Tax Reform: The Good, The Bad and The Lost Opportunity

By Kelly McCutchen

Kelly McCutchen, President, Georgia Public Policy Foundation

Tax reform has been a popular topic this year. In South Carolina, Gov. Nikki Haley is championing a plan to lower the state’s 4, 5 and 6 percent individual income tax rates to 3.75 percent. In Oklahoma, Gov. Mary Fallin called for a “gradual elimination of the income tax” in her State of the State address. Oklahoma legislators have presented a plan “to eliminate most personal tax credits, exemptions, deductions, and exclusions—and to drop the top income-tax rate from 5.25 percent to 2.25 percent, then steadily drive the levy down for a decade, leading to its elimination.” Kansas, Idaho, Maine, Nebraska, New Jersey and Ohio are also debating significant income tax reforms.

Here in Georgia, in December of 2010 after a year of study, a nonpartisan tax reform commission presented a comprehensive plan to simplify the tax code by eliminating most deductions, exemptions and credits and adopting a flat rate personal income tax with a rate as low as possible. The original goal was a rate of 4 percent, but a later study indicated the plan could have reduced the personal income tax rate from 6 percent to 3.5 percent or lower. (The new numbers showed a surplus of more than $700 million.)

After modifications were made by the General Assembly last year, a vote was called off at the last minute on a plan that would have reduced the income tax rate to approximately 4.5 percent.

After another year to study the numbers and refine the plan, the General Assembly started back to work this January as citizens remained hopeful for a fresh look at comprehensive tax reform.

We waited.  And waited.  And waited.

This week the plan was unveiled.  And it was not exactly what we expected.

The plan includes one solid, pro-growth idea (the energy tax exemption) that originated from the tax council’s recommendations, accompanied by a hodge-podge of unrelated proposals.

A small step in the right direction, but this clearly does not pass for comprehensive tax reform. For that, we optimists will have to wait yet again.

So what do we have? Here’s our take after a quick review:

Energy Exemption: Georgia is one of a handful of states that tax energy used in manufacturing, mining and agriculture. Why remove the tax? Because liberal and conservative tax experts agree that it is terrible tax policy. This is not a special interest giveaway. This tax hurts Georgia’s competitiveness. In fact, just the likelihood the tax would be eliminated played a role in Caterpillar’s recent decision to locate a plant here. There will be many other jobs that come Georgia’s way (or don’t leave) if this is passed — meaning that it likely won’t lose nearly the amount of revenue the fiscal note says it will.

Modernizing and Streamlining the Tax Code: Although it has been ignored by most, this proposal eliminates a tremendous amount of red tape by rewriting the tax code in a simpler manner that will make compliance easier and dramatically less expensive for small businesses. These changes clarify and simplify a patchwork quilt of exemptions that haven’t been evaluated since 1936! As a part of the cleanup, “hobby farmers” are excluded from receiving exemptions meant for farmers who are actually trying to make a living from their efforts. True reform in every aspect.

Motor Vehicle Title Fee: Sales taxes and ad valorem taxes on motor vehicles would be phased out and replaced with a title fee. For most Georgians, the new 7 percent fee will be roughly the same as the sales tax they have always paid on their motor vehicles, but they will enjoy a property tax cut because they won’t owe ad valorem taxes every year on their birthday.

Until now, individuals could avoid paying sales tax by buying their vehicle from someone other than a dealer — so-called “casual sales.” With the new title fee, everyone other than military families will pay the tax. (Transfers between immediate family members will be assessed at a much lower rate.

There are many assumptions necessary to estimate the fiscal impact of the new title fee. The official fiscal note shows an increase in revenue, even after factoring in “hold harmless” payments to local governments.

Marriage Penalty: Reducing the marriage penalty is good tax policy, but it does little to improve Georgia’s competitiveness. It would make more sense to include this as a part of a comprehensive tax reform plan to reduce marginal income tax rates.

There are two parts of the Georgia tax code that penalize marriage. First, the standard deduction for a single person is $2,300, while the standard deduction for married couples is only $3,000. The simple, most efficient solution is to increase the standard deduction for married couples to $4,600, exactly twice the amount of the single amount.

Second, Georgia’s progressive tax rate system causes a marriage penalty if both individuals are working. Before marriage, both individuals have portions of their income taxed at rates lower than the top 6 percent rate. However, once married, more of the combined income is taxed at the highest rate resulting in higher taxes than when they were single. The best way to fix this problem is to move to a flat rate tax, which the tax council originally proposed.

This proposal adds $2,000 to the personal exemption for married couples, which almost eliminates both of the marriage penalties in the current code. Just like the child tax credit in the federal tax reform, I’m sure these families will appreciate the tax cut, but it does nothing to encourage more work, savings or investment. The money spent on this tax break (and many of the others) could have been used to elimanate the marriage penalty completely AND reduce the income tax rate, which is a pro-growth reform.

Retirement Exemption: Georgia’s current retirement exemption ($130,000 per married couple) is among the most generous in the nation. The exemption is scheduled to increase each year until 2016, when no retirement income would be taxed. This proposal caps the exemption at its current amount. Again, if coupled with significant rate reduction it would make more sense.

Sales Tax Holiday: We are not aware of any research group that thinks sales tax holidays are good tax policy. The Tax Foundation says it well: “At first glance, sales tax holidays seem like great policy. They enjoy broad political support, with backers arguing that holidays are a highly visible form of tax cut and provide benefits to low-income consumers. Politicians and other supporters routinely claim that sales tax holidays improve sales for retailers, create jobs, and promote economic growth. Despite their political popularity, sales tax holidays are based on poor tax policy and distract policymakers and taxpayers from real, permanent, and economically beneficial tax reform.” (See the full report here:

Research shows that these “holidays” don’t lead to more sales — consumers just hold off on purchases they would have made anyway. Although there are likely sales lost by Georgia retailers located close to the state border (all of our neighbors have sales tax holidays), it is not a good policy for the state. The fiscal note shows nearly $30 million of annual lost revenue until the holiday sunsets in 2015. If this lost revenue results in higher local property taxes, it will be a double negative.

Sales tax exemptions: Good tax policy broadens the tax base and lowers tax rates. Tax exemptions that reduce the tax base are made worse when elected officials choose winners and losers. On one hand, the bill expands the jet fuel exemption in current law, which primarily benefits just one company, to at least make things fairer by apply the exemption to most all airlines. On the other hand, the bill adds a discretionary, two-year sales tax exemption for construction materials.

E-Fairness – Technically, we all owe “use” tax on purchases we make on the Internet or by mail order. (Raise your hand if you have ever paid use tax.) The U.S. Supreme Court has ruled that businesses that do not have a physical presence in a state are not obligated to collect sales taxes on purchases made by residents of that state. This puts many Georgia retailers at a disadvantage if they are competing with an online retailer with no physical presence in the state. allows small businesses to use their web-based platform to sell merchandise. Several states have adopted “Amazon” taxes that require and other online retailers to collect sales tax if they have “affiliates” in their state. The fiscal note suggests Georgia would bring in more than $32 million a year if this proposal passes. However, if simply fires its affiliates as they did when North Carolina passed a similar law, the fiscal note states the “incremental revenue would be negligible.”

In summary, the proposal includes at least one, solid pro-growth proposal that our economy desperately needs. There are certainly pieces of the bill we would eliminate, but the good outweighs the bad. The worst part of the bill is not what is in it, but what isn’t. Opportunities to enact comprehensive tax reform are few and far between. Let’s hope we haven’t allowed our window of opportunity to shut.

Update: The Tax Foundation has published a short analysis of the bill.

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