Metro Pulse/Insights/Local Sales Tax Entitlement

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by Joe Sullivan

Increasing sales taxes is not a good solution to the state's fiscal crisis in any longer run. Yet there is a compelling case in the short run for raising the local option sales tax in Knoxville and Knox County to the full 2.75 percent permitted by state law. (It's presently 2.25 percent atop the 6 percent levied by the state.)

This case starts from the point of departure that in all probability local option sales taxes are going to be abolished in Tennessee within the next year or so. Indeed, their abolition came close to being enacted by the state Legislature this year. Getting rid of them is not an ideological issue; it's a purely pragmatic one that draws support across the entire political spectrum.

The impetus is that setting a uniform statewide rate is a prerequisite to enabling Tennessee to start collecting sales taxes on catalogue, Internet and other "remote" sales that presently go untaxed. UT's Center for Business and Economic Research has estimated that by 2003

Local Option Sales Tax Revenues
(rounded to nearest million $s)

@ 2.25% @ 2.75% Increase

Schools 100 116 16

Knoxville 31 43 12

Knox County 9 13 4

Farragut 2 3 1

Totals 142 175 33

the state will be missing out on $500 million in annual revenue due to its inability to tax these rapidly growing sales. To say the obvious, capturing these revenues can make an enormous contribution to overcoming the state's financial woes. But it will take an act of Congress to enable the state to do so.

Bipartisan legislation that contemplates such enablement is being sponsored by Democrat Sen. Ron Wyden of Oregon and Republican Rep. Christopher Cox of California. Under the Wyden-Cox bill, states that adopt a uniform state sales tax code would become eligible to start collecting, provided that a "sufficient number" have done so. Tennessee has been in the forefront of efforts to produce such a uniform code, which would preclude the variant local option sales tax rates that presently range from a low of 1.5 percent in two Tennessee counties to the 2.75 percent max in 28 counties.

What has all of that got to do with the case for raising the rate in Knox, you say. The answer is, a lot of revenue that would be lost to Knox citizens.

Under all the bills before the Legislature for abolishing local option sales taxes in the name of uniformity, localities would be reimbursed by the state for the amount of revenue foregone as a result of abolition. These reimbursement levels set the base for what are termed "hold harmless" payments that would also entitle localities to a pro rata share of the future growth in state revenues over and above the base.

For the fiscal year ended June 30, local option sales tax revenue in Knox County as a whole totaled approximately $142 million. Raising the rate to 2.75 percent from 2.25 percent would increase the take—and thus the base for hold harmless payments—by about $33 million. The accompanying table breaks out these totals into their component parts.

At first blush, raising the rate may look like just another tax increase, at least until abolition occurs. But this ain't necessarily so. Indeed, in the extreme case, all the additional revenue generated by a sales tax increase could be returned to taxpayers via a property tax rollback. Thus, a prospective claim to $33 million in additional state revenue could be established at no cost to local taxpayers collectively. Or, said the other way around, failure to stake this claim could cost local taxpayers $33 million, which should certainly rouse their ire toward elected officials responsible for the failure.

Granted, substituting sales taxes for property taxes, even in the short run, would be regressive in that a larger part of the tax burden would be borne by non-property owners with generally lower incomes. Moreover, such a substitution could be deemed a sham and thus jeopardize hold harmless payments.

As it happens, a number of county commissioners are already mulling a referendum to raise the sales tax as a way to deal with Superintendent Charles Lindsey's unmet demands for additional schools funding. In his annual budget message to commission in May, County Executive Tommy Schumpert said, "I want to tell you and the superintendent that the level of new funding he is requesting to run the school system he envisions is probably only achievable by passing a county-wide referendum increasing the local option sales tax by one-half cent." Lindsey had been seeking a $13.8 million increase in the school budget to $289 million but got less than half of what he sought.

Schumpert stopped short of recommending a sales tax increase referendum, and some of the commissioners who now lean toward one are doing so in the belief that it would be voted down. Rejection by the voters, it's reasoned by these negativists, would squelch Lindsey's demands for more money to fund the "internationally competitive school district" that he's been heralding for two years but hasn't defined very well.

Positivists, epitomized by commission's finance committee chairman, Frank Leuthold, recognize that the school budget has been very lean for the past two years and will be again next year when county elections, by all tradition, preclude commissioners from voting for a tax increase. Yet all tradition also points toward a big property tax increase in the year following the election—an increase that could be obviated by getting the voters to approve making maximum use of the county's sales tax entitlement while the getting is still good. Leuthold recognizes the wisdom of this strategy. So does Mayor Victor Ashe from the city's standpoint.

Time is of the essence, against the prospect that the window of opportunity could close in the state Legislature next year. In order to get a sales tax referendum on the ballot in conjunction with this November's city election, commission must resolve to do so by its Aug. 27 meeting. If Lindsey can get his act together by then, better that the resolution stress additional school funding. But in any event voters should be afforded the opportunity to protect a $33 million source of revenue for this community.