Four States Consider Income Tax; Four States Reject It

Facing education funding woes and a variety of budget shortfalls, New Hampshire and three other states that do not collect income taxes considered reversing course this year – and in each case defeated or abandoned those plans for fear of the political costs.

Lawmakers in Tennessee, Alaska and Wyoming joined their Granite State colleagues in considering the unpopular reality that instituting, or re-instituting, a personal income tax would offer a long-term cure for their respective revenue woes.

In the end, though, tax opponents in each state overwhelmed supporters.

Florida, Nevada, South Dakota, Texas, and Washington are the other five states that either levy no personal income taxes or tax only dividend and interest income.

While New Hampshire’s school funding fight might have received the most media attention, it is the tax overhaul plans of Tennessee Gov. Don Sundquist and Alaska Gov. Tony Knowles that led to the most rancorous debate.

A projected $400 million budget shortfall this year forced Sundquist, a Republican, to become only the third governor in the past 25 years to submit a state income tax proposal to the Tennessee legislature. The previous two proposals, both easily defeated, were submitted by Democrats Ned McWherter in 1992 and Ray Blanton in 1976.

Tennessee lawmakers abruptly ended a special session last week devoted to studying the tax reform proposal, handing the governor a stinging defeat by refusing to even vote on his plan. Sundquist had worked closely with Democrats to build consensus for the controversial plan, but made the call to “pull the plug” after having the rug pulled out from under him by the state Republican party chairman.

Sundquist’s tax reform plan, which included a 4% income tax and a rollback in state sales taxes, died after state GOP chairman Chip Saltsman publicly reiterated the party’s traditional opposition to an income tax. GOP lawmakers questioned the political consequences of voting for an income tax and quickly closed ranks against the proposal.

Democratic state Senator Bob Rochelle, known in Tennessee as one of the governor’s harshest critics, had been instrumental in lining up Democratic support for the plan.

The Saltsman news release, Rochelle said in his own press conference, “was the stake in the heart of the governor.

” It’s sort of like the Republican Party is having an ethnic cleansing of its own, and they’re evidently starting out with the cleansing of their governor,” he said.

Sundquist’s ill-fated proposal did not initially contain an income tax. He had proposed eliminating the state grocery sales tax, which generates approximately $2 billion in annual revenue, and replacing the funds by repealing business sales tax exemptions and levying additional business taxes.

Bowing to fierce opposition from business interests, Sundquist and his supporters turned to an income tax as a more progressive revenue tool than the statewide sales tax. From a purely revenue standpoint, proponents argued that an income tax would keep Tennessee revenue in Tennessee.

Forty-two of the state’s 95 counties border other states and 52% percent of Tennessee’s population live in those counties, noted a report by State Comptroller John Morgan. Because of the state’s high sales tax, many Tennesseans cross those borders and shop in other states.

Morgan’s report concluded that a 3.9% income tax would balance the state’s budget and provide an additional $150 million for higher education and the TennCare health program.

Republican legislative leaders calculated the political risks as being too great, however.

“It’s just the beginning. We are going to try to find a long term solution for Tennessee,” said Sundquist press secretary Beth Fortune.

Each of the nine states without income taxes has traditionally relied upon specific revenue streams to fill their coffers. Tennessee and South Dakota rely on sales taxes. Nevada has gambling. Florida has tourists. Texas and Alaska depend on oil. Wyoming relies on mineral wealth. New Hampshire relied on high local property taxes. And Washington has a two-tiered business tax, and Microsoft to tax.

Proponents of income taxes say they allow a state to grow its government at the same rate as its economy. A sales tax catches only revenue as money is spent, they say, while an income tax collects money as it is earned.

Opponents argue the same point, but from a different perspective: people should only be taxed on what they spend, not what they make.

The last state that enacted an income tax was Connecticut, which imposed an income tax ranging from 3 to 4.5 percent in 1991.

The prognosis is far different in Florida, where the most difficult budget debates this year centered around determining how to spend an unexpectedly large surplus fueled by strong tourism revenue and money from its tobacco suit settlement.

“There are four major state tax sources: sales, income, business and property. You pick from among them,” said Ron Snell of the National Conference of State Legislatures. “Unless you have a pool of oil to tap, nobody’s found an alternative.”

But, as Alaska Gov. Tony Knowles found out this year, even oil is no revenue guarantee.

