In this interview, Meg Wiehe of the Institute on Taxation and Economic Policy shares her views on state tax base erosion and the state’s various responses to unstable revenue and fiscal issues. In short, Wiehe believes that a progressive tax system stimulates the economy better than targeted business tax breaks and incentives. Progressivity paired with infrastructure, community and health care spending can do as much to attract businesses to a state as targeted incentives. As a result, she believes lawmakers should focus on implementing these policies as a sure way to grow the economy and stabilize state revenues.
Bloomberg BNA: Tell us a little bit about yourself and your work at the Institute on Taxation and Economic Policy (ITEP)?
Wiehe: I am ITEP Deputy Director, my primary responsibility being to plan and execute state policy work, so I have a real bird’s eye view for what is happening in all 50 states, plus the pleasure of following the federal tax debate.
Bloomberg BNA: What is state tax base erosion?
Wiehe: Base erosion is happening to all major taxes. The one that gets the most attention sales tax—with the exception of a few states, like Oregon and Delaware—is one of a state’s major sources of revenue. The problem with sales taxes is that they were created in the early 20th century and are largely still an early 20th century tax. When the majority of sales taxes were put on the books, the kind of purchases consumers made were largely goods, so if you bought a lawnmower, you did not pay a service to mow your lawn.
As our economy has shifted to a service economy, we now expend more of our income on services rather than goods, and state sales tax statutes have not kept up with that change. It’s a historical accident that services were not included in the sales tax base. The issue is not confined to services. The shift to services happened in the late 20th century; but now we are in this 21st century economy, where we have online commerce, digital downloads and what people call the “sharing economy” embodied in companies like Airbnb and Uber. As our economy changes and as we change our pattern of consumption, sales tax statutes need to keep up. Until they do and until lawmakers really embrace the changing economy, sales tax bases are going to continue to erode, and it is certainly a short-, mid- and long-term budgetary problem.
Bloomberg BNA: What effect does state tax base erosion have on state budgets?
Wiehe: Sales taxes are not the only problem with base erosion, as income taxes in the majority of states are also quite narrow. Most states have some special provision targeted to older adults, and, as older adults are a growing share of the population of the states, those provisions become more costly. There are actually three states that allow residents 65 years old and older to exclude all of their retirement income, [from gross income] including pension and Social Security. Those states are facing a real problem in another five or 10 years when all the baby boomers are fully retired. There are a number of states (more than 30) that allow the taxpayer to take federal itemized deductions on their state return, and that creates a narrower base. Believe it or not, there are states that allow taxpayers to deduct federal taxes from their state taxes and even their state taxes from their state taxes. And then some states have some significant capital gains exclusions. There are all sorts of places, even in personal income taxes, that have narrowed bases and have had a tough time maintaining revenue over time.
The problem also extends to the corporate income tax. As the corporate income tax as a share of the economy and as a share of budgets declines, the race to cut corporate tax rates has really eroded the corporate income tax base. Beyond cutting the tax rates, there are lots of deductions and credits and ways of tax avoidance that corporations are allowed to use. It creates race-to-the-bottom special tax incentives for multiple corporations (but [the incentives are] specially targeted for one special corporation) that erode the corporate income tax base and exacerbates state revenue issues.
Bloomberg BNA: Some states have proposed to tax new goods and services as a way to stabilize budgets or to fund new government initiatives. What balance should states strike between attracting business through low taxes and strengthening fiscal stability?
Wiehe: There is an over-fixation on tax rates and tax breaks to attract or retain corporations leading to an economic boon that the states need. On the flip side, having adequate revenue both in the short and long term to ensure you are providing a quality education to the future workforce is equally important. Businesses who are located in or plan to relocate to a state are attracted by a highly educated workforce as much as gimmicky tax breaks. Having modern infrastructure in place, easy access to ports, access to airports, a highway system that isn’t congested with traffic and having a welcoming community with lots of amenities, like parks and other things that are very attractive to the workers and families who would want to work for these companies, are all equally—if not—more important. This idea has panned out and been shown in surveys of CEOs when making relocation decisions.
We have also found there are many cases in which a corporation was likely going to move to a particular state without regard to the tax incentives thrown at them. Business location decisions rely more on the need to access a port or an area like “The Research Triangle” in North Carolina, where there are multiple universities and a trained workforce from which to recruit. It is a mistake for lawmakers to ignore the short- and longer-term adequacy and sustainability of their revenues and instead rely on gimmicks and race-to-the-bottom tax incentives to attract one or two corporations.
The other thing that gets overlooked is that every state has a constitutional requirement to have a balanced budget, so every dollar cut in taxes is a dollar that the state is not spending. It’s a trade-off: if the dollar cut goes to X Corporation for a business tax cut, there is no guarantee that it stays in the state. Hundreds of millions of dollars in tax breaks could go to shareholders who live all over the country or the world; it could go to fund some expansion or hire workers in a different area, or it could be stashed in the record levels of profit in which the corporations are sitting on. However, if you spend the dollar in the state, either on a targeted tax cut to low income workers who are more likely to spend that money in the community, boost teacher pay or improving infrastructure, those dollars are going to stay in the state, and they will have a guaranteed economic impact.
