Let’s say that you want to buy the example property we mentioned earlier. Remember, this property consists of two houses on one 5,197-square-foot lot, which were built in 1948. The mix has two one-bedroom houses that are in good condition. The owner wants $279,000 for this property. Is that a fair price? We’ll see. After checking with a few local brokers and appraisers, let’s further assume that you are able to locate three comparative sales (comps). We’ll call these comps Properties “X,” “Y,” and “Z.” Here’s what we know about those properties.

Property “X” also has two houses and looks like it may have been built by the same contractor as the property you want to buy. The difference is both units have two bedrooms each (the Lawndale duplex has one one-bedroom and one two-bedroom). Property “X” also has nicer landscaping. This property sold two months ago for $293,900.

Property “Y” is an attached duplex, was also built in 1948, and is the same size and condition as your property. The units have open parking instead of garages. This building sold a few months ago for $264,000.

Finally, Property “Z” is also just like the property you want except that it sold one year ago for $262,000. Because the sale occurred so long ago, it may be less relevant, albeit still important, to analyze, for there aren’t any other comps available.

What does it cost to run this property? That is  the next component to understand. Expenses include such things
as:

Property taxes
Insurance premiums
Utilities
Gardening costs
Management fees
Maintenance and repair costs
Vacancies, etc.

Note that you will not be including interest expense here for  the capitalization-of – income approach assumes you paid all cash  for your building (even though you didn’t).  Although getting an accurate analysis of expenses may be easier  said than done, it is still imperative that you do so. One owner  might not pay for professional management yet another may, and  one owner may have rents too low and another may be right on.

Whatever the case, finding out what the expenses actually are is  critical to determining if the property is a sound investment.  Often, appraisers are forced to estimate the expenses for a certain  property based on the type of property that is being appraised and the area where it is located. Obviously, a duplex with no amenities  has far less expenses than a full-security building with tennis  courts and extensive landscaping does. Similarly, the cost of heating  a building in Boston, for example, will be considerably more than  heating one in Arizona. Remember that these types of size and regional  differences must be accounted for when analyzing expenses.

There are other ways to deal with the problems shown by these projections. Three major policies are involved.

First, about 38% of the structural deficit projection for Tennessee is federally related. That is, by planning to cut its spending on “discretionary” grants the federal government is planning to shift the burden of paying for its share of increased spending for inflation and workload changes to state and local governments. For example, the federal government now pays 8-9% of Tennessee school costs. If it covered its 8-9% share of the costs of serving more students and inflation-driven increases in teacher pay and other costs, it would still cover about 8-9% of costs in FY 2000, FY 2005, and beyond. If it follows its budget plan, it won’t cover its share of these costs, so Tennessee will have to do so while watching the federal share drop to something like 7-8% and even lower as the years go by.

If federal officials can be convinced to pick up additional costs or at a minimum maintain the current federal share, the outlook for all states and local governments gets better. However, to achieve this federal officials would have to abandon their balanced budget targets or make huge cuts in defense and other federal spending.

Second, the Tennessee government can raise money without raising taxes. At a minimum, governments can raise existing charges to match inflation, charging more for everything from getting a copy of a birth certificate to attending a state university. Charges could be raised considerably more than inflation would suggest — making, for example, the cost of attending the University of Tennessee more like those of going to private universities. Charges could be levied for things that are now free, such as for textbooks or extra-curricular activities for public school students and for admission to all state parks.

The alternative to raising taxes to cover the cost of maintaining current services is to cut services to correspond to what current taxes will raise. This is not quite as horrible as the word “cut” implies because the projections have spending increases built into them that Tennessee doesn’t have to make. For example, increasing enrollments could be handled by increasing class sizes and increasing compensation costs for state and local workers could be held to inflation alone, denying these workers the real (inflation-adjusted) increases in living standards that private sector workers will enjoy. The state could attempt a similar squeeze on compensation of workers the state pays indirectly, such as workers in hospitals, nursing homes, and child care agencies.

Obviously, state policy could combine tax increases and spending cuts. For example, maintaining a moratorium on tax cuts and expanded programs, raising taxes about 1% a year, and squeezing current service budgets by about 1% a year would work — mathematically at least.

Raising Taxes: One policy course for Tennessee would be to raise the money to finance current spending patterns. That policy works this way.

