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Lawmakers in Nebraska, Kansas, Louisiana and North Carolina are debating this spring whether to repeal the state income tax. Ohio’s governor wants to cut personal income taxes by 20 percent. The governor of Virginia would like to do away with the state gasoline tax.
What all these proposals have in common — in red, blue and purple states — is this: An increased or expanded sales tax.
“People seem to have concluded that the sales tax is either the least harmful for the economy or the least unpopular,” said Eric Thompson, an economist at the University of Nebraska in Lincoln.
Dayton’s budget proposal — which would raise $2.2 billion in new sales tax revenue to help pay for a $627 million budget shortfall, funding for schools and property tax rebates for homeowners — has sparked a vigorous debate that’s now playing out at the Legislature.
Fresh off a recession in which state revenue plummeted, a key question in state governments from St. Paul to Topeka to Baton Rouge is how to craft a system that raises the money a state needs while still encouraging economic growth.
Minnesota is one of at least seven states that are considering an expanded or increased sales tax, signaling momentum for a marked shift toward greater reliance on consumption-based taxes.
One element of this, in Minnesota and elsewhere, is a move to broaden the sales tax to include a wider range of services. Proponents argue that this more appropriately reflects the modern, service-driven economy, even as debate swirls around exactly which services to tax.
In other states there is a push to tax more transactions as a path to moving away from income taxes. Some see this as a way to stimulate the economy by promoting savings and investment, though critics argue that such policies tend to favor the more affluent.
Aside from such questions of fairness or economic benefit, tax policy analyst Norton Francis of the Urban Institute pointed out that an increased sales tax is generally more palatable to the public than an increased income tax.
“It’s a drip-drip-drip with each transaction, rather than one bill at the end of the year, which makes a huge difference psychologically,” he said.
A changed economy
The drive to tax services reflects the fact that state tax codes have not kept up with an economy that’s flipped in the past 40 years from primarily goods-producing to primarily service-providing.
Between 1970 and 2010, the share of household spending on services grew from 43 percent to 60 percent, according to research by John Mikesell, a tax policy expert at the University of Indiana. Yet states continued to exempt a variety of services from the tax, and sales taxes as a share of personal income have shrunk in all but the handful of states that aggressively tax services.
States have jumped on this largely untaxed portion of the economy in 2013.
“The economic reality is the same to Ohio and to Louisiana and to Nebraska and Kansas and Minnesota,” said Myron Frans, revenue commissioner for Minnesota. “The service economy has to be taxed in some way to generate revenues that reflect that service economy.”
The plan that most closely resembles Dayton’s is Gov. John Kasich’s budget in Ohio. Kasich plans to lower the sales tax rate from 5.5 percent to 5 percent, but broaden the tax to a raft of services such as legal, accounting and real estate.
Ohio’s Republican governor wants to use new sales tax revenue — plus increased levies on oil and gas drilling — to pay for a 50 percent income tax cut for businesses and a 20 percent personal income tax cut across all brackets, to be phased in over three years.
“Services will be taxable unless otherwise exempt,” said Joseph Testa, Ohio’s tax commissioner. “That’s the shift we’re trying to make, move more toward a consumption base than an income tax base.”
In North Carolina, Senate Republicans have proposed replacing the income tax with a far more aggressive sales tax on services from shoe repair to legal work and public relations. The plan closely resembles Dayton’s proposal, with two differences: It proposes raising the sales tax rate dramatically, perhaps to as high as 8 percent, and the proceeds would go to phasing out the income tax instead of property tax relief.
Looking to boost jobs
In most states other than Minnesota, the goal is to cut income taxes, which states see as a way to attract businesses and jobs.
“There is a lot of movement into higher sales tax and limiting income taxes, often by Republican governors,” said Kim Rueben, an economist at the Tax Policy Center.
Income taxes are seen as punishing earning, saving and investment, she said, while a sales tax is seen as a tax of choice. Though sales taxes are criticized as regressive — falling harder on the poor by taking more of their total income — states see them as more friendly to economic growth.
Studies — notably the conclusions of supply-side economist Arthur Laffer — have asserted that if a state lowers or eliminates its income tax, it will grow faster than states with high income taxes. This point is hotly disputed, but it has found currency among Republican governors, Rueben said.
Louisiana Gov. Bobby Jindal, Nebraska Gov. Dave Heineman and Kansas Gov. Sam Brownback all have proposed eliminating their state individual income tax, and paying for it with new sales tax revenue.
In Kansas, Brownback has called for a “glide path to zero” income tax. The state cut income taxes in 2012 to compete with surrounding states for economic activity and population. Texas, which has no income tax, looms large in the region, and Great Plains states are racing to lower income taxes.
Steve Anderson, the Kansas budget director, argues that companies will move to states with lower income taxes to give their employees an effective raise and bolster their companies’ bottom line.
“If I can drive profits up $90 million just by moving, and that rolls to my bottom line, while that seems small, that’s an annual event,” said Anderson, who was appointed by Brownback after he was elected in 2010. “That’s a factor. Companies think that way.”
Brownback wants to help pay for income tax cuts by keeping in place a 0.6 percent state sales tax increase that was imposed in 2010 and meant to be temporary. The seemingly small increase demonstrates the quietly massive revenue-generating capacity of a consumption tax.
Those six-tenths of a penny on the dollar raise $262 million each year.
The only change Dayton has proposed for individual income taxes is an increase.
He wants to raise taxes for the wealthiest Minnesotans by 17 percent. His revenue commissioner, Frans, is careful to distinguish Dayton’s plan from those of his GOP counterparts.
Abolishing the income tax is not in the cards, Frans said, because that would be “too regressive.” Dayton instead intends to structure Minnesota’s tax system so the three sources of revenue — sales tax, income taxes and property taxes — share the load more evenly. In 2010, only 27 percent of Minnesota state revenue came from sales taxes. Under Dayton’s proposal, by 2015 that share would grow to 32 percent, nearly creating an even three-way split.
Dayton’s goals are not Bobby Jindal’s, but his payment plan is the same: more sales tax. The strategy’s been popular lately.
“I think this trend is what’s going to happen in the future,” Frans said. “We’re just seeing it happen pretty quickly in a number of states of different political persuasions.”