PAR urges waiting for smart tax reform

Published 12:00 am Saturday, June 1, 2002

By JIM BRANDT, president Public Affairs Research Council

Thus far in the fiscal session, three distinct and different plans have been submitted to “reform” the state tax structure. A common impetus for each of these efforts was the desire to end the state’s “temporary tax” insanity which requires nearly one-tenth of the state’s tax revenues to expire and come up for renewal every two years.

Since 1986, the temporary tax habit has made a farce of the budget process. The drama of presenting a budget with massive cuts, the resulting deal-making, and the negative impact on the state’s fiscal stability and bond rating are bad enough. But even worse is the false impression that the nearly $600 million in “temporary” taxes represents “temporary” spending. While these taxes are renewable, they have been paying for ongoing state services that primarily affect the health and education of Louisiana citizens.

In most other states, the Legislature would have enacted a permanent tax to pay for the level of services it wished to fund. For nearly two decades, the Louisiana Legislature has clung to the fiction that a half-billion dollars or more in state spending is only temporary. In presenting his annual list of potential spending cuts to the Appropriations Committee this year, the legislative fiscal officer could only find about $80 million. Most of this was in minor programs, one-time money and very politically-sensitive items such as the $10 million general fund subsidy for college athletics.

PAR agrees with the fiscal officer’s assessment that the easy cuts have been made and that significant spending reductions may only be achieved by enacting major structural changes in the way the state carries out its health, education, corrections and other important functions. The dramatic changes that may well be required, such as privatizing or closing public hospitals, downgrading universities or ending supplemental pay for local employees, would face tremendous political hurdles and would likely take years to accomplish. Such changes could not be responsibly accomplished in the final weeks of the session, if at all.

Last year, a number of legislative committees met in the interim to find spending cuts. With the exception of a suggested change in sentencing guidelines and the use of generic drug formularies, the effort produced relatively minor recommendations. Cutting overall spending is made more difficult by the alleged deficiencies in various governmental services and functions – an $8 billion backlog in highway construction, underfunding of higher education, teacher salaries below the Southern U.S. average, $900 million in unfunded liabilities in the risk management program and massive coastal restoration costs, just to name a few.

The temporary taxes have unfortunately created an easy out for those who wish to cut state spending. Rather than present a program of specific cuts, they can simply argue against renewal of the taxes, thus forcing the administration to figure out which services to cut. Ironically, the governor’s own plan to eliminate the temporary taxes buys into this approach. It would preserve the funding for the remainder of his term and let the next governor deal with the loss of revenues as they are phased out. It is interesting that the administration defends its plan by showing that, if it had been in effect for the last 10 years, the temporary taxes would be phased out by now. What the administration does not say is how it would have filled the $500 million hole that would have been left in its current budget.

The state needs a balanced, equitable and stable tax structure that grows with the economy and is conducive to economic development. PAR and others have long promoted comprehensive tax reform that would shift reliance from the regressive sales tax to the more progressive, growth-related income tax and expand the property tax base for local governments. “Tax reform” also implies a reordering of corporate taxes to remove disincentives to investment. The current proposals before the Legislature fall short in many respects. What they do have in common is that they would preserve the current level of state spending and taxation, at least for the next year or two.

It would be a big mistake to try to cobble together a complex revenue package in the last few weeks of this session and expect it to provide the type of tax reform that is needed. It would also be a mistake to attempt to combine tax reform with overall tax increases or reductions. The tax reform movement has always assumed that it would be a revenue-neutral effort. Tax reform should be disassociated from questions of the appropriate level of state spending.

The current proposals would have no impact on next year’s revenues and little on the following year either. This being the case, why not take the time needed to carefully design and cost out a comprehensive tax reform package? At the same time, efforts should be made to ascertain the proper level of state spending, examine optional delivery systems for major services and assess spending excesses and deficiencies.

In the meantime, the current “temporary” taxes should be renewed. It is unlikely that major spending cuts can be identified in this session. However, it may not be necessary to renew all of the taxes if legislators are willing to make some of the obvious potential smaller cuts, such as the $19 million in urban and rural “slush funds.”

Louisiana’s tax system needs to be comprehensively restructured, and it cannot be done piecemeal. If the result is to come close to being revenue-neutral, a number of trade-offs and offsets will have to be made at the same time. The piecemeal process tends to make the politically easy changes first.

A comprehensive tax reform package should include the following basic elements:

1. Reduce the state sales tax rate by up to 2 percent on a broad base, including food and utilities.

2. Reduce or eliminate the deduction for federal income taxes paid from the individual and corporate income tax.

3. Remove the deduction from the individual income tax for federal excess itemized deductions.

4. Exempt manufacturing machinery and equipment from the state sales tax.

5. Remove debt from the corporate franchise tax base.

6. Phase out or reduce the homestead exemption and industrial tax exemption.

Comprehensive tax reform could be accomplished in a special legislative session or a constitutional convention prior to the 2004 fiscal session. However, recognizing political realities, especially the impending 2003 legislative and gubernatorial elections, the next fiscal session may represent the first realistic opportunity.

As much as PAR would like to see an end to the recurring budgeting instability caused by the use of “temporary” taxes, waiting another few months – or even two years – to enact a complete plan would be far preferable to rushing into a politically expedient partial fix that may only further delay consideration of real reform.