Thinking About State Taxation

January 29th, 2013 at 7:56 am

Out here in Oregon, I’ve been diving a bit more deeply into the question of taxation at the state level.  In earlier posts, I’ve highlighted the excellent work by CTJ on the regressivity of state taxes, especially in states that rely more on sales versus income taxes.

Well, if there’s a regressive idea out there, be assured some supply-side, trickle-downer will pursue it.  And so here’s my CBPP colleague Liz McNichol on the recent push to replace state income and corporate tax revenue with sales taxes.

Proponents claim that eliminating income taxes and expanding the sales tax would make tax systems simpler, fairer, and more business-friendly, with no net revenue loss.  In reality, they would tilt state taxes against middle- and lower-income households and likely undercut the state’s ability to maintain public services.  Specifically, they would:

  • Raise taxes on lower- and middle income families while businesses and high-income households would pay less.  That’s because repealing the income tax would disproportionately benefit high-income families (since they generally face higher tax rates), while a sales tax hike would hit low- and middle-income families the hardest (since they pay a bigger share of their incomes in sales tax than wealthier families do).
  • Require huge sales tax hikes…Sales tax rates would have to be markedly higher than they are now to make up for the revenue lost from eliminating income taxes.
  • Create an unsustainable spiral of rising rates and widening exemptions. A large expansion of the sales tax would spark furious efforts to exempt many purchases from the tax.  But if a state granted such exemptions, it would have to compensate by raising the sales tax rate even higher.  The ultimate result, most likely, is that the new tax would fail to meet its revenue-neutral promise — forcing cuts to education, transportation, and other essential services to meet state balanced-budget requirements.
  • Fail to boost state economies. Replacing income taxes with an expanded sales tax would do little or nothing to improve a state’s business climate or economic performance.  On the contrary, the resulting high sales tax could hurt in-state businesses as residents shift purchases to neighboring states or the Internet.
  • Make state revenues much less stable. By making a single tax a state’s sole significant revenue source — rather than the mix of sources now utilized — these proposals would deprive a state of a balanced revenue portfolio and jeopardize its ability to collect enough revenue for future needs.

Still, sales taxes are not necessarily all bad.  Economists like their efficiency, simplicity, and the fact that they incentivize saving over consumption.  But in order to offset their inherent regressivity, they need to be the third leg of a stool that has progressive income and corporate taxes in place, along with exemptions for necessities or a rebate for low-income households.

I like the idea of devoting the sales tax revenue to a tangible service that means a lot to people, like education, or health care, kind of like what Gov. Brown recently did in CA (with education).  We need a good conversation in this country about what it is we want in terms of public services, public goods, and public investments and what we’re willing to pay for them.

So, should OR think about a sales tax, a question I was asked a few times today?  Not, IMHO, until they deal with corporate tax breaks that are too regressive and would thus put too much of a revenue-raising burden on the sales tax.

This requires a quick dive in the state corporate tax weeds: beware the single sales factor tax (SFT), a hefty tax dodge by companies that locate in states where they have few sales.  Nike recently got the state to lock in this break for the next 30 freakin’ years!

Apportioning corporate taxation at the state level is—or should be—a balancing act between factors of production in the state—payrolls and property—and sales.  But under an SFT, a company only pays taxes on its in-state sales, not on its payroll or property in the state.  Nike has always had this advantage in OR but this new legislation locks it in for decades to come.

How large of a tax break is it?  Look at this little example from OCPP, using conservative guesstimates about the apportionment factors (such information is not reported).  Relative to an equally weighted formula, the SSF provides a 95% tax cut.

So, I wouldn’t reject a sales tax as part of the mix at the state level, but if you don’t have the other parts—income and corporate—in place, the state system will invariably end up either too regressive or too limited in terms of the revenues it can raise.

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24 comments in reply to "Thinking About State Taxation"

  1. Ogden Wernstrom says:

    Oregon and Washington make a nice contrast. Oregon has no general sales tax, but has a fairly-high state income tax. (Marginal rate of 9% for most households, higher above ~250,000 AGI.) Washington uses sales tax as its primary source of revenue, with no state income tax. Oregon has much higher property tax rates than Washington.

    Pundits often say that savings in property taxes and income taxes will be passed on to the consumer, thereby offsetting any sales taxes paid by the consumer. Retail prices either side of the Columbia River do NOT back up that claim.

