The Center's work on 'Taxes' Issues


More Evidence That State Income Taxes Have Little Impact on Interstate Migration

August 26, 2014 at 1:00 pm

The New York Times’ Upshot blog has published a fascinating set of graphs of Census Bureau data on interstate migration patterns since 1900, bolstering our argument that state income taxes don’t have a significant impact on people’s decisions about where to live.

We plotted the same Census data, which shows which states do the best job of retaining their native-born populations, on the chart below, also noting which states have (or don’t have) a state income tax.  Our chart shows that taxes have little to do with the extent to which native-born people leave their states of origin.

If Heritage Foundation economist Stephen Moore’s claim (which other tax-cut advocates often repeat) that “taxes are indisputably a major factor in determining where . . . families locate” were true, states without income taxes would see below-average shares of their native-born populations leaving at some point in their lifetime, while states with relatively high income taxes would see the opposite.  But the graph shows no such pattern:

  • Three of the nine no-income-tax states perform very poorly in holding on to native-born residents.  Wyoming, Alaska, and South Dakota have three of the nation’s four highest shares of native-born residents who left the state.
  • Four other no-income-tax states are closer to the middle of the pack.  Nevada is almost exactly in the middle of the state rankings, while New Hampshire and Tennessee fall almost equally below and above Nevada; Washington falls within that interval as well.  New Hampshire does no better in retaining its native born than its high-tax neighbor, Vermont.  Tennessee’s neighbor, North Carolina, has had the highest income tax rates among southern states for the past 20 years but outperformed nearly all of them in retaining its native born, tying for second nationally.
  • Only two of the nine no-income-tax states are top performers in retaining their native born.  Threeof the five states that retain the largest shares of their natives — California, Georgia, and North Carolina — have income taxes, and California and North Carolina in particular have had higher income taxes than their neighbors.  Texas and Florida are the only no-income-tax states that rank highly for retention.  

A Deserved Downgrade of Kansas’ Bonds

August 11, 2014 at 9:41 am

The meaning of Standard & Poor’s recent downgrade of Kansas’ credit rating, in which it cited Kansas’ “structurally unbalanced budget,” is clear:  Kansas’ budget is a train heading off a cliff.

Here are the details:

  • Kansas’ massive tax cuts have sharply cut state tax revenues.  Since Kansas’ massive tax cuts took effect a year and a half ago, revenues have nosedived.  Revenues were down about $700 million in the last fiscal year.  That’s much more of a drop-off than the state’s official forecasters expected.
  • There’s not enough revenue coming in this year to cover the state’s budget.  Hoping the tax cuts would produce more economic growth and wanting to avoid additional spending cuts, Kansas lawmakers approved a budget for this fiscal year that’s $326 million larger than the state forecasts it will collect in revenue.  In reality, the imbalance is even worse, because the budget is based on overly optimistic revenue projections.  The state assumes revenues will surge over the next year — even though more tax cuts will kick in in January.  That’s why Duane Goossen, the state’s former budget director, recently wrote, “[t]he Kansas budget appears to be teetering on the edge of a fiscal cliff, but that’s an illusion.  We’ve already gone over the edge.”
  • Kansas is avoiding immediate budget cuts only by drawing down its operating reserves.  The state isn’t in emergency mode already because it’s using its only operating reserves to cover the cost of state services.  (Kansas is one of only four states with no formal “rainy day fund,” so its operating reserves are not well protected and can be used in this imprudent way.)
  • The reserves likely will run dry sometime in the next few months, creating a budgetary emergency.  Once the reserves are gone, Kansas will be forced to make emergency cuts to state services, or to raise new revenue.  And any cuts would come on top of deep cuts the state has already made in recent years to its schools and other services.
  • The future looks even worse.  The new tax cuts taking effect at the beginning of 2015 will be followed by even more income tax rate cuts in each of the subsequent three years.  The additional cuts in 2016 alone will reduce revenues by about another $113 million.  So when the legislature comes back in session next January to write the state budget for 2016, lawmakers will have even less revenue to work with, making it even harder for Kansas to fund its schools and other services.

It’s no wonder that Standard & Poor’s downgraded Kansas’ credit rating, or that another major credit rating agency — Moody’s — did so earlier this year.  The rating agencies rightly understand that Kansas’ fiscal policy is a disaster.

