Tennessee Tax Fight Scrambles State’s Political Battle Lines

NASHVILLE — How’s this for a story line: a Republican governor proposing a new state income tax in a state where opposition to an income tax has long been a prerequisite for statewide office? His party has all but deserted him, while Democratic legislative leaders and constituency groups have become his biggest defenders.

That unlikely scenario is playing out in Tennessee, where the legislature is meeting in special session this month to debate Gov. Don Sundquist’s controversial state tax reform proposal.

The plan centers around enacting a flat-rate, 3.75 percent general income tax, cutting the 6 percent state sales tax to 3.75 percent and abolishing the state sales tax on grocery food. Local sales taxes, which have a ceiling of 2.75 percent, would be unaffected and would remain on food.

The plan would also increase the corporate excise tax (a tax on corporate profits) from 6 percent to 6.5 percent and raise the exemption levels in the inheritance and gift taxes so that Tennessee taxpayers can take full credits for those state taxes on their federal tax returns.

Sundquist’s tax package has set off the most acrimonious political fight involving the Volunteer State’s citizenry in memory. Tennessee is one of only nine states without a general income tax (along with Alaska, Florida, New Hampshire, Nevada, South Dakota, Texas, Washington and Wyoming), and “taking the pledge” against an income tax has been a routine fixture of gubernatorial campaigns.

Indeed, Sundquist, now 63, successfully campaigned for governor in 1994 on a platform built largely around opposition to an income tax, after 12 years as a fiscal conservative member of Congress. Although he repeated that pledge in his 1998 re-election effort, it was less of an issue against a token Democratic challenger who raised and spent less than $100 on the campaign.

In a written response to a Memphis Commercial Appeal survey of the gubernatorial candidates in 1998, Sundquist said, “First and foremost I would exclude a state income tax from any review or reform. I have been and continue to be opposed to a state income tax.”

But two weeks after his 1998 re-election, Sundquist says his finance commissioner gave him a stunning report on the state’s finances: while other states were cutting taxes and adding programs with their budget surpluses, Tennessee’s two main business taxes were actually in decline, generating less revenue than they had the year before, despite record economic growth.

Without new taxes, the state faced a $180 million revenue shortfall in the fiscal year ahead. Officials attributed the turnaround to the state’s 76-year-old tax system, created when Tennessee was shifting from an agricultural to a manufacturing economy but now unable to keep pace with a services and information economy.

That was in late November. During his second-term inaugural address in January, Sundquist vaguely alluded to the need for “tax fairness” while the thrust of his speech was a new “Clean Tennessee” program.

However, when the state legislature convened for its regular session in late January its rank and file members largely unaware of the looming fiscal crisis Sundquist stunned lawmakers by calling for major reform of business taxes and to tax, for the first time, the burgeoning limited liability companies and partnerships.

To do that equitably, the plan included a payroll tax to be paid by the businesses not by employees, as traditional income taxes are.

The plan drew the immediate wrath of the business community. The Sundquist administration and legislative leaders debated alternative after alternative until the governor finally did the unthinkable: embracing an income tax idea advanced by Democratic legislative leaders. But the plan never gained any traction, and legislators finally adjourned May 29 having passed a limited “Band-Aid” tax plan to shore up state finances until a rare special legislative session in November Sundquist had vowed to call.

The governor unveiled his new tax package a week before the General Assembly convened Nov. 1. The plan would raise a total of $2.67 billion in new taxes but repeal or reduce $2.14 billion in existing taxes.

In his speech to the opening night of the special session, Sundquist said the state is in a fiscal crisis and critical state services including education and the state’s innovative health insurance system, TennCare face drastic cuts without tax reform.

“I’m not going to look into the eyes of our children and tell them we aren’t going to give them a good education, we aren’t going to help their parents keep them healthy, we aren’t going to try to make their neighborhoods safe. I’m not going to tell our citizens that it’s so important that we remain 50th in taxes that we’re prepared to settle for 50th in everything else. That will be on you,” the governor told lawmakers.

Sundquist makes four central points in favor of his plan:

• that state income taxes, unlike sales taxes, are deductible on federal income tax returns;
• that income tax revenue grows with the economy, allowing the state to maintain programs and services;
• that an income tax is fairer than a sales tax to low-income taxpayers, who the governor says would pay less under his plan;
• and that out of state residents who work in Tennessee would pay $114 million in Tennessee income taxes for the first time.

But the new proposal started the tax battle all over again. Conservative and anti-tax groups and radio talk show hosts immediately attacked the income tax. Vitriolic calls and emails flooded the governor’s and legislators’ offices in opposition to the plan. The Tennessee Republican Party reiterated its opposition to an income tax.

Traditional Democratic constituency groups, including the Tennessee Education Association and the Tennessee State Employees Association, are strongly backing the plan. At a Capitol rally Wednesday, those groups and college students fearful of more sharp tuition hikes turned out, and one by one, speakers praised Sundquist’s “courage” in advocating the unpopular tax plan.

By the end of the special session’s first week Nov. 5, there was little movement in favor of the plan. It is currently bogged down in the Senate Finance Committee where there are reportedly only four of the six votes needed to send it to the floor.

Legislative leaders said they will probably end the special session by mid-November if there is no movement on the plan. But Sundquist has vowed to call lawmakers back repeatedly until they enact tax reform. So the saga is expected to continue into 2000.