Tax Justice Digest stories about South Carolina

Earlier this month, Apple announced that it had surpassed Wal-Mart as the largest music retailer in the United States, citing data from market research firm NPD for the first two months of 2008.  The announcement will hopefully help to draw more attention to a long-standing shortcoming in some states' tax systems -- namely, their inability to tax electronic commerce properly.  Simply put, the form a transaction takes should not affect the amount of tax it might incur.  Someone who downloads the latest Mariah Carey album from iTunes should pay the same state sales tax as someone who purchases the CD at his or her local record store, and a hotel reservation made through Orbitz should result in the same amount of revenue to the state as one made over the phone or in person. 

Yet, flaws in state tax laws mean that purchases of intangible goods -- like a downloaded version of E=MC2 -- are often not subject to the same sales taxes levied on purchases of tangible goods.  For example, California loses an estimated $500 million in sales tax revenue each year because it makes such a distinction between tangible and intangible goods.  A proposal to move towards ending that distinction was defeated in the Assembly’s Revenue and Taxation Committee this past week, the victim of lobbying by the American Electronics Association, Yahoo, Microsoft, and others.

Similarly, states and localities continue to lose vital tax dollars due to hotel reservations made via the Internet.  That is, online travel companies like Hotels.com frequently avoid paying the correct amount of taxes by maintaining that they only owe tax based on the wholesale price they paid to the hotels for the room reservations they offer, rather than the retail price they charge their customers.  Different jurisdictions have taken different approaches to this problem. A number of cities have brought lawsuits against hotel resellers, while the state of South Carolina recently served one such company with a bill for $6.3 million in unpaid sales taxes.  On the other hand, Florida, predictably, has the worst idea. A bill before one House committee -- and backed by Expedia -- would let online travel companies keep this tax break, at a cost of $22 million in forgone revenue. 

According to the Tennessee Department of Revenue, state and local governments in Tennessee lose over $3.5 billion per year as a result of sales tax exemptions.  Just five years ago, that number was only $2.2 billion.  Five years before that, only $1.1 billion was lost annually.

So why is this number so large?  And why is it growing so quickly?  The answer to the first question is especially interesting in light of the fact that Tennessee is one of a minority of states that continues to tax groceries.  Exempting groceries is widely recognized as an easy way to reduce the disproportionate impact that sales taxes have on the poor, but Tennessee doesn’t do this. So where is the money going?  For one thing, less than 40 percent of potentially taxable services in the state are actually taxed.  Despite the gains in revenue and in fairness to be had from taxing services, haircuts, taxidermy, limousines, dating services, and many others remain tax-free in the state.

This also helps explain why the losses to the state have grown more than three-fold in the last decade.  It is no secret that the U.S. has steadily been moving towards a more service-based economy.  As this has happened, consumption has been shifted into purchases that are tax free under Tennessee law.  This shift in the economy has a lot to do with why one University of Tennessee professor believes that only 48% of Tennessee’s sales are subject to the sales tax.  In 1979, it is estimated that that number was 65%.

But services don’t explain the entire loss.  Under pressure from organized interest groups, year after year, Tennessee legislators continue to add more exemptions to the tax code.  This year alone, football merchandize, solar panels, and flatbed farm trucks were proposed to be made exempt from the sales tax.  Exemplifying the problem perfectly was one bill that proposed to exempt mulch from taxation.  Upon being introduced, a long list of goods including fencing wire and machine oil were added to the bill, ballooning its cost from $88,000 to $1.3 million per year.

This problem is by no means unique to Tennessee. As one South Carolina newspaper recently pointed out, shrinking sales tax revenues are partially a result of “small, targeted tax cuts [that] get even less scrutiny -- and make even more of a mess of our Swiss-cheese tax code”.  But this problem is especially noteworthy in Tennessee because the state lacks a broad-based income tax.  With Tennessee state and local governments relying almost exclusively on sales taxes for revenue, these kind of exemptions are cutting into the fiscal foundation of public services. Tennessee state and local sales tax rates have already been raised to levels that are among the highest in the nation in order to make up for this lost revenue.

A state cannot improve the lives of its residents by becoming the "discount store of the U.S." warned Dr. William Fox, the respected Director of the Center for Business and Economic Research at the University of Tennessee, in a speech at the Annual Economic Outlook Conference in South Carolina this week. Fox said of South Carolina's tax structure, "If you want to be the discount store of the U.S. that certainly is an option. But it is not the way to create a rising income relative to the U.S. and the rest of the world."

According to The State, Fox reportedly said that South Carolina "needs to put in place a tax system that grows with the need for education and infrastructure, "so that you can invest in yourself." Fox and other colleagues are consulting with the Palmetto Institute (a South Carolina based think-tank) regarding ways to improve the state's tax structure. Let's hope that in the coming legislative sessions South Carolina follows Fox's advice instead of attempting to become the tax policy equivalent of K-Mart.

In a move towards a more progressive tax structure, lawmakers in both Tennessee and South Carolina have floated plans to eliminate or reduce the sales tax on groceries. However, several competing proposals are under discussion in both states, and a political food fight of sorts has broken out.

In Tennessee, the Democrats in the House of Representatives have proposed a targeted food sales tax exemption for milk, eggs, and baby formula. Meanwhile, some Senate Republicans are lining up behind the bizarre idea of completely eliminating the state sales tax on groceries for a single month.

Tennessee's neighbor to the east is also grappling with various tax cut proposals. The South Carolina Senate Finance Committee passed a measure that would phase out the state sales tax on food over three years. The proposal is competing against a House measure that would reduce the top income tax rate.

