Abolishing a State Income Tax Is Easier Said Than Done

By: - November 7, 2011 12:00 am

On September 24, 1980, a few weeks before Ronald Reagan was elected president, Alaska Governor Jay Hammond signed into law a bill abolishing his state’s personal income tax. In the past 31 years, no other state has taken that step. But lawmakers in Kansas, Missouri and Oklahoma are talking seriously about it.

In Missouri, supporters of a constitutional amendment to eliminate the personal income tax began collecting signatures last month to place their initiative on the ballot next year. In Oklahoma, Republican Governor Mary Fallin and key legislators have endorsed the concept of ending the tax. In Kansas, Republican Governor Sam Brownback is expected within weeks to propose a plan to cut income tax rates, possibly with the eventual goal of getting rid of the tax entirely.

All these plans reflect an important piece of conservative orthodoxy: that taxes on the creation of wealth are undesirable because they impair economic growth. To turn that principle into reality, however, anti-income tax activists will have to overcome both political and practical concerns.

After all, getting rid of the personal income tax, currently a central revenue source in each of these states, means one of two things. It either means cutting state revenue deeply, which, critics warn, wouldn’t leave enough money to pay for state services. Or it means finding new tax revenue somewhere else, most likely through levies that will fall more heavily either on low-income people or on businesses. Those complications are the reason no state has eliminated its personal income tax since 1980 and why some lawmakers are starting to sound cautious notes, even as they pursue an exceedingly ambitious goal.

Power of inertia

Today, 41 states impose broad taxes on personal income. In the nine that don’t, proposing an income tax is a dangerous political move. In Washington State, a ballot initiative to create an income tax received only 36 percent of the vote last year, even though it would have applied only to incomes above ,000 and even though some of the proceeds would have been used to lower property taxes. No state has created a new income tax since Connecticut in 1991.

Yet in the other 41 states, getting rid of the income tax has been nearly as unthinkable. Alaska eliminated its tax only after the completion of the Trans-Alaska Pipeline System augured billions of dollars in new revenue. States routinely argue about whether their income tax rates are too high or too low, but with personal income taxes supplying 40 percent of states’ general fund revenue, lawmakers rarely have considered reducing the rate to 0 percent.

In the past few years, however, as conservative majorities have taken over in many legislatures, the idea has resurfaced. The Missouri House of Representatives voted in 2009 to eliminate both the personal and corporate income tax. In Louisiana, one of the most high-profile debates of this year’s legislative session was over eliminating the personal income tax. Neither of those efforts went anywhere, but more are sprouting up. The one in Kansas is very much alive. The state House of Representatives voted earlier this year to phase the tax out gradually, leading the governor to consider his own options for accomplishing the same goal.

The motivations behind these movements reflect more than just a conservative preference for lower taxes. In fact, some of the plans are intended to be revenue-neutral, not tax cuts at all. Many conservative and libertarian thinkers view income taxes as discouraging work, wealth creation and, ultimately, economic prosperity. They don’t view taxes on consumption, such as sales taxes, as being quite so bad. It’s in this spirit that Republican presidential candidate Herman Cain’s 9-9-9 tax plan creates a new national sales tax while dramatically lowering personal and corporate income taxes.

The argument in places such as Oklahoma and Kansas is that if Tennessee or Texas can get away without an income tax, why can’t they? “If you look over the last 50 years there have been 10 states that implemented income taxes and it’s been just destructive to their economic growth,” says Andrew Koenig, a Republican state representative from Missouri. “The no income tax states are winning.”

The purest form of this idea is the so-called “fair tax” — a higher, broader sales tax to replace levies on both personal and corporate income. Koenig’s fair tax bill stalled in the Missouri House this year, but supporters are turning to the ballot. The constitutional amendment planned for 2012 would phase out the personal income tax by 2016 and authorize higher sales taxes. It is being supported by wealthy activist Rex Sinquefield, who spent millions of dollars of his own money on a successful initiative last year to restrict cities’ taxing power.

It’s being opposed, though, by some of the business groups it’s intended to benefit, including the Missouri Association of Realtors. Currently, real estate transactions are exempt from taxation in Missouri. “When the legislature is confronted with what we believe would be a .5 billion revenue shortfall in this economy,” says Scott Charton, a spokesman for Missourians for Fair Taxation, which opposes the initiative, “nobody’s exemption is safe.”

Long, slow slog

The same concerns are bubbling up in Oklahoma and Kansas: If the states are going to get rid of the personal income tax, will they cut services or will they shift taxes somewhere else? The two states may end up with different answers to that question.

In Kansas, Governor Brownback is finalizing a major tax proposal. Among his advisers is Arthur Laffer, the Reagan administration economist closely associated with the view that tax cuts can pay for themselves by boosting growth.

While the details of Brownback’s plan aren’t clear yet, two people who have consulted with the governor on his plan — Representative Richard Carlson and Senator Les Donovan, the Republican chairs of the state House and Senate tax committees, respectively — describe the governor’s thinking in similar terms. The concept is to use revenue growth to reduce income tax rates slowly over time, while still allowing for some growth in spending for services such as education and corrections. “I know he’s a smart man and I know he realizes it’s not going to be an easy quick fix,” Donovan says. “It’s going to be a long, slow slog in that direction.” Still, Brownback’s plan may be accompanied by an ultimate goal of eliminating the tax altogether.

Oklahoma is in the middle of its own slow slog. Republicans in the state have opposed the personal income tax for years and helped approve rate cuts in 2004, 2005 and 2006. In the 2010 elections, the GOP won complete control of Oklahoma state government — with majorities in the House and Senate and Fallin as governor — for the first time in history. A legislative task force studying taxes will offer recommendations by January, but already the co-chairs of the task force have said they’d like to eliminate the income tax.

That has some Oklahomans worried. David Blatt, director of the Oklahoma Policy Institute, is concerned about the effect on the poor. In Oklahoma, as in most states, the income tax has a progressive rate structure, while sales taxes are regressive — they hit the poor hardest. Chris Benge, a Republican former speaker of the Oklahoma House who now works for the Tulsa Metro Chamber, warned lawmakers last month that any move against the tax would need to consider the effects the change would have on funding for education, transportation and heath care. Oklahoma already has had successive rounds of deep budget cuts in recent years. “Caution was the word of the day for us,” Benge says.

Another reason the business community may be concerned is that Oklahoma legislators are looking at balancing the tax cut with new revenue that might come from eliminating favorable treatment of businesses in the tax code. Legislators spent months scrutinizing tax credits. “You can’t keep giving away the store and stay open,” says Republican state Representative David Dank, who is co-chairing the Oklahoma tax reform task force.

Still, the warnings seem to be having at least some effect on lawmakers. Oklahoma leaders are speaking in cautious terms. “What we have to do is approach this taxation discussion responsibly and analytically and not ideologically,” says Ken Miller, Oklahoma’s state treasurer. “We’ve been talking about this for years. Now we can actually accomplish it. It’s that, ‘Be careful what you wish for, you might get it.’ “

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Josh Goodman

Josh Goodman helps lead research on fiscal management and place-based economic development programs as part of Pew’s state fiscal health project. Goodman has served as a primary author for Pew studies that examine how states should evaluate tax incentives and maintain budget discipline when implementing those incentives.