Taking Tax Cuts to a Deeper Level

Four states have already considered eliminating income or property taxes this year.
by | June 14, 2012

Tax cuts are an increasingly popular legislative mantra. Generally, the debate centers around whose taxes should be eased and why. But this year, the discussion took a significant turn in four states. Legislators in Georgia, Kansas and Oklahoma considered proposals to eliminate the income tax, while voters in North Dakota went to the polls June 12 to vote on a ballot initiative that would abolish property taxes.

The initiative was defeated decisively by a vote of 76.5 percent to 23.5 percent. But that still raises the question: Are these proposals game changers? I put that question to Joe Henchman, vice president of state projects at the Tax Foundation, which tends to favor lower taxes as a means of spurring economic growth; and to Nick Johnson, vice president for state fiscal policy at the Center on Budget and Policy Priorities (CBPP), which tends to see taxes as revenue that a state can invest in its economy and residents. (For more information on the proposals, here are links to CBPP papers on Kansas, Oklahoma and North Dakota.) What follows is an edited transcript of their responses.

Is this a sea change in the direction tax reform is heading?

Joe Henchman (JH): No state has abolished a tax base since Alaska eliminated their income tax in 1980 -- although, of course, right now seven states have no income tax and five no sales or use tax. So you can do it. In many ways, however, it can be more beneficial to eliminate a tax than just reduce it. Putting aside other considerations, when you get rid of an entire tax you get rid of distortions and compliance costs associated with that tax.

Nick Johnson (NJ): At this point, these proposals are a change in direction in rhetoric and aspiration, and not in policy. If these states were to eliminate a major tax base, you would call it a change in direction. But they haven't done it yet. When people look at the numbers and what it means for schools, health care, infrastructure and for other revenue sources, they will inevitably rise in response. Both legislative chambers in Oklahoma got pushback on the size of proposed spending cuts. Leaders in North Dakota stepped up to make the case on why the state needs to keep the property tax. These boomlets are hitting up against limits.

What's driving the phenomenon?

JH: It's hard to say. In North Dakota, revenue is growing rapidly. New tax dollars are pouring in. One can understand why there's pressure for tax relief. For Oklahoma and Kansas, it is because they're near Texas and are constantly trying to talk to businesses that compare them with Texas. Georgia is next to Florida, which also doesn't have an income tax. The common feature is, the nearest competitors for business and job growth don't have income taxes.

NJ: One clear reason is that advocates of these radical measures are hoping to capitalize on the frustration a lot of people feel with the sluggishness of the economic recovery and with all the institutions that have let them down. The hope by advocates is that voters will bite big, simplistic solutions.

What are the implications for a state if the elimination proposals were to win? How would a state make up the money or is a shrinking pot the point?

JH: You can cut spending, raise another tax and swap out revenue for something else. If that's the case, you have to ask whether you're replacing a bad tax with a worse tax. It could be like North Dakota where you would replace the lost revenue with oil production money. Oklahoma's proposal was based on spending cuts. It would be a lot of cuts. Even one of the proponents of the proposal says that the added economic growth would only replace one-fifth of the revenue. So the remaining four-fifths would come from cutting government spending or raising taxes somewhere else.

NJ: It's uncharted territory. In these states we are talking 30, 40 or even 50 percent of general revenue. It means big cuts in all the major and minor things states fund. Does that mean states then raise other kinds of taxes to fill in and shift responsibilities down to the local level, or do services get cut? Could it be a combination or all three? A state could end up with much higher sales taxes and excise taxes, much higher local taxes and larger class sizes, fewer teachers, libraries and cops on the street, and less availability of health care. It's magical economic thinking -- this idea that there's a free lunch to be had.

If a state were to repeal a major tax, what would be your biggest concerns if you were a legislator or governor in that state?

JH: I would want to make sure there is a holistic approach and that the state is not just banking on economic growth to make up the difference. If you eliminate a tax, that money is now in people's pockets and businesses or individuals can use it. That will cause economic growth, and the implication is that that will bring in extra tax revenue. But it won't erase the revenue loss. My question would be, is some other tax going up and if so, is that a worse tax? Are we going to cut spending? If so, are we really prepared to make those cuts? You have to know if the politics of the state will support spending cuts. If people value government services at zero, then cutting a bunch of them and leaving money in taxpayer pockets could be a net benefit. Depending on what you cut, you will have an economic effect. If you cut education, that might make your state less competitive. There are trade-offs.

NJ: You would basically get something equivalent to or worse than the worst days of 2008 and 2009, when the recession was hitting state revenue -- except that no recovery would be in sight. Once you get rid of a revenue source, it doesn't bounce back by itself. You create big existential questions: Should we still have a state university system? Should we still try to do stuff at the state level? Dump it on localities? In the case of North Dakota, it would have worked the other way around -- a huge resorting of the division of responsibilities. Putting a change like that into the constitution is very dangerous. Proponents say, "Oh well, it's not a big deal; you can change the constitution again if it doesn't work out." But that's disingenuous. Honestly, even if it's only statutory, undoing a tax change is hard. States like Oklahoma have a three-quarter supermajority to raise taxes, so it's almost impossible for Oklahoma to turn around on that.

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