Federal taxes. A ll states provide fo r

The graduated income tax is generally regarded

some type o f personal exem ption, but both the

to be the most progressive o f the major sources o f

size and the rules governing the exem ption vary

state tax revenue w ith respect to income.

w idely. For example, Maryland allows $800 per

income tax

person; Mississippi allows

$4,000 fo r a single

considered to be pro p o rtion a l; and a sales tax,

individual and $6,000 fo r a fa m ily; and Wisconsin

regressive. However, the various adjustments and

allows a tax credit o f $10 per person to be applied

alternatives to the tax base th a t are perm itted

to the actual tax bill.

based on

a fla t

O

An

rate generally is

under the state laws have drastically altered these

The rate structures o f the state personal income

general

relationships.

The

fla t

rate

personal

taxes can be classified in to tw o general categories:

exem ption, fo r instance, w hich is used in many

graduated

most popular

graduated income taxes, tends to lessen the degree

method is the graduated rate structure, and it is

o f progressiveness because an individual in a high

used by over tw o-third s o f the income taxing

tax bracket w ill benefit more from the exem ption

states. The New Y o rk income tax structure begins

than an individual in a lower tax bracket. W ith

w ith a 2 percent rate on the firs t $1,000 o f income

respect to the retail sales tax, exemptions can

and

make the tax less regressive. Therefore, the low

and

fla t.

increases to

By far the

14 percent on

income

over

$23,000. The fla t rate tax generally tends to be a

income

relatively low rate, such as the 2 percent used in

benefit from the exem ption o f a necessity such as

individual

w ould

Indiana. A nothe r fo rm o f the fla t rate tax is a

food from

fixed percentage o f Federal income tax lia b ility ,

degree o f regressiveness.

w hich

is used

by

Alaska and

V erm ont.

This

m ethod, although a fla t rate, tends to tax high

receive

the

greatest

the sales tax base, causing a lower

Intergovernmental

Transfers.

A n o th e r m ajor

source o f revenue fo r state governments, w hich has

incomes more heavily than low incomes because o f

been increasing rapidly in recent years, is inter­

the graduated rates b u ilt in to the Federal tax

governmental transfers from the Federal Govern­

structure.

ment. Most o f the funds are cu rre n tly earmarked

When the fla t rate income tax is used, revenue

fo r specific uses, such as highway construction,

can be increased in a manner similar to retail sales

education, and welfare. However, there has been

tax; all

considerable debate concerning the desirability o f

th a t is required

appropriate
however,

legislation.

is the enactment o f

W ith

a graduated

tax,

new schedules must be constructed.

Depending on the

p riorities o f the state, the

allowing

the

recipient,

both

governments and

individuals, fu ll discretion in spending transferred
funds. Under most "revenue sharing" plans, the

increase can be evenly spread out over all incomes
or concentrated on one or more income levels.
W ith an income tax, it is also possible to change
the am ount o f total revenue raised by the tax

O
No other single source o f tax revenue contributes as
much

as

10

percent of total

revenue, and only the

corporate income tax contributes as much as 5 percent
(see Table II) . In this article, a tax is considered to be

w ith o u t changing the tax rate structures. This can

progressive if the am ount o f tax paid as a percentage of

be accomplished by changing the rules concerning

income increases as income increases. If the percentage of

exemptions, deductions, and credits or by altering
the d e fin itio n o f taxable income.



income paid as tax is equal for all income levels, the tax is
considered

to

be proportional; and if the percentage

decreases, the tax is considered regressive.

19

ECONOMIC REVIEW

recipient government u n it w ould be granted a

In view o f the current debate involving the

specified share o f designated funds instead o f

relationship o f Federal revenue sharing to state tax

receiving fixed amounts o f money fo r a specific

efforts, tax e ffo rt and Federal transfers to states

project. One o f the prime objectives o f such plans

were

is to transfer Federal tax revenue fro m those areas

analysis. Results indicate th a t 21 percent o f the

o f the co u n try w ith the least pressing need to areas

Federal transfer payments per $1,000 o f personal

w ith

the

sharing

greatest

relative

need.

