Rich Huddleston: A Fairer Tax System

Editor’s note: Talk Business solicited four state business leaders to construct a fairer state tax code. This guest commentary, written by Rich Huddleston, executive director of Arkansas Advocates for Children and Families, is the third in the series of four. It appears in the latest magazine issue of Talk Business Arkansas, which you can read online at this link.

The goal of any good tax system is to raise enough revenue to fund critical public investments that improve well-being of children and families while also promoting economic growth and prosperity. A good tax system is also fair. It asks all citizens, and the businesses that benefit from public services, to contribute to the cost of government based on their ability to pay.

The Arkansas tax system fails on both counts.

As has been widely acknowledged for many years now, our state tax system raises most of its revenue in ways that place a larger and unfair burden on low- and middle-income taxpayers, those with the least ability to pay. This was recently confirmed by new estimates from the Institute on Taxation and Economic Policy for an upcoming study by Arkansas Advocates for Children and Families.

According to the Institute’s estimates, which take into account tax changes the Legislature passed this year, Arkansas imposes a state and local tax burden on low- and middle-income families that is twice that of high income earners. The 40 percent of Arkansas taxpayers with the lowest incomes pay nearly 12 cents in state and local taxes on every dollar they earn. In contrast, the top 1 percent of Arkansas taxpayers pay less than 6 cents in state and local taxes on every dollar they earn.

Our tax system also fails to generate enough revenue to support needed investments to improve the state’s ability to compete for better-paying jobs. Research clearly shows the most important factors associated with state economic development are the education and quality of the workforce, public amenities, good highways and roads, access to markets for goods, etc. State and local taxes comprise a small fraction of the cost of doing business, on average less than 3 percent of the total expenses of the average corporation. Other costs – such as transportation, energy, and labor – far outweigh the costs of taxes, vary more widely among states, and have a greater impact on business location decisions.

One only has to look to this year’s state budget for evidence that our revenue system needs strengthening. Medicaid and K-12 education again received the lion’s share of any new money in the state budget. While the need to fund these investments is understandable given their importance in promoting the future health and education of so many of the state’s citizens, there wasn’t enough revenue to fund other critical investments that are important to the well-being of our citizens and future economic growth.

Take, for example, quality pre-school education for at-risk 3- and 4-year-olds, an investment that research shows has one of the highest rates of return for economic growth. It hasn’t had a funding increase since 2008. Highways and roads are another example. Even with last November’s passage of a dedicated sales tax, funding is widely regarded as inadequate. The lack of revenue to fund critical investments led to crazy proposals that are nothing more than robbing Peter to pay Paul, such as the introduction of the “highway robbery” bill to transfer $2 billion in state general revenue from human services, education, and public safety to highways and roads.

So where do we start building a tax system that is more fair and also provides revenue critical to invest in our state’s future? There are constitutional challenges to some of the best improvements of our tax system. But reforms we can take on right now would be:

• Close corporate income tax loopholes that allow larger, multi-state companies doing business in Arkansas to shift the profits earned here to other states to reduce or avoid paying Arkansas taxes. In 2010, more than 18,000 of the corporations that filed taxes here (60%) owed no corporate income taxes. We conservatively estimate this would increase tax revenue by about $42 million annually. It would also help level the playing field for small companies that rarely employ such tax avoidance strategies.

• Increase the severance tax on natural gas. Our severance taxes are still among the lowest in the region. According to estimates from Histecon and Associates, increasing Arkansas severance tax rates on natural gas by 1 percentage point would generate $35-40 million in new revenue annually. Arkansas could easily do this and still have rates lower than other states in the region.

• Modernize the sales tax. Arkansas must broaden its sales tax base to include more services that are currently exempt, such as advertising and veterinary services. The base should also be broadened to include Internet downloads — such as software, music, movies, and e-books – as well as close loopholes such as those that allow travel companies to collect only part of the tax owed on hotel room bookings.

• Offset the impact that revenue increases would have on low- and middle-income families. One way to do this would be to establish a state earned income tax credit, long regarded by experts as one of the nation’s most successful anti-poverty programs. A state credit equal to 5 percent of the federal version would cost the state about $40 million a year, and would provide an average tax refund (over and above the elimination of any tax liability) of about $121 to more than 300,000 filers. That is money that would be spent locally and help boost local economies.

Strengthening the foundation of our tax system should be used to fund critical investments that allow all Arkansans to become productive members of a high-quality workforce. New revenue should not be used, as several lawmakers have recently suggested, to further cut state personal income tax rates. Such a move would mostly benefit high-income taxpayers and would have little impact on the state economy. By far the most important reasons people move to another state are for a new job, family issues, housing prices, and weather – not taxes.

Short of putting a comprehensive tax reform package before the voters that would overhaul the state’s entire system, including property taxes, these are steps that the legislature could take on today to improve our tax system.