NOV. 6, 2009 -- Fixing the state’s convoluted tax structure may be as hard as straightening out a knotted ball of twine while walking backward in a maze. Especially since the legislature may have tied one hand behind its back.
Faced with historic drops in tax revenues and a tax structure that business leaders say is hampering the state’s economic competitiveness, the legislature earlier this year passed a bill that created the Taxation Realignment Commission.
The TRAC commission originally was to be a blue-ribbon panel that would produce a single bill for a single up-or-down vote that would take on the $2 billion-plus in state sales tax exemptions that some in the Statehouse believe have contributed to the state’s difficulties in funding its budget.
But as the bill wound its way through the General Assembly, it was concurrently watered down and expanded. Legislators wanted the bill to create a commission to take on a wider scope of taxation issues, but still allowed them to amend the eventual product.
Bill watered down
Initially, TRAC legislation was to be offered up without amendments. But as legislators added horsepower to the bill, they also wanted the ability to reign it in. As it is, the commission is now charged with simply producing a set of recommendations next year for the legislature to consider.
One of the most contentious compromises inserted into the bill was that the commission would leave alone Act 388, the state law that in recent years shifted the funding source for public K-12 education from local residential property taxes to a statewide sales tax increase.
Some have argued that not addressing how the state funds its $2 billion-plus in education costs, one of its biggest duties, might doom the commission’s recommendations to a dusty slot on legislators’ and staffers’ shelves alongside other past tax restructuring efforts.
But after a 2009 legislative session when even House and Senate leaders admitted that little major was accomplished beyond passing a state budget, TRAC recommendations could become a major focus in the 2010 legislative session.
No wonder, considering how much money and taxes are being discussed in the TRAC commission’s ongoing meetings.
Sales tax base actually shrinks
At a recent meeting of the commission, staffers from the Senate Finance Committee presented a set of numbers that indicated an expanding economy between FY1999 and FY2008 may have become a tightening noose on state government.
Staffers found that the percentage of state’s net taxable sales in the state over that time had actually dropped from nearly 48 percent to just under 41 percent. So as the state’s economy grew, until this latest recession, the percentage of what could be taxed actually dropped, thanks to special-interest exemptions and other legislative giveaways.
During the recent commission hearing, members learned that roughly half of the state's retail sales were subject to tax 10 years ago. But now, that number has become “perilously” close to 40 percent. That may surprise some, especially since there had been a 55-percent increase in retail sales over the last decade, according to the report. Some would argue, however, that taxing a larger retail sales tax base still generated much more revenue to the state than what happened 10 years ago. Others would counter that things cost more too and the increases didn't keep pace with inflation, growth and demand for services.
Compounding the shrinkage to the sales tax base was that while the state’s retail sales grew at close to an adjusted 5 percent a year over that same time, researchers discovered that a legislature allowed the tax base to grow 3 percent. That equated to less than the rate of growth of the state’s population and inflation – and that was before the recession.
Researchers warned commission members that this “structural deficiency” may have cost the state $450 million over the last 10 years. They said the gap could worsen, as the state’s economy continues to grow away from a goods-based to a service-based economy, where the majority of taxation will be on non-tangible items.
What does the business community say?
So, the state’s sales grew while the sales tax base shrunk. And the business community must be ecstatic, right? In a word, no -- because problems with the state‘s tax structure go deeper than that.
The state’s current sales tax is 6 percent. A House Ways and Means staffer, responding to a request from the TRAC chairman, calculated that if all of the state’s sales tax exemptions were removed, the state would only need a 3.4 percent sales tax to raise the same amount of money for its General Fund budget.
The argument that has emerged is the state needs to broaden its tax base, tax more items and categories, but reduce its overall rate – in short, hit more pockets, but hit’em more lightly.
There are bigger business tax numbers at play. According to a 2009 study completed by a Washington, D.C. tax watchdog office, businesses paid $590 billion in state and local taxes nationally in FY2008, paying 83 percent more than the value of services they received. (View the study here) According to that same report, South Carolina businesses kicked in $6 billion in state and local business taxes in FY 2008, including $2.9 billion in local property taxes.
An interesting idea
So what does Otis Rawl, president and chief executive officer of the S.C. Chamber of Commerce, see as the solution to the state’s taxation mess? Another tax.
Huh?
Among other things, Rawl argued this week for a new, statewide commercial property tax to independently fund and support public K-12 education, a service he said that was vital to the state increasing its competitiveness. He also said there should be a corresponding property tax reduction on the local level.
Rawl said that while the TRAC bill took Act 388 off the plate, the commission and legislators should look at all the other possibilities, like commercial property taxes. And Rawl was and is desperate for a mechanism to make rural counties more attractive to investment and corporate expansion.
Rawl pointed to Kershaw County, which he said was forced to heavily tax businesses “because they are the only ones left standing” in the current economy.
When a prospective business considers rural South Carolina, in many cases, according to
Rawl, they see the comparative advantage of cheap land and available work force evaporated by increasingly higher property tax rates.
Frank Knapp, who heads up the S.C. Small Business Chamber, worried about taking commercial property taxes away from counties and municipalities. “How would they fund anything they needed to do, then?” asked Knapp, who had little optimism for the TRAC’s outcome.
Knapp liked the original single bill/single vote structure, and now sees too many opportunities for special interests to muck up the process. He’s not too sure that Rawl's new state tax will play well in 2010, an election year.
Knapp, fighting for the little guy, hoped the legislature would figure out a way to balance the books, “smooth-out inequities,” and not hamstring municipalities and counties.
Crystal ball: There may not be enough political will in the upcoming legislative session to do something monumental about the state’s tax structure. Knapp argued that South Carolina has tended to do better, historically, with incremental change. And that’s probably what voters can expect from TRAC: incremental change with a big chunk of the debate and heavy lifting put off (again) for the following years. Oh – and there will probably be something else in the coming political year – some sort of tax cut, which may exacerbate the revenue problem.
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