The Tax Policy Blog

Illinois has agreed to settle, without admitting wrongdoing, charges by the Securities and Exchange Commission (SEC) that the state misrepresented the financial health of the public employee pension system and what the impact of chronic underfunding would be. The system is now at least $96.7 billion short of what it has promised retirees—barely 40 percent funded.

From the SEC order:

The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations – a condition that worsened over time.

The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures.[…]

This enforcement action marks the second time that the SEC has charged a state with violating federal securities laws in their public pension disclosures. The SEC charged New Jersey in 2010 with misleading municipal bond investors about its underfunding of the state’s two largest pension plans. 

In related news, the Illinois Policy Institute’s project NoPensionBailout.com is seeking signatures to oppose any effort by the federal government to bail out the Illinois pension system. They include a map of which states would win and lose in such a massive bailout.

Louisiana Gov. Bobby Jindal (R) today released details about his tax reform proposal, which we first discussed in January here. We’ve been communicating extensively with the Governor’s staff in recent months about ideas and the pros and cons of various possibilities, but it should be said that the Governor and his staff ultimately decided what mix of policies they considered best for Louisiana (as it should be). As much as I wish sometimes that I had the power to rewrite state tax systems, we stick to the role we’re best at: describing what policies can best create a simple, sensible tax system in line with good public finance principles that are supported by research and evidence.

The plan, as a whole, is a major step toward creating a pro-growth tax system that can work for Louisiana. Corporate and individual income taxes are generally considered the most destructive taxes to economic growth, and both have a great deal of complexity and compliance costs associated with them. I’m no fan of the cigarette tax increase portion and despite being a lawyer I’m all for lawyers having to pay sales tax, but overall it’s a plan for a simple, stable, and modern tax system.

The highlights:

• Revenue neutral. Designed to raise as much revenue as the state does now, but through taxes that are less harmful to job creation and economic growth.
• Eliminates the state income tax. Despite a 6% rate on income over $50,000, Louisiana's state and local governments get just 14 percent of their revenue from the tax—the third lowest reliance among the states with an income tax. It’s a change that Louisiana can achieve.
• Eliminates the corporate income tax and the franchise tax. The state gets only about 2 percent of its revenue from the corporate income tax, so again not much reliance there. Franchise taxes are taxes on investment and capital accumulation and are widely recognized as destructive to economic growth.
• Broadens the sales tax base and raises the state tax rate from 4.0 percent to 5.88 percent. (Including local sales tax; for example, the New Orleans sales tax will be about 10.9 percent, up from the current 9 percent.) The sales tax base would be expanded to many personal and professional services. Among the items remaining exempt are food for home consumption, utilities, prescription drugs, fuel, manufacturing machinery and equipment, farm and agricultural inputs, leases and rentals, trade-in value for new vehicle purchases, historical structure rehabilitation, non-profit organizations, government purchases, healthcare, education, construction, real estate, financial services, legal services, oil and gas services, funerals, and advertising. Additionally, any service providers with revenue under $10,000 per year are exempt.
• The cigarette tax, currently 40 cents per pack, would rise to $1.41 per pack (matching the Texas rate).
• Low-income families and retirees will receive a rebate to offset some of the impact of the higher sales tax. (Note: an earlier version of this post mentioned a $60,000 cut off - this is for retirees only).
• State and local sales tax bases will be made uniform, and all collection and administration across the state will be done by a new state entity. Retailers will thus face a streamlined sales tax payment process.
• An independent tax tribunal would be set up. Presently, taxpayers challenging the Department of Revenue must file lawsuits against the state in trial court. Instead, there will be a single Tax Court to hear all tax-related disputes.
• Maintains many targeted economic development programs. Louisiana spends hundreds of millions of tax dollars on things like film and television production incentives, which are poor policy.
• The plan would take effect January 1, 2014.

Jindal summarized his plan as six main points:

First, eliminating income taxes will give more control to the taxpayer. Taxing what people spend instead of what they earn gives taxpayers more control over their own money.

Second, eliminating income taxes will make Louisiana the best place to start a business. This is the best way to grow our economy and create good-paying jobs throughout the state.

Third, in our plan, everyone will pay their fair share, but no more than that.

Fourth, our plan will close special interest loopholes. Powerful special interest groups will no longer be able to rig the system. For far too long average Louisiana citizens have felt the state’s tax code works for the rich and powerful, but not for them. By closing special interest loopholes, we level the playing field for everyone.

Fifth, we are going to protect food, prescription drugs and utilities from increased sales taxes.

Sixth, and finally, by switching to a state sales tax base, there will be more stability in funding for government services. Stability breeds confidence. Switching to a more stable tax base can smooth out many of the rough edges and stabilize state budgeting, and stability in government attracts businesses and creates good jobs.

