For an Income Tax

May 1997By and Comments

THIS IS NOT THE BEST TIME TO BRING the subject up, with memories of April 15 so fresh, but … Texas needs a state income tax. It’s not going to get one, of course, even though the Legislature, prodded by Governor George W. Bush, is desperately searching for a way to lower school property taxes and replace them with other taxes to fund education. Opposition to a state income tax is the one sacred tenet of Texas politics. The last time any major political figure spoke strongly in favor of an income tax was in 1991, when Lieutenant Governor Bob Bullock endorsed the idea. The public responded in such force and with such unanimity that the next time the Legislature met, there was a successful drive for a constitutional amendment that prohibits a personal income tax unless the voters approve it—a drive led by Bob Bullock.

Now Bush has raised the issue of tax reform anew. For two months after his State of the State speech on January 28, when he made property-tax relief the top priority of the legislative session, a handpicked committee of House leaders struggled with the problem of how to make the cuts without leaving the public schools short of money. Day after day, lobbyists, reporters, and staffers filled every available seat in the intimate hearing room two floors below ground level in the Capitol Extension. They stood five and six deep inside the doorways, they took over a raised bench normally reserved for TV cameras, they gossiped in the hallways outside, and a few settled for watching the proceedings on closed-circuit television. It was not just the subject matter that drew the crowds but also the political theater. The exchanges were frank and spontaneous, and every once in a while the spectators were rewarded with a glimpse of politicians plying their craft. When an urban legislator suggested ending agricultural tax breaks, a rural representative replied, “Do you remember what we talked about this morning? The answer is no.” The CEO of Continental Airlines, testifying against a sales tax on jet fuel, drew an audible gasp from the audience when he explained why he could say with certainty that his 17,000 employees were against the tax too: “That’s the way the food chain works.”

The committee of six Democrats and five Republicans, chaired by Paul Sadler (Democrat, Henderson), looked at every conceivable idea for raising revenue, except you-know-what. They quickly decided that Bush’s plan—cut property taxes by $3 billion and replace them with a new business tax, a sales tax increase, and some spending cuts—didn’t go far enough. Taxation, it is said, is the art of plucking the goose so as to get the most feathers with the least hissing, and the trouble with the governor’s plan was that it did just the opposite. Only by making massive reductions in property taxes, the committee realized, could they build the public support necessary to overcome the inevitable resistance to tax increases.

Only three kinds of taxes can consistently produce enough revenue to fund a public school system: a tax on consumption (for instance, a sales tax), a tax on wealth (for instance, a property tax), and a tax on income. Since the point of the entire exercise is to relieve property taxes, and since an income tax is off the table, the Legislature has no choice but to look at the sales tax, either by raising the rate—already a hefty 8.25 percent in big cities—or by expanding it to include business transactions now exempt. That would mean that the sales tax could apply to such items as legal fees, haircuts, manufacturing equipment, utility bills, lottery tickets, medical payments, even—have they lost their minds?—magazine subscriptions.

Altogether, exemptions and exclusions from the sales tax cost the state a whopping $14.5 billion a year, enough revenue to eliminate all school property taxes and still have several billion dollars left over. Getting rid of these exemptions has the aura of plugging loopholes. But it became apparent as the committee went through the list of exemptions (known to the lobbyists trying to protect their clients’ tax breaks as “the pain sheet”) that every one is there for a reason. Sometimes the reason is political. Of the 45 states that have sales taxes, 41 do not tax haircuts, because politicians know that men sitting in barbers’ chairs are a captive audience, and if the barber has something to complain about, the result of all those men listening during all those haircuts is going to show up in the next election. Removing the exemption on taxing groceries and prescription drugs would bring in more than $1 billion a year, but it’s not going to happen. In 1969 the Senate voted to tax groceries, and the uproar was so great that the House voted the idea down without a dissenting vote.

Other exemptions exist for economic reasons. None of the big industrial states taxes equipment used in manufacturing; for us to do so would put the state at a disadvantage when the time came for plant relocation or expansion. Custom computer programming is exempt because it is an activity that Texas wants to encourage. Research and development laboratory services are exempt for the same reason. Do we really want to slice at these bones before they get meat on them?

The deeper the committee went into the list of exemptions, the more economic problems it uncovered. Commercial businesses pay taxes on gas and electricity; industries do not. This looked like a fat source of revenue—$348 million a year—that most industries could pass on to their customers. When the committee targeted it, however, a few companies came forward to say that utilities represent more than half of their total costs. For an aluminum plant in Rockdale and chlorine manufacturers on the Gulf Coast, the loss of their sales tax exemption meant that the plants would have to close. Often the committee found that removing an exemption created winners and losers inside a particular industry. Southwest Airlines, for example, with many short-haul flights inside Texas, would be particularly hard-hit by a jet fuel tax.

The most glaring deficiency in Texas’ current tax structure is that it doesn’t reach the service professions, the heart of the state’s postindustrial economy. Doctors, dentists, lawyers, accountants, architects, engineers, consultants, and advertising agencies do not pay significant business property taxes, and their services are excluded from the sales tax. (The legal and health care exclusions alone are worth $1 billion.) Since most of these professionals are organized in partnerships, they do not pay the corporate franchise tax. And, of course, they pay no state income tax. But sales taxes won’t solve the problem. Taxing medical services, for example, is a levy on being sick, which is why Texas does not tax prescription drugs. Other services can just as easily be purchased out of state—to avoid paying sales tax—as in Texas; in the age of the computer, big clients can have their taxes figured in Atlanta, their blueprints drawn up in Chicago. There are good reasons why 43 states don’t tax physicians’ services and 42 don’t tax accountants’.

The ultimate problem is not what the Legislature is trying to do; it is what the Legislature is not allowed to do. Because income taxes were off limits, legislators had to look at the sales tax exemptions. There was no other choice. The committee gave the Texas tax system the most thorough public scrutiny that it has ever had. They toiled with spreadsheets and calculators and studies and reports trying to create a plan that would provide enough revenue with the least harm and disruption. All the while the most sensible solution to their problem hovered in the air above them. They all knew it, whether they liked it or not, and they all knew that it was unmentionable and impossible. They were like Tantalus in the Greek myth, doomed to see treasure on a tree branch that sways forever, just out of reach.

A personal income tax of 2 percent of one’s federal taxable income would produce about $4 billion a year. It would grow as the state’s economy and population grew, assuring the public schools of adequate funding. It would be a fair tax, because—unlike the property tax—it has to be paid only if one makes money. It is a desirable tax, because—unlike the sales tax—it is deductible from one’s federal income tax. It is a sensible tax, because—unlike the elimination of exemptions—it taxes professionals without hurting the Texas economy. It is simple and efficient to collect. It is a flat tax that assesses everybody at the same rate. And it does not represent an increase in revenue, because it would simply replace the property tax and the rate would be locked into the constitution. One has to wonder why we regard a state income tax with such revulsion.

Texas has a tax structure that dates from a century ago, when wealth was in property rather than in wages, investments, and brainpower. For most of the twentieth century, oil and gas revenue has shielded our tax structure from reality. Now, as the oil plays out, we find ourselves in the same position that other states faced two or three generations ago, but we still coddle the attitudes we cherished while the oil was flowing.

We can’t afford to bungle this opportunity. We have a popular governor with a real determination to reform taxes and legislators who are similarly inclined. We can shift the tax burden from property to income without increasing it. We can assure equitable funding for public schools. Instead of cobbling together some weird package that causes who knows what kind of harm to the state’s economy, the Legislature should do the only thing that makes sense: Pass a personal income tax.

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