Metro Pulse/Insights/State Income Tax

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by Joe Sullivan

The "Black Hole Committee" of the state Legislature has gained notoriety over the years as the place where undesired spending bills get dispatched, never to see the light of day again. But this year, instead of being a burial ground, the committee could well provide the impetus for revival of legislation widely written off for dead: namely, a state income tax.

All tax and spending bills must go through the nine-member panel, formally known as the Revenue and Expenditure Subcommittee of the House Finance, Ways and Means Committee. Its Democrat chairman, Rep. Tommy Head, may not stand as tall in Nashville as his sister, Pat Head Summit, does in Knoxville. But he commands a lot of respect among his colleagues, and he has reportedly begun letting them know privately that an income tax will be an acid test of how pet spending bills fare.

Publicly, Head waives aside the notion that legislators will be subjected to a reward and punishment regimen. But the burly Democrat from Clarksville says, "We've got to build recognition of the needs, and we've got to look at all of the alternatives for meeting them. But after we've done that I think it will become clear that the income tax is the only way to go."

Head is a co-sponsor, along with Sens. Bob Rochelle and Gene Elsea, of a bill establishing a graduated income tax with rates ranging from 3.5 to 6 percent. For an average family of four, the 3.5 percent rate would kick in on income in excess of $41,000, then rise in four brackets to 6 percent on income in excess of $105,000.

The income tax is the engine that drives what Rochelle heralds as a "comprehensive reform of state and local taxes." Other elements of the bill include removal of sales taxes on food, apparel and non-prescription drugs coupled with imposition of a uniform, statewide sales tax rate of 7 percent on goods that remain covered. That's up from the state's present 6 percent take, but the bill would eliminate local option sales taxes that can range up to 2.75 percent over and above. Localities would be "held harmless" from resultant loss of sales tax revenue and also from the loss of their share of the state's Hall income tax on dividend and interest income, which would be repealed. Moreover, "by sharing the growth of the tax on income," Rochelle asserts the bill "will enable them [local governments] to build and operate schools in the future without having to finance it by raising the property tax."

Rochelle is widely acknowledged to be the sharpest single state legislator—too sharp for some with his propensity for making deals. As a longtime proponent of a state income tax, though, he's seemingly lost standing over the past two years as his numerous attempts at engineering one through the Senate got rebuffed. Even Gov. Don Sundquist has backed away from his futile support of Rochelle's previous mainstay plan—the so-called flat tax that would couple a 4 percent state income tax with a reduction in the sales tax to that level.

So why does the liberal Democrat from Lebanon stand a good chance of succeeding now, when all of his previous attempts at tax reform have failed?

The answer starts with widespread recognition that the state's fiscal bind has tightened to the point that new sources of revenue are needed. Projected revenue growth of $250 million in the fiscal year ahead won't even cover the $300 million shortfall now anticipated for the current fiscal year as a result of budgetary hocus pocus and an economic slowdown. Moreover, Sundquist has done a good job of building acceptance for most of his recommended $550 million increase in state spending, primarily for education, TennCare and a 3 percent pay raise for state employees.

However, the governor has gained anything but acceptance for his hodgepodge of proposed new taxes to fund the increases. Extension of sales taxes to presently exempt goods and services is running into the same resistance from the same potent lobbies who've thwarted them in the past. A proposal to subject compensation of professionals and business owners in excess of $72,000 to business income taxes is both unwieldy and inequitable.

Rochelle also spurns the other sources of new revenues that get bandied about the most. An increase in the sales tax rate would compound its regressivity and the state's overdependence on an inelastic tax whose yield fails to keep pace with growth in the economy. A gross receipts tax on service providers, he contends, is so easily evaded that it's well nigh unenforceable. Last year's 4 percent "flat tax," which would have raised about $400 million, is no longer sufficient to the need, and simply raising the flat rate would create undue hardship for low-to-middle income Tennesseans.

Rochelle's proposal to eliminate the local option sales tax seems to meddle with a mainstay of city and county revenues. But there is method to his meddling. The variations in this tax, which ranges from 1.5 percent in some counties to 2.75 percent in others, is a major impediment to making e-commerce, mail order and telephone sales (collectively termed remote sales) subject to the state sales tax. "The remote sellers are never going to accept a tax that has to be calculated on a ZIP-code-by-ZIP-code basis," Rochelle asserts.

Under a U.S. Supreme Court decision, only Congress can authorize remote sales taxes, and a movement is underway to do so. Sen. Ron Wyden of Oregon is sponsoring a resolution that contemplates their enactment once a "sufficient number" of states have agreed to sales tax uniformity, including a uniform rate in each of the states. Tennessee is in the forefront in pressing for such an agreement. In the meantime, UT's Center for Business and Economic Research projects that foregone state revenue on remote sales will reach $550 million by 2003.

If and when these revenues start coming in, they could go a long way toward obviating the need for an income tax of the proportions Rochelle is proposing. Even in the meantime, the $800 million tax increase he's seeking appears excessive and, thus, so do its higher rates and brackets. Getting rid of sales taxes on apparel and non-prescription drugs would be very nice, but groceries represent the place to make a more needed and affordable start in that direction. Moreover, the $360 million that the state is due to receive this year and the $160 million in subsequent years in tobacco claims settlement money needs to be channeled into the budgetary hopper. That means putting a halt to present legislative propensities to squirrel away the tobacco money in trust funds and then squander the income from the trusts on boondoggles.

By no means have all nor even a majority of legislators reached the conclusion that an income tax is inexorable. Sen. Bill Clabough of Maryville more nearly reflects the conventional wisdom when he says, "I don't foresee an income tax nor any other single major revenue enhancement. I think it's going to take a combination of a lot of things to get the job done." But some legislators at the opposite end of the political spectrum from Head and Rochelle privately share their prognosis.

Knoxville's Rep. Harry Tindell, a middle-of-the road Democrat who's anything but enamored of an income tax, tends to as well. "When this happens, it's going to happen so fast that nobody's going to know what hit them, and there won't be any turning back," he ventures.

That may not be the way they teach it in Civics 101. But neither is the way that horn honking and fax frenzies spurred on by radio talk show demagogues have helped thwart consideration of a long overdue state income tax up to now.