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Thursday, December 12, 2019

Utah Tax Reform: Lessons for Wyoming

The talk about a "comprehensive review" of the Wyoming tax structure is a source of worry for all of us. Some point to Utah as a good example of how to do it. I would not recommend it. 


As I explained yesterday, any pursuit of some kind of shield for government against the ups and downs in the business cycle is ill-fated and runs in the face both common sense and economic theory. 

In a coming article I will demonstrate how such a reform also flies in the face of empirical evidence.

So far, our legislature has not appointed any task force to reform our tax system, but given Governor Gordon's support for the idea of a "comprehensive review", we can safely expect a task-force (tax-force) bill to be introduced in the coming session. 

As part of the appointment of a task force, it is likely that the legislature would glance at the reform currently being discussed in Utah. This would be a good idea, but not necessarily for the reasons that a Wyoming task force would consider.

The Utah proposal, in its current draft, explicitly seeks to lower the overall tax burden by a statically estimated $80 million. Superficially, this is good news, but the path they take to that reduction is complicated to a point where it is almost certainly bound to fail. The bottom line, namely, depends on the creation of two new entitlements, and the overall design of the tax reform suggests that the task force behind it is trying to pursue "neutrality" in the tax burden - and in state revenue. 

As such, the reform violates two important principles for tax reform.

Before we get there, let us first recognize that Utah has a lot going for it. The economy is strong and businesses seem to like the state. It would be a big mistake for the Beehive State to reform its tax system in such a way that it put its own solid economic success in jeopardy.

In GDP growth, Utah runs circles around Wyoming: in the past three years, average real annual GDP growth in Utah has been 3.76 percent, while Wyoming lost almost one percent of its GDP, on average. Plainly: adjusted for inflation, 

  • for every $100 in business sales or personal income in 2015, Utahns earned $111.70 in 2018;
  • by contrast, in Wyoming $100 of economic activity had declined to $97.

The Utah success has many components to it, but one of the most important is fiscal conservatism. while not spectacularly conservative, they do outshine Wyoming by a margin. The Economic Freedom of North America report from the Fraser Institute awards Utah a score of 7.2 out of 10 on government spending: measured as a share of personal income, Utah government spending is not the most conservative in the nation - South Dakota and Tennessee scored 9.0 - but it is leaps and bounds above Wyoming, which scored an embarrassing 2.7.

Yes, government spending is high in Wyoming. It is higher, in fact, than every other state except Alaska, which beat us to the bottom of the barrel. We even have a more burdensome government than four Canadian provinces. 

The Fraser Index also reports its own version of the Government Employment Ratio: in terms of government employment as share of total employment, Utah scores a 7.4 compared to ours absolutely abysmal 0.8. As I have explained repeatedly, we have the largest government workforce in the country.

Another component of Utah's fiscal conservatism is their prudent approach to insurance and retirement spending, again as share of personal income. Scoring an 8.0 out of 10, they left us in the dust with our bad 3.1 score. We could have done worse - New Jersey and New York both scored 1.9 - but there is something wrong when Quebec, often said to be the most socialist state in Canada, does better than we do.

On the tax side, the Fraser Institute naturally gives Wyoming a perfect 10 for not having an income tax. However, as soon as we move over to property taxes, our score falls precipitously. Measuring property-tax collections as share of personal income, the Fraser index gives Wyoming a pathetic 3.8, beaten into the night by Utah's 7.9. And before we rush to the conclusion that they can have low property taxes because they have an income tax, it is worth noting that income-tax free South Dakota scores a 5.4, Texas comes in at 5.2 and Tennessee beats them both with a solid 7.7. 

We are essentially neck-and-neck with Utah in sales-tax revenue: we score 5.4 vs. their 5.2. However, with government spending being much worse and our advantage of having no income tax being eaten up by property taxes, we have little to brag about compared to the Beehive State. 

Lower spending levels have allowed Utah to have less onerous taxes than we do. This has led to economic growth, with which comes growth in the tax base; in 2017 their total state and local government sector ran a surplus of 8.4 percent of total spending. That same year Wyoming state and local governments ran a combined deficit of $4.60 for every $100 they spent. 

A fair measure of fiscal conservatism has helped Utah in terms of economic growth. It would make perfect sense for them to set the preservation of that strong record as the first and foremost priority when designing their tax reform. However, that is not necessarily the case. As mentioned, they are officially shooting for a reduction in the overall tax burden, but they are also violating two important principles for tax reform:

1. Do not try to shift the tax burden based on some kind of "neutrality" concept. As I recently noted, there is no such thing as "neutrality" in tax reforms. It does not matter if neutrality is defined in terms of revenue for government, or the burden on taxpayers; either way, the dynamics of the economy, set in motion by the tax reform, will eventually upset the pursuit of neutrality and result in less revenue.
2. Do not mix tax cuts with new entitlements. Over the past 40 years, from Reagan to Trump, Congress has passed three major tax reforms. All of them have stimulated economic growth, primarily because they were not designed to be "neutral" but to give money back to taxpayers. The problem has been that while the tax cuts have generated more economic growth and strengthened the tax base, Congress has also grown spending at entirely irresponsible rates. 

Utah is about to violate both these principles. Their errors are not major, but big enough to be noteworthy - and we should absolutely pay attention here in Wyoming, given that we may be looking at a reform effort inspired by theirs.

On the good side of the Utah reform proposal, the Tax Restructuring and Equalization Task Force proposes a cut in individual and corporate income taxes from 4.95 to 4.64 percent (maintaining the uniform rate). They also want to provide more tax exemptions with a new income tax credit for some Social Security retirement income and an expansion of the state's income-tax exemptions for dependents. 

