Good tax plan economically faces tough battle politically

While there are more hits with Gov. Bobby Jindal’s proposal to swap sales for income taxes, there are enough misses that could derail the change that needs a supermajority in the Louisiana Legislature.

The plan would eliminate all personal and corporate income taxes, plus the corporate franchise tax (in essence a licensing fee based upon corporate capital that is perhaps the most unfavorable of all the states that have one), in exchange for raising the state tax rate 1.88 percent and coverage of that to a host of previously-exempt services. However, several large exemptions will continue to exist against the entire state sales tax portion, principally concerning the acquisition of unprepared food, medicines, and utilities. Plus, any person whose income falls below $20,000 annually will be able to apply for a rebate of up to $300, and anyone drawing retirement payments such as Social Security can get a rebate tied to the first $60,000 of income (currently, recipients and state and local government retirees do not pay income taxes). Finally, it raises the tax on tobacco products, by $1.05 per pack of cigarettes.

Evaluated on economic terms, the plan has much going for it. Over the decades, research results continue to demonstrate that the most reliable path to increased societal wealth comes through systems relatively light on income taxes compared to sales taxes (nine states currently have no income taxes). Empirically, states with the lowest income taxes for decades have seen the most economic growth, while those with the lowest sales taxes have seen the least growth.

Of course, the exceptionalities distort this benefit to some degree. The continued constitutional food/drug/utilities exemptions necessarily forces a higher rate which in turn prompts the rebate strategy and higher. At least three major exemptions are left in, but one towers over the other two (which have minor changes limiting them) in terms of money forgone: the wasteful motion picture tax credit. Fortunately, change is proposed for this as well: excluding the credit against any actor salaries over $1 million and disallowing a few other things.

This would have a beneficial impact on state finances. Currently spewing out in an annual range of roughly $200 million a year for which the state sees an average return of $30 million, the salary limitation would discourage big-budgeted efforts, reducing the amount significantly the state must cough up for little return. The deal also halves the natural resource extraction exemption.

Yet overall it should provide a substantial boost to economic development fortunes, which perhaps is why the Department of Revenue estimates that the typical citizen will pay a small percentage less in overall state taxes. Although designed to be revenue neutral, perhaps analysts are factoring the benefits of increased economic productivity: even though different individuals will experience differential income savings and consumption payments, the extra output may raise incomes and thus saved from income tax at a faster rate than proportion of income that goes to the added sales tax.

But while the economic case for the swap is strong, it is the evaluation on political terms that may prove to be its undoing, and that starts with that fact that there will be winners and losers in the deal in the immediate term. For example, the services to face new sales taxes will see reduced business, a dropoff that may be greater than the income tax savings realized by their business, at least in the short run.

One consideration that could mitigate potential wariness among business would have been introducing as part of this centralizing the collection of sales taxes, which just about every state does. Instead, the Jindal Administration seems to have caved to parish concerns that currently collect these taxes, so now there are no reduced compliance costs and increased ones for those to be brought newly under the state sales tax umbrella (local sales taxes still will not apply to these). Reducing paperwork might have relieved concerns, especially among small business.

Nor is it just these parochial interests that watered down the idea that also will try to sabotage the finished product. Prepare to hear local officials carp about how the increase makes it more difficult to raise local sales taxes – although this makes the assumption that government spending desires will outpace current economic growth, the latter of which across the board ought to increase in rate as a result of the deal. The key here is that “desires” are not the same as genuine “needs,” but assuredly many politicians at the local level will obfuscate on that point as they see this move as a threat reducing their abilities to acquire more power and privilege.

Other ways to stir the political pot against the change exist. For example, even though the rebate offer for low-income persons is substantial – at the maximum income level it assumes 80 percent of all spending occurs in ways to which the additional sales tax would apply at present, not even counting the old rate also now applied to new services so it’s a pretty fair argument that lower income individuals actually will profit with the rebates – there are those who will ignore the data and math and rail against the swap in order to fulfill a political agenda. No sooner had the details emerged than a proclaimed Democrat candidate for governor in two-and-a-half years, state Rep. John Bel Edwards, began populist demagoguery against the plan with the claim it would disproportionately hurt the poor if not a majority of the state’s people and businesses, despite the evidence otherwise.

Additional issues cloud the picture. Left uncertain until the legislation gets introduced are issues such as how prominently does online sales tax take play, or whether the state’s Earned Income Tax Credit will continue. Yet clearly one interest disadvantaged under the plan are smokers, where the majority likely would oppose the whole thing on that basis alone.

And, there will be those interests that, because of the elimination of around 200 exemptions and restructuring of others, that will turn out to be net immediate losers. Even though over the long haul as a result of increased growth they may do better, human psychology makes people prone to fixate on the short run, overestimating those costs and benefits while underestimating those in the long run.

This will be the greatest challenge the Jindal Administration faces, the multitude of different rank-orderings of preferences people have in their economic lives, which threatens to stop this kind of change that requires supermajority support. Some businessman might be perfectly happy that 199 exemptions are going away, but he benefits from one in particular also on the chopping block that he feels he can’t operate without. A single mother might wonder why she just can’t stay under the old system where she doesn’t have to file anything, except maybe the federal and state EITC requests if she works, and not pay extra sales tax, to now having to pay and then file to get that reimbursement.

It’s change that could die from a thousand small cuts, with ideological opponents who see government primarily as a vehicle for wealth redistribution to favored interests rather than as an agent to assist people in cultivating and pursuing talents and tasks that benefit themselves and society itching to whip into a frenzy a mob wishing to inflict those slashes on the infant in the cradle. It could have been set up more effectively, and may be altered before becoming legislation, but in this form it seems to be the hand Jindal wants to play. For the state’s sake and future, he needs to play it well.