    Some high-income sole proprietors have “gone Galt” by moving their businesses from Oregon to Washington.

    “…sales taxes are not necessarily all bad. Economists like their efficiency, simplicity, and the fact that they incentivize saving over consumption.”

    Progressive income taxes incentivize business owners to invest in their company (rather than take more of their profits as income). I think the postwar boom was due in part to the very high top marginal rates of federal income tax.

    I hope to get to the Portland talk tonight!

    • save_the_rustbelt says:

      “Progressive income taxes incentivize business owners to invest in their company (rather than take more of their profits as income).”

      I keep hearing this but as a CPA I don’t understand.

      There will likely be taxes paid regardless. Are you suggesting rapid depreciation shelters income? Something else?

      A common media myth is that business owners will spend $1 to save .35 in taxes. Only the dumb ones.

      • Ogden Wernstrom says:

        My guess is that you earned your CPA after 1987, so you’ve never seen truly high marginal tax rates.

        If you are going to wear your CPA on your sleeve, it won’t help your credibility to say that there “will likely be taxes paid regardless”. Tax strategies do not consist entirely of *not* paying tax, but consist mainly of paying the lowest aggregate tax possible. In my limited experience, the tax attorneys are much better at finding strategies – especially long-term strategies – than the CPAs are.

        Let me try a story. I own a sole proprietorship, and I have taken $500,000 as a salary from it already this tax year. The tax year is near an end and I have another $100,000 in profits that will be seen as income for tax purposes – and my marginal rate, fed+state, is 75%. My choices are to get $25,000 net income *or* come up with a way that the $100,000 is not taxable income. About half of my fleet of vehicles is already fully depreciated, but has a lot of miles before repair expense and downtime expense make replacement of those vehicles a good business decision. A consultant claims she could greatly increase my market with a $100,000 marketing campaign.

        The marginal utility of another $25,000 as current income is quite small compared to the value of my company when I sell it and retire on the proceeds. (I know that most states do not have a requirement for Econ courses before the CPA exam, so I apologize for using the term “marginal utility”.)

        My question: Do I have to go see a tax attorney, or can a CPA help me?

        • save_the_rustbelt says:

          Actually, 1976. Perhaps I wasn’t clear.

          I have no objection to the strategy, I helped clients execute year end avoidance/deferrals of taxes hundreds of times.

          My objection is the liberal notion that with higher marginal rates this is a strategy easily available to most businesses.

          If you really need the trucks and/or the marketing campaign that is the proper strategy.

          IF, you have the cash flow and/or credit to execute it.

          If you are spending money just to avoid taxes that is not such a good strategy.

          By the way, a sole proprietorship is a pass-thru entity, you do not take a “salary.”

    • Fred Thompson says:

      Oregon does not have higher property tax rates than Washington.

      • Ogden Wernstrom says:

        You are right about that – on average across each state, they are very close on property taxes. I made the mistake of comparing some rates in Multnomah County, Oregon with some rates in Clark County, Washington, directly across the border from each other…and generalizing that to each state.

  2. save_the_rustbelt says:

    The difference between a SALT discussion (state and local taxes) and a federal discussion is that businesses and individuals can and do move because of taxes.

    Rustbelt states have had double burdens, higher taxes and really crappy weather during the winter (last night we [mid-Michigan] had thunder snow and a thunderstorm followed by sleet and then some more rain, now flood warnings).

    Ohio’s inheritance tax combined with a progressive income tax drove most of my retired clients to Florida, and now they are moving before retirement.

    Lots of complex issues, lots of revenue needs, no easy answers.

  3. D. C. Sessions says:

    Economists like their efficiency, simplicity, and the fact that they incentivize saving over consumption.

    Is this an article of faith (like the popular idea of the Laffer curve) or is it something that can be derived as applying to our current state of economic affairs? Like tax rates, where both 0% and 100% produce no revenue, it’s obvious that neither 100% savings nor 100% consumption are optimal — but it seems to me that unless we know what the optimal mix of savings and consumption are, we can’t say that on should receive preferential treatment over the other.

  4. mikedmitchell2 says:

    Question. Do you think many of these states pushing for elimination of the income tax are really after the ‘starve the beast’ dystopia? Sure, they’ll make up some of the lost revenue with a bump in the sales tax, but after that? Cut, cut, cut.

