The rise of the state
Unemployed men outside a soup kitchen during the Great Depression
Sales taxes may seem like a timeless and fundamental part of American life. However, they, along with many other state functions, are legacies of the Great Depression.
The Great Depression sparked the rise of state governments at the expense of local governments. In the May issue of the American Economic Journal: Economic Policy, authors Daniele Coen-Pirani and Michael Wooley develop and test a hypothesis to explain why.
From 1927 to 1940, the share of state revenues (out of combined state and local revenues) increased by 19 percentage points. Similarly, the states’ share of expenditures increased by 21 percentage points.
Figure 2 from Coen-Pirani and Wooley (2018)
The authors argue that, at the onset of the Depression, the sudden decline in income led to high levels of property tax delinquency, and so governments needed an alternative source of revenue. Sales taxes worked because they were difficult to avoid, but implementing them was only cost-effective at the state level. As expected, the authors find that the hardest-hit states were more likely to pass a sales tax.
As these new revenue sources became more important, they enabled states to have a more direct role in financing expenditures — including those that had traditionally been left to local governments, such as education.
The Great Depression provided the impetus for today’s tax institutions, motivating one of the largest changes in intergovernmental fiscal relationships in US history: the shift from local to state power.