Many have expressed concern over South Carolina's ability to pay for either measure, noting (wisely) that reducing revenues during a time of budget surpluses can lead to budget deficits down the road. There are ways to make tax breaks for food more targeted to those who need them the most (ways to get the most "bang for their buck" in other words). But almost any tax break on food would be more progressive than lowering the top income tax rate. For more on the best ways to target tax breaks to those who could really use them, read ITEP's policy brief on providing targeted tax relief for residents who need it the most.

While the Democratic takeover of the House of Representatives (and apparently also the Senate) on Tuesday has has given new hope to advocates of progressive tax policies at the federal level, the results of ballot initiatives across the country indicate that state tax policy is also headed in a progressive direction. 

In the three states where they were on the ballot, voters rejected TABOR proposals, which involve artificial tax and spending caps that would cut services drastically over several years. Washington State defeated repeal of its estate tax. Several states also rejected initiatives to increase school funding which, while based on the best intentions, were not responsible fiscal policy. Two of four ballot proposals to hike cigarette taxes were approved and the night also brought a mixed bag of results for property tax caps. 

Taxpayer Bill of Rights (TABOR):
Maine - Question 1 - FAILED 
Nebraska - Initiative 423 - FAILED 
Oregon - Measure 48  - FAILED
Voters in three states soundly rejected tax- and spending-cap proposals modeled after Colorado's so-called "Taxpayers Bill of Rights" (TABOR). Apparently people in these three states had too many concerns over the damage caused by TABOR in Colorado. 

Property Tax Caps:
Arizona - Proposition 101 - PASSED - tightening existing caps on growth in local property tax levies.
Georgia - Referendum D - PASSED - exempting seniors at all income levels from the statewide property tax (a small part of overall Georgia property taxes. (The Georgia Budget and Policy Institute evaluates this idea here.)
South Carolina - Amendment Question 4 - PASSED - capping growth of properties' assessed value for tax purposes. The State newspaper explains why the cap would be counterproductive. 
South Dakota - Amendment D - FAILED - capping the allowable growth in taxable value for homes, taking a page from California's Proposition 13 playbook. (The Aberdeen American News explains why this is bad policy here - and asks tough questions about whether lawmakers have shirked their duties by shunting this complicated decision off to voters.)
Tennessee - Amendment 2 - PASSED - allowing (but not requiring) local governments to enact senior-citizens property tax freezes.
Arizona's property tax limit will restrict property tax growth for all taxpayers in a given district. South Dakota's proposal was fortunately defeated. It would have offered help only to families whose property is rapidly becoming more valuable, and those families are rarely the neediest. Georgia's is not targeted at those who need help but would give tax cuts to seniors at all income levels. The Tennesse initiative, which passed, is a reasonable tool for localities to use, at their option, to target help towards those seniors who need it.

Cigarette Tax Increase:
Arizona - Proposition 203 - PASSED - increase in cigarette tax from $1.18 to $1.98 to fund early education and childrens' health screenings.
California - Proposition 86 - FAILED - increasing the cigarette tax by $2.60 a pack to pay for health care (from $.87 to $3.47) 
Missouri - Amendment 3 - FAILED - increasing cigarette tax from 17 cents to 97 cents
South Dakota - Initiated Measure 2 - PASSED - increasing cigarette tax from 53 cents to $1.53.
While many progressive activists and organizations support raising cigarette taxes to fund worthy services and projects, the cigarette tax is essentially regressive and is an unreliable revenue source since it is shrinking.

State Estate Tax Repeal:
Washington - Initiative 920 - FAILED 
Complementing the heated debate over the federal estate tax has been this lesser noticed debate over Washington Stats's own estate tax which funds smaller classroom size, assistance for low-income students and other education purposes. Washingtonians decided it was a tax worth keeping.

Revenue for Education:
Alabama - Amendment 2 - PASSED - requiring that every school district in the state provide at least 10 mills of property tax for local schools.
California - Proposition 88 - FAILED - would impose a regressive "parcel tax" of $50 on each parcel of property in the state to help fund education 
Idaho - Proposition 1 - FAILED - requiring the legislature to spend an additional $220 million a year on education - and requiring the legislature to come up with an (unidentified) revenue stream to pay for it.
Michigan - Proposal 5 - FAILED - mandating annual increases in state education spending, tied to inflation - but without specifying a funding source. The Michigan League for Human Services explains why this is a bad idea.
Voters made wise choices on education spending. The initiative in California would have raised revenue in a regressive way, while the initiatives in Idaho and Michigan sought to increase education spending without providing any revenue source. Alabama's Amendment 2 takes an approach that is both responsible and progressive.

Income Taxes:
Oregon - Measure 41 - FAILED - creating an alternative method of calculating state income taxes.
Measure 41 was an ill-conceived proposal to allow wealthier Oregonians the option of claiming the same personal exemptions allowed under federal tax rules and would have bypassed a majority of Oregon seniors and would offer little to most low-income Oregonians of all ages.

Other Ballot Measures:
California - Proposition 87 - FAILED - would impose a tax on oil production and use all the revenue to reduce the state's reliance on fossil fuels and encourage the use of renewable energy  
California - Proposition 89 - FAILED - using a corporate income tax hike to provide public funding for elections 
South Dakota - Initiated Measure 7 - FAILED - repealing the state's video lottery - proceeds of which are used to cut local property taxes 
South Dakota - Initiated Measure 8 - FAILED - repealing 4 percent tax on cell phone users.