Income Originating in the State and Local Sector

In this paper we develop an accounting framework for the state and local sector which is consistent with the accounting framework for the private sector of the economy. We show that the public sector capital stock generates an imputed return which takes the form of a reduction in local taxes and that failure to recognize this income distorts the measurement of the output of this sector, confuses the debate over federal tax reform, and hides the distinction between general subsidies for capital formation. Our implementation of those accounts for the 1959- 1985 period indicates that current national income accounting procedures misstate the amount of income originating in the state and local sector; in recent years this misstatement has been on the order of $100 billion. We also show that the state and local sector is one of the more capital intensive sectors of the economy.