The Lopsided Fight Over Tax Cuts

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On Tuesday, on a 30-1 vote, the Senate passed a budget for the forthcoming 2016-17 biennium. Their version, which proposes $211.4 billion in all-funds spending for the two-year cycle, is almost two billion dollars larger than the House’s, which passed on April 1st, but the spending breakdown is similar, and broadly sound. The most notable and controversial budget-related discrepancy between the chambers has to do with tax cuts. The House is calling for $4.9 billion in biennial tax cuts, as laid out by Ways and Means Chair Dennis Bonnen: a 25 percent cut in the franchise tax rate plus a cut in the state sales tax rate. The Senate proposal, which works out to $4.6 billion, proposes franchise tax cuts and property tax relief.

Both proposals are ominous from a certain perspective. Democrats in both chambers have argued that the money would be better used for critical priorities like public education, higher education, roads, or water. And even Republicans have agreed; Kevin Eltife, in the Senate, has been the most vocal skeptic of the session’s tax-cut fever, arguing that it would be better to use the revenue available to tackle the state’s fiscal obligations, such as public pension liabilities. As I’ve written before, I’m with the skeptics; Texas already has one of the lowest average state tax burdens (and one of the lowest average tax rates) in the country, and one of the lowest rates of state spending per capita. We could always aspire to spend less, like Wyoming, but we have five million children enrolled in public school, and their enrollment is closer to five; more concretely, no one has proposed $4.7 billion in biennial spending cuts, or admitted that they’re happy to let their counterparts in the future take the blame for proposing the tax hikes that will be inevitable in the absence of such cuts.

On the other hand, if you’re in the “death to all taxes” camp, the two proposals may seem equally appealing, because they’re about the same size; as Senate Finance Chair Jane Nelson put it, “we’re both right.” And Governor Abbott is apparently similarly agnostic. Back in January, he threatened to veto any budget that didn’t include some business tax relief, and in his state of the state he specifically called for $2.2 billion in property tax cuts. But yesterday, as R.G. wrote, he offered the clarification that he wouldn’t necessarily veto a budget that doesn’t include property tax relief, and indicated that he is open to considering either tax-cut package.

In my view, this was an unnecessary clarification on Abbott’s part. He had never threatened to veto a budget that doesn’t include property tax relief and—state of the state notwithstanding—it doesn’t really make sense to demand that the state cut a tax that it is constitutionally barred from levying in the first place. However, it was probably a worthwhile clarification, because the House and Senate are apparently prepared to go to war over this. Last week, on the day that Bonnen (joined by most of the House Republican caucus) laid out his preferred tax cuts, Lieutenant Governor Dan Patrick issued a blistering statement about that chamber’s proposal, and yesterday he reiterated the arguments on behalf of the Senate’s plan. Since Nelson is the chair of Senate Finance, her expressed agnosticism is telling. But since Patrick is the lieutenant governor, the Senate can be expected to follow his lead.

In the end, I expect the House to prevail, because Bonnen’s plan is better than Patrick’s for at least half a dozen reasons.

To start, let’s table the debate over the respective franchise tax proposals. Both are reasonable, assuming that you think Texas needs to cut taxes by several billion dollars, which is the operating assumption for the rest of the post. The Senate’s hybrid proposal—raising the exemption and otherwise cutting the rate—would eliminate the franchise tax burden altogether on slightly more than half the state’s businesses, without creating a huge revenue hole; the 15 percent cut in the franchise tax rate, meanwhile, lessens the burden on the businesses not exempted. The House’s version, the 25 percent cut in the tax rate for all businesses, doesn’t do as much for smallish businesses, but it does something for all businesses currently subject to the tax. Either approach is defensible on the basis that Texas’s franchise tax is relatively high, at least on paper, and either would meet Abbott’s stated demand for business tax relief. So the debate is really about the relative merits of the House’s idea on sales taxes, and the Senate’s on property taxes. Here’s the case for the House’s proposal:

1) Since everyone pays the sales tax, the House plan benefits a greater number of taxpayers than the Senate plan, which only benefits homeowners. According to the Census, the homeownership rate in Texas is about 63 percent; that’s a large group of people but not as big as “everyone”.