Bloomberg BNA: The Georgia Budget and Policy Institute also released a report entitled “A Tax Blueprint to Strengthen Georgia.” The Institute recommends a “bottom-up” tax cut designed to be progressive up to $10,000, with a $10,000 standard deduction for those making under $50,000 per year, while those at the top end of the income spectrum would pay more. The Institute rejects H.B. 329, a bill instituting a slightly lower flat personal income tax with the loss of revenue being made up by H.B. 61, legislation introducing an e-commerce sales tax. Which plan would strengthen Georgia’s finances and lead to higher growth?
Wiehe: H.B. 329 and H.B. 61 morphed into different plans, so when I talk about them, I may talk about the two different versions of them. H.B. 329 absolutely is a 5.4 percent flat tax, paid for by getting rid of an inefficient tax break that allows taxpayers to deduct state income tax from state income taxes. The elimination of the tax break was a positive piece of the bill, but it was still a revenue loser.
The original version of the bill created a nonrefundable earned income tax credit, which was then morphed into a targeted, low-income tax credit. It is somewhat helpful that they recognize that by having a 5.4 percent flat tax, you are actually hiking taxes on the lowest income taxpayers who currently aren’t paying 5.4 percent on the first several thousand dollars on their income. But being nonrefundable, the credit didn’t reach as many taxpayers as it could have otherwise. Further, it doesn’t help to offset the regressivity of the rest of Georgia’s tax code.
In the end, even though there was an attempt to do some offsetting at the bottom and base broadening, a flat tax of 5.4 percent, over time, is just not going raise the same amount of revenue as the current tax system. Georgia essentially has a flat tax now, and while there are multiple brackets, the top bracket kicks in a $9,000, but at a higher 6 percent rate. Lawmakers will talk about flat taxes as a simplification of the tax code, but there is nothing complicated about a graduated tax system. A flat tax is going to mean less revenue from those with the most income (and the fastest growing income) at the top. Over the long term, it could have major implications for the state’s ability to collect adequate revenue from the income tax.
Georgia has this extra issue of an income tax cap at 6 percent. Lawmakers sent a question to the ballot two years ago, essentially asking voters whether to cap the income tax at 6 percent, and it was approved. The Senate version [of H.B. 329] eliminated the flat tax and simply did a top rate cut indexing some pieces of the tax code. While that is a preferable approach, that bill on its own lost well over $200 million dollars. Part of the problem with the final days of the session is that when the Senate tied it to the e-commerce bill, it gave the illusion that the e-commerce bill would pay for the income tax cut. The issue is that, other than Amazon, which is now collecting sales tax in all states, there is no guarantee any state could legally force any other online seller to collect and remit sales taxes. There are a lot of reasons to reject the package of bills. One last important thing to note is that, going into 2018, the House will return to being very adamant about the flat tax. Negotiations broke down at the end of the current session because the House dug in on the flat tax and the Senate wanted to go in a different direction, and they didn’t have time to come to an agreement.
On the other hand, there is no doubt in my mind that the Georgia Budget and Policy Institute’s plan that will strengthen Georgia’s finances and lead to higher growth over the short and long run. Kansas is proof positive that tax cuts, particularly those tilted to the top, do not lead to economic growth. Nor do they pay for themselves as was promised. Conversely, we do know that lower middle-income families are more likely to use a tax cut to make purchases to both improve their lives and futures, such as repairing a car to get to work, purchasing a car if they are able to take a job a little further away or moving into a better housing situation, all of which pumps money into local economies and improves those individual situations and opportunities. Further, Georgia has what we call an “upside-down tax system,” in which a greater percentage of a low- or middle-income family’s income is taken than families at the top of the income spectrum, increasing the need for targeted tax breaks for people in this income range. The Institute’s budget plan tackles base broadening more broadly, gets rid of the double-dipping deduction and modernizes the state sales tax in a more meaningful way. I would think they would agree that they should tax e-commerce but aren’t going to pretend that the revenue would be immediately available by including it in the plan, so their plan looked more at digital downloads—goods that are in our digital economies that weren’t there 10 or 15 years ago.
Bloomberg BNA: Focusing on the issue of an online sales tax levy, what do states need to do to ensure compliance?
Wiehe: Before we begin to think about compliance, it is important to note that states currently do not have the full authority to enforce all online retailers to collect and remit sales taxes on online purchases made by residents of their states. The U.S. Supreme Court has placed limits on states’ authority in this area, so it will take either an act of Congress, via the Marketplace Fairness Act, or a new decision from the Supreme Court before states can require that all online retailers collect sales taxes.
As of April 1, the nation’s largest e-retailer, Amazon, is now collecting sales taxes in all 50 states which largely reflects a change in that company’s business practices. Amazon’s effort to shorten delivery times caused it to open distribution centers around the country. Whenever a retailer establishes a physical presence in a state, it comes within reach of that state’s sales tax collection laws.
