Growth and Stability of Local Government Taxes: An Analysis of the Lexington-Fayette Urban County Government’s Tax Revenue Portfolio

Adequate tax revenues are critical for a government to operate and maintain the delivery of services that its citizens depend. The stability of these revenues is necessary for a government to accurately forecast future revenue growth and to ensure that balanced-budget requirements are met. The Lexington – Fayette Urban County Government (LFUCG) depends upon five primary tax sources for nearly 95% of its tax revenue. These taxes comprise the city's tax revenue portfolio and include the business net profits tax, employee withholdings tax, franchise tax, insurance premiums tax, and the property tax. Each of tax possesses unique characteristics that dictate their susceptibility to year-to-year fluctuations. These tax sources, on average, maintain a disproportionate share of the total tax revenue portfolio, ranging from 61.4% to 4.8%. This research sought to identify the tax sources which the city depends on most for its tax revenue, their respective degree of volatility, and whether the current tax revenue portfolio is " mix-efficient " with regard to the Markowitz portfolio model. Data for these five tax sources from FY 1993-2007 was used to find the relationship each of tax has on the other taxes within the portfolio. The analysis found that a positive relationship to exist between each possible tax pairing, except for the employee withholding tax-insurance premiums tax combination and the franchise tax-insurance premiums tax combination. A study of variance-covariance of the taxes supported that assumption that the presence of two or more taxes serve to reduce the volatility of the tax revenue portfolio, where the variance of the entire portfolio was significantly less than the variance of any single tax, except for the property tax. Using the coefficient of variation as a method of statistical dispersion, the following research found the tax source which the city depends on most, the employee withholding tax (61.4% of the tax revenue portfolio) has low level of unitized risk. This infers that the tax source experienced low volatility during the fifteen-year period, relative to the other taxes in the portfolio. The Urban County Government may choose to change the proportions of the tax shares within the revenue portfolio in order to reduce volatility. By placing greater weight on a tax share with lower historical volatility, it can improve the volatility of the overall tax revenue portfolio. However, such an adjustment will reduce the expected the return of the portfolio. Reducing the volatility, a normative concept, through an …