The second in a series on school finance, this report describes the principles of fair and adequate state and local income taxation. The political setting is discussed, and the nature of indiviudal income taxes is explained by examining which states tax income and what income they tax. Tables 2, 3, and 4 demonstrate the expanding school financing role of the states and individual income taxes as a percentage of total state taxes. The following issues and topics about taxing individual income are reviewed: principles of taxation; tax equity; constraints on tax rates; progressive taxation; inflation and indexing; the income tax as a social and economic policy tool; the lack of conformity among federal, state, ad local income taxes; and tax competition. Tables related to this material generally illustrate the responsiveness of state personal income taxes to changes in taxpayers' income elasticity--a factor that comments on the progressivity and the regressivity of the income tax and its potential for offering financial support to school districts. Several state practices are identified that tend to reduce its yield to the detriment of educational support. The potential for additional revenues are also discussed. The findings are that the income tax is and should continue to be an important source of school finance means and that the states must ensure that it is levied in a manner that facilitates equity and taxpayer compliance. (JAM)