I was recently up in Vermont testifying about H. 234, a bill that would put a $1.28 per gallon tax on soda. Beer, by contrast, is taxed at $0.27 per gallon in Vermont. In my last post on the progress of the bill, I noted that it was killed in the Vermont Health Care committee, ostensibly because one of the expected “yay” votes (who is a doctor) was unable to attend the vote because a medical emergency had called him away. The Huffington Post reports that this was actually a political ploy though:
In a phone interview with The Huffington Post Thursday, [Rep. George] Till said he understood why everyone assumed he'd been pulled away by work -- but admitted that he had actually missed the vote on purpose, as a "purely political maneuver."
Till explained that prior to Friday's scheduled vote, several of his fellow committee members had expressed their intention to vote against the soda tax because of minor, budget-related provisions elsewhere in the bill. Till knew that he could count on getting the six "yes" votes the bill would have need to pass last week. But he feared sending the soda tax bill to the Ways and Means committee with a 6-5 vote would imply lukewarm support for the issue, guaranteeing its failure down the road. Till had sponsored soda tax bills in the previous two session of the Vermont House, only to see both fail, and he wanted this one to have the best possible chance of succeeding, he said.
He made a motion to reconsider this week, the bill passed the Health Care committee 7-2, and now it is awaiting a vote from the Ways and Means committee. Till reasons:
"I'm a physician, so I look at this as a health care bill," Till told HuffPost. "If we don't start doing something to fight obesity now, it's going to crush us down the line. Sugar-sweetened beverage taxes have a unique impact on obesity; it's clearly the most rational first step. I thought the message out of the policy committee should be a strong endorsement of that."
But this is ultimately a tax bill, which means that we need an economic understanding of how the tax would affect consumption behavior. In that regard, the economic literature is not on Till’s side. A 2010 study showed that adolescents consumed less soda when it was taxed, but they just substituted in the same amount of lost calories from other sources. A 2012 study showed that consumers that drink beer were particularly likely to switch to beer when soda was taxed. This resulted in almost 2,000 more calories consumed on net each month—not exactly a desirable outcome if your goal is trimming waistlines.
I think my takeaway from this literature is that nutrition is made up of complex choices that are personal to each individual. The tax code, by contrast, is a blunt tool with one lever, so it is not particularly well-suited to dealing with obesity.
Finally, as for obesity “crushing us down the line,” it looks like we are already turning the corner on obesity, with the most recent research showing that rates are dropping in many cities across the country.
For my testimony in Vermont, click here.
Follow Scott Drenkard on Twitter @ScottDrenkard.
I'll be appearing on a panel at the Urban-Brookings Tax Policy Center this afternoon covering everything relating to state taxes: the role of states in the economy recovery, state tax reform, public employee pensions, the impact of sequestration, and implementation of the Affordable Care Act.
Given the lineup of the panel, I'll have my work cut out for me defending the idea that tax systems should be simple, neutral, and focus on economic growth rather than trying to reward and punish different people.
Panelists:
You can watch the panel live online at 12pm eastern time today, or watch the recording later at this link. If you'd like to attend in person, register with the Urban Institute here.
Don’t believe taxes affect behavior? Tell that to the Bureau of Economic Analysis which just released January income numbers:
Personal income decreased 3.6 percent in January after increasing 2.6 percent in December, reflecting accelerated bonus payments and dividend distributions in December in anticipation of income tax rate changes.
Current-dollar disposable personal income (DPI), after-tax income, decreased 4.0 percent in January after increasing 2.7 percent in December.
As First Trust notes, this is the biggest drop in personal income since Bill Clinton raised income taxes in 1993 (see the history of rates chart below):
Personal income fell in January by the most in twenty years, but this is no big surprise. Back in December 1992, personal income jumped 3.4% in anticipation of higher tax rates under President Clinton. There was a huge payback the following month as personal income fell 3.7%. The same thing happened in the last two reports. In anticipation of higher tax rates on both regular income and dividends, personal income surged 2.6% in December and then dropped 3.6% in January. In particular, dividends surged 33% in December and then dropped 35% in January. Private wages and salaries declined 0.8% in January after surging 0.9% in December, as some firms paid normal January bonuses one month early.
