How To Cut Taxes In Arkansas: Basic Principles Of Tax Policy

By Dan Greenberg, Advance Arkansas Institute: Because of the 2010 elections, fiscal conservatives hold a stronger hand in our state legislature. Many legislators have filed bills to reduce Arkansas’s tax burden, but enacting them all would be impossible. Any tax reduction deserves some praise, but legislators should note that some tax cuts are better than others. Writing second-rate tax relief into law will threaten the passage of first-rate tax policy. Legislators should keep the principles of tax policy in mind, because every one of those principles – if established in law – will increase revenue. Among the principles that an ideal tax system encourages and embodies are:

• Simplicity. Taxes should be easy to administer and comply with, in order to encourage voluntary compliance and discourage tax shelters and disguised income.
• Transparency. Taxes should be obvious and apparent: they shouldn’t be hidden from consumers by being lumped in with the price of the purchased good.
• Neutrality. The tax code should not micromanage the economy, encourage people to make decisions for tax reasons, or otherwise distort price signals that affect individual choice.
• Stability. Constant changes in the tax code make planning and investment difficult.
• Economic growth and prosperity. A broad-based, low-rate tax best encourages job creation, capital investment, and economic growth.

These values may seem abstract. However, their importance becomes more apparent when they are used to rank the tax proposals of the 88th General Assembly.

If the goal of tax policy is to create a thriving economy that attracts investment and jobs to the state, the most preferable tax relief is broad-based reductions in income taxes (HB 1387), capital gains taxes (HB 1002), and/or industry taxes on utility consumption (SB 269). Such tax relief will lead to capital investment, job creation, and a prosperous state economy. If the Arkansas tax code treats capital investment more favorably by lowering the cost of doing business here, Arkansas will succeed in attracting investments and businesses that create jobs when it lowers income taxes. The double taxation that Arkansas manufacturers face – because of our state’s extra layer of energy taxes – makes utility tax relief another priority for advocates of economic growth and job creation. (With respect to economic development, any of these three tax measures is far superior to Arkansas’s current policy of trying to attract new businesses into the state with an array of special tax breaks and subsidies. Such favoritism is demoralizing and insulting to other businesses in Arkansas; it could encourage them to leave the state to see if they can get a better deal elsewhere.)

Tax cuts limited by area or time are inferior. They score poorly on neutrality, simplicity, and stability. For instance, a sales tax holiday on selected consumer goods (HB 1369) appears to have very little impact, except that people buy more untaxed goods during the holiday and correspondingly less when the holiday is over. There appears to be no evidence that a sales tax holiday improves the economy or increases purchasing power in the long term. Similarly, measures like HB 1118 that are designed to improve the fortunes of a particular business or economic sector are often ineffective. For instance, the film tax credits that Arkansas wrote into law two years ago, which were intended to spur film production and job creation, will likely have the same result as Louisiana’s: a recent Louisiana state government study found that every dollar the state lost in film tax credits was replaced with about 18 cents of tax revenue, making the credit a large revenue-loser.

Proposals that benefit small groups are inferior. Legislators have introduced many measures to provide credits or exemptions to particularly admired businesses, causes, or people, such as individual nonprofits (HB 1137), certain spouses of military personnel (HB 1314), volunteer firefighters (SB 152), and stay-at-home parents (HB 1025). Although lawmakers’ intent is doubtless praiseworthy, proposals that benefit small groups score poorly on neutrality, simplicity, transparency, and fostering economic growth. For example, there is no economic difference between giving a volunteer firefighter a $100 state grant and a $100 tax credit. But there are huge political and fiscal differences: estimates of the effect of tax cuts on revenues are notoriously inaccurate, and state legislators don’t have to account for revenue loss in the way that they bear responsibility for increased spending. Provisions in the tax code that act as subsidies are easily hidden or overlooked. Fiscally responsible lawmakers will accept the responsibility of budgeting for their preferred special-interest expenditures by openly and honestly paying to cut checks to them from the state budget. Policymakers who want to use the tax code to help small groups or redistribute wealth should consider the more efficient and transparent alternative of direct payments or grants.

Proposals that create or expand consumer exemptions are inferior. If advocates of shrinking the sales tax on food (HB 1389, SB 276) want to help the poorest of the poor, cutting the food tax is a misguided way to accomplish it. The poorest of the poor receive a direct food subsidy: food stamps. Treating food differently from other purchases can create costly and complex administrative problems; it does very little to encourage investment and job growth in Arkansas. Rather than narrowing the tax base by shielding some purchases from taxation, a better policy option is a broad-based sales tax with a lower rate. Legislators who want their values of equity or redistribution written into state law should consider the possibility that there are more effective ways to accomplish these goals than increasing the complexity of the state tax code. Expanding the food stamp program would be an economically superior, less distortive way of helping the poor than cutting sales taxes on roughly one-fifth of all consumer purchases. Because it scores poorly on simplicity and economic growth, food tax relief is therefore not at the top tier of preferable tax relief.

CONCLUSION: Lawmakers who support economic development in Arkansas should focus on creating a pro-growth tax code. A state’s tax policy is the most direct, immediate way to foster economic development and attract the capital investment which creates more jobs. Directly subsidizing new businesses runs the risk of picking losers instead of winners, which leads only to wasted taxpayer money and disused facilities. Improving education, while worthwhile, might take a decade or two to produce appreciable results. In general, higher-quality public services can fall victim to citizen mobility: it is not much of an exaggeration to say that many of Michigan’s current economic problems can be traced to former Michigan residents who have attended its top-tier universities and then used its top-tier roads to escape its top-tier taxes, instead moving to states with top-tier jobs.

Except for certain poverty exemptions, all economic activity should ideally be taxed at the same rate. Arkansas tries to do this for agricultural goods, fails to do this for industrial goods when it loads on the double taxation discussed above, and introduces further distortions in its wide array of deductions, credits, and varying sales tax rates for consumers. Simplicity in the tax code will shrink administrative costs and economic distortions, increase revenue, and lead to economic growth. Above all, policymakers should resist temptations to narrow our tax base or raise our tax rates.

In short, the foundation of tax reform that will help Arkansas is a simple, open, stable, and neutral tax code that establishes a broad tax base and a low tax rate. Lawmakers who want to bring job creation and economic growth to Arkansas should look to the tax policy of successful regional competitors like Texas, Tennessee, and Florida. Notably, those job-creating economies are entirely unsaddled by a state income tax.
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Dan Greenberg, a lawyer and former state legislator, is President of the Advance Arkansas Institute.

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Specific legislation mentioned in this paper is cited only to demonstrate what some particular policy might look like in legislative form. The Advance Arkansas Institute does not support or oppose any particular legislative proposal.

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