Tax Reform

United States House of Representatives Committee on Ways and Means Written Testimony

Dear Chairman Brady, Ranking Member Neal, and Members of the Committee,

Thank you for the opportunity to comment throughout this important policy discussion. By way of background, my name is Jonathan Williams, and I serve as Chief Economist and Vice President of the Center for State Fiscal Reform at the American Legislative Exchange Council (ALEC).  As you may know, ALEC is the nation’s largest non-partisan individual membership organization of state legislators. Comprised of nearly one-quarter of the country’s state legislators and stakeholders from across the policy spectrum, ALEC members represent more than 60 million Americans and provide jobs to more than 30 million people in the United States. We believe all Americans deserve an efficient, effective and accountable government that puts the people in control.

In my role, I work with our members to develop sound tax and fiscal policies based on best practices from the 50 states. ALEC does not support or oppose legislation and I personally submit these comments to bring some observations from our non-partisan research and analysis on state level tax reform efforts.

I commend this committee for taking on the difficult but economically advantageous task of reviewing our federal tax code. As you know, it has been more than 30 years since President Ronald Reagan signed the last comprehensive federal tax reform into law in October of 1986.

As this committee deliberates fundamental changes to our nation’s tax policy, states are enacting major changes to their own tax codes. In the past year alone, nine states significantly reduced taxes, according to our Center for State Fiscal Reform research, State Tax Cut Roundup 2016.  In 2015, 17 states substantially reformed their tax systems in a pro-growth manner. All told, in the past four years, nearly 30 states have significantly reduced their tax burdens. The case studies from these states exemplify how states can indeed be the “laboratories of democracy” as described by United States Supreme Court Justice Louis Brandeis.

Every year, I have the privilege of co-authoring the national economic study, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index. Together with my co-authors (Reagan economic advisor, Dr. Arthur Laffer and Stephen Moore)-we analyze how economic competitiveness drives income, population and job growth across the states. The new 10th edition of Rich States, Poor States offers a roadmap to economic competitiveness based on policy reforms. The report presents rankings of the 50 states based on the relationship between policies and performance, revealing which states are best positioned to grow economic opportunity, and which are not.

Consistent with the sizable majority of the academic research, we also find that taxes matter for economic competitiveness. People and businesses often seek out lower tax burdens across state lines. Rich States, Poor States data show states that keep taxes low, avoid job-killing over-regulation and follow prudent budget practices consistently and significantly outperform their highly taxed, over-regulated counterparts.

Rich States, Poor States adds to a growing body of evidence that taxes matter, and some taxes matter more than others. For many years, our research has warned against an over-reliance on income taxes – on both personal and business income. For instance, we analyzed the nine states without an individual income tax versus the nine states with the highest individual income taxes over the past decade. From 2006 to 2016 (the latest data available from the Census Bureau), the population in states with no income tax grew 111 percent faster than their high tax counterparts (11.9 percent vs. 5.6 percent) on an equally-weighted basis. In aggregate, population grew by 15.2 percent in the no income tax states vs. 6.7 percent in their high tax counterparts. According to the Bureau of Labor Statistics and the St. Louis Fed, over the past ten years (March 2007-March 2017), private sector job growth in the states with no income tax increased 28 percent faster than the states with the highest income taxes (6.9 percent growth vs. 5.4 percent growth) on an equally-weighted basis. In aggregate, private sector jobs increased by 12.2 percent in the no income tax states compared with 7.9 percent growth in the high income tax states. Obviously other factors, including right-to-work status, regulatory environment, and makeup of state economies clearly factors into these statistics; but these general trends are reflected decade after decade for the past 50 years.

The reasons why income-based taxes are economically damaging to states range from the adverse economic effects of the taxes, to purely public finance objections, such as the volatile nature of income tax revenues. Recently, Governor Jerry Brown of California admitted Sacramento’s over-reliance on progressive income taxes has caused some serious budget problems for the Golden State. Meanwhile, Governor Dannel Malloy in Connecticut has acknowledged that numerous tax increases have hurt his state’s competitiveness and economic growth after their loss of General Electric to Massachusetts.

Additionally, an analysis on the impact of various types of taxation, conducted by scholars at the Organization for Economic Cooperation and Development (OECD), found that taxes on productivity, such as personal and corporate income taxes, are particularly harmful to economic growth.

Regardless of the form of taxation policymakers choose to utilize moving forward, the key is having competitive tax rates and eliminating special preferences or carve-outs wherever possible. This avoids the temptation of government picking favorites in the tax code, and essentially driving up tax rates for everyone else.

North Carolina provides us a clear example of the constructive effects of pro-growth tax reform and budget prioritization. Despite being handed a $3 billion budget gap for the 2011-12 fiscal year, North Carolina’s General Assembly took great strides in repairing the ailing budget and its structural problems, all while providing substantial tax relief.