For more on how capital gains tax increases fail to raise additional tax revenue, see our recent report.
Follow William McBride on Twitter @EconoWill
In Ohio, when you buy something from a convenience store, or a big box retailer, or a department store, or even online (increasingly), you will pay sales tax on that purchase. But when you buy services from a lawyer, you don’t pay sales tax. The reason is a historical accident: sales taxes were designed in the 1930s, when the economy was mostly goods and not services.
As our economy became less goods-oriented and more services-oriented, the sales tax base did not keep up. Sales of services to consumers in many states, including Ohio, remain untaxed. Because the base was not expanded as our economy expanded into the new things, the rate on what is taxed has had to go up and up. So while the tax was 3% in 1934, it rose to 4% in 1967, to 5% in 1980, and then to 5.5% today. In 1991, Ohio expanded the tax to a few personal services like lawn care and private investigative services, but the big ones (like legal and accounting services) remain tax-free.
Ohio Gov. John Kasich (R) has proposed ending these tax exemptions and applying the sales tax to all final retail purchases of services, and using the revenue to cut sales tax and income tax rates. It’s long overdue.
The Ohio State Bar Association opposes the plan’s ending of tax-free treatment of their services. Of course they couldn’t just say “we like what we do being tax-exempt because it makes us more money,” so they wrapped their opposition into concern for the plight of others:
A compelling reason for this decision was the board’s agreement that imposing a sales tax on legal services is inappropriate tax policy because it will unnecessarily burden Ohio consumers and impede access to the legal system.[…]
On behalf of the lawyers of Ohio and the clients they serve, the OSBA opposes the imposition of the Ohio sales tax on legal services because it jeopardizes access to the very legal services that are essential to every Ohio citizen and every Ohio business.
At one point, they even say that taxing legal services “could constitute an unconstitutional burden on the right to counsel,” which is garbage since it’s a broadly applicable tax, and as the saying goes, taxes are the cost of civilized society.
Certainly there could be a discussion about the best way to tax services. (We are not uniformly supportive of what Kasich wants to do.) But the OSBA statement is just putting a self-interested tax carveout ahead of a simple, neutral, pro-growth tax reform.
David Cay Johnston wrote an article this week for Tax Notes (linked from TaxProf) with the following rather large illustration of what the author claims is growing income inequality:
The graph shows that, if measured by inches, the top 1 percent of earners gained 884 feet, or $628,817 dollars in income, while the bottom 90 percent gained one inch, or $59 dollars from 1966 to 2011. From the article:
“In 2011 the average AGI of the vast majority fell to $30,437 per taxpayer, its lowest level since 1966 when measured in 2011 dollars. The vast majority averaged a mere $59 more in 2011 than in 1966. For the top 10 percent, by the same measures, average income rose by $116,071 to $254,864, an increase of 84 percent over 1966.” He goes on to essentially blame the tax system for this inequality.
Analyses like these are fascinating, but they do not tell you much and can be very misleading. However, people still jump to conclusions about them without much thought. There are a number of issues that people need to keep in mind when looking at average incomes, especially that aggregates tell you very little about the well-being of individuals. These issues have nothing to do with the tax system, but have everything to do with data.
Take this example: A mother has two children and wants to measure their height this year. The average of the two children is 40 inches. Next year, she measures again and those children grow, so the average grows to 42 inches. The third year, the lucky family has a third child. The mother measures the height again, but lo and behold the average now shrinks to 35 inches. “Oh no, my children are shrinking!” But we all know this isn’t the case. She just had a third child with a lower height; the other two children did not shrink.
A silly example, but this has to be considered when looking at “average incomes” for income quintiles. The composition of your quintiles matters a lot and a change in that composition over time can play tricks on you. Demographic and economic changes such as millions of low-skilled immigrants entering America slow the rate of income growth of the bottom quintile, creating the same new-child illusion in your data. And as with the new child, there is no reason to think the immigrant will be forever stuck in the bottom quintile.