Tax exemptions are not ideal; general tax cuts are better than selective tax cuts. That said, every measure to lower the burden on taxpayers is welcome. What is less welcome is the combination of these good measures with both new entitlements and an effort to "neutrally" shift the tax burden from individuals to businesses.

On the entitlement side, the biggest proposal is a state-specific Earned Income Tax Credit. The Task Force estimates that the state EITC will leave individual taxpayers with $6 million more in their pockets. However, this money does not come from a tax cut - it comes from a refundable tax credit. 

In plain English: a new entitlement program. This means more government spending. 

Compounding the problem with increased spending is a "grocery tax credit" aimed at lower-income households. It is not a pure tax credit, but a refundable one - in other words, another entitlement that taxpayers will spend money on. 

This grocery credit is a significant spending item: the combination of "lost" tax revenue and new spending is estimated at $125 million for Fiscal Year 2021.

And please pay close attention now, dear Wyoming lawmakers. Your Revenue Committee has discussed a sales tax on groceries in the past - and I fully expect that idea to return to the top of the agenda as we go into the 2020 session. 

The Utah tax task force has come up with this grocery entitlement program because they want to raise the sales tax on groceries from 1.75 percent to 4.85 percent. It is a common objection that sales taxes on groceries hit low-income families particularly hard since groceries are a relatively big item in their monthly budget. If our lawmakers here in Wyoming went ahead with a sales tax on groceries, we should expect a proposal for the same kind of grocery entitlement program. 

It would be a bad idea, in Utah as well as here in Wyoming, not only because it increases government spending, but because it imposes a marginal-tax penalty on low income workers. 

Here is how that penalty works. The Task Force in Utah wants a benefit of $125 per member of eligible families, but they also want to phase out the benefit according to an intricate formula. The phase out would happen at a rate of 
0.0035% of the credit per dollar above 138% of the federal poverty limit ... for example, a family of four with a household income of up to $35,535 per year would qualify for the full grocery credit amount (4x$125=$500). That amount would be reduced for each dollar the family makes over $35,535, with the credit phasing out entirely at $64,106.
This looks good in an excel spreadsheet, but it is a bad idea in practice, especially when combined with a new state EITC. 

In my book The Rise of Big Government I demonstrated how the federal EITC can impose a 36-percent marginal income-tax rate on a $30,000 annual family income - a tax rate otherwise reserved for families making $467,000. For a family making twice as much, the marginal income-tax effect would only have been 15 percent.* Now add a state EITC and a grocery entitlement, as proposed in Utah, and low-income families are heavily penalized when they try to improve their economic standard by earning more money.

On top of new entitlements, the Utah task force also proposes a broad expansion of the state's sales tax. After having suggested that feminine hygiene products be exempt from the sales tax, they offer a list of items for which they want to repeal the sales-tax exemption:

  • Electricity to ski resorts for lifts;
  • Vehicles used for temporary sporting events;
  • Admissions to college athletic events;
  • Textbooks purchased by a student (not including a college bookstore; seller sales primarily textbooks);
  • Certain electricity produced from a new alternative energy source;
  • Certain car washes.

They also want to raise the cost of motor fuel by repealing the sales-tax exemption on this group of products; their goal is to turn it into "a broader consumption tax". There is also an excise tax included on diesel. 

Then we get to the list of services to be targeted by a broadening of the sales tax. Some examples:

  • Installation of tangible personal property when part of a taxable sale;
  • Pet boarding and daycare services;
  • Personal transportation services (the Uber tax);
  • Towing services;
  • Parking lots and parking garages;
  • Dating referral services;
  • Identity theft protection;
  • Streaming services;
  • Storage facilities.

The broadening of the sales tax is an effort at making the reform "neutral". The task force's own estimate suggests that it will not be neutral at its bottom line, reducing the tax burden by $80 million for Fiscal Year 2021. However, any tax reform that raises some taxes while cutting others sets dynamic economic forces in motion that upset this kind of static calculations. It is doubtful that the task force has taken these dynamic forces (multipliers and accelerators, in econ parlance) into account. 

Their own figures give away that this is not a well-done dynamic estimate. They divide their numbers into impacts on individuals and businesses:

  • On the individual side the impact would be a reduction of the tax burden by $121 million;
  • On businesses, however, there would be an increase in the tax burden of $41 million.

It is very likely that the gains to households will be dominated by the two proposed entitlements. The grocery entitlement alone would cost the state of Utah an estimated $125 million per year (suggesting one million eligible residents). This puts the tax reform proposal in a less favorable spotlight, highlighting again the dangers with tagging new spending onto tax cuts. 

The reliance on entitlements to eke out a bottom-line benefit for taxpayers is yet another signal that this reform is tainted by a "neutrality" ambition. The numbers on its impact on businesses and individuals, suggesting some kind of shift in the burden onto businesses, only reinforce this impression. The problem is that individuals ultimately pay every dime of taxes that businesses are formally responsible for. More than likely, these estimates have isolated households from what the task force considers to be tax hikes on businesses, assuming that businesses will simply eat those tax increases without passing the cost onto their employees or customers. 

A good tax reform should never pursue neutrality - that only leads to higher taxes somewhere - and it should never be combined with increased spending. As valiant an effort as the Utah reform idea is, it also represents a potential threat to the state's strong economy. 

From a Wyoming perspective, the threat is even more precarious. While Utah has some economic padding before a misguided tax reform has done its full share of harm, our state has absolutely no margin for error.

*) My numbers were based on the federal personal income-tax code as it looked before the Trump tax reform.

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