Knowles, faced with a $1 billion budget shortfall due to a sustained slump in oil prices, proposed a statewide income tax as part of his plan to balance the state’s budget. Alaska last levied a personal income tax in 1980.

Months after declaring the tax proposal dead, Republican lawmakers allowed the bill to come to the Senate floor last week in order to embarrass the governor with a very public, and overwhelming, repudiation of his plan.

“If the governor is so proud of his plan, he ought to defend it,” said state Sen. John Torgerson, Chairman of the Senate Finance Committee, which resurrected the bill and orchestrated the vote.

Supporters of the governor say that’s exactly what he has done for the past four months, expending hard-won political capital to sell a difficult solution to the state’s budget crisis.

“We knew from the beginning that this proposal would not be popular. We think that an income tax is the most fair way to gain these revenues, but as we said right from the beginning, we are willing to look at alternatives,” Knowles spokesman Bob King said.

The most likely alternative now involves dipping into the state’s $26 billion Permanent Fund, a reserve made up of oil revenue traditionally untouched by government budget writers. Each year, Alaska citizens receive a portion of Permanent Fund interest profits in the form of a dividend check.

Knowles called a special session of the legislature to address the budget issue, ordering lawmakers to continue work until a compromise plan is reached.

Under the proposal which emerged, $4 billion will be transferred from the fund to beef up the Constitutional Budget Reserve Fund and balance the state budget; dividend checks would be guaranteed to be at least $1,340 starting in 2001. The plan will be put to a statewide vote on September 14.

Knowles’ tax plan was troubled from the start. Six weeks after broaching the subject in his State of the State address, not one of the state’s 60 senators had endorsed the plan. Key House and Senate leaders from both sides of the aisle said the proposal was unfair to the wealthy, to single people, and to married people without children.

Prior to the Senate action last week, Knowles’ plan had only been granted two brief hearings in House committees. Aside from its political challenges, legal experts also questioned whether the plan violated the U.S. Constitution because it gave special breaks to Alaska residents at the expense of nonresident workers.

The governor’s proposal would have taxed Alaska workers 31 percent of their federal income tax liability, with Alaska residents given a tax credit equal to one third of that year’s Permanent Fund dividend. Nonresident workers would not have received the credit.

Knowles has said that he based his tax proposal on the federal tax formula so that it would be progressive and specifically hit those with the highest incomes the hardest.

In another widely publicized battle, New Hampshire legislators were forced to consider imposing an income tax after facing a court order to fix an unbalanced education funding system.

After months of debate, dissatisfied legislators signed on to a compromise $825 million education spending plan that relies heavily on statewide property taxes. Lawmakers had fought uphill battles for consumption taxes and expanded gambling, but the most controversial proposals centered on a state income tax.

Gov. Jeanne Shaheen frequently and vocally announced her opposition to an income tax, going so far as requesting the state senate pass an income tax bill just so she could veto it. State senators denied her the pleasure, killing any possibility of an income tax after lengthy debate. The New Hampshire House of Representatives rejected a 3.5 percent income tax bill by a healthy 211-168 margin less than a month after giving preliminary approval to a 4 percent income tax plan.

In the end, the compromise package of property taxes, cigarette tax increases, business profits tax increases, and tobacco settlement funds resolved the issue.

The final state to consider instituting an income tax this year, Wyoming, has empanelled a government advisory panel to study the state’s tax structure and propose legislative remedies for the state’s precarious dependence on mineral severance tax revenue.

The Wyoming Tax Reform 2000 Committee, which met out of sight of the public and the media, produced an initial report that encouraged serious thought about instituting a statewide income tax. Created by the legislature in 1997 and comprised of six lawmakers and five members of the public appointed by the governor, the panel voted 6-3 to recommend individual and corporate income taxes.

The proposed income taxes would raise about $150 million a year and divide Wyoming taxpayers into seven tax brackets.

The panel’s 14 page report, issued January 11, drew immediate criticism from both lawmakers and the public, and its tax proposal is unlikely to come to a legislative or referendum vote.

“Wyoming residents haven’t had to pay their way for so long and so they’re shocked by the possibilities of new taxes. Change is very difficult,” said Melinda Brazzale, a spokesperson for Gov. Jim Geringer.

Geringer issued his own, much more blunt response to the income tax proposal in a two word press release that captured the sentiments of legislators this year in New Hampshire, Tennessee, and Alaska: “Forget it.”