Other factors that tend to exaggerate growth in income inequality include:
1) The entrance of women into the workforce.
2) The aging of the baby boomers.
3) The income measure comes from the IRS, and does not include fringe benefits such as healthcare, which go disproportionately to low-income households and have grown substantially since 1966.
4) Nor does the income measure include government transfer payments, which also go disproportionately to low-income households and have grown substantially since 1966.
5) It ignores the changing size and structure of households, including increased cohabitation rather than marriage and increased dual-income marriages.
See this and this for more on how to properly measure income inequality, as well as our chartbook.
The lesson here is to be wary of these analyses; they are often misleading and far too simplistic. Aggregates are useful, but they can be misused.
Follow William McBride on Twitter @EconoWill
Identical bills have been introduced in Congress which would grant each state the power to require collection of sales and use taxes by sellers with no physical presence in the state (PDF here). The “Marketplace Fairness Act” (S. 336 and H.R. 684) is the latest step of a lengthy and rigorous effort to expand state tax authority beyond historical limits, increase state revenue, end an economically unjustifiable tax treatment disparity between brick-and-mortar retail sales and online/catalog sales, and bring about uniformity and perhaps even simplification in the nation’s byzantine sales tax system.
In a presentation I routinely give, “The History of Internet Sales Taxation: 1789 to the Present,” I explain at least seven identifiable perspectives on the issue. It’s a complex one with a lot of big players. On one hand you have the idea that state services are bound geographically and therefore so should state taxation. On the other you have justifiable outrage at consumers buying stuff online without paying tax while brick-and-mortars have to collect. Proposed solutions include origin sourcing (taxing based on the seller's location, rather than the buyer's), a national online sales tax (ugh), the status quo of course, and the approach taken by these bills – expand state tax authority in this one area while requiring significant sales tax system simplification by each state that opts to take advantage of it.
The bill mostly resembles the Senate version of the bill from the last Congress, with some changes. Below I go through what’s in the bill, and then offer suggestions about what’s not in the bill.
The bill’s requirements for state legislation:
The bill also specifies:
Things the bill does not do but could:
Every year since 1992, advocates of expanded state sales tax authority have said that this year will be the year that they win. Past methods have included defiance and passing unconstitutional state laws, so the approach of hammering out a trade that would result in a simpler system is a welcome one. The sponsors continue to express a willingness to improve the bill. I hope it's a sincere one, as a few more improvements would be welcomed! I'm on record as predicting such a bill will pass inside of three years, but I'd like it to be a good one.
In a combative interview between Sean Hannity and Rep. Keith Ellison (D-MN) on Fox News this week, Hannity brought up the $16 trillion national debt. Rep Ellison followed with his suggestions on where to start in order to bring it down:
“[L]et’s close loopholes on large corporations; let’s say that yachts and jets should not be something you can write-off; let’s say that ExxonMobil and Chevron should not get a tax rebate and a subsidy…”
First of all, there is much debate around what is actually a loophole, but let’s cede the point for now. Even if we are generous, Rep. Ellison’s suggestions would not get us very far in debt reduction.
The Joint Committee on Taxation estimated the 2012 corporate tax expenditures to total about $148 billion - a number that includes provisions that are decidedly not loopholes. But for now we’ll put aside whether everything included in that total is actually a loophole and we’ll assume that if you eliminated those expenditures, the Treasury Department would get that entire $148 billion in revenue. That would hardly have made a dent in the $1.089 trillion deficit from 2012, leaving a deficit of $941 billion, and not coming close to touching the $16.6 trillion debt.
Of that $148 billion, only $2.7 billion comes from expenditures specific to the oil and gas industry. That would fund the government for a couple hours.
Rep. Ellison is right that if the federal government wants to maintain current spending levels, or even post sequestration levels, then we're going to need more revenue. But the last couple years of recession are proof that when the economy is down, revenues are too.
