Columbia Tribune:

By Terry Ganey

Sunday January 17, 2010

Jefferson City, MO

Taxing decisions

Messing around with our tax system

JEFFERSON CITY - "Don't tax him. Don't tax me. Tax the man behind the tree."
U.S. Sen. Russell Long, a Louisiana Democrat and an expert on tax policy, once made that remark about the political ramifications of "tax reform." For many years, Long, now deceased, was the chairman of the Senate Finance Committee.

Long's quote came to mind last week as state senators heard about one of the more bizarre ideas gaining traction among term-limited Missouri lawmakers. The plan would eliminate the state income tax on individuals and corporations and replace it with a higher sales tax on the purchase of all goods and services.

Some might fuss with the use of the term "bizarre," but consider that the plan, if implemented, would make Missouri's tax system unlike any other state in the nation. Currently, nine states do not have an income tax. If Missouri would join them, it would be the only state that extends the sales tax to services as well as goods. It would impose a higher sales tax rate and extend it to cover not only the sale of goods, but also services that touch all areas of domestic life - from child day care to the bill for a funeral ceremony.

There are many questions about the plan. No one knows the exact amount needed to replace the budget hole that would be created by eliminating the income tax. No one knows what the impact would be on Missouri businesses that compete with firms in neighboring states where the taxes would be lower. And there is debate over which individuals would be affected the most as the state's tax burden shifts from corporations to people.

"This proposal would eliminate about 95 to 96 percent of our general fund receipts and replace them with a tax that we don't know what it does," said Jim Moody, a former state budget director who now works as a lobbyist.

As remarkable as the plan itself is the fact the General Assembly has moved on it so quickly with little investigation. The House approved the plan 90-65 late in last year's session, but it didn't get beyond the committee hearing stage in the Senate.

Now the issue is alive in the Senate, where Sen. Chuck Purgason, R-Caulfield, has filed a constitutional amendment to implement the tax change. Some have indicated a willingness to give it floor time.

Last week, Senate President Pro Tem Charlie Shields, R-St. Joseph, hosted a two-hour Senate briefing session on the revolutionary idea. Calling it an "important discussion," Shields sounded like free-market economist Milton Friedman, saying times of chaos call for bold solutions.

"No sane person," Shields said, would design Missouri's current tax structure, which relies on a combination of state corporate and individual income taxes and sales taxes to generate the majority of the state's revenue. The plan the senators heard about would mean a higher state sales tax - the debate puts it between 5 and 9 percent - to be levied on all forms of retail trade and contracts for services. The proposal would remove all 131 existing sales tax exemptions, including food for home consumption, prescription drugs and domestic utilities.

Services that would be taxed include medical services such as hospital stays and doctor visits, dental services, tuition (except at institutions of higher education), legal services, real estate agent fees, advertising, rents, insurance payments, tickets to the theater and sporting events, and nursing home services, among others.

The youngster who mows your lawn would impose a sales tax.
"If you have a service business, I think you're a loser in this," said Moody, who as a lobbyist would have to add the tax onto bills he sends his clients. "People with a lot of unearned income would benefit the most from it."

SALES VS. INCOME

Joseph Haslag, who holds the Kenneth Lay Chair in Economics at the University of Missouri, is one of the supporters of the movement. Haslag also is the executive vice president of the Show-Me Institute, an organization launched by wealthy financier Rex Sinquefield, who has contributed hundreds of thousands of dollars to state lawmakers. (Haslag is paid $165,000 from the endowment given to MU by the late, disgraced Enron executive, and the Show-Me Institute pays Haslag more than $65,000 annually.)

Haslag told Shields and a dozen other state senators the state income tax is holding Missouri down.

"If you look at states that have no income tax, those states have been growing much faster," Haslag said. In the decade between 1995 and 2005, Missouri's gross domestic product had increased 24 percent compared to the national average of 34 percent. He said eliminating the income tax would produce a $430 billion boost in Missouri's standard of living within the next generation.

While there is uncertainty over how much the tax should be, proponents said the levy will be "revenue neutral," that is, it will produce no more money than the existing income tax. Haslag co-authored a paper in October that said a sales tax rate of 5.79 percent would be needed to replace the revenue from Missouri's income tax. Missouri's current sales tax, which includes special taxes for parks, soils and conservation, is 4.225 percent.
Purgason's legislation would peg the rate at 5.11 percent. But opponents said the tax would have to be much higher, perhaps 9 percent. Local sales taxes would have to be readjusted, too, to collect the same amount of revenue.

The difference in state income between the 5.79 percent rate and 5.11 percent is more than

$1 billion. Haslag suggested if there is an under-collection as the new program is implemented, the state could seek temporary borrowing authority to make up the difference until the tax rate could be reset at the more correct amount.

Joining Haslag was Arthur Laffer, an economist who served as a member of President Ronald Regan's Economic Policy Advisory Board for both of his two terms. Laffer said people and businesses migrate to states with lower taxes and that states that introduce an income tax see a decline in their gross domestic product.

And Laffer said that sales taxes as a source of state revenue are more dependable than income taxes, which are subject to volatility, especially in troubled economic times. Laffer acknowledged the sales tax is regressive - that is, poor people pay a proportionately larger share of their wealth in tax. But there is a mechanism in the legislation that attempts to make up for that.