Next, they repealed the state’s “Death Tax,” consolidated the individual income tax brackets into a single rate of 5.8 percent, and raised standard deductions for single and joint filers. They also addressed the state’s corporate income tax rate, formerly highest in the Southeast, cutting it to 6 percent in 2014, 5 percent in 2015, 4 percent in 2016 and 3 percent in 2017, all contingent upon meeting certain revenue growth targets.

In 2015 lawmakers cut personal income taxes again, raising standard deductions and lowering the rate from 5.75 percent to 5.499 percent beginning in 2017. North Carolina has cut taxes for families and businesses by over $4.5 billion this decade, and among states that have a corporate tax, North Carolina is now the lowest.

The state led the nation with 13.4 percent growth in its GDP from 2013 to 2015 and preliminary numbers have it continuing this trend in subsequent quarters. Strong domestic in-migration and job growth put North Carolina ahead of every regional competitor and in the top 10 nationwide. Over the last 10 years, North Carolina has attracted more than 500,000 new residents, on net, from the other 49 states, earning the economic vitality, social capital and tax revenue from these new taxpayers.

In spite of, or perhaps because of, all this tax relief and budget prioritization, the state has maintained its AAA bond rating, met every revenue requirement, balanced its budgets every year, and as of February 2017, the state reported a $552 million budget surplus. Opportunity thrives in North Carolina, and in no small part due to these reforms. What the future holds looks brighter still, with long-run effects of these reforms putting the state on track to provide nearly $6 billion in total tax relief by 2020. North Carolina serves as a textbook example of what pro-growth tax and budget reform can do for an economy.

Of course, even in the face of all of this positive economic data from the North Carolina tax reforms, some opponents of tax reform might suggest the policy experiences in Kansas since their 2012 tax cuts prove tax reform does not produce growth.  In reality, the Kansas tax reform story is far from the abject failure some like to suggest. In fact, recent data suggest there are some very positive trends for hardworking taxpayers in Kansas.

Perhaps the most important complexity to keep in mind is the Kansas tax reform plan was never fully implemented as intended. Many political compromises gave us the fiscal policy patchwork that Kansas taxpayers face. Taxes were lowered, but spending was not. Then taxes were raised in a significant way. Some of the tax increases came in the form of broad-based retail sales taxes, while others were discriminatory taxes on consumers of specific products.

Many critics of the Kansas tax reform experience are quick to point to relatively lackluster economic growth and budget shortfalls in the years following tax reform as proof of the reforms’ failure. However, like many other states at the time, the significant downturn in oil prices and agriculture prices hit Kansas especially hard. Controlling for these sectors, the rest of the Kansas econ­omy enjoyed growth.

One of the key reasons Kansas policymakers took up the cause of tax reform in 2012 was to reverse decades of economic stagnation in the state. After the tax reforms of 2012 were enacted, Kansas started to catch up in private sector job growth, shooting up from 40th in the nation for job growth between 1998 and 2012 to 30th in the nation from 2012 to 2015, according to data from the Bureau of Economic Analysis. Pass-through entities have led the way in this jobs boom, accounting for 98 percent of jobs gains since 2012 through 2015—up from 82 percent first two years, according to the U.S. Census Bureau. Furthermore, business startups continue to break records since tax reform was enacted in 2012. The 2012 record was broken in 2013, and again in 2014. New business filings set another record in 2016 with 18,147 new domestic business filings.

Kansas provides a number of important lessons, the most important of which is that broad-based tax relief must be paired with responsible prioritization of spending. After all, taxes and spending are opposite sides of the same fiscal coin. Kansas has increased actual annual general fund spending by more than $2.94 billion since 1995. This is an 89 percent increase. Adjusted for inflation, this is still an outsized 55 percent increase during a period in which population grew by only approximately 12 percent.  Since 2012 alone, general fund spending has increased by more than 4 percent adjusted for inflation. In short, for every 1 percent in population growth from 1995-2017, spending increased by nearly 5 percent in real terms. Based on this spending growth, it is clear why Kansas has faced budget shortfalls as they reduced tax rates.

Much of the criticism about Kansas is based on preconception and myth, rather than empirical data and actual trends. Pro-growth tax relief can be trusted to make states more competitive, but it takes time to develop and must be offset with appropriate spending reforms.

Overall, the economic evidence clearly showcases the success of states that have enacted pro-growth tax reforms. The 50 “laboratories of democracy” give us numerous examples of this every year.  In conclusion, I have included the ALEC Principles of Taxation for your review. This document provides some helpful guidelines as you look to create a fairer, pro-growth tax system, which empowers hardworking American taxpayers to enhance their economic opportunity.

I wish you all the best with your important task at hand.


The ALEC Principles of Taxation are publicly available at https://www.alec.org/model-policy/statement-alec-principles-of-taxation/

 

 


In Depth: Tax Reform

Mainstream economists, small business owners and taxpayers across the country understand that growth-oriented reforms mean increased opportunity for all. As demonstrated by the annual Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, sound tax and fiscal policies are critical to economic health, allowing businesses and households to flourish. A …

+ Tax Reform In Depth