Instead, the best way to gain revenues and cut the deficit, and eventually the debt, is economic growth. Fundamental corporate tax reform would advance that goal.
A code built from scratch – ideally a territorial system with a low rate – would not need extensive tax expenditures or special interest carve-outs. The code would be transparent, simplified, and competitive.
A reformed corporate tax code would put us back on equal footing with our competitors around the globe and spur the economic growth that would lead to the revenue – and the jobs – the U.S. needs.
Last week, Wisconsin Gov. Scott Walker (R) released his budget proposal for the next two years, which includes a permanent reduction of the three bottom tax brackets:
|
Income Brackets for Single Filers |
Income Brackets for Joint Filers |
Current Rate |
Proposed Rate |
|
>$0 |
>$0 |
4.60% |
4.50% |
|
>$10,750 |
>$14,330 |
6.15% |
5.94% |
|
>$21,490 |
>$28,650 |
6.50% |
6.36% |
|
>$161,180 |
>$214,910 |
6.75% |
6.75% |
|
>$236,600 |
>$315,460 |
7.75% |
7.75% |
The overall reduction is roughly 2.2 percent, totaling $343 million over two years. All taxpayers will pay lower taxes on income up to $161,180 (singles) or $214,910 (joint filers), and the average person would save $83 a year: a modest but probably welcome amount.
Walker already ruled out complete repeal of the state income tax, but that shouldn’t rule out reductions in its burden. The state’s top tax rate of 7.75% is relatively high, beaten only by California (13.3%), Hawaii (11%), Oregon (9.9%), Iowa (8.98%), New Jersey (8.97%), Vermont (8.95%), New York (8.82%), Maine (7.95%), and Minnesota (7.85%).
Today is the 49th anniversary of the Revenue Act of 1964, the legislation signed into law by President Lyndon Johnson that contained the tax code changes generally referred to as the “Kennedy tax cuts.” President Kennedy had emphasized the need for tax reform in his 1963 State of the Union address:
To achieve these greater gains, one step, above all, is essential--the enactment this year of a substantial reduction and revision in Federal income taxes.
For it is increasingly clear--to those in Government, business, and labor who are responsible for our economy's success--that our obsolete tax system exerts too heavy a drag on private purchasing power, profits, and employment. Designed to check inflation in earlier years, it now checks growth instead. It discourages extra effort and risk. It distorts the use of resources. It invites recurrent recessions, depresses our Federal revenues, and causes chronic budget deficits.
Now, when the inflationary pressures of the war and the post-war years no longer threaten, and the dollar commands new respect-now, when no military crisis strains our resources--now is the time to act. We cannot afford to be timid or slow. For this is the most urgent task confronting the Congress in 1963.
After Kennedy’s death, President Johnson announced his intention to push tax reform forward in his own 1964 State of the Union address:
…every individual American taxpayer and every corporate taxpayer will benefit from the earliest possible passage of the pending tax bill from both the new investment it will bring and the new jobs that it will create.
That tax bill has been thoroughly discussed for a year. Now we need action. The new budget clearly allows it. Our taxpayers surely deserve it. Our economy strongly demands it. And every month of delay dilutes its benefits in 1964 for consumption, for investment, and for employment.
For until the bill is signed, its investment incentives cannot be deemed certain, and the withholding rate cannot be reduced-and the most damaging and devastating thing you can do to any businessman in America is to keep him in doubt and to keep him guessing on what our tax policy is.
Congress took up Johnson’s suggestion and passed what became the Revenue Act of 1964, which the President signed on February 26, 1964. The bill dropped the top marginal tax rate from 91% to 70% (and also reduced the corporate tax rate from 52% to 48%). In the wake of this reduction on high-earner households, federal revenue actually increased, rising from $94 billion in 1961 to $153 billion in 1968, an increase of 33 percent in real terms.
For more analysis, see Tax Foundation Fiscal Fact No. 15, "Comparing the Kennedy, Reagan and Bush Tax Cuts" by William Ahern.
