September 22, 2008
PROS AND CONS OF VARIOUS TAX PROPOSALS
By: Judith Lohman, Chief Analyst
You asked us to provide brief arguments for and against the following tax proposals: (1) a 3% property tax cap, (2) abolishing the state income tax and replacing the lost revenue with revenue from the sales tax, (3) a property tax freeze for “fixed-income” senior citizens, and (4) cutting the gasoline tax and capping the petroleum products gross receipts tax.
Possible arguments for and against each proposal are listed below, along with brief background information. Arguments are taken from research organizations or public hearing testimony.
3% PROPERTY TAX CAP
There are several possible ways to limit property tax growth, including (1) limiting each municipality's total annual allowable growth in revenue from property taxes, a type of property tax cap known as a “levy limit;” (2) limiting increases in each taxpayer's annual property tax bill; (3) limiting increases in property tax revenue for one or more classes of property (residential, commercial, industrial); (4) limiting increases in mill rates (property tax rates); or (5) limiting increases in property assessments.
The pros and cons below apply generally to all these types of property tax caps unless otherwise noted. They are derived from the report of the 2007 Connecticut Property Tax Cap Commission and State Tax and Expenditure Limits—2007, published by the National Conference of State Legislatures.
● A property tax cap slows the growth in property taxes, protecting local residents from sudden sharp annual property tax increases.
● A property tax cap moderates the growth in property taxes so that it more closely matches income growth rates. Since taxpayers pay their property taxes out of income, increases in the former should reflect increases in the latter.
● A cap forces towns to exercise discipline over budget and tax practices and gives them an incentive to find more efficient ways to deliver services.
● A cap puts pressure on the state to increase aid to municipalities while ensuring that state aid is used to provide property tax relief rather than fund new programs.
● Lower property taxes benefit local businesses, improves their economic competitiveness, and reduces the chances that they will relocate to other states or communities.
● Caps require governments to think of creative ways to generate other types of revenue.
● Caps do not reduce property taxes that are already too high.
● Caps do not address the underlying causes of property tax increases, many of which, such as employer health care, energy, and state and federal mandate costs, are outside the direct control of local officials.
● Unless state aid increases, revenue losses from a cap may lead to cuts or deterioration in municipal services and may affect educational achievement.
● Increases in state aid to municipalities to make up lost property tax revenue may lead to state tax increases and loss of local control over policies and programs.
● Pressure to make up revenue may lead towns to increase local fees or expand the property tax base by zoning more land for development.
● Unless exceptions are allowed for debt service payments, a cap could adversely affect a town's bond rating,
● Caps do not target tax relief to residents according to their ability to pay; consequently they may disproportionately benefit wealthier residents.
● Limits on assessments or tax bills for certain classes of property or certain types of residents could lead to different taxes and tax rates for similar properties.
ELIMINATE THE INCOME TAX AND REPLACE IT WITH SALES TAX REVENUE
In FY 07-08, the income tax generated $7.5 billion or 46% of total state revenue; sales tax revenue was $3.6 billion or 22% of total revenue. Based on these figures, sales tax revenue would have to rise to more than $11 billion annually to replace revenue from the income tax. To achieve this level of sales tax revenue, the General Assembly would have to (1) increase the sales tax rate from the current 6% to more than 18%; (2) eliminate sales tax exemptions, including those for food and medicine, and extend the tax to many services that are not currently subject to the tax; or (3) enact a combination of tax rate increases and expansions of the goods and services subject to the tax.
Some of the following arguments are based on information from the Program Review and Investigations Committee's January 2006 report on Connecticut's Tax System.
● Eliminating the state income tax could attract and retain wealthy residents who are more likely to stimulate economic activity in the state through spending and investment.
● Without the income tax, residents would have more incentive to earn more and to invest in businesses and jobs here.
● Residents, employers, and the state would save the administrative costs of filing, implementing, and enforcing the income tax.
● Because sales tax revenue grows more slowly than income tax revenue, the change might require the state to reduce spending and become more efficient.
● Sales taxes are generally less volatile than income taxes, providing more stability for the state budget.
● The sales tax is easier for taxpayers to understand than the income tax.
● The sales tax only applies to taxable transactions, thus giving a taxpayer some measure of control over how much tax he or she pays.
