Texas sets bar high for states axing income taxes - Omaha.com
Published Sunday, February 24, 2013 at 12:30 am / Updated at 6:55 am
Texas sets bar high for states axing income taxes

A year after pushing a major income tax cut through the Kansas Legislature, Gov. Sam Brownback returned last month angling for another.

It's part of his bold goal of ultimately eliminating the tax, joining fast-growing Texas and eight other states that generally don't tax income.

Sam Brownback

“Look out, Texas,'' Brownback said. “Here comes Kansas!''

When it comes to taxes, it seems lots of governors today want to be more like Texas.

Nebraska Gov. Dave Heineman was one of four governors in the past year who vowed to get rid of state individual income taxes, and a half-dozen other states have debated major cuts in the tax. The argument: Axing the income tax in favor of sales taxes would make their states magnets for job creation, economic growth and wealth.

While Heineman has pulled his proposal in favor of further legislative study over the next year, some level of swapping income taxes for sales taxes could remain on the table in Nebraska — a proposition that would involve both potential benefits and less-appealing trade-offs for the state and its taxpayers.

A World-Herald analysis suggests there would indeed be potential for more economic growth in eliminating income taxes.

States with no income taxes have enjoyed markedly higher growth since 2000 than similar neighboring states that levied the tax — about 50 percent more population growth and more than double the job growth. The no-income-tax states also showed more income and gross domestic product growth, though the advantages were more limited.

But moving from income taxes to sales taxes also directly shifts the tax burden away from higher earners to low- and moderate-income families. That's because such families tend to spend the majority of their income just getting by.

Advocates for low- and moderate-income families say it's no coincidence that states without income taxes — including Washington, Florida, South Dakota and Texas — also have among the most regressive tax systems, with the highest effective tax rates on lower-income taxpayers.

John Cederberg, a business tax accountant in Lincoln who has long been active in Nebraska tax policy debates, said the consistently higher job and population growth seen by states without income taxes is revealing.

He said that growth plus the fact a competitive neighbor like Kansas has been sharply cutting income taxes make such issues worth considering as Nebraska moves ahead in the next year with a first-in-a-generation, comprehensive study of state tax policy. The Legislature's Revenue Committee last week worked on the framework for a Tax Modernization Committee that would examine whether the state's tax system has kept up with the times.

“We won't want to fall out of the picture in terms of competing for business,'' Cederberg said.

Tale of the tape

There's no magic to how states without individual income taxes are able to get by without them. Most are able to take advantage of mineral wealth or tourism, rely heavily on sales taxes, property taxes or both, or spend less, particularly on education. Here's a breakdown on how the nine states do it:

Oil. Black gold accounts for 90 percent of state revenues. Since oil began flowing from the North Slope through the Trans-Alaska Pipeline, the state has been able to eliminate income taxes, pay dividends to residents and build up billions in tax reserves. It's the only state ever to repeal its individual income tax. It retains its corporate income tax.

As a sunny destination for vacationers and winter snowbirds, it cashes in on tourism, collecting more than 25 percent more sales taxes per capita than Nebraska. It also spends significantly less than Nebraska per capita on higher education, K-12 education and roads. Has corporate income tax.

Gambling. Casinos in a good year pay more than $1 billion in gambling taxes and also make the state a tourist mecca. Also spends far less than Nebraska on education, roads and welfare.

New Hampshire
What residents save on income taxes is more than made up for with the nation's fifth-highest property taxes. Property taxes in 2010 were almost $1,000 per capita higher than in Nebraska (per capita income taxes in Nebraska were $828). While New Hampshire has no general income tax, it does tax dividends and interest and also corporate profits.

South Dakota
Has very broad sales tax applied to many things not taxed in Nebraska, including groceries. It also has a tourism niche with Mount Rushmore and spends far less than Nebraska, particularly on education.

Charges the highest sales tax rates in the country, with the combined state and local tax rate averaging 9.45 percent, according to the Sales Tax Clearinghouse. Spends far less than Nebraska on K-12 and higher education — a combined $1,900 per capita annually compared with almost $3,000 in Nebraska. Also taxes interest and dividend income and has corporate income tax.