The Buffett Rule is back in the news. The Senate Democrats have included it as a part of their solution to avoid the sequester, which is slated to take effect on March 1st. A recent Tax Foundation study found that trading spending cuts for tax increases is typically not a good formula for economic growth, but that’s not the only reason the Buffett Rule is poor policy.
First, some background: The Buffett Rule was first proposed by President Obama in 2011 in response to the claim by billionaire Warren Buffett that he pays a lower tax rate than his secretary. The rule is a tax designed to place an effective tax rate of 30 percent on high earners, phasing in between $1 million and $2 million.
Although the Senate has yet to release the official language for the recent iteration of the Buffett Rule, the proposal would probably be similar to the one that failed in the Senate last April.
The rule itself would have little budgetary impact, raising a meager $47 billion over ten years according to the Joint Committee on Taxation. The roughly $5 billion in annual revenue would cut last year’s $1.1 trillion deficit by less than half of 1 percent.
Instead, the push follows a narrative of fairness, citing the need for the wealthy to pay higher tax rates than the middle class. But this is already the case. The U.S. currently has the most progressive income tax system according to the OECD. IRS data show the average tax rate for the top 1 percent is 24 percent and the average tax rate for the bottom 99 percent is 8.4 percent.
The low rates we sometimes see from wealthy individuals is because they derive much of their income from investments, which is double taxed anyway. A capital gain or dividend is first taxed at the corporate level, as a corporate profit, then at the shareholder level. The result is a combined average tax rate of 56.7 percent in the United States – higher than every developed country in the world except, France, Denmark, and Italy. This creates a huge disincentive to invest, ultimately slowing economic growth.
Investment, and through it economic growth, is not something that only benefits the wealthy – it impacts us all. Higher capital investment leads to greater productivity, which leads to higher wages and better living conditions for workers across the income spectrum.
Warren Buffett has made his fortune, and good for him. But his political musings if made law would further stagnate the U.S. economy and prevent millions of Americans from achieving a higher standard of living.
For more of our work on the Buffett Rule, click here, here, here, and here.
With the recent comments from Phil Mickelson and the emigration of French actor Gerard Depardieu and other celebrities for tax reasons, people have been abuzz about millionaires fleeing high tax states in favor of low tax states. New York Times writer James B. Stewart, however, thinks millionaire migration due to taxes is a myth. Unfortunately, he greatly simplifies the issues, while ignoring ample evidence that migration is in fact happening. While the studies and evidence Mr. Stewart cites are interesting, he ignores how high tax burdens tend to slow economic growth and immigration over the long run.
It is no coincidence that the states that are famous for their “millionaire taxes” are also famous for their overall high tax burden. These tax burdens have persisted for decades in some states. New York, New Jersey, and California, with high personal and corporate income tax rates, have routinely been among the states with the highest overall tax burdens on businesses and individuals. Small changes to the top marginal income tax rate may not be the biggest factor in a person’s move. However, when it comes time to move for retirement, or to relocate a business, high tax states are much less desirable compared to states such as Nevada and Wyoming with no personal or corporate income tax.
IRS data indicates a migration trend from high tax states to low tax states. Between 1999 and 2010, high-tax New York, New Jersey, and California lost about 1.2 million individual taxpayers and more than $97 billion of personal income. This does not include the corporate losses. Meanwhile, low-tax Nevada, Wyoming, and South Dakota –not known for their magnificent climates – gained about 172 thousand individual taxpayers and $15 billion of personal income during the same period, again not including corporate losses. People are moving to these states and their money is following. Certainly this trend is not a coincidence.
There is one point that Mr. Stewart is right about: one of the main reasons people move is because of job prospects. However this cannot be divorced from a state’s high tax burden. Most academic studies on the subject have found that high and progressive income taxes are related to slower economic growth. For instance, a forthcoming paper by Mertens and Ravn in the American Economic Review finds that a one percentage point cut in the average personal income tax rate raises real GDP by 1.4 percent in the first quarter and 1.8 percent in the next three. Higher taxes may not have a huge immediate effect on migration, but their negative effect on the economy will eventually drive the jobs and the job seekers elsewhere.
