Trading Bad Policy for Good Policy in Arkansas

February 21, 2017

Last week, Senator Lance Eads and Representative Andy Davis introduced Senate Bill 362 (SB362) in Arkansas. The bill, if adopted, would eliminate Arkansas’s investment credit, known as InvestArk, in exchange for fixing the way that repair parts for manufacturing and machinery are taxed in Arkansas. This tax change, if adopted, would help correct one of the worst provisions in Arkansas’s tax code.

Created in 2003, InvestArk is the largest tax credit in Arkansas for businesses. It represents half, or $40 million, of all business credits in Arkansas, based on the most recent data from the Arkansas Department of Finance and Administration. We discussed InvestArk at length in our recent book on Arkansas tax policy, Arkansas: The Road Map to Reform:

InvestArk provides a credit against an established business’s sales tax liability as the firm invests $5 million in a “project, including land, buildings, and equipment used in the construction, expansion, or modernization.” The credit equals 0.5 percent above the state’s current sales tax rate, and is used to offset a corporation’s direct sales tax liability. The credit cannot exceed 50 percent of a firm’s sales tax liability in one year, and it can be carried forward for up to five years.

The availability of InvestArk, however, covers Arkansas’s mistreatment of repair parts under its sales tax code. Currently, repair parts for machinery and manufacturing are partially taxable under the state’s sales tax. The state currently refunds taxes paid on repair parts in excess of 4.875 percent, compared to the full tax rate of 6.5 percent. We’ve written frequently about the harmful nature of taxing business inputs. The taxation of business inputs leads to “tax pyramiding,” or higher prices for consumers. Ideally, all business inputs would be exempt from sales taxation. Arkansas seemed to understand this, but the state decided to fix bad tax policy—taxing business inputs—with another bad tax policy—business tax credits.

Under SB362, InvestArk would stop the approval of applications as of June 30, 2017, and subsequently begin the process of winding down its operations. At the same time, the sales tax rate on repair parts would start decreasing. Taxes would be limited to 3.875 percent on July 1, 2018, 2.875 percent on July 1, 2019, 1.875 percent on July 1, 2020, and 0.875 percent on July 1, 2021, with full elimination as of July 1, 2022. Additionally, when the tax is eliminated in 2022, the taxing authority of local governments in Arkansas would also be rescinded. This is a huge step forward, considering that the average local sales tax rate in Arkansas is 2.80 percent.

The changes proposed in SB362 would be a large step forward for Arkansas. As we wrote in our book, “Fixing the state’s sales tax base to exclude business inputs would be a better long-term strategy than relying on tax credits that seek to ameliorate the damage.” In fact, this change, as drafted in SB362, would improve Arkansas’s tax competitiveness. According to the State Business Tax Climate Index, Arkansas’s rank on the corporate tax subcomponent would improve from 40th best overall to 34th best overall.

Obviously, there is still much work to be done in Arkansas, but this is a great step to fix one of the worst provisions in Arkansas’s tax code.

 


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