Our outmoded tax systems.

• Author: Snell, Ronald K.
• Position: State tax systems

State tax systems were invented in a different age for a different set of circumstances. The fit between the systems and the realities becomes more imperfect every day.

Now that state tax collections have improved, Medicaid cost increases are no longer burning like a prairie fire through state budgets, and sustained economic growth seems likely, can legislators put tax issues out of their minds?

If state finances are improving, why even raise the issue? "If it ain't broke, don't fix it." Why should state officials subject themselves to the stress and misery of talking about taxes, let alone the fundamental reconsideration of state tax policy?

States' tax policy may not be broken. But it's chugging along like a '39 Studebaker on a 1990s expressway: getting somewhere, in a manner of speaking, but not efficiently, not reliably, not in a very satisfactory way.

From 1989 through 1993, budget shortfalls and tax increases dominated legislative sessions. Legislators debated countless changes designed to give larger shares of shrinking resources to corrections, education and health care while revenue growth stalled. Time and again, unhappy legislators voted to increase taxes to sustain state spending while constituents' incomes were stagnant or shrinking. Legislators, governors and taxpayers alike are ready to put the subject of taxes aside--except for the possibility of tax cuts, which occupied many legislatures in 1994.

But the time to stop thinking about taxes has not yet come. The issue that needs attention, however, is not revenue raising in the short term. For now, most states appear to be in solid fiscal health--with the exception of northern New England and California, places where the recession of 1990 has never ended.

It's Time to Remodel

It is time to consider more fundamental questions of how well state tax systems in the 1990s reflect the American economy of the 1990s. That is the subject of the book Financing State Government in the 1990s, published jointly by the National Conference of State Legislatures and the National Governors' Association. Three other formidable 50-state policy associations--the Federation of Tax Administrators, the Multi-state Tax Commission and the National Association of State Budget Officers--provided much of the policy discussion in the book. The result, according to Hal Hovey of State Policy Research Inc., is "the new conventional wisdom among state officials." Conventional wisdom or not, the book asks legislators and governors to consider remodeling a structure of state taxation that has developed haphazardly for over half a century.

To see why this is necessary, consider the general nature of state tax policy--the kind of taxes state governments rely upon, what they tax and how the taxes operate. Then consider how America has changed since the foundations of current state tax policy were laid.

States Tax Alike

It's possible to talk about tax systems in terms of the 50 states, despite the great differences in individual policies, because states have tended to make their policies resemble those of their neighbors. The 50 state governments have two major sources of tax revenue--the general sales tax and the personal income tax. The third state tax source is the corporate income tax, which in terms of revenue is far less important than either of the two mainstays. And all 50 states mandate that local governments impose property taxes, usually to finance a substantial chunk of elementary and secondary education as well as to pay for local administrative expenses.

Every state, except New Hampshire and Alaska, has either a general sales tax or a broad-based personal income tax and most have both. Only five states (Alaska, Delaware, Montana, New Hampshire and Oregon) do not impose a general sales tax. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) have no personal income tax, and two more (New Hampshire and Tennessee) tax only investment income.

States rely heavily on sales and personal income taxes. In FY 1992 state governments collected $328 billion in taxes (not including any local government taxes). Of that amount, $108 billion or 33 percent came from the general sales tax and $104 billion or 32 percent from personal income taxes. The corporate income tax (collected by 45 states) produced $21.5 billion, a little under 7 percent of total state tax collections.

Local property taxes produce more revenue than any state tax. Figures for FY 1992 are not yet available, but in the year before, local property tax collections were more than half as large as total state tax collections. For that reason, any substantial reduction in local property taxes, such as the one the Michigan Legislature approved in 1993 or the one Oregon voters approved in 1990, forces major revisions in finances if state government makes up for the revenue forgone.

This basic picture of heavy reliance upon general sales taxes and personal income taxes, supplemented by a corporate income tax at the state level and by property taxes at the local level, has characterized state government since 1971. From 1961 through 1971, income taxes were enacted in 10 states and sales taxes in 10 states (for 19 states in all--Nebraska double-dipped). Only two states have added...