Metro Pulse/Insights/Tax Cuts

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by Joe Sullivan

One of the big issues facing the Michigan state Legislature this year has been where to cut taxes. In the end, the Legislature backed Gov. John Engler's recommended reduction in the state income tax rate to 4.2 percent from 4.4 percent. It marked the 31st tax cut of one sort or another adopted in the state since Engler became governor in 1991.

And Michigan is by no means alone in passing along the benefit of unprecedented boom times in the form of lower taxes. According to a survey by the National Association of State Budget Officers, 34 states reduced taxes for the current fiscal year, following on the heels of reductions in 36 states the year before.

"Fiscal 2000 represents the sixth consecutive year that states reduced taxes and fees, totaling $27.3 billion over the six-year period," the survey states. While the returns for fiscal 2001 aren't in yet, "Most states are still showing surpluses and there will continue to be cuts," says Mandy Rafool, an analyst with the National Conference of State Legislatures.

Just about everywhere—that is, except in the handful of states that don't have a state income tax. And even in four of these eight states (Alaska, Florida, Nevada, and Texas) some combination of mineral wealth and tourism have enabled them to balance their budgets and then some.

That leaves the Tennessee Legislature almost alone on the opposite side of the fence from Michigan: namely, having to raise enough revenue to cover an impending budget deficit. The $375 million projected deficit that Gov. Don Sundquist proposes to cover with tax reform is NOT the result of spending growth in Tennessee that is out of line with other states. To the contrary, state appropriations growth of 4.3 percent in Tennessee for the current fiscal year is well below the national average of 5.5 percent, according to the NASBO survey.

While it's true that Sundquist's budget proposes a 7.4 percent increase in state spending for the fiscal year ahead, much of it would go to make up for false economies in prior years. For example, the $105 million earmarked for a 3 percent pay raise for state employees and teachers attempts to compensate for the fact they went without a raise this past year. The $113 million increase proposed in higher education outlays represents an attempt to start restoring funding that has declined by nearly 25 percent per student over the past decade, when adjusted for inflation. (The largest single component of an overall $555 million increase in state spending is, of course $132 for the beleaguered TennCare program, an amount that needs to go up by yet another $100 million according to a recent actuarial study by Pricewaterhouse Coopers in order to keep its health care provider networks afloat.)

It cannot be said too often that the root cause of Tennessee's fiscal plight is a deficient tax structure that fails to generate enough revenue growth to keep pace with the state's basic needs. By coupling a reduction in the state's inelastic sales tax with the introduction of a highly elastic income tax, Sundquist's tax reform plan provides the state with the fiscal stretch it needs, once and for all.

The fact it would raise $416 million to cover this coming year's deficit is less important than the fact it would align Tennessee with the vast majority of states where revenue growth is producing surpluses, not deficits on an ongoing basis.

Of course, this growth has been based in part on economic good times that cannot be expected to continue to roll forever. When an economic downtown hits, every state legislator with a grain of sense knows that an income tax is the only way out of the resultant fiscal crisis. But the majority that's now resisting Sundquist's reform plan would evidently prefer to postpone the day of reckoning until this painful crisis starts hitting the electorate right between the eyes.

In the meantime, resort will be made to a motor vehicle tax, extension of the sales tax to presently exempt services, or an increase in the business gross receipts tax—anything but the dreaded income tax. These will balance the budget in the short run but leave taxpayers vulnerable to more of same over any longer term.

Why not bite the bullet now and put the problem behind us once and for all? Conventional wisdom has it that legislators can't stand the risk of being swept out of office by an electoral majority that is undeniably income tax averse. But the filing deadline for next fall's election is now behind us, and not that many legislators face serious challenges. Even if every last one of them voted against tax reform, it could still pass handily.

By acting this year, foresighted legislators would appear to have bettered their position for the future (leaving aside what's best for the state) under either good or bad economic scenarios for the years ahead.

Assuming the economy keeps growing, our elected representatives can start taking credit, just like their counterparts in the vast majority of other states, for subsequent tax reductions. Does anyone believe they won't be quick to seize any opportunity to do so? So long as times are good there is no basis for believing that Sundquist's proposed 3.75 percent income tax is just a stepping stone to a higher one. At least, experience in every other state with an income tax stands for that proposition.

Assuming an economic downturn, the need to resort to an income tax to make ends meet could come at a much less opportune time for the legislators than presently. Hitting up an electorate that's otherwise contented seems much less of a political hazard than having to take more money out of the pockets of a populace that's already anxious about their jobs and businesses.

But then again what does this columnist really know about what's good for politicians? Up until now, a legislative majority seems inclined toward haplessly failing to come to grips with the state's fiscal crisis until it's drifting out of control—and then clutching at some straw.