The plan is particularly responsive to key possible objections. One objection would naturally be from the services industry, which would want to keep its existing sales tax carveouts. I’m hopeful that the elimination of the income, corporate, and franchise taxes makes it a worthwhile tradeoff, but one never knows. In any event, it’s just not fair that retailers have to collect tax when they sell goods, while service providers don’t. This plan corrects much (but not all) of that inequity.

Another objection would be on equity grounds—that relying more on the sales tax and less on the income tax is a regressive move. The Governor’s proposed rebate program would remove the negative impact to low-income individuals and households. The sales tax base expansion applies mostly to services purchased by higher-income households, not low-income households. Finally, it must be said that Louisiana’s tax system ought to focus on creating the best environment for jobs and opportunity for everyone in the state, because what the distributional tables say doesn’t really matter if the economy isn’t growing and people aren’t working.

A final objection I hear sometimes is that states need a balance of revenue sources—I sometimes hear this described as the “three-legged stool.” This is the weakest argument because there is no evidence that having three types of taxes instead of two or one or four leads to revenue stability. In fact, California has the fifth most volatile revenue system despite having every major tax, and the state with the most stable revenue (South Dakota) has only a broadened sales tax (no individual or corporate income tax). What matters is how your tax system is designed, not how many taxes you have. California has a lot of taxes but they’re all badly structured with high rates and narrow bases. Louisiana aims to mimic South Dakota, with a better-structured and stable sales tax that grows with the economy.

We previously estimated that a plan roughly in line with what Jindal has proposed would have made Louisiana 4th best on our 2013 State Business Tax Climate Index, instead of 32nd. (Now that we have the details, we’ll put out an update soon.) This would primarily be because of the elimination of significant complexity, compliance burdens, and tax obstacles to long-term economic growth.

My colleague Scott Drenkard discussed the plan earlier on our podcast program here.

There’s been lots of coverage of the dueling House and Senate budgets that were released this week and how they represent such contrasting views of the proper size and role of the federal government, particularly in regard to taxes.  House Republicans propose to keep total taxes as a share of GDP about where they are projected to be under current law (19 percent of GDP), but lower the top rate to 25 percent and broaden the base by closing “loopholes”.  Senate Democrats propose to just broaden the base, raising taxes by $1 trillion or more over 10 years, by closing “loopholes” benefitting the rich and corporations.  Neither budget is very specific beyond that, but these are very clear statements of philosophy, with Democrats arguing their budget is more fair, and Republicans arguing their budget is more conducive to economic growth.

But New York Times reporter Eduardo Porter doubts the premise that lower taxes grow the economy:

Problem is, there is little evidence that tax cutting has worked as advertised.

Thomas L. Hungerford, an economist with the Congressional Research Service, got into trouble with Republicans last year when he published a study suggesting that the sharp drop in top tax rates since 1945 did little to lift economic growth but probably did contribute to soaring income inequality.

And there’s no clear evidence that lower tax burdens have helped the United States grow faster than other advanced industrial nations with higher tax rates and much heavier tax burdens. Economic growth per person in the United States was a little faster than in France or Australia over the last 40 years. But it was a little slower than in Austria, Germany and the Netherlands, according to data from the Organization for Economic Cooperation and Development, a research organization for the world’s richest countries.

While high taxes do have an effect on variables that affect growth, many other factors are much more significant and overshadow whatever taxes do.

First, we debunked the CRS study on numerous occasions. There is no peer-reviewed academic journal in the world that would accept such a sloppy analysis.

Second, casual correlations can be dangerously misleading when it comes to the complexity of economic growth.  This is why I reviewed all the major studies on the subject from the last 30 years, and 90 percent of them indicate high taxes hurt economic growth, particularly taxes on profit and income. 

Third, the studies show taxes on profit and income have bigger effects on the economy than government spending.  Yes, these studies find other factors matter as well, such as inflation and demographics, but these factors do not “overshadow whatever taxes do.”

This is a very misleading article because it has the patina of science, quoting Nobel laureates and expert economists:

 “It’s hard to say for sure what our economic trajectory would have looked like with higher taxes,” said Alan Auerbach, an expert on the economics of taxation at the University of California, Berkeley. “Some of the disappointment that our low taxes haven’t had a more obvious impact comes from overblown claims of tax cut supporters.”

Yes, of course it is impossible to predict the future with 100 percent certainty.  But the preponderance of evidence gives us a clear sense of the most likely effects of taxes.  Ignoring and obscuring this evidence is the opposite of science. 

Such reporting makes it even less likely there will ever be broad agreement on the federal budget.

Follow William McBride on Twitter @EconoWill

On Tuesday, the Missouri Senate approved SB 26 by a 23-11 vote. The bill would phase in reductions of the state’s income and corporate taxes while raising the sales tax by half a point:

If the Marketplace Fairness Act or similar legislation becomes federal law, the top income tax rate and the corporate tax rate will both fall a further 0.25 percentage points.