The

revenue

in

Congress

plans under consideration

w ould make the size o f the grant dependent upon

statistically

income

in

depended

1970
on

the

related

were
tax

by simple

distributed
efforts

regression

as if they

of

the

states

(measured by the tax paid per $1,000 o f personal

a com plicated form ula based on the population,

income). If the population o f the state were added

income level, and possibly the tax e ffo rt o f the

to the regression, an additional 10 percent o f the

recipient
approved

government.
by

the

In

the version

House

Ways

and

recently
Means

Federal

transfer can be explained.

Per capita

transfer payments to states were n o t as strongly

Com m ittee, an additional allowance is made fo r

related

the degree o f urbanization, w ith large urban areas

transfers per $1,000 o f personal income, although

eligible to receive the greatest benefits.9

tax

to

tax

e ffo rt and

e ffo rt did account fo r

population

as were

12 percent o f the

In 1970, Federal transfers provided nearly 25

Federal transfers per capita and population an

percent o f to ta l state revenue and 40 percent o f

additional 4 percent. In general, then, w ith o u t

total tax revenue. N ationally, these transfers repre­

revenue sharing and a specifc form ula fo r the

sented

$1,000 o f

d is trib u tio n o f Federal funds, a state's own tax

personal income. The range o f Federal transfers,

an

average

of

$25.99

e ffo rt and population were in fact related to the

however, was from $82.24 in Alaska to $15.13 in

state's revenue per $1,000 o f personal income

New Jersey. In Alaska, o nly 8.7 percent o f the

from the Federal Government in 1970. To date,

general revenue came fro m the Federal Govern­

revenue sharing proposals have contained form ulas

ment, even though the transfers were 120 percent

th a t

o f to ta l tax

p opulation, some aspects o f its tax e ffo rt, and its

revenue.10

In

per

New Jersey, even

w ould

take

in to

consideration

a state's

though the transfers per $1,000 o f income appear

level o f personal income in determ ining the alio-

to be small, the Federal payments provided 21.7

cation o f funds.

percent o f the State's general revenue fro m all

th a t revenue sharing w ould n o t replace all o f the

sources and 34 percent o f its tax revenue.

current Federal revenue transfers to states.

11

It should be noted, however,

Property Tax. In 1970, property tax accounted
g

The $ 5 .3 billion revenue sharing plan agreed to by the

fo r o n ly 2.3 percent o f state tax revenue, b u t 84.9

House Ways and Means Com m ittee contains both general

percent o f local tax revenue. This tax is relatively

and special revenue features. The proposal contains no
restrictions on the $ 1 . 8 billion allocated to state govern­

u n im p o rtan t at the state level, b u t it does provide

ments, while $ 3 .5 billion allocated to local government
units w ould be restricted to certain types o f spending,
including capital outlays, maintenance, and operations.

11 It is likely th at, if only those funds th at are transferred
to states at the discretion o f the Federal Governm ent—not
depending on matching funds or other fixed programs—

10This is caused by the large am ount of general revenue

are studied, the im portance o f the level o f income in the

derived through state oil and gas holdings and leases.

state would increase.

20



MARCH 1972
local educational funds.