Maintain Current Services: For example, provide schools and teachers to handle added public school and university students and provide teachers raises just large enough to keep up with the average wage and salary increases in the private sector.

Do Not Increase Any Services Or Adopt New Programs: For example, do not make classes smaller, nor raise teacher salaries relative to those of private sector workers, or buy lots of new equipment and supplies, like computers, except through savings from buying less of something else, like textbooks.

Do Not Cut Any Existing Taxes

Raise State And Local Taxes By About 2% A Year: Revenue will automatically grow with the Tennessee economy. As more houses and offices are built there will be more property to tax. As inflation increases prices of houses, the property tax base and thus revenues from existing property taxes will rise. Growing personal incomes and inflation will cause sales tax revenues to increase. This revenue is already in the projections. The extra 2% has to come from increasing rates of sales, property and other taxes or adding to the tax base by such actions as ending exemptions of various kinds or taxing something new like wage and salary income or sales of services.

The projected Tennessee structural deficit is the mathematical result of projecting spending and revenues, comparing the two, and finding a budget gap or structural deficit equal to the excess of projected spending over projected revenues. Because Tennessee shows a bigger gap than any other major state, there must be something in its spending, its revenues, or some in each that explains the difference from the average state.

To make a long story short, the answer isn’t spending. By the standard national projections used in the study, the demographic factors driving spending such as population and school enrollment in Tennessee will grow somewhat faster than the national average. But Tennessee’s economy and thus tax bases will grow a little faster too. In these characteristics, Tennessee is similar to neighboring states which don’t show the same large structural deficits. The Tennessee structural deficit problem comes from its revenues, not its spending pressures. In sweeping terms, Tennessee’s spending for maintaining current services will grow about as fast as Tennessee personal income grows. So if revenues also grew about as fast as personal income, state and local taxes would remain about the same percentage of personal income they are today. (Economists use the term elasticity to describe the relationship between tax revenue growth and personal income growth. For example, if revenue growth from a particular tax were exactly equal to personal income growth, that revenue source would be said to have an elasticity of one.)

State Policy Research, Inc. has projected spending and revenues for state and local governments combined in each of the 50 states, allowing comparisons of structural deficits and surpluses in each. This is the first time such calculations have ever been made using a nationally uniform approach. The research will be published early next year by its sponsor, the National Education Association. The results summarized in this paper are preliminary and subject to change. Changes, described at the end of this paper, will affect the rankings of certain states other than Tennessee significantly and may affect the exact size of the structural deficits and surpluses shown for each state.

No changes contemplated will affect the basic conclusions for Tennessee:

• Tennessee has a structural deficit problem. Its revenues from existing taxes will grow more slowly than personal income, forcing a constant shrinkage of state and local government relative to the private economy unless tax rates are increased.
• Tennessee has a worse structural deficit problem than any of its eight neighboring states.
• Tennessee has a worse structural deficit problem than any major state (state with more than two million residents) in the nation.
• Tennessee’s tax system does a poorer job of capturing revenues from economic growth than the systems of any of its neighboring states.
• In capturing economic growth, Tennessee’s tax system ranks 46th among the 50 states. Only the tax systems of Florida, Nevada, Texas, and Washington do less well at capturing growth.

Structural deficits are mismatches of spending and revenues built into a government’s tax system and spending patterns. Structural deficits and structural surpluses, their opposite number, are calculated by
projecting a government’s spending and revenue and comparing the two. These projections are called current service or baseline projections. Not all states make such projections. Not all states having such projections make them public. And not all projections use the same methodology.

Having a structural deficit means a government cannot continue its current spending patterns without raising taxes. The shortfall is often called a budget gap. Conversely, a structural surplus means that current taxes will generate enough revenue to pay for current services with some money left over, sometimes called a fiscal dividend. This money could be used to add new spending, or cut tax rates, or some combination of the two.

Structural deficits and surpluses differ from cyclical deficits and surpluses. The effects of strong economic growth are so positive for most governments that they will show a temporary cyclical surplus in a year of economic boom even if they have a structural deficit. Likewise the impacts of recession are so negative that even states with a structural surplus over the long term may show a deficit in a recession year. Federal and state long-term budget projections do not include predictions of recessions and booms on the theory that they average out in the longrun and their exact timing is impossible to predict.