The final item needed for this valuation method is the expected capitalization rate. The capitalization rate is determined by understanding how much of a return investors can expect to realize in a particular market. The rate will vary in different parts of the country, in different parts of a city, even in buildings within a few blocks of each other.

Additionally, residential, commercial, and industrial properties also have varying capitalization rates. Remember, because the capitalization rate measures the profitability of an investment, certain types of properties involve other risks and thus dissimilar profit possibilities.

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.

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.

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.