Pennsylvania, K entucky, and West V irg in ia —o nly

Recent rulings by the California Supreme C ourt

the major p o rtio n

of

K entucky and West V irginia had both a personal

and other state supreme courts, however, have

income tax and a retail sales tax in 1970.14 Ohio

raised the question o f whether or not the property

and Pennsylvania rely p rim a rily on a sales tax,

tax can be considered an equitable source o f funds

although

fo r

income from its corporate income tax (see Table

com m u n ity

schools.12

If

the

"C a lifo rn ia

Pennsylvania

does receive substantial

decision" is upheld, the financing o f public educa­

IV ). It is, therefore, not surprising th a t Ohio and

tio n could become a state function. If this should

Pennsylvania

receive

considerably

lower

tax

occur, the states w ould be required to increase

revenue

the ir tax revenue, on average, as much as 80

K entucky and West V irginia. As m ight be expected

per

$1,000 o f personal

income

than

percent, ceteris paribus. An increase o f such large

from the previous discussion, K entucky and West

propo rtion in state tax revenue could be financed

Virginia, w hich ranked 43rd and 47th, respec­

through a broad-based tax such as the income or

tive ly, in per capita personal income among the 50

sales tax. A lthough the additional state taxation

states—received more intergovernmental transfers

could be offset by lower local property taxes, it is

per $1,000 o f personal income (and per capita)

u n like ly th a t individuals w ould fin d the changes

from

the

Federal

Government than Ohio and

offsetting. Many w ould fin d their to ta l state and

Pennsylvania, which ranked 15th and 16th, respec­

local tax burden increased, while others w ould

tive ly,

find their burden decreased.

A lte rn a tive ly, a

d istrib u tio n pattern o f Federal transfer payments

state may decide to maintain the current property

possibly reflects the greater need in the relatively

in

per

capita

personal

income.

This

tax structure and to make the state the recipient

low income states. This is especially true o f West

rather than the local school district. Either method

Virginia, which received more than double the

w ould require a greatly expanded revenue e ffo rt

national average transfer per $1,000 o f personal

by the state, b u t w ould perm it equal d istrib u tio n

income.

o f funds among all schools in the state, thus

The 1970 d is trib u tio n o f Federal transfers to

elim inating the objections raised by the California

Fourth D istrict states can be compared w ith the

court.

d is trib u tio n th a t w ould result fro m any o f the

T A X STRUCTURE AND FEDERAL
TRANSFERS IN THE FOURTH
FEDERAL RESERVE DISTRICT

share o f all intergovernmental transfers fro m the

proposed revenue sharing plans by calculating the

Federal Government th a t is allocated to each o f
the

Fourth

D is trict states. The most notable

O f the fo u r states included w h o lly or partly

difference between the 1970 d is trib u tio n pattern

w ith in the Fourth Federal Reserve D is tric t—Ohio,

and the revenue sharing plan proposed by the

1~2

A d m in istra tio n

Several other state courts, including those in Texas,

in

1971

is th a t the tw o most

New Jersey, have also ruled th at the

populated states in the D istrict (Pennsylvania and

property tax can no longer be used as the prim ary source

Ohio) w ould receive a greater p roportion o f total

Minnesota, and

of school financing.
13

A ltern atively, the Federal Government may provide the

14

Exactly how the tax burden will shift among individ­

needed financing required fo r education either through

uals depends on what taxes are used, what tax schedules

general revenue sharing or earmarked grants.

are used, and on how the property tax is administered.




21

TAB LE IV
Sources and Distribution of Tax Revenue in the Fourth District States
Per $1,000 of Personal Income*
1970
O hio
Pennsylvania

100.0%

n.a.
n.a.

$ 7 6 .4 0
2 9 .0 9
1 3 .20
4 .2 9

n.a.
42

Percent of
Total Tax
Revenue

49
34
n.a.
n.a.

$ 6 4 .3 2
2 1 .9 6
n.a.
12.27

100.0%

30

38 .7
n.a.
n.a.

34.1
n.a.
19.1

21

6 1 .3

n.a.

3 0 .09

4 6 .8

48

2 0 .4 5

21.81:

$4 2.41
To tal tax revenue
16.41
Sales tax
n.a.
Individual income tax
n.a.
Corporation income tax
Revenue from Federal
2 6 .0 0
Other ta xest
Revenue from Federal
1 6 .3 8
G overnm ent

100.0%

2 3 .5 $

$ 3 ,7 3 8

15

Nation;
Rank

$ 3 ,6 5 9

n.a. N ot applicable.
* Personal income data are U. S. D ep artm ent o f Commerce estimates for calendar
year 1969.
t As defined in Table II.
| As percent o f to tal general revenue.
Source: U. S. D epartm ent o f Commerce




Percent of
To tal Tax
Revenue

Tax
per
$ 1 ,0 0 0

Percent of
To tal T ax
Revenue

Per capita personal
income

Tax
per
$ 1 ,0 0 0

National
Rank

Tax
per
$ 1 ,0 0 0

West Virginia

K entucky

16

National
Rank

T ax
per
$ 1 ,0 0 0

Percent of
T o tal Tax
Revenue

100.0%

38.1
17.3
5.6

19
n.a.

