ABSTRACT
This chapter addresses what has become a commonplace assertion concerning the fiscal difficulties of state and local governments: the inability of these governments to meet their rapidly expanding budgetary needs because of the relatively low income elasticity of their revenue systems. The argument typically runs as follows. Because of rising relative costs of most public services and the growing demand for these services as incomes expand, the budgets of state and local governments necessary to keep pace with the demand for public outputs increase more than proportionately with aggregate personal income. Most state and local tax structures, however, possess an income elasticity not much in excess of unity, so that revenue "needs" grow more rapidly than do actual revenues at existing tax rates. This shortfall is sometimes described as a "revenue gap," implying that political obstacles to raising tax rates and introducing new sources of revenues are likely to result in an underprovision of public services.
