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The right approach

Cut Texarkana’s tax exemption by Nicole Kaeding and Jeremy Horpedahl Special to the Democrat-Gazette | July 22, 2017 at 2:28 a.m.

As the task force of Arkansas lawmakers contemplates how to overhaul the state's tax code, one senator is already jockeying to protect a local exemption. State Sen. Jimmy Hickey represents a district encompassing Texarkana, and some of his constituents have a special deal: They are exempt from the state's income tax.

Senator Hickey argues that repealing the Texarkana exemption would cause residents to move to the income-tax-free Texas side. But that ignores the bigger picture. His commentary doesn't account for the burden from other local taxes, nor does it justify keeping the exemption in place. Instead, it's a symptom of much larger problems with Arkansas' tax system, which is littered with special provisions that create an imbalance in how Arkansans are taxed.

Under Act 28 of 1977, Texarkana residents were given an option to exempt themselves from the state's individual income tax, now topping at 6.9 percent. The residents, obviously, chose this path, and in exchange they pay an additional 1 percentage point in state sales tax. This trade saves taxpayers in the city a great deal, but costs the rest of the state millions. In 2016, the lack of an income tax in Texarkana cost the state $16.6 million in net revenue.

That means all other Arkansans pay more in taxes.

A closer look at the data also calls into question whether the tax break provides much of a benefit. Eliminating the exemption doesn't immediately spell tax flight from Texarkana. While Texas has no individual income tax, Texans face an effective property tax rate that is 2½ times higher than Arkansans. For the median taxpayer, that amounts to an extra $1,149 in annual real estate taxes, according to the Census Bureau. Instead of eliminating the tax disparity between Texas and Arkansas, the exemption simply shifts the disparity to the city limits.

Those concerned about what might happen to Texarkana without the exemption can take a look at another border city in Arkansas with a similar divide. The metro area of Memphis also straddles our state's border, with West Memphis falling in Arkansas and Memphis falling in Tennessee.

Like Texas, Tennessee does not have a personal income tax. West Memphis residents, however, do not receive an income-tax exemption like their Texarkana counterparts.

Following Senator Hickey's reasoning, West Memphis should be depopulated from tax-avoidance migration. Yet, West Memphis is still home to more than 25,000 residents, just a few thousand less than Texarkana. And there are at least six other metropolitan areas in the United States with some portions in no-income-tax states. None get income-tax exemptions, and none are completely depopulated.

One possible explanation is that there is a large difference in effective property-tax rates between Memphis and West Memphis. The effective rate in West Memphis was just 0.59 percent, compared to an effective rate of 1.60 percent in Memphis. Residents of West Memphis could be attracted to the lower property-tax rates, among other benefits of Arkansas.

The rate difference in Texarkana is even larger. In 2015, Texans paid 1.77 percent in effective property taxes compared to the 0.67 percent paid in effective property taxes by Arkansans in Texarkana. To ignore this, along with numerous other considerations, misses the nuances in why individuals choose to live where they do.

Now, Senator Hickey has a point: Total taxes are higher in Arkansas than Texas. The Tax Foundation's "State-Local Tax Burden" report finds that Arkansans have the 17th highest tax burden in the country, while Texans have the 46th highest. But even given that, the income-tax exemption still isn't good policy. Ideally, the state would seek to provide tax relief for all residents, not just those in Texarkana. Exemptions like this make real, comprehensive tax reform more difficult.

The Arkansas tax code needs reform. The state's last comprehensive tax reform came in 1971. An almost 50-year-old tax code does not serve the state well and harms its competitiveness.

As we wrote in our book last year, Arkansas: The Road Map to Tax Reform, the Texarkana exemption is an explicit acknowledgment of the state's inferior tax code. Trying to fix the issues within just the city limits of Texarkana does nothing to improve the tax climate for the almost 3 million Arkansans who don't live in Texarkana. The legislature should focus on improving the tax code for all Arkansans, not just the few in one border city.

At a time when legislators are considering eliminating exemptions in the state's tax code, the Texarkana exemption should be at the top of the list. Taking exemptions off the list before the process even begins is a sure way to kill good tax reform. Pursuing broad and equal reforms makes for better policy than keeping an inefficient exemption in place.

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Nicole Kaeding is an economist at the Center for State Tax Policy at the Tax Foundation. Jeremy Horpedahl is a professor at the University of Central Arkansas and a scholar at the Arkansas Center for Research in Economics. They are the lead authors of Arkansas: The Road Map to Tax Reform.

Editorial on 07/22/2017

Print Headline: The right approach

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