"From all evidence, the income tax is detrimental to growth," Laffer said. "The objective here is to create economic growth."

To buy the arguments of Haslag and Laffer, a person must believe taxes are the sole determinant in deciding where businesses locate and where people want to work and live. As some have pointed out, other variables, such as climate, location, the quality of the educational system, the labor market and access to resources make a difference. And some noted during the senators' briefing that states that have no income tax might have the benefit of revenue from other sources, such as tourism and the extraction of minerals.

THE COST OF A HAIRCUT

State Rep. Chris Kelly, D-Columbia, supports the idea of supplanting the income tax with a sales tax, but he said the problem is people who support it philosophically have not thought through all the problems with implementing it.

"There has been some lack of commitment to making sure the details are worked out correctly," Kelly said. "You cannot get it wrong. If you get it wrong, you can very badly screw up the state of Missouri and screw up the chances of passing a sales tax nationwide."

One of the more obvious issues is what to do about all the people who live in places like St. Louis, Kansas City, Hannibal, Cape Girardeau, St. Joseph and Joplin who might go across the state line to neighboring states to buy goods where the sales tax is lower or, in the case of services, non-existent.

Amy Blouin, executive director of the Missouri Budget Project, said 70 percent of Missouri's population lives in urban centers near neighboring states that would have lower sales taxes on goods and no sales taxes on services.

Rep. Ed Emery, R-Lamar, a sponsor of the tax change in the House, said some businesses might adjust their prices to deal with the competitive factors created by the tax.
"If I'm a barber who charges $10 for a haircut, in 2012, I'd have to charge an extra 50 cents," Emery said. "In a competitive situation, I may want to drop the cost of the haircut to $9.50 and instruct my accountant to keep track of receipts for three months to see how it affected the bottom line."

Emery said the advantage of reliance on the sales tax is it puts consumers in charge of how much tax they have to pay. Right now, the worker has no choice in the tax matter because the income tax is withheld by the employer and the employee pays at the rate of 6 percent. The sales tax is more reliable in terms of revenue.

"It's steady because there is a basket of items that everyone is going to buy," Emery said. And he said the new tax would catch people who now don't declare income.

However, the income taxpayer knows what he or she is paying because it's there on the W-2s and calculated when income taxes are due April 15. How much the state tax will be under the new system depends on how much a person would consume in goods and services each year.

Certainly the tax would be good for big corporations. Missouri companies that pay the corporate income tax and the corporate and bank franchise taxes would no longer have that as a cost of doing business. They could charge less for their products, Emery said.

And all of the businesses that collect the sales tax under this new system would be able to keep some of it, just as retailers are now allowed to retain 2 percent of the taxes that belong to the state if they are remitted on time.

State Auditor Susan Montee reported last week that under the current sales tax collection system, retail businesses kept $93 million in the 2008 fiscal year in return for collecting the tax and providing it to the state on time. Missouri is one of only 13 states that do not cap what the sales tax collectors can keep. A not-for-profit research group, Good Jobs First, reported in 2008 that Wal-Mart received 25 percent of Missouri's total payments under this system.

Although the proposal would remove the tax burden from corporations, organizations such as the Missouri State Chamber of Commerce and Industry have not taken a position on the notion of switching to the higher sales tax. Karen Buschmann, a spokeswoman, said the chamber is watching developments closely. She noted that one of the problems with eliminating the income tax is that it removes the existing tax credit structure that many businesses now use for economic development.

A REGRESSIVE TAX

One of the problems with the proposal is poor people who pay little or no income tax now would pay higher taxes for the basic necessities of life through the sales tax. But there is a mechanism in the legislation in which every household would be eligible for a rebate, an amount of money calculated based on the tax rate and federal poverty guidelines.

The state Department of Revenue would have to determine how much would be distributed and which households would receive it. Emery said state and federal records are available for calculating who should receive the payments.

Officials of the Missouri Budget Project, which assesses revenue issues from the standpoint of poor people, said the rebate wouldn't adequately compensate many people affected. Working parents with two children in day care would pay $371 more in taxes, and seniors requiring nursing home services would pay between $1,226 and $3,270 in new taxes, the organization reported. It said the wealthiest 5 percent would not pay higher taxes under the new system.

Blouin said people with an income in excess of $230,000 a year would benefit the most from the change. Haslag disagreed, saying he believed the change would increase his tax burden. He said people earning $68,000 and less would have an overall smaller tax bill.

Another component affecting individuals is what it does to federal income taxes. Current federal law allows for the deduction of state income tax or state sales tax - but not both - on federal returns for individuals filing itemized deductions.

Moody, who served under both Republican and Democratic governors, told the senators he believes the new sales tax would have to generate about $10 billion: $6 billion to replace lost revenue from the income tax and additional money to pay for the rebates and the lost earnings taxes in St. Louis and Kansas City.
Moody said he believes the legislature would be better served by going after revenue that's not taxed now, such as Internet sales, where out-of-state retailers have a 7 percent advantage over local merchants. If the legislature is serious about the big sales tax, Moody said, it needs a detailed study by independent researchers.

"I think we have done too much messing around with our tax system in the last 10 to 12 years without adequate research and adequate knowledge of the consequences of our actions," Moody said.

Because the proposal is a constitutional amendment, it must be implemented through a statewide vote. If the resolution is approved by the legislature, the issue would be on the ballot in November.