● The higher sales tax rates and taxes on additional goods and services that would be required to maintain state revenue without the income tax would almost certainly lead to more tax avoidance through online, mail-order, and out-of-state purchases.
● Connecticut's small size makes it easy to buy goods and services in states with lower sales tax rates.
● Businesses located near the state's borders would be hurt by any big disparity between Connecticut's sales tax rates and the rates in neighboring states. Currently, state sales tax rates are: 5% in Massachusetts, 7% in Rhode Island, and 4% in New York.
● Businesses pay nearly half of all sales taxes, so a very high sales tax could make the state less economically competitive.
● Because the sales tax is more regressive than the income tax, higher sales taxes would shift the state's overall tax burden toward residents with lower incomes.
● Sales tax revenues are vulnerable to economic downturns and tend to fall during recessions when state expenditures typically increase.
● Sales tax revenues tend to grow more slowly than the overall economy, thus making it unlikely the tax could fully replace income tax revenues over the long term.
FREEZE PROPERTY TAXES FOR “FIXED INCOME” SENIORS
In addition to the following specific arguments, many of the arguments for and against the 3% property tax cap listed above also apply to this proposal. The arguments below are based on public hearing testimony on various elderly property tax relief proposals over the past three years.
● Tax freezes provide protection against future tax increases. Property taxes are not based on income, so those living on fixed incomes are more vulnerable to high property taxes on their homes.
● Senior citizens are likely to have lived in their homes for a long time and may not have enough income to keep pace with higher property taxes resulting from rapidly rising property values.
● A tax freeze allows seniors to remain in the homes and towns they have lived in for a long time.
● Assuming a town wants to maintain or increase spending, a freeze for senior citizens may shift the tax burden onto taxpayers not eligible for the freeze.
● If a shift occurs, taxpayers not benefiting from the freeze may not have enough income to pay the higher taxes and meet their other obligations.
● A freeze does not reduce high property taxes.
● A freeze may not provide enough tax relief nor does it target the relief to all those who need it.
CUT AND CAP THE GASOLINE TAX
The state imposes two taxes on gasoline: a 25-cent-per-gallon motor fuels tax and a 7% tax on the wholesale price of petroleum products, including gasoline. Although oil distributors pay the 7% tax, its cost is passed through to buyers at the pump. For purposes of this report, we assume that the proposed tax cut would apply to the 25-cent-per-gallon tax and the proposed cap to the wholesale price of oil subject to the 7% petroleum products tax.
All revenue from the 25¢ per gallon tax goes to the Special Transportation Fund (STF) for transportation infrastructure projects. All the revenue from the 7% petroleum products tax goes first to the General Fund, but specified sums from that revenue are then transferred to the STF. The transfer amounts are established by statute (CGS § 13b-61a (b)). For FYs 09 and 10, the required transfers are $141.9 million per year, which is less than half of the projected annual petroleum products tax revenue. Thus, about half of the revenue from the petroleum products tax supports general state expenditures.
Some of the arguments below come from information in “Deconstructing Connecticut's Gasoline Excise Taxes,” by Arthur W. Wright, The Connecticut Economy, Fall 2008.
● Reducing gasoline taxes stimulates the state's economy by increasing discretionary income available for other consumer spending.
● Lowering gasoline taxes gives customers an incentive to stop at Connecticut service stations instead of driving straight through the state. Service station customers often buy other items, generating additional sales tax revenue.
● The taxes are regressive because they are a disproportionate expense for people with middle and low incomes.
● Capping the petroleum products tax makes the state less reliant on a volatile commodity (oil) that is subject to big price swings.
● Sudden sharp increases in gas prices have been attributed to speculation, which hurts the economy. The state budget should not benefit from oil price speculation.
● The state should not rely on a petroleum products tax that is complicated, invisible to consumers, and hard to explain and understand.
● Because revenue from both taxes goes to the STF, revenue reductions reduce the state's ability to address transportation infrastructure needs.
● Lower gas taxes encourage people to drive more and to drive bigger cars, leading to (1) faster depletion of a finite natural resource (oil), (2) adverse effects on the environment and air quality, (3) more traffic, and (4) faster road and bridge deterioration.
● Capping the wholesale oil price subject to the petroleum products tax merely protects against additional price increases; it does not reduce gas taxes or gas prices.