$81.31
3 8 .3 8
8.4 6
0.8 2

2 9 .8 2

3 9 .0

n.a.

3 6 .6 6

2 8 .8 $

17

$ 2 ,8 4 7

15

8

43

National
Rank

8

1.0

4
31
n.a.

3 3 .6 5

4 1 .4

n.a.

53.71

3 5 .8 $

4 7 .2
10.4

$ 2 ,6 0 3

4

47

MARCH 1972

Federal funds, w hile the other tw o states (West

the state level o f Government was raised through

Virginia and K entucky) w ould receive a smaller

tw o broad-based taxes—the personal income tax

propo rtion o f funds (see Table IV ). It is like ly,

and the retail sales tax. The im plem entation o f

however, th a t the programs that are most sensitive

these taxes and the

to need and low levels o f income w ould continue

greatly among the states. Many o f the state income

independently

taxes

of

any

revenue

sharing

plan,

have

resultant tax

graduated

rate

e ffo rt vary

structures allowing

although the House Ways and Means Com m ittee

progressiveness, b u t often the degree o f progres­

proposal favors those areas w ith the greatest need,

siveness

particularly

deductions, and credits.

cities and areas w ith

low

average

incomes.

is

lessened

by

income

exemptions,

Being broad-based, the sales and income taxes

In the F ourth D istrict, as w ould be expected,

are capable o f raising large amounts o f revenue.

the tw o states w ith the largest income bases—Ohio

Small increases in the tax rates result in large

and Pennsylvania—are also the most capable o f

increases in tax revenue. A lthough the property

increasing their tax revenue. Neither o f these states

tax is also broad-based, other things being equal,

had a personal income tax in

its base can be increased only through property

1970, although

Pennsylvania did receive 19 percent o f its tax

revaluation,

and

require

taxes

th a t the financing o f education—w hich is currently

states

is also

relatively

low;

financed

p rim a rily

recent

usually

decisions are upheld in higher courts, it is possible

these

If

increases

revenue from a corporate income tax. The revenue

in

approval.

rate

per $1,000 o f personal income received from sales

this is probably because o f the exem ption o f food

voter

actual

state

co u rt

through property ta x a tio n —

and numerous other items. West V irginia and

may become a state fu n c tio n requiring an increase,

K entucky, however, already rank among the to p

on average, o f as much as 80 percent in state tax

15 states in terms o f tax e ffo rt and use both a sales

revenue.

and in c o m e ta x , as well as a c o r p o r a te in c o m e

A nother major source o f state revenue th a t has

tax. In spite o f a relatively low retail sales tax rate

been growing in im portance is transfers and grants

o f 3 percent, West V irginia ranks fo u rth among all

from the Federal Government. In coming years,

states in revenue per $1,000 o f personal income

intergovernmental transfers are lik e ly to increase,

from a sales tax because o f its low level o f per

although the method o f d is trib u tio n may become

capita income. The regressions discussed in the

more form alized w ith the advent o f a revenue

previous section, however, indicate th a t fo r all 50

sharing or sim ilar program.

Congressional pro­

states the relation between per capita income and

p o sa ls

consideration

tax e ffo rt is weak.

distrib u tin g

SUMMARY AND CONCLUSIONS

state's population, b u t also its income level and

currently

under

fo r

Federal funds to the states include

provisions th a t take in to consideration n o t o n ly a

Nearly one-half o f all the 1970 tax revenue at




possibly its tax e ffo rt.

23