Five Ways That States Can Produce a More Trusted and Reliable Revenue Estimate

August 7, 2014 at 12:10 pm

Update, August 7: We’ve updated this post to correct the number of states in which forecasting meetings are closed to the public.

Every state estimates how much revenue it will collect in the upcoming fiscal year. A reliable estimate is essential to building a fiscally responsible budget and sets a benchmark for how much funding the state can provide to schools and other public services. Yet, as our new report highlights, some states forecast revenues using faulty processes that leave out key players and lack transparency.

While there is no one right way to forecast revenues, research and experience suggest that states benefit from the following common-sense practices.

  • The governor and legislature should jointly produce a “consensus” revenue estimate. More than half the states (28) employ such a “consensus” process. In the other 22 states and the District of Columbia, either the governor and legislature produce competing forecasts (a recipe for gridlock and political infighting) or one branch of government is left out of the official process, which may reduce the revenue estimate’s value as a trusted starting point for writing the state budget.
  • The forecasting body should include outside experts. Including experts from academia or business, along with economic and budgeting experts from within the government, widens the economic knowledge available to the forecasting body and can improve how well a forecast is trusted. While more than two-thirds of the states draw on outside experts, 15 states do not.
  • The forecast and its assumptions should be published and easily accessible on the Internet. Most states follow this practice, but seven do not, leaving their estimates less transparent to anyone who is not directly involved in the forecasting process.
  • Meetings of the forecasting body should be open to the public. In 21 states and the District of Columbia, forecasting meetings are closed to the public, unnecessarily diminishing the trust that the forecasts might otherwise engender.
  • Estimates should be revised during the budget session. Reviewing earlier estimates to adjust them for changing economic circumstances can improve their accuracy. Fifteen states do not regularly review their estimates during the course of the budget session.

Together, these components create a strong, reliable revenue estimate. For example, a professional and open revenue estimating process makes revenue forecasts more transparent and accessible to the public and a broader group of legislators, which can lead to a healthier and more democratic debate and greater fiscal discipline.

States wishing to improve their revenue estimating practices have a number of models, since many states have adopted practices that produce a more trusted forecast (see map). Thirteen states employ all five of the best practices identified by our research and can serve as models for the rest of the country. One state — Arkansas — does not use any of the five best practices, and 11 others employ only one or two. These states, in particular, could benefit from adopting the better revenue estimating practices that many other states use.

Click here for the full report.

Congress Shouldn’t Renew Internet Tax Freedom Act Unless It’s Paired With the Marketplace Fairness Act

July 21, 2014 at 2:54 pm

The Internet Tax Freedom Act’s (ITFA) ban on state and local sales taxation of monthly Internet access fees costs state and local governments about $6.5 billion annually in forgone revenue, and the states and localities currently taxing access under ITFA’s “grandfather” provision would lose at least $500 million on top of that each year if the provision expired, as I’ve recently explained.  Despite these costs, the House last week approved making ITFA permanent while letting the grandfather clause expire.  A new bipartisan Senate bill, however, would help state and local governments make up for the lost revenue.

The Senate bill would pair a 10-year ITFA extension with the Marketplace Fairness Act (MFA).  The MFA would enable states and localities to receive a substantial share of the sales tax that is legally due on purchases of goods and services from Internet and catalog merchants like Amazon and L.L. Bean but that they can’t collect from the companies.

Due to 1967 and 1992 Supreme Court decisions, a state can require out-of-state companies to charge its sales tax only if they have a physical presence in the state like a store, warehouse, or sales force.  The tax is still legally due, and consumers are supposed to pay it directly to their state, but few people do.  Those lost revenues could help pay for schools, roads, police, and other critical state and local services, and they keep sales and income tax rates higher than they’d otherwise need to be.

MFA would authorize states to require out-of-state sellers with more than $1 million in nationwide interstate sales to charge the applicable taxes — provided that states simplify their sales taxes and give merchants free software that calculates the correct tax.