Able to collect more than 8 percent of its state tax revenue from taxes on oil and gas production. It also relies heavily on sales taxes, with most Texans paying an average rate of 8.5 percent, and has higher per-capita property taxes than Nebraska. State imposes a franchise tax on businesses in lieu of a corporate income tax.

Levies nation's second-highest average sales tax rate, at 8.9 percent, and applies the tax broadly. Its sales taxes per capita, the highest in the nation, are more than double Nebraska's.

Severance taxes on coal, oil and other minerals account for about a fourth of state tax revenues. Also has second-highest per-capita sales taxes and third-highest per-capita property taxes.

What are the roots of this sudden drive across the country to cut state income taxes?

Joe Henchman, a policy analyst for the Tax Foundation in Washington, said he can sum it up in a single word: Texas.

No state is better known for its lack of an income tax. Earlier this month, Texas Gov. Rick Perry was touring California, talking up his state's lack of income tax and its overall business climate, hoping to lure away jobs.

Texas is already booming. Since 2000, it has added 5 million people — roughly equal to the combined populations of Nebraska and Iowa.

And it seems to have the ear of site development consultants. Texas is a name governors and state economic development officials constantly hear when they attempt to lure jobs and new investment to their states, Henchman said.

“When they consider 'What does Texas have that we don't?,' for a lot of people what jumps out is the (lack of) income tax.''

On a more theoretical level, economists for years have argued that the income tax runs counter to economic growth because it penalizes work, investment and savings.

“You always get less of what you tax,'' said Creighton University economist Ernie Goss. He and others suggest a better option is to tax consumption instead, through sales taxes.

Eliminating state income taxes has also become a major cause for right-leaning groups that advocate limited government. The American Legislative Exchange Council, a business-backed consortium of conservative state legislators, has particularly taken up the call. It has annually published a report by Arthur Laffer, the economist often called the “father of supply-side economics,” that argues states would supercharge their economies by swapping out income taxes for sales taxes.

But such shifts face strong opposition from the left. Those groups point out that a progressive income tax such as Nebraska's, with rates rising as income goes up, helps counter the regressiveness of sales and property taxes. Together, the three taxes make up the bulk of state and local finances.

“We know, if you look at the private economy, wages have stagnated, with all the income gains at the top,'' said Peter Fisher of the progressive Iowa Policy Project. “When you shift from income to sales taxes, you are aggravating that income inequality.''

Others also argue that because sales taxes don't grow as dynamically as income taxes, states without income taxes over time have less to spend on education. And without the “human capital'' education helps create, there is no growth.

“Businesses say they need better-skilled employees, and on the other side they say they want lower taxes,'' said Norton Francis, a research associate with the Tax Policy Center in Washington.

Still, shifting from income to sales taxes has suddenly found a lot of currency among Republican governors. The governors of Kansas and Oklahoma last year first came out with plans to phase out income taxes in their states. Heineman and the governor of Louisiana joined them this year with their own plans to ax the tax. North Carolina, Ohio, Indiana, Montana, Missouri and Idaho also have debated significant income tax cuts in that time.

Overall, those pushing the big income tax shifts haven't made a lot of headway.

What doomed Heineman's proposal was not so much the idea of shifting away from income taxes but the idea of paying for that move by putting sales taxes on things such as inputs and machinery used in farming and manufacturing. That generated strong business opposition.

Income tax cuts were also rebuffed last year in Oklahoma and Missouri and are facing headwinds in other states this year.

The state where proponents have had the most notable success is Kansas.

Last year, hiring Laffer as a consultant, Brownback pushed to passage a bill that dropped Kansas' top income tax rate from 6.45 percent to 4.9 percent, among other major changes.

Kansas, however, offset only a small portion of the $800 million in lost revenue, taking away millions in tax credits that the lowest-income Kansans had received to offset the sales taxes paid on food and for working in low-wage jobs.

Kansas instead is gambling that a tax-cut-induced surge of economic growth will drive new revenues. The only result so far has been a massive $700 million gap between annual spending and revenue that has to be made up — one that critics say is sure to lead to deep cuts in education.

