Sources of Revenue for State Government

BREAKING NEWS: "The state government has just announced that they will be building a new highway that will connect three different states. The project will cost not two million, three million, or even four million but a whopping five million dollars."

As you sit there listening to the news anchor ramble on about the new highway project, you wonder what you would do if you had six million dollars. But then you wonder, "how would I get six million dollars in the first place?" Where does the state government get all this money from? Is it from all the taxes that you pay? These questions come to mind when trying to understand state government revenue sources. Keep reading to learn about where the state governments get their revenues from!

Sources of Revenue for Most State Governments

Economies consist of governments contributing significantly to economic activities and the economy's health. Whether it be the federal, state, or local governments, they all play a key role in the economy. Governments, just like businesses and you and me, require sources of revenue to run their operations. Sources of revenue are similar for both federal and state governments for the most part, with minor differences. The following are the main sources of revenue for most state governments.

Intergovernmental Revenue

Intergovernmental revenue is the revenue that one level of government passes on to another, usually in the form of funding. The federal government collects and transfers these funds to the state government. You may wonder, what happens next? Well, then the state government uses the transferred funds towards its expenditures. The types of expenditures that the state government use this type of revenue for include healthcare, education, infrastructure, and welfare payments. The state government also passes intergovernmental revenue on to local governments.

Sales Taxes

Sales tax is a source of revenue that is received through a tax levied on consumer purchases. This type of tax is a percentage of the purchase price of the good or service that is added to the final price that the consumer then pays. Interestingly enough, this tax doesn't go straight to the state government. Rather, the tax is collected on behalf of the government by businesses at the time of the sale, which then gets turned over to the government periodically.

The sales tax was originally introduced by one state, Mississippi, back in 1930 during the Great Depression. It was introduced as a strategy to lower property income tax within the state, which was the primary source of revenue for the state during that time. Soon after, sales tax was adopted by many other states throughout the nation. Today, most states levy a sales tax.¹

Let's take a look at an example of sales tax:

Individual Income Tax

Individual Income Tax is a tax levied on the income of those employed in the labor force. Income tax is collected through the payroll withholding system, which is a system designed to deduct taxes from wages paid by the employer and then send them to the Internal Revenue Service (IRS). Most states have a progressive income tax, while some have a proportional income tax.

Income tax was first introduced in 1861 by the Union government as a means to fund the Civil War. Interestingly, income tax was later considered unconstitutional. However, it was recognized for its ability to be a strong source of revenue. In 1913, when the ratification of the sixteenth amendment took place, Congress enacted the current individual income tax that many states use. Since then, the states that do have income tax have their own income tax rate and system.

Let's take a look at some examples of income tax:

Largest Source of Revenue for State Government

Depending on the state, there are two large sources of revenue for the state government.

The majority of the states receive their largest source of revenue through intergovernmental revenue. Intergovernmental revenue is funds that are transferred by the federal government to the state government for its expenditures. This source of revenue is in the form of shared revenue, reimbursements for conducting government functions and services for the federal government, and grants from the federal government.

The other largest source of revenue for other state governments is taxes. This includes general sales tax, income tax, selective sales tax, corporate tax, and property tax. We have discussed sales and income taxes, so let's take a closer look at corporate tax and property tax.

Corporate Income Tax

Corporate income tax is a tax that is paid by businesses on the profit they have earned. Just like how individual income tax is deducted from an individual's taxable income, corporate income tax is deducted from a business's taxable income. The rate of corporate tax rate today varies from state to state, and many states have options for tax deductions.

Property Tax

Property tax is a tax levied on properties such as real estate and automobiles that can be owned by businesses or individuals in the economy. In most states, the type of property tax implemented is known as the ad-valorem tax. Ad-valorem tax is a type of tax where the tax rate is dependent on the assessed value of the property or any other.

Stats For The Largest Sources Of Revenue For State Government

Let's look at some stats that showcase the percentage of revenue generated through the largest sources of revenue.

Figure 1 above shows the sources of state government revenue for the year 2020. In the year 2020, 45.8 percent of the revenue was generated through taxes. Whereas 36 percent of the revenue came from intergovernmental revenue.

Figure 2 above shows the sources of state government revenue for the year 2019. In the year 2019, 49 percent of the revenue for states was generated through taxes. Whereas 32 percent of the revenue came from intergovernmental revenue.

Figure 3. above shows the sources of state government revenue for the year 2018. In the year 2018, 58 percent of the revenue for states was generated through taxes. Whereas 36 percent of the revenue came from intergovernmental revenue.

Examples Of Revenue Sources For State Government

So far, we have discussed the main and largest revenue sources for state governments. Now, let's look at some other examples of revenue sources for state governments. Other sources of revenue for state governments include employee retirement and insurance and service charges.

Employee Retirement and Insurance

State revenue through employee retirement and insurance includes employee and employer contributions to employee pension plans, which also serve as a source of revenue for the state government.

Service Charges

State revenue through service charges includes a list of things that are part of daily economic activity. For example, highway tolls and tuition and educational fees, to name a few.