Sam Sicard: Reforming The Tax Code

Editor’s note:  Talk Business solicited four state business leaders to construct a fairer state tax code. This guest commentary, written by Fort Smith-based First National Bank CEO Sam Sicard, is the first in the series of four.  It appears in the latest magazine issue of Talk Business Arkansas, which you can read online at this link.

I would like to share a few examples of ways we could have a state tax code that better rewards work, promotes innovation, and helps make Arkansas the best place to start and build a business that creates jobs for Arkansans.

Our state tax code resembles our federal tax code: it is loaded with exemptions, deductions and credits that make the code complicated, inflates tax rates, and creates numerous unintended consequences. In 2013, there will be about $1.3 trillion of spending in the federal tax code alone through all of these “tax expenditures” that deflate tax revenue collections and inflates tax rates to try to make up the difference.

One massive tax expenditure is the mortgage interest deduction. Both the federal and state tax codes allow taxpayers to deduct the interest paid on mortgages on both primary and secondary homes up to a maximum total amount of $1 million in mortgage debt.

As an example, we have two small business owners who have the same annual income: one who owes $1 million on his two homes, and another who only owes $100,000 on his one home. Despite having the same income, the frugal business owner who prefers to live in a modest home pays substantially more in income taxes than the spendthrift business owner. If rates on their loans are both at 5%, the frugal business owner only receives a $5,000 deduction, and the spendthrift owner receives a massive $50,000 deduction. Let’s not even question the fairness of this, and just question whether this is smart tax policy. What if the frugal business owner chooses to live in a modest home because he wants to continue to reinvest his future earnings back into his business to help it grow and add jobs to our state? Is it smart to reward the spendthrift owner with much lower income taxes than the frugal business owner? Is it smart tax policy to reward Arkansans for borrowing up to $1 million to finance their personal lifestyle, even though the vast majority of Arkansans do not have the means to borrow anywhere close to that?

The argument in favor of the mortgage interest deduction is that it encourages home ownership, however, there are numerous ways to encourage Arkansans to own a home at a much lower cost and without giving them preferential tax advantages for borrowing large sums of money.

One is to provide a tax credit to first-time homebuyers. Another way to lower the burden of owning a home is to raise the homestead tax credit to offset the property taxes homeowners pay. This would help the lower-income elderly who have already paid for their modest homes and aid them to stay in their homes after retirement. It could also help retain and recruit the rapidly growing retiree population to Arkansas. If we would like to leave the mortgage interest deduction in place to support home ownership, how about lowering the interest we could deduct to the first $250,000 in debt, and use this much lower deduction cap to lower tax rates for all Arkansans?

There are numerous examples of other deductions and exemptions in the tax code that create preferential treatment and unintended consequences. My recommendation would be to do exactly what Senators Hatch and Baucus recently announced. First, they propose eliminating all tax expenditures and reduce rates accordingly. Then, lawmakers must justify which tax preferences to add back in, keeping in mind that tax rates would have to rise in order to offset any costs. This would allow everyone to see how these expenditures increase rates, and would force legislators to explain why we need to put all of these special interest-backed tax expenditures back into the tax code.

The other major concern I have with our state tax code is the tax burden we place on small-to- medium sized local businesses relative to our surrounding states. The Tax Foundation’s 2013 edition of the State Business Tax Climate Index indicated Arkansas ranked #33, putting us well below the majority of states that border us. Texas ranked #9, Tennessee was #15, Missouri was #16, and Mississippi was #17.

One category in this index that pulled our ranking down was our corporate income tax ranking, which was #37. Our current corporate tax rate is at 6.5% on income above $100,000. One way to lower the corporate tax burden and focus this reduction on small-to-medium sized businesses is to lower the corporate tax rate on the first $1,000,000 in income, while leaving the current rate at 6.5% on all income above $1,000,000. In addition, since the vast majority of businesses are S-corps or LLCs, we should consider lowering the tax rate on passthrough business income on individual tax returns.

Lowering the tax burden on businesses will create more incentives for people to come here to start or grow their business. More importantly, it will encourage more Arkansans to start a business, and will allow them to retain more of the income from their business and reinvest these funds to grow their business and create new jobs in our state.

How would we pay for a reduction in taxes on businesses?

One way is to start requiring out-of-state online retailers to collect sales taxes on sales to our residents. Presently, Arkansas does not have the authority to do so. However, Congressman Womack has sponsored the Marketplace Fairness Act to allow our state to have this choice. This was passed with strong bipartisan support in the Senate, including Senators Boozman and Pryor, but faces an uncertain future in the House. Not only would this bill allow us to cut income taxes, it would end the completely unfair advantage online out-of-state retailers have on our local businesses who are required to collect sales taxes from customers. The continuing result of this unfair advantage will be fewer local retail jobs and more vacant commercial buildings, which will just further the vicious cycle of lowering our sales and income tax bases needed to fund our state, county, and municipal governments.

If the majority of Congress doesn’t support this bill to defend our local businesses and respect our state’s rights, another way to cut taxes on our local businesses is to lower future spending increases. While I certainly support cutting wasteful spending and trying to continuously make government more efficient, just like we continuously try to do at our bank, it is also vitally important that we don’t cut our investment in Arkansans and the infrastructure needed to increase commerce. To continue to grow our economy and create an environment that supports job creation, how and where we spend taxpayer money needs to be evaluated in the same manner that we evaluate how to reform our tax code: strategically.