This change would allow state and local governments to collect as much as $23 billion in annual revenues that they are owed under current law.  That would help them maintain and possibly reinvest in public services they cut during the recent recession.  It would also help offset states’ and localities’ ITFA-related $7 billion revenue loss — lost dollars that will grow as more people subscribe to Internet service; others trade-up to faster, and therefore more expensive, service; and others cancel their taxable landline telephones and cable TV in favor of Internet-based alternatives like Skype and Netflix.

MFA’s long-overdue enactment would also:

  • Create a more level playing field for local store-based retailers.  Because combined state and local sales tax rates typically range between 5 and 10 percent, Internet retailers that don’t collect sales taxes outside their home states start out with a price advantage over their local competitors.  This makes it harder for Main Street merchants to create local jobs.  It also has a ripple effect on local economies, as depressed sales at the neighborhood book or musical instrument shop lead to fewer purchases by their owners and employees at the farmers’ market and dry cleaner. 
  • End the unfair sales tax treatment of consumers who don’t shop online.  Low-income people who lack the computers, Internet access, or credit cards needed to shop online pay more than their fair share of sales taxes because online shoppers can avoid these taxes. 

These are worthy goals, and Congress should have passed the MFA long ago to achieve them.  But if lawmakers decide to extend ITFA, it’s even more urgent that they also enact MFA.  Congress should not extend the moratorium without also enacting MFA.

Busting Three Myths About the Internet Tax Freedom Act’s “Grandfather Clause”

July 18, 2014 at 4:08 pm

The Senate next week will likely consider its version of a bill to renew the Internet Tax Freedom Act (ITFA), a federal law prohibiting state and local governments from taxing the monthly Internet access subscription fee that households and businesses pay.  The House voted earlier this week to make ITFA, which is due to expire on November 1, permanent.

ITFA was enacted in 1998 with strong bipartisan support, and it has always included a “grandfather clause” that allowed states and localities that were taxing Internet access to keep doing so.  Despite its long history, there’s widespread misunderstanding about the grandfather clause in the current debate about renewing ITFA.  Here are the facts behind three widespread myths about that clause:

Myth:  The House and Senate bills that would make ITFA permanent preserve the grandfather clause.

Fact:  The House-approved bill and its Senate analog both effectively eliminate the grandfather clause.  There has been confusion about this because both bills strike ITFA’s November 1, 2014 expiration date with no mention of the grandfather clause.  But the current law terminates the grandfather clause as of November 1, 2014, meaning that it expires as of that date unless policymakers explicitly extend it.  Neither the House nor Senate bill does so.

Myth:  Eliminating the grandfather clause would affect the revenues of only seven states that directly tax Internet access service. 

Fact: Virtually every state, and thousands of local governments, would be at risk of losing revenue if the grandfather clause expires — dollars they use to pay teachers and police, provide financial aid to state university students, repair roads, and provide many other critical services.  That’s because the clause not only preserves the pre-1998 direct taxes on Internet access service of Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, it also preserves all pre-1998 taxes that could be considered indirect taxes on Internet access.  That would include, for example, state and local taxes that Internet access providers pay on the things they buy in order to provide Internet service, such as computer servers, fiber-optic cable, or even gasoline for their vehicles.  Almost all of these taxes existed before 1998, so the grandfather clause protects them from legal challenge.  But if Congress eliminates the clause, Internet access providers could challenge these taxes in court as indirect taxes on Internet access service and therefore voided by ITFA.  (For more on this issue, see pages 8-10 of my recent analysis.)

Myth:  The grandfather clause was intended to give states time to phase out Internet access taxes, which they’ve had ample time to do.

Fact:  The original 1998 committee reports on ITFA don’t back up this claim.  Such a rationale wouldn’t have made sense anyway, because ITFA itself was supposed to be temporary.  As the 1998 Senate Commerce Committee report said, ITFA was intended to be “a temporary moratorium on Internet-specific taxes [that] is necessary to facilitate the development of a fair and uniform taxing scheme.”  Lawmakers included the grandfather clause to protect the interests of states and localities that had already come to rely on Internet access tax revenues to fund services.  If Congress had wanted to push the states taxing Internet access to phase out those taxes, it could have had the grandfather clause expire sooner than the overall moratorium in the original 1998 legislation or in any of the three subsequent renewals, but it didn’t.

The facts make the case:  if Congress extends ITFA, no matter for how long, the law must continue to include the grandfather clause.