In 'low tax' states, how low can you go?

Aug 4, 2014

Missouri is headed to the polls this week to vote for, among other things, a ¾ cent sales tax increase that would be used to fund Missouri’s Department of Transportation, or MoDot. Missouri citizens have the special privilege of deciding whether to bankroll a decade of transportation projects, thanks to former Missouri congressman Mel Hancock.

Hancock grew up in Springfield, Mo and before being elected to the U.S House of Representatives in 1989, he forever changed Missouri’s tax code with something called “The Hancock Amendment.” The amendment limits the power of the state legislature to raise taxes on its own, only allowing for small, inconsequential bumps. Voters have to approve bigger tax increases in an election, like the one Missouri is having this week.

Even though the Hancock Amendment was created in 1980, the idea still resonates. Having a low tax image, or being in favor of tax cuts, plays well in politics these days. Not only does it get politicians elected, but some lawmakers think it will help bring jobs to a state.

“I think it’s wise to be able to have a state that shows potential business customers that are considering moving to another location that you have a state that is equitable on taxes,” says Missouri State Senator Mike Kehoe. “And states are using that as a tool to lure businesses into and locate in their state.” 

The Hancock Amendment certainly keeps Missouri in the low tax game - it’s effectively made statewide tax increases a rarity in Missouri. In 2002 Missouri failed to pass a 1/2 cent sales tax increase for the state road fund. The last time Missourians voted in favor of any new tax increase was 1987.

But the only way to tell if you’ve really achieved low tax status as a state is to look at the numbers. One way to figure out where Missouri sits in terms of total tax collections is to take all state and local revenue and divide it by total population or the size of the size of the state economy.

If you calculate this number using the size of the economy as measured by personal income, Missouri ranks 48 in total revenue and 47 in total tax collections. If you use the population indicator, Missouri ranks 43 in total tax collections and 47 in revenue.

“Those are really low [numbers],” says Nick Johnson, vice president for state fiscal policy at the Center on Budget and Policy Priorities. “For it to be in the 40’s on all four of those measures, that’s a pretty consistent suggestion that Missouri is a low tax state.”

But the competition among low tax states can’t just be an economic version of “How low can you go?.” Sure, businesses want lower taxes. But they also look for good schools to send their kids to and good roads to ship their products. And one of the most common ways of raising money for schools and roads is by raising taxes. So the big question for the low tax state is “how do you solve this problem?”

“By definition if you cut taxes you’ve kind of got two choices,” says Johnson. “One is you can find some other source of revenue to raise, or you have to cut services.”

So the first option for low tax states is to get creative with revenue sources. Johnson says the low tax state of Colorado has been experimenting with this. Like Missouri, Colorado also has an amendment in its constitution that puts limits on tax increases (theirs is called the TABOR Amendment, which stands for “Taxpayers Bill of Rights”). But the state has also found ways to get around its restrictive tax code.

According to Johnson, Colorado has wisely “avoided digging its own hole any deeper” through new tax cuts since the late 1990’s. It’s also scrutinized its tax code.

For example, in 2011 Colorado closed an agricultural tax loophole that made property owners eligible for hefty tax breaks if they could prove they tried to make a profit through agriculture. The law helped Tom Cruise save thousands of dollars in taxes on his $18 million dollar estate based on his decision to let sheep graze there for certain parts of the year.  But even though it gets more of Cruises money, Colorado still struggles under TABOR to raise the kind of revenue that would substantially contribute to the state budget.

So the second option for low tax states is to cut services. And for that, Johnson says, you have to look at Kansas. Kansas Governor Scott Brownback has been in the news recently – he’s touring the country touting the advantages of what is being called “the red state model” for economic success. In 2012 and 2013 Kansas enacted broad based income tax cuts and pulled money out of the state’s public education system.

“Kansas is one of very few states in the country that is cutting K-12 education spending, even beyond the cuts that were necessitated during the recession. Whereas other states in the country are starting to put money back into K-12 schools,” says Johnson.

As it turns out, Kansas job and business creation has been no better than the national average and hasn’t led to the kind of economic boom the state’s been looking for.

But Kehoe doesn’t buy Johnson’s black and white equation for tax cuts vs. state services.

“For me it is not either/or,” says Kehoe. “You can do both.”

Missouri’s answer to the question of how to be a low tax state has been to try and both raise and lower taxes simultaneously. This year the Missouri legislature passed an income tax cut that will cost the state $620 million dollars annually (or save taxpayers that much, depending on how you look at it) beginning in 2017. The move to cut income taxes was prompted by the actions of Missouri’s neighbor, and all-around rival, Kansas.

“I think the stated reason…was looking across the state line at Kansas saying that they had cut taxes businesses were just going to flee the state for Kansas and we had to do something to keep up” says Traci Gleason, director of communications with the Missouri Budget Project.

“But when we look across the state line at Kansas we have seen their revenue come in dramatically below even what their estimates were going to be,” she says. We’ve seen their bond ratings cut by Moody’s. The news in Kansas is not good.”

But, unlike Kansas, Missouri hasn’t scaled back on providing state services…yet. The legislature is hoping that voters approve the ¾ cent sales tax increase so it can fund MoDot for the next 10 years. And Governor Nixon has promised to fully fund the state’s education formula by 2017, although that will be more difficult to do in light of Missouri’s new income tax cuts.

If Missouri residents don’t approve the sales tax increase this August, MoDot has said it will have to continue looking for new funding, maybe through another proposal, or a toll road, which wouldn’t affect Missouri’s low tax ranking.

There’s also still a chance Missourians will pay for new roads and bridges in their communities through a local tax increase. In low tax states, local governments are the ones picking up the slack for what the state can no longer afford. Average local taxes in Colorado are higher than those in New York, and Kansas and Missouri rank among the top fifteen states with the highest average local taxes.

“Moving to a more low tax model is a tax shift,” says Johnson. “You’re really just shifting the burden of paying things onto someone else.”

So maybe the idea of a low tax state is just an illusion.