Mr. Stewart is off the mark if he believes he has uncovered a myth. Besides the posturing of celebrities, no one claims that at the very moment someone whispers “tax increase” one thousand millionaires head to the border. What really happens is that these higher tax burdens cause wealth and income to flee to states and countries with lower burdens and higher economic growth over time. High-tax states such as Vermont, Michigan and Missouri have not been magnets for jobs over the long run. Look over at Europe, which is once again scaring investors. It is a continent with excellent climate, culture and an educated workforce, but its high taxes and spending have stalled population and economic growth for a decade or more. America will go that way if we continue down the same path, driving out investment, businesses, and jobs.
As the sequester looms this Friday, you can bet that politicians will tell aggrandized stories of how federal agencies will be forced to cut the most sympathetic programs you could possibly imagine. Don’t fall for it though; this is a political game that has been used for ages called the Washington Monument Ploy. It got its name from a 1969 episode where the director of the National Parks Department closed the Washington Monument and the Grand Canyon for two days every week to deal with budget cuts. These are obviously the most visible, popular landmarks the parks department operates, and so complaints rolled in and the funding was reinstated.
Here are some Washington Monument doozies from around the country:
Zoo May Close, Euthanize Animals: In 2009, a Boston Zoo claimed it would have to euthanize 20% of their animals if their budget was cut.
Zakim Memorial Bridge Turns Off Lights: The Massachusetts Transit Authority opted to turn off the lights that adorn the scenic Zakim Bridge, a famous part of the Boston skyline, to save a just $60,000 per year. Onlookers noted that the agency could save over $60,000 by laying off just one toll-taker.
Toilet-Paper Shortage: The Detroit school system claimed in 2009 that budget cuts had forced them to beg parents to send their children into school with toilet paper, because they did not have the funds to provide it.
I think Nicole Kaeding at Americans for Prosperity put it best this morning on a phone call. “If you make $50,000 a year ($137 a day), the sequester is like you deciding to cut $3.40 a day from your budget. That’s it. Too bad the President is asking us to choose between not paying rent or cutting the electricity, instead of cutting out a cup of Starbucks.”
More on the Fiscal Cliff deal that got us where we are today here.
Follow Scott Drenkard on Twitter @ScottDrenkard.
In case you missed the recent Cato Institute event featuring Tax Foundation chief economist William McBride, you can watch it below. The Capitol Hill briefing, "Taxes and Economic Growth: Understanding the Effects" also included Tax Foundation alumni J.D. Foster of the Heritage Foundation and Chris Edwards of Cato.
For more background, see McBride's recent study Tax Foundation Special Report No. 207, “What Is the Evidence on Taxes and Economic Growth?”
Last week I testified before the Vermont Ways & Means and Health Care Committees with regard to H. 234, a bill that would create a penny per ounce tax on sugar-sweetened beverages. In 2011, I authored a large study on sugar and snack taxes, and in 2012 I wrote a smaller piece on how two California cities might be affected if they instituted a similar tax to the one Vermont is considering. The citizens of Richmond and El Monte, California ultimately resoundingly voted down the soda tax on their November 2012 ballot. In Richmond, 67 percent of voters voted no, and in El Monte 77 percent of voters did.
So why? There are four primary reasons why soda taxes are poor tax policy:
Regressivity: A 2006 study found that a 10 percent excise tax on fatty foods would harm high-income individuals to the tune of $24.29, whereas low-income families had a burden almost double: $47.38. This effect would be amplified by the proposal in Vermont, which is a $1.28 per gallon tax, which equates to between 24 and 132 percent depending on the product it is levied on.