2) Since everyone pays the sales tax, the House plan is more egalitarian than the Senate plan, which only benefits homeowners. Patrick is correct to note that many people who own a home are genuinely burdened by property taxes. Texas’s average property taxes are among the highest in the country, and soaring home values mean that people who bought their homes years ago are often dealing with higher property taxes than they could have imagined or planned for. However, if you own a home in Texas, you’re not among the poorest of the poor; the state’s relatively strict mortgage laws, for better or worse, have effectively guaranteed that.

3) The projected savings for the average recipient are in the same range. With the Senate’s property tax relief, the average homeowner would save about $200 a year. With the House’s sales tax cut, the average person would save about $50 a year. The average household in Texas, per the Census, has 2.8 people. So to put it simplistically, the question is whether the state leaves an additional $150 a year to every household in Texas, or an additional $200 a year to two-thirds of them.

4) It’s debatable whether people would notice the savings, since either version works out to roughly $13 a month. However, they’re clearly more likely to notice the sales tax cut than the property tax relief, since property taxes are typically collected by the mortgage lender and held in escrow. My own property taxes just jumped, last month, by about $200. I have no idea why. I just pay the mortgage. By contrast, when gas prices dropped from $3.50 to $2 a gallon, I noticed; I’m also tickled when I put on a jacket I haven’t worn for a few months and find $5 in the pocket. From a strictly analytical point of view this doesn’t make sense. But time and time again economists have demonstrated that human behavior isn’t strictly rational. That’s why prices so often end in .99 rather than .00. And rational or not, the sales tax savings are conferred directly to individual businesses and consumers, rather than abstracted as a slightly smaller monthly payment; that’s why, as Bonnen has noted, the sales tax cuts have a higher projected economic stimulus effect.

5) The Senate’s proposed property tax relief will do nothing to constrain tax growth. I’ve compared it to Obamacare before, but I haven’t unpacked the analogy yet, so here it is. The stated purpose of the Affordable Care Act is to make health insurance affordable. A worthy goal, because spiraling health care costs have yielded spiraling health insurance costs, particularly for certain subsets of the population. However, the federal government’s solution—to offer subsidies to people who couldn’t otherwise afford insurance on the marketplace—did nothing to mitigate the actual underlying problem of health care costs. The subsidies only offset the pocketbook impact of the actual costs. They create no incentive for insurers to economize; if anything they alleviate pressure on the insurers, by guaranteeing a captive market for an overpriced product, and by guaranteeing that the product will be “affordable” regardless of its market price, because of the federal government’s explicit commitment to provide the necessary subsidies. The Senate’s proposal, to raise the homestead exemption for school district taxes, is structurally similar and therefore similarly flawed. At first, homeowners might notice that their property tax burdens are not rising as quickly as they have in previous years. But any savings would be quickly obscured as local taxes (levied by several layers of local government, but paid as a bundle) continue to rise. And local taxes will continue to rise. Why wouldn’t they, if the state voluntarily commits at least $2bn a year to subsidies for local government, no strings attached? The sales tax cut, by contrast, is actually a tax cut. Imagine that.

6) Because the sales tax cut is just a simple old fashioned tax cut, it hasn’t inspired any of the revolting gimmicks that the Senate pre-emptively advanced in preparation for passing its budget. Nor would it. For those of us who support Texas’s spending cap, which is not just an aspirational ideal but a parameter enshrined by the people of Texas in the constitution of the state of Texas, that is important. 

That’s half a dozen reasons the House’s proposal is better than the Senate’s. I’m sure I can think of others. If there’s a counterargument from the Senate side, please leave it in the comments. But fair warning: “it was a campaign promise” doesn’t count.

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