Nebraska Governor Withdraws Tax Reform Proposal; Legislature Look to Commission to Develop Alternatives

February 25, 2013

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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