    Unlike the federal government states are required, and really should, have balanced budgets. Destroying your tax system is the perfect opportunity to say “we just can’t afford that anymore.”

    This movement is frustratingly short-sighted and only works toward increasing the number one long-term problem facing our country, income inequality.

  5. Tom Cantlon says:

    Others ways states shift to sales tax. Here in AZ we years ago set corporate tax on auto-glide, and without any legislator having to make a vote it dwindles down year by year, leaving us more dependent on other taxes. Also we have a proposal to revise how the sales tax is implemented which will cause it to catch more things that weren’t being taxed, resulting in a stealth sales tax rise. Sales tax is great for a tourist state that needs to get some from those tourists, but needs to be offset.

  6. JohnR says:

    So, let’s see. I already buy far less than I could (and should), simply because my salary ($40K) is barely able to cope with the immediate demands of a family of four. Get rid of my state income tax (which is something like $1200/yr iirc) and I gain about half of one month’s net pay. The state sales tax is presently 6%. Depending on how much that increased, and whether or not things like food become taxable, I might come out a bit ahead, or I might actually lose ground. History tells me that I wouldn’t find out until the plan has been in place for a few years and the hidden extras start poking their heads out. Personally, I wouldn’t trust any of these clowns a single step – they have made it clear for as long as I’ve been alive that they want more for the very wealthy and less for folks like me; why should this be a positive for me, then?

  7. Fred Donaldson says:

    Why am I not surprised that austerity/deficit economists neglect to endorse the fairest of all sales taxes – the Luxury Tax. You pay $75 when you land on it.

    The big objection in the 90s was that it hurt job creation in the yacht industry.

    Of course, there was no concern in that era about eliminating many welfare benefits for destitute folks under welfare “reform” – probably because the very poor weren’t good at building yachts.

    The tax argument shouldn’t be about getting money from everyone to pay for government, but about not taxing people you have decided are in need of assistance.

    We provide a social safety net, and then ask those same people to pay 6% tax when they buy a undershirt.

  8. Th says:

    Besides the distributional impact of lowering income taxes and increasing sales taxes, is it even “pro-growth” as a recent AP article said is believed by most economists? Isn’t this an idea that is 50 years out of date? With hedge funds, private equity, sovereign wealth funds and corporate larders full of cash, why is it pro-growth to encourage people to save more and spend less? With an economy very heavily weighted toward consumption compared to our first world brethren, will reducing consumption not have a larger negative impact than in other countries?

    On the distributional front, my friends and I are in our last gasps of retirement planning and many of us have worked to have income tax free money to use in retirement. Lots of people converted traditional IRA’s to Roth’s and now will face jacked up sales taxes.

  9. Brian Dell says:

    “Make state revenues much less stable.”

    This isn’t true and I’m alarmed that so many blogs are repeating this as fact. The only evidence cited is portfolio diversification, but moving a “diversified” revenue stream to a single, less variable revenue stream is only more variable instead of less if the “diversified” sources are not correlated. The aggregate sales of all the Walmarts in a state are far more stable year to year than, say, stock market profits.

    re corporate taxes, Sweden has cut its corporate tax rate to 22% effective January 1, 2013. The federal corporate tax rate in Canada is just 15%. The federal U.S. rate is 35%. Yet both Sweden and Canada have social safety nets, and the Swedes pay 25% for most goods and services at the till, something that would surely be denounced as extremely regressive if adopted in the USA.

    If you are not prepared to tax at the till because it’s “regressive”, then you will not be able to afford Scandinavian style social supports. If corporate taxes don’t reduce investment in additional property, plant, and equipment then what does? Brookings Institution’s Tax Policy Center reckons that $1 in corporate tax cuts boosts wages 20%, and not just management’s wages.

    • Fred Thompson says:

      They can still be highly correlated. Don’t confuse a low beta with a low R^2. The coefficient of determination of state level PIT bases and consumption bases are, in fact, >.65.

  10. Tom in MN says:

    States seem to be in a race to the bottom on corporate taxes in the hopes of attracting businesses. But this is a zero sum game for the US as a whole, so lowering taxes just gives the companies a break for no good reason when viewed over all of the US. I think state corporate taxes should be deductible at the federal level (perhaps with a maximum limit of some kind), thus making differences in state taxes disappear to corporations and making states able to raise revenue they need without having to worry about neighboring states rates. The federal tax rate would need adjusting to account for this, but it would avoid such crazy things as the 30 year tax break you mention.

