Sales Tax on Energy Targeted for Reform

Pressure is coming to bear on Arkansas to reduce or exempt the sales tax on utility bills for industry. It’s a fiscal perk that is drawing more attention as states vie to retain existing employers and recruit new ones.

The sales tax on industrial utility usage accounts for an estimated $54 million in annual state revenue. That represents about 2 percent of the total sales and use tax collected by the state in fiscal year 2005.

Gubernatorial candidate Asa Hutchinson is championing an industrial exemption in his campaign for governor as part of his advocacy for tax reform.

“It’s important from two aspects: first, in terms of recruiting industry and secondly, we have to realize that over 80 percent of our job growth comes from our existing manufacturing base,” Hutchinson said.

The only meaningful sales tax break on industrial utility use in Arkansas is for steel mills in which 50 percent or more of electricity and natural gas consumption goes into processing steel. Hutchinson believes the benefits from expanding the exemption will more than offset the loss of sales tax revenue.

“It looks like surrounding states use it very liberally, and it would allow Arkansas to be more competitive,” he said. “Ultimately, it would provide an increase of jobs and an increase in revenue down the road for our state. The question is: Can we afford not to do it?”

At 6 percent, Arkansas and Kentucky have the highest sales and use tax on industrial electricity and natural gas in the South. Florida also has a 6 percent rate for natural gas but exempts electricity.

Industries in Missouri, Oklahoma, Texas and South Carolina are exempt from paying sales tax on electricity and natural gas. That rate is 1.5 percent in Tennessee and Mississippi.

Supporters of the exemption also point out that Arkansas is reaping a financial windfall from the sales tax on energy use. That windfall is not so much linked with increased use by industrial plants cranking out more products as it is with escalating commodity prices for fuel such as natural gas.

In other words, companies aren’t just having to pay more for the energy itself. Companies — and other ratepayers — are having to pay more sales tax on the higher-priced energy.

“More states are looking at the fairness of their tax structure so they can be competitive for the job creators,” Hutchinson said. “And that’s one of the challenges we face. We’re being more aggressive, but we haven’t landed that jewel we want for our state.”

The 2005 special session of the Louisiana Legislature was host to a buffet of bills to reduce, cap or eliminate the state sales tax on energy. The proposals included:

Exempting all state sales on natural gas purchased by pulp and paper mills;

Providing a cap of $6.20 per million British thermal units on the price of natural gas subject to sales tax;

Using the above cap on natural gas and exempting all sales tax on electricity used by paper or wood products manufacturing facilities through 2008; and

Reducing the effective tax rate on natural gas, electric power or energy to 3.3 percent through June 30, 2009, and to 1 percent after that.

Hutchinson is well aware there is a balancing act to tackle the sales tax issue on energy, but he is confident a plan can be worked out that won’t hurt the state’s revenue stream.

“You have to move cautiously in that regard, but it’s fiscally conservative to address this exemption need,” Hutchinson said.

Attorney General Mike Beebe’s campaign manager said his candidate is interested in the possibility of changing the sales tax for industrial energy use.

“One, he recognizes that utility costs continue to grow and we need to continue to help industry find ways to reduce the cost of doing business,” Chris Masingill said.

“His thought is we need to make sure we look at a phased-in approach as revenue growth allows so that any reduction in the sales tax doesn’t affect the delivery of state services.

“He recognizes that energy costs are a significant consideration for industry and that we need to look at our tax policy in this area to see how competitive Arkansas is with other states.”

The idea of altering the sales tax on utilities was broached during the 2005 legislative session. But the proposal didn’t get very far.

Brent Stevenson, director of the Arkansas Forest & Paper Council, was among those who lobbied unsuccessfully for a change in the sales tax during the session.

“There is an investment window opening up, and we want to position Arkansas so that we can land more of those expansion dollars,” Stevenson said. “We’re not positioned to take advantage of it. That’s a little disappointing.

“The economy does not wait on anyone. Money is going to flow where a company can get the best return on investment. Arkansas still doesn’t have an auto plant. You can draw your own conclusion.”

A legislative report on Arkansas business and economic development incentives recommended changing the sales tax on electricity, natural gas and water.

“The state needs to consider lowering the sales tax on these services from the current rate … to a much lower rate or even exempting these services for targeted industries.”

In his advocacy for tax reform, Hutchinson has used New Mexico as an example of how reducing taxes can improve state revenue. Gov. Bill Richardson cut the top marginal tax rate from 8.2 percent to 4.9 percent over a five-year period and reduced taxes on capital gains.

He credits those reductions with economic growth that led to $216 million in new state revenue in 2005.

Hutchinson is confident that both Arkansas and its businesses will experience similar results, even if the tax reform item involves reducing the sales tax on energy.