The shortfalls, however, haven't stopped Brownback from coming in with another income tax cut this year, proposing to further slash the top rate to 3.5 percent by 2017. Now Kansas is seen by many as a grand experiment, one that could even affect U.S. tax policy.

Just how much the elimination of income taxes would spur growth is subject to much debate nationally.

It's true that states without income taxes have grown faster than the nation as a whole, and particularly when compared with states that have the highest income taxes.

Click here for a closer look at state income taxes and population growth.

But what is less known is how much the growth in those states has been caused by other factors, such as climate or regional economic advantages. The vast majority of the growth in no-income-tax states has been centered in Texas, Florida and Nevada, three Sun Belt states that are attractive for a lot of reasons.

To get some insight into the impact such a tax policy can have, The World-Herald examined the states without income taxes in a different way, pairing each with a similar neighboring state that does levy income taxes. Pairing no-income-tax states with similar neighbors is an imperfect but simple way to help control for climate and other regional factors that influence economic growth.

The pairs: South Dakota with Nebraska; New Hampshire with Vermont; Wyoming with Montana; Tennessee with Kentucky; Nevada with Arizona; Washington with Oregon; and Texas with California.

While Texas and California are not direct neighbors, they do share many important traits, including large populations; large, diverse economies; significant borders with Mexico; and favorable climates. There was no pairing for Alaska or Florida, two no-income-tax states without comparable neighbors.

On population growth since 2000, all seven of the no-income-tax states examined outpaced their neighbors. The average was 18 percent growth compared with 12 percent for the income-tax-levying states.

On job growth, no-tax states overall grew jobs an average of 8 percent compared with 3.5 percent for those with the tax, though two no-income-tax states — Washington and New Hampshire — trailed their neighbors.

The results were more mixed when it came to growth in personal income, gross domestic product, unemployment and attraction of people with college degrees, with the no-income-tax states having a slight average advantage overall on each measure.

Nebraska, despite a relatively strong economy and larger, more dynamic urban centers, trailed South Dakota on all the measures but unemployment rate.

The results of the analysis certainly don't mean that eliminating income taxes would turn Nebraska into another Texas. But David Drozd, a demographer for the University of Nebraska at Omaha, said states without income taxes do seem to have an advantage in growth. It could help explain why Nebraska has seen outmigration for a decade to sparser South Dakota and Wyoming.

“It's not the only factor (in growth), but it's one that tends to make some difference,'' he said.

Iowa's Fisher said the fact that personal income growth in the no-income-tax states has lagged job growth suggests that many of the new jobs created have been low-wage ones.

“What the state has done to raise income for families is probably a better metric for the economy,'' he said.

Cederberg said it's likely unrealistic to think Nebraska could totally eliminate income taxes. The state isn't blessed with mineral resources or other advantages that help many states avoid the tax.

Nebraska also has consistently supported a well-funded public education system, often spending far more on schools and universities than states without the tax do.

But he said the results of The World-Herald analysis suggest that if Nebraska “did something dramatic'' in the way of reducing income taxes, it could get the attention of those with the capital to create jobs.

Other recent studies have split on the question of whether simply cutting income taxes generates growth.

Last week, an Economic Policy Institute report said income tax cuts don't generate new jobs because most small-business owners who benefit from them don't have the resources to hire. In December, the Tax Foundation said its comprehensive look at academic studies over the past three decades consistently shows a relationship between reduced income taxes and economic growth.

Cederberg said he has high hopes for the Legislature's tax study. He's hopeful the discussion sparked by Heineman's proposal will help lawmakers craft a tax structure that makes the most sense for the state.

“The direction of that (study) will be critical to Nebraska's tax path for probably a couple of decades,'' he said. “We need a plan that works for Nebraska that would allow us to stay competitive.''

Contact the writer: 402-444-1130, henry.cordes@owh.com

Contact the writer: Henry J. Cordes

henry.cordes@owh.com    |   402-444-1130    |  

Henry's a general assignment reporter, so he could end up writing just about anything, though he usually focuses on public policy matters affecting the state, region or nation.

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