Missouri’s rather absurd income tax brackets – stepping up in $1,000 increments to top out at $9,000 – are a relic of 1931, when $9,000 was a lot of money (equivalent to around $136,000 today). Missouri might be better off junking everything but that top rate, since most taxpayers are probably in the top bracket anyway. The bill instead creates a new 50 percent income tax deduction for business income, a problematic trend started in neighboring Kansas.

The state’s sales tax rate is currently 4.225 percent, comprised of 3 percent for the general fund, 1 percent for education, 0.125 percent for conservation, and 0.1 percent for parks and soils. Local sales taxes average an additional 3.23 percent for a combined average of 7.46 percent. The 8.925 percent combined sales tax rate in St. Louis would rise to 9.425 percent in 2018 under this bill.

The legislation also centralizes sales tax administration, collection, enforcement, and operation with the state – a key reform for Missouri, where many of those functions currently rest with local sales tax authorities. The state’s list of local sales tax rates runs 53 pages, so there’s a lot of them.

Altogether, the Joint Legislative Research Committee estimates the bill would reduce revenue by about $477 million annually when fully implemented. Governor Jay Nixon (D) has criticized the bill but has not yet threatened a veto.

While Nevada legislators consider mimicking the Texas margin tax, no less than 99 bills are under consideration in Texas to modify or repeal the tax. Most relate to credits, exemptions, and other carve-outs, but others permanently increase the exemption level or alter the constitutional requirements for raising rates. Five bills call for the phase-out or direct repeal of the tax. Because of the way tax overhaul’s design shifted the burden of the tax from certain entities to others, the tax has mixed reviews among the business community. A few companies have attempted to challenge the constitutionality of the tax, and there’s even a petition for its repeal.

We’ve criticized this particular Texas tax a few times (here and here), despite the state’s merits in other areas of taxation. There are two compelling economic reasons why this is a poorly-designed tax. First, it’s complicated to calculate and drains economic resources due to high compliance and administrative costs. Second, it isn’t neutral, treating certain business types, industries, and operations differently. Both of these lead to economic distortions that would not be present in the absence of such a tax.

Overly complicated tax calculations create compliance and administrative costs that are a loss to society. The calculation of a business’s margin tax liability is far from simple. Businesses subject to the tax must choose one of three bases. The definitions used in determining these tax bases are statutorily defined and different from definitions set by the federal government. Since calculations are so complicated, compliance and administrative costs are high. In a 2010 interim report of the House Committee on Ways and Means, one taxpayer, represented by the National Federation of Independent Business (NFIB), reported an increase from $400 to $2,500 in compliance costs after the margin tax was implemented. Economic resources wasted on complying with a complicated tax could be utilized more efficiently elsewhere in the economy. Further, when a tax treats different activities differently, it implicitly favors certain practices and operations over others. This generates economic distortions that would not be present in the absence of the tax. The less economic decisions that are created due to a tax, the better.

Taxes should be neutral, and the margin tax favors certain industries, practices, and business types by design. The margin tax isn’t neutral for a variety of reasons. First of all, there are two separate rates—0.5 percent for businesses “primarily engaged in wholesale or retail trade” and 1.0 percent for everyone else. Businesses with sufficiently low revenues have another separate rate. Second, it isn’t horizontally equitable, meaning that businesses that are similarly situated don’t face the same liability. For example, as described by the Texas Taxpayers and Research Association (TTARA):

[T]he retail outlet of a manufacturer may be taxed at one percent because the combined group of companies may be classified as a manufacturer. In contrast, an independently-owned retail store is classified as a retailer and pays a half percent tax rate…A company that hires its own employees may deduct salaries as compensation; however, a company engaged in the same line of business that chooses to use independent contractors to conduct its operations may not. Companies in the business of renting equipment may not deduct the cost of their equipment as cost of goods sold, while companies that sell that same equipment may. As a retailer, the company selling equipment will also qualify for a lower tax rate, while the rental company will not because they are considered to be engaged in providing services.            

(Note that these observations are based on the law as of October 2011.) The tax treats businesses differently based on the industry in which they operate, how they are organized, and on minute operating and organizational details. Again, this implicitly favors certain activities over others—something the tax code shouldn’t do.

Back to Square One. Unfortunately, Texas is right back where it began. Last month, the school financing system was again deemed unconstitutional by the same District Judge that ruled on the system in 2005. (This had been the impetus for enacting the tax in the first place.) The decision will likely be appealed to the Texas Supreme Court, which could result in more than a year of additional litigation time. In the meantime, perhaps this will provide the needed impetus for Texas to find a more efficient way to fund state operations, rather than relying on a tax that is complicated and confusing, generates wasteful costs, and creates economic distortions. 

Tax Foundation Vice President for Legal and State Projects Joseph Henchman returned to C-SPAN's Washington Journal on Sunday to discuss the states with the highest and lowest tax burdens.