  11. Nick Batzdorf says:

    The other big issue with this is the same one that applies to all flat tax schemes: tax policy is the best way to encourage desirable behavior that’s in a “free market” blind spot!

    There are many examples, but the obvious ones are all related to the biggest challenge facing our planet: moving to the next energy economy.

  12. Chuck Sheketoff says:

    With Facebook and Google paying $150.00 a year (that’s right, just one-hundred and fifty dollars)in corporate income taxes under single sales — or minimum corporate minimum tax — because they have no sales in Oregon, Intel going from $50 million a year in the late 1990s to the minimum tax, and Nike saving over 90 percent of its taxes, before Oregon goes down the sales tax route we need to put the “income” back into the corporate income tax. Corporate taxes used to pick up 18 percent of income taxes, now they account for just 7 percent. That’s a cost shift that must be addressed.

    • Fred Thompson says:

      In theory moving from three-factor to single-factor apportionment ought to be revenue neutral, in practice it is not. It is associated with greatly reduced corporate income-tax collections – typically on the order of fifteen to forty percent; the higher the tax rate, the bigger the drop. The reason is simple. Single-factor apportionment makes it easy for businesses to bamboozle state tax collectors. One doesn’t have to be very sharp to count employees or buildings. Accurately measuring revenue, especially where businesses hire legions of accountants and lawyers to minimize their tax liabilities, is tough.

      That doesn’t make single-factor apportionment a bad idea. The reason Oregon abandoned three-factor apportionment is that it directly taxes and, thereby, discourages two things that we want to promote: employment and productive investment. Since Oregon moved to single-factor apportionment, it has outperformed nearly every other state. In fact, only North Dakota’s inflation-adjusted gross state product (GSP) increased faster than Oregon’s during this period. Moreover, Oregon has gone from a middling state in manufacturing to number one, measured in terms of the rate of growth in manufacturing plant and equipment and as a share of value-added GSP. I cannot say that the shift to single-factor apportionment caused these changes, but it certainly didn’t hurt. IMHO the increase in tax mobility is an argument for upgrading tax administration not for returning to three-factor apportionment.

  13. Fred Thompson says:

    What Sheketoff persists in fuzzing, is that, from a S&L perspective, escaping a jurisdiction’s tax net does not necessarily involve physical movement. It can be accomplished by “a mere stroke of a pen.” This is especially true of corporations, which are legal fictions or constructs. But it is nearly as true for anyone with enough wealth to make tax arbitrage worthwhile. Relatively high marginal tax rates (which is implicitly what moving from multi-factor to single factor CIT apportionment creates) call for for more and better tax administration. We have ignored that fact in Oregon. Second, the portfolio benefits of reliance on multiple tax sources at the the S&L level may be real in theory but as Dell notes above are very small empirically – tax bases and, therefore, all equally progressive tax sources are elastic, volatile, and correlated.

    • Fred Thompson says:

      This is a very nice piece of analysis. Nevertheless, I would offer one caveat. The ITEP’s periodic report, Who Pays?, is the best source on the incidence of state and local taxes. In fact, it’s just about the only source. Aside from the omission of transfer payments and user fees, it is a reliable ranking of relative fairness of state and local tax systems. At the same time, one shouldn’t take its findings as to the progressivity of state systems as dispositive. Arguably it does four things that overstate regressivity. First, it includes the federal offset. This is already included in assessments of federal tax progressivity and, therefore, looks like double counting. Excluding the offset converts Oregon’s tax system from one that is mildly regressive to one that is barely progressive. Second, the incidence of the property tax is not a settled matter, especially the portion shifted from property owners to renters and from businesses to their customers. Nevertheless, the weight of evidence suggests that that ITEP goes too far, overstating the property taxes paid by poor people and understating the property taxes paid by the wealthy. Making this adjustment converts Oregon’s system to one that is markedly progressive. Finally, the ITEP fails to allocate the bulk of state business and corporate income taxes to business owners, who are generally wealthier than the rest of us.

      The poor and middle classes may pay more in Oregon, but probably not.