State Tax Reform
Options, Challenges & Creativity
The February/March 2013 edition of ABFM’s newsletter, Line Item, features several articles on the pertinent topic of State Tax Reform. Click here to check out the rest of this special issue, and click here for information on a special webinar featuring contributors to this issue, hosted by AABPA on Wednesday, March 13th (1PM Eastern).
By Douglas C. Drake
Two very different states, Louisiana and Nebraska, are each considering dramatic changes to their tax structures that many analysts and citizens might consider rejections of longstanding definitions of good tax policy.
Both share significant common features: Republican Governors have suggested tax structure changes involving elimination of Individual Income and Corporate Income taxes (and Corporate Franchise in Louisiana), with “revenue neutral” replacement via elimination of sales tax exemptions and increases in state sales tax rates. These proposals seem to have policy links to recent work by ALEC and economist Arthur Laffer asserting that states without income taxes may have better economic growth prospects.
Both states also have significant local use of sales taxes, with Louisiana’s statewide average rate already at 8.84% in 2012 and Nebraska’s at 6.77%.
Nebraska’s proposal, contained in LB’s 405 and 406, was recently withdrawn by Governor Heineman in the face of significant opposition after an initial hearing in Nebraska’s unicameral Legislature. He is now talking about creating a study commission to examine Nebraska’s tax structure and recommend changes.
Louisiana Governor Jindahl has proposed a similar sweeping reform with income tax elimination financed by sales tax rate and base changes, but there has been no public discussion of details. While no legislation has been introduced, Legislators and some interest groups have been briefed from a one page document, but were not allowed to take that document from the room or to take notes. Actual introduction of a bill, if it comes, is not expected for several weeks.
Both proposals have been advanced with arguments asserting that the changes would be pro-business and pro-economic development and growth, and would simplify each state’s tax structure.
At this early stage, neither proposal appears to have given much consideration to issues such as: the political battles that could erupt from changes to the status quo of key industry groups; the potential for mis-estimating the magnitude of the changes; the need for re-visiting with much greater care the definitions of exempt and non-exempt transactions; the issues of overall equity in the tax structure; the “announcement effect” of the dramatically higher sales tax rates that would result; and the complex interaction with local sales taxes and overall difficulty in administration. This brief note will discuss some, but admittedly not all of these issues.
Both states show evidence of division along traditional lines relative to favoritism of sales taxes versus income taxes.
Changing the Relative Position of Interest Groups
As is often the case, removal of long-standing exemptions for key sectors of the business community creates guaranteed opposition. In the case of Nebraska, the proposed removal of sales taxes exemptions for agricultural machinery and other inputs certainly contributed to the Governor’s decision to take a strategic step back.
The Nebraska bills also appeared to eliminate sales tax exemptions for religious and non-profit groups that have rarely been subjected to sales taxes in the 50 states, and this was also a signification source of opposition.
Potential For Mis-Estimating The Yield of Things Not Now Taxed
The Nebraska proposal was nominally balanced and the Louisiana proposal has been described as revenue neutral in intent, but those of us who have worked in the area of tax “expenditure” estimating over the years are well aware that estimates based on economic statistics are often better considered as “ballpark” estimates than certain balance sheet numbers. Small variances in estimates can create major budget problems in multi-billion dollar tax shifts.
Administrative and Policy Concerns
Dramatic structural changes of this sort create administrative issues that are often not considered until the implementation stages—or in real time as individuals and businesses learn in the future that what they understood about their tax liability for years or decades is no longer true. Changing methods of sale (internet), distribution and delivery, and in our federal system, cross border issues create still more concerns. A Nebraska official interviewed for this brief note observed that his state had border issues on all sides, with major agricultural implement dealers located just across each border. The proposed bills did include some provision for increased staffing that to this observer seemed modest given the scope of the proposed changes.
In both states, the common use of city and parish (county) sales taxes could create an additional level of administrative complexity. Further, the potential of “announcement” effects of very high combined sales tax rates could become a deterrent to tourism, and contribute to evasion/avoidance by cross-border purchasing. Businesses with substantial purchased inputs would find this a deterrent as well. In addition, the impetus to internet and mail order purchases that exists today in every state with a sales tax, and is far from clear resolution in policy or legal terms would continue.
Douglas C. Drake is former of the State Budget Office of Education and Infrastructure and has been involved in tax administration and tax policy in Michigan on both the legislative and executive branch sides since the 1970’s. His accomplishments include development of Michigan’s Tax Expenditure Report, development of the State’s “Proposal A” school finance reform program in the 1990’s and project developer, co-editor and a contributor to the 2003 report, Michigan at the Millennium, A Review and Analysis of Its Fiscal and Economic Structure.