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Facing Up to the State's Harsh Realities

by Joe Sullivan

Ever so lamentably, it's time to face up to the harsh reality that critically needed tax reform in Tennessee has been thwarted. Despite a concerted effort over the past several weeks on the part of state Senate leaders of both parties, a majority in that body could not be mustered for a state income tax that is the cornerstone of any meaningful redress of the state's fiscal delinquency.

Yet with every passing week, the state gets deeper in the hole in terms of its inability to cover the costs of the jury-rigged budget that was adopted for the current fiscal year. Beyond that $300 million to $400 million shortfall lies the prospect of an additional $500 million needed just to sustain the status quo in the fiscal year ahead. Unless the Legislature acts with dispatch to close these holes, the state is headed straight for Davy Jones' locker.

Amid the trauma of an unprecedented national disaster and its aftermath, a state government fiscal crisis can seem to pale by comparison. And lack of public concern to date is clearly part of the reason legislators haven't been quicker on the uptake to resolve the crisis.

Essentially, there are three ways the state can go to cover this year's projected shortfall that is attributable to economic weakness. One is to raise revenues, but alternatives to an income tax are all fraught with their own set of perils. The second is to cut expenses, but substantial reductions are well nigh impossible without running afoul of some court order or another—except in the case of higher education, which is already starved for resources. The third is to siphon off reserve funds, but the state's rainy day fund balance of $178 million is already far below the $500 million needed to meet a national norm. It's hard to imagine a worse time to deplete an emergency reserve fund than amid all the post-September 11 uncertainties. Other special funds have been tapped to cover deficits in the past, but Commissioner of Finance Warren Neel says, "We've already used just about all the accounting latitude that we have."

Any revenue-raising measure should be designed not just to cover this year's shortfall but also to meet the state's projected future needs. These include about $250 million a year in what Neel terms "obligatory growth," plus, in the case of the fiscal year beginning next July 1, an additional $233 million to meet recurring expenses that were covered this year by one-time tobacco settlement money.

In the obligatory growth category are formula or court-order driven funding of everything from K-12 education and children's services to mental retardation services and corrections. Gov. Don Sundquist's recommended curtailments of TennCare are intended to cut out $150 million if and when they are implemented, but after they are in place TennCare would once again become subject to medical inflation that has been escalating in all sectors of the health care market (including the coverage of state employees).

Moreover, Neel's obligatory growth estimate doesn't make any allowance for a state employee pay raise, let alone for increased funding to start redressing the state's dereliction of derelictions: higher education. In the current fiscal year, state employees got a 3 percent raise costing about $100 million, while higher ed got next-to-none of the $100 million increase Sundquist recommended.

None of the alternatives to an income tax that are now being floated once again have anything like its elasticity for growth in future years. Extending the sales tax to cover services would improve its elasticity in an increasingly service-oriented economy, but extension to big revenue generators such as health care and construction labor has been rejected time-and-time again. Sin tax increases may hold more appeal, but they are highly inelastic, and a 10-cent per pack increase in cigarette taxes would yield only about $50 million.

The one revenue raising measure approved in either chamber of the Legislature this year was a Senate-passed automobile tax that the House spurned. Initially, it took the form of a regressive $100-per-vehicle registration fee—but only for as long as required to convert to a more progressive 1 percent tax on the value of a car. Either way, the tax would yield about $500 million, and its principal sponsor, Republican Senate leader Ben Atchley, believes it could readily be adopted once again.

"When the two houses agree to work out a alternative tax, it can be worked out pronto," Atchley says.

House Speaker Jimmy Naifeh gets my profiles-in-courage award for his ardent advocacy of an income tax. But the time has come for Naifeh to stop berating the Senate for its inability to follow his lead and start collaborating instead. An automobile tax might be coupled with a broadening of the one form of income tax the state already has: the Hall on tax dividends and interest. Its extension to capital gains on the sale of stock would yield on the order of $360 million, but with a lot of variability from year to year.

Another possibility that's gaining some support is to tap into the $812 million derived from gasoline and diesel fuel taxes that are presently dedicated to TDOT's road building empire. Mayor Victor Ashe, to his credit, has called for stripping TDOT of its dedicated funds and placing them all in the state's general fund where they could be used for any purpose. Short of that, the Legislature could at least extract enough to cover the $70 million cost of the highway patrol, truck inspections and the like that now come out of the general fund.

It's an outrage and a source of shame—not pride—that Tennessee's interstate highways rank number one in the country while the state ranks next-to-last in education.

There's also a movement in the Senate to appoint a proverbial blue-ribbon commission to address tax restructuring and long term revenue needs—as though they hadn't been addressed before. But the state's next governor is likely to have a lot more sway on these issues than any commission. And both of the front runners, Democrat Phil Bredesen and Republican Van Hilleary, are running away from meaningful tax reform rather than toward it.

"I get very despondent when I look at the lack of vision for the future of the state," says Neel, who was the long-time dean of UT's College of Business before taking his post in Nashville.

So does the undersigned.

November 15, 2001 * Vol. 11, No. 46
© 2001 Metro Pulse