We saw a couple of years ago that a number of states passed bills that said, “when Congress passes the Marketplace Fairness Act, we are going to cut revenue in the state by doing X,Y and Z with it.” Bills of this type are a little disingenuous because who knows if, when or in what form Congress will pass the Marketplace Fairness Act.
Bloomberg BNA: In the April 19 Tax Justice Blog, you wrote that Alaska has taken a step closer to implementing an income tax for the first time in decades when the House passed H.B. 115. Alaska’s Legislature is also considering a reduction in the Permanent Fund Dividend (Dividend), Alaska’s annual payout of oil revenues to Alaskan residents. How would the implementation of an income tax and a reduction in the Dividend affect Alaskan residents and businesses?
Wiehe: Alaska is in a complicated situation right now. The House did pass an income tax bill that would institute an income tax, while the Senate wants to tackle the budget with a larger Dividend reduction and making some different spending choices. At this time, they are at an impasse but are working through it.
Kansas is a great story to look at what has gone awry in the last few years. Alaska is a different sort of cautionary tale: a state that, in 1980, completely eliminated an income tax because they thought we can always rely on this oil and gas revenue. And that turned out not to be the case. Even if oil were to pick back up next year, this is still a long-term problem, and they have long-term structural revenue issues. It would make a lot of sense for lawmakers, now that there is at least agreement in two of the three chambers making policy decisions in the state, to shore up their long-term revenue situation and add another major tax to the mix. Alaska has no personal income tax or sales tax, so there are several options.
Bloomberg BNA: A major issue facing Alaska is a reliance on oil revenues in an era of persistently low oil prices. Are there any policy proposals in Alaska to diversify its revenue sources and create a more sustainable fiscal environment?
Wiehe: Last week, we put out a report that compares the impact of four different revenue options in Alaska: an income tax, a sales tax, a Dividend cut and a payroll tax. Not surprisingly, what we found was that the income tax would be the least regressive (depending on how you design your income tax) and cutting the permanent fund would be the most regressive. Cutting the permanent fund by several hundred dollars or more is a significant change to income that people in the state have relied on for many years. It operates in essence like a tax hike and would mean less money in people’s pockets to make purchases and less stimulation of the local economy.
This is a real moment in Alaska—with the potential to get a progressive personal income tax on the books. H.B. 115 already excludes a large share of income from that tax, and the Legislature could implement the tax in a way to shield a lot of people or start with a low rate. But it sets them up in the long term to be in a much better place when oil and tax revenues decline again.
Bloomberg BNA: Minnesota enjoys a budget surplus for the fiscal year, but is now grappling with how to allocate the estimated $1.65 billion in surplus revenue. Republican legislators seek to cut business taxes and regulation, while Democrats have proposed to increase spending and tax breaks for low- and middle-income taxpayers, including Gov. Mark Dayton’s (D) interest in targeted relief for low-income residents, according to Bloomberg BNA’s Daily Tax Report: State (subscription required). Which proposal do you prefer from a policy standpoint, and why?
Wiehe: Clearly, I don’t think they should spend all of the surplus on tax cuts or spending. Some of that money can be put into the rainy day fund, which is one of the features of Dayton’s plan. As much attention that Kansas gets for being the poster child of what not to do, Minnesota doesn’t get enough credit for making good fiscal choices. Dayton ran on a campaign of increasing revenue permanently, not temporarily or ad hoc. States need adequate revenue over the long haul, and under the governor, two more income brackets were added and income tax breaks to low- or middle-income taxpayers were strengthened. Minnesota still has an upside down tax system, but it is closer to being balanced than most other states.
If you look around the country this year, Minnesota is in a small group of states that actually have a surplus. I definitely think the best ways to use a surplus of this size is to put some away for a rainy day, make some new investments in education, infrastructure, early childhood education and health care that are going to both improve economic opportunity—not only for low- or middle-income taxpayers—but make the state a more thriving place for everyone. Those are the types of investments that should attract businesses because it creates better opportunities for the workforce.
It is a mistake, particularly at the state level, where a dollar out is not a dollar in, to focus on spending a lot of money on business tax cuts when there is no guarantee that the money will come back to the state. This is particularly true if they are corporate tax cuts, which are more likely going to shareholders than going to create more jobs, with no guarantee that the jobs will be created in Minnesota. I definitely think that putting some money into critical public investments, and giving more money to the targeted tax breaks for low income residents, would have a better pay off for the state in the short and the long run.
This is the final part of a three-part series discussing state tax base erosion and evaluating state policy responses. Thanks again to Joseph Henchman of the Tax Foundation and Meg Wiehe of the Institute on Taxation and Economic Policy for taking the time to speak with Bloomberg BNA about this important topic.
Continue the discussion on the BBNA State Tax Group on LinkedIn: Should states expand their revenue base or increase tax rates to make up lost revenue?
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Interviewed by Kevin Thayer
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