Ineffectiveness: While the law of demand states that increasing the price of a product will make people buy less of it, economic actors don’t behave in a vacuum. Several studies show that people just substitute calories from other sources when soda is taxed. A 2012 study showed that taxing soda leads many people to switch from soda to beer more often, and this behavior change results in an increase of 1,930 calories consumed per month for those people. Bear in mind that Vermont currently only taxes beer at 27 cents per gallon, and the proposed soda tax would be almost five times as high at $1.28. The highest tax on beer is $1.17 in Tennessee.
The Externality Argument is a Myth: This one is a bit complex, but it is really the proper way to think about excise tax policy. Economists sometimes support taxes on products if their consumption creates side-effects (externalities) on the rest of society. The thought is that if you tax a product at exactly the size of its externality, then the externality cost will be embedded in the price of the product and market actors will consider it when deciding to purchase the product (lengthier discussion of this concept here). Soda tax advocates make the case that since obese people have higher healthcare costs, taxpayers and anyone who shares an insurance pool with obese individuals are paying in part for their healthcare costs, and this is an externality problem that needs to be addressed with tax policy.
This argument is entirely unsatisfactory because the externality in question here is not sugar-sweetened beverages, it is actually healthcare costs. What’s more, this healthcare cost spillover is actually by design in government programs like Medicare and Medicaid. By definition, those programs rely on general tax dollars to fund healthcare spending. It’s unreasonable to call for additional government intervention to solve problems primarily created by government programs, and these externality problems could be better addressed through adjusting the structure of those programs.
Nutrition Has Many Inputs: Ultimately, soda is just one source of calories in an overall diet (the literature suggests just 7 percent), and it is entirely possible to have the occasional (or even regular) soda and not become obese. But an excise tax on soda is a blanket policy that would affect all soda drinkers regardless of weight. Ultimately, the tax code is far too blunt and instrument to be used to address something as complex as nutrition choices.
According to the Huffington Post, the bill was defeated in committee because of a medical emergency of one of the committee members.
More on Vermont here.
Follow Scott Drenkard on Twitter @ScottDrenkard.
Just over a week ago, Nebraska Gov. Dave Heineman decided to withdraw his two bills that would reduce the state’s income tax rate by expanding the sales tax base to additional business-to-business transactions. His action came after a contentious legislative hearing where witnesses (particularly from agriculture) expressed strong concern.
Their concern was justified, as I testified to at that hearing. B-to-B transactions, or business inputs, should actually be exempt under a properly structured sales tax system. This is not because businesses deserve special treatment, but because not doing so leads to the “pyramiding” of hidden taxes on taxes, distorting prices between goods based entirely on how many steps in the production chain there are. Instead, sales taxes should aim to tax final retail sales once and only once. It’s a mistake nearly every state with a sales tax makes, but one that should be addressed in tax reform.
This suggestion and criticism, I must note, does not reduce my enthusiasm for the Governor’s overarching goal: a simpler, more sensible tax system for Nebraska that will mean more jobs and economic growth. His approach – reducing taxes on wages and investment and shifting to taxes on consumption – would boost economic growth and be in line with strong academic evidence for tax reform. Taxing services rather than business inputs could keep the plan revenue-neutral while ending a disparity between those who sell goods and those who sell services, which is actually just a holdover from how sales taxes were designed in the 1930s.
Legislators are now considering a bill to set up a commission to study the state’s tax code and recommend changes. If enacted, a preliminary report would be due December 15 and a final report by November 15, 2014. Nearly everyone seems supportive of this approach.
I am too and even started sketching out some back-of-the-envelope options, using the Governor’s basic approach but instead exempting business inputs and expanding the sales tax to services. Depending on how broad the sales tax expansion is, the state could get the income tax and sales tax rates both down to 5.5 percent on a revenue-neutral basis. If the sales tax rate stayed where it is, you could get the income tax down to 4 percent, lower than all neighboring states. A very aggressive sales tax base broadening could get it down even further. An 8 to 10 percent sales tax rate would be needed to completely eliminate the income tax.
There’s a lot of moving parts of course. Besides the sales tax and income tax, there’s the property tax, the inheritance tax, and other taxes. I am pleased that legislators seem to be taking this step because they want to do something and do it right. Go Big Red!
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