Tax reform is heating up in Arkansas, as the newly created tax task force is beginning its meetings. While much of the conversation so far has focused on exemptions and tax cuts to improve Arkansas' competitiveness, the task force would be well served to devote time and energy on another topic: tax triggers.
Tax triggers provide a predictable, phased-in approach to tax reform, balancing the budgetary needs of the state with the desire for an improved tax code.
A tax trigger is a cut to the tax rate that only takes place once increased tax revenue occurs. It is a way to phase in tax cuts slowly as tax revenue expectations are met. In other words, tax cuts are not simply phased in; they are contingent on reaching revenue targets.
The use of tax triggers is not uncommon. In fact, 11 states currently use them. For instance, North Carolina, a shining example of state tax reform, enacted a trigger that would cut the income tax rate by 1 percentage point if tax collections were above $20.2 billion, and prompt a second cut if revenue increased to almost $21 billion.
Using tax triggers rather than simply inserting a tax cut is important for ensuring that the state maintains its ability to fund essential functions. Tax triggers make certain that the state is still able to fund education, Medicaid, police, roads, and other essential government functions before tax cuts take place. It would be imprudent to cut taxes without having a specific plan involving spending cuts or revenue replacement.
It is easy to forecast rosy tax revenue. But believe it or not, sometimes economic forecasts are off. There are too many things that can affect tax revenue, much of which is unforeseeable. Some of the things that affect tax revenue are controlled by state government, but national and international decisions have an impact on state revenue as well. It is hard to accurately predict the impact of those issues.
But tax triggers protect states from the dangers of forecasting. Tax triggers mean that if forecasts are correct, the tax cuts take effect immediately. But if forecasts are off, the tax cuts take effect later. For example, Massachusetts planned to have tax cuts in 2008, but its tax trigger did not take effect in that year due to the recession. Likewise, Missouri is working to reduce its income-tax rates, but the reduction will be delayed by a year since the state's revenue target was not quite reached.
There are also examples of irresponsible tax cuts. Whenever tax reform comes up, so does the Kansas fiasco. Kansas adopted very large tax cuts but did not reduce government spending to match the tax cuts, or broaden the tax base to replace lost revenue. Kansas also bypassed the use of tax triggers, instead opting to implement the tax cut all at once.
Unsurprisingly, it had serious budget problems and put a negative connotation on tax reform in other states.
Despite the Kansas fiasco, Arkansas legislators can look to several other states for models of prudent tax reform. North Carolina is one of the many states (and D.C.) that have lowered taxes responsibly.
Broadening the tax base and lowering tax rates with the help of tax triggers have led to good things happening with North Carolina's economy. The state is experiencing growth, and it has avoided the budget crisis that Kansas is experiencing. In fact, North Carolina had a budget surplus in 2015, 2016, and expects one this year.
Tax-reform discussions in Arkansas will no doubt include simplifying the code by reducing the number of personal income-tax schedules, broadening the tax base by eliminating the wide range of tax exemptions available to special interests, and lowering marginal tax rates. But the discussion is not complete if it does not include lowering tax rates responsibly with tax triggers.
Tax triggers are a prudent method for phasing in tax cuts. Those cuts will make Arkansas more competitive nationally and in our region. Phasing the cuts in based on revenue ensures that Arkansas can meet its obligations even in uncertain times. It is the judicious way to make our state more competitive.
Dr. David Mitchell is an associate professor of economics and the director of the Arkansas Center for Research in Economics (ACRE) at the University of Central Arkansas.
Editorial on 07/20/2017