April 13, 2008

Sales Tax More Stable Revenue Source than Income Tax

A few years ago, during the great Tennessee Income Tax War, the pro-income tax experts often asserted that an income tax would protect the state against revenue shortfalls during an economic slump. They repeated it like a mantra, especially during the recessionary year 2001, pointing to the state's revenue shortfall and its sales tax-based tax code and claiming that an income tax would have prevented the fiscal crisis.

The facts, of course, said otherwise. As I often pointed out on this blog and in my City Paper columns during those years, states that rely on income taxes suffered much larger deficits during that economic slump than did states that rely on sales taxes. But no amount of pointing out the facts seemed to sway the pro-income tax folks, or the media that often carried their water bucket during those years.

But now, the leader of Tennessee's pro-income tax political party - that would be the Tennessee Democrat Party - has admitted the truth: Tennessee's sales tax and lack of a state income tax helps the state avoid huge revenue shortfalls during economic slowdowns. Gov. Phil Bredesen, as quoted in today's Tennessean article, talking about the state's sales tax:

"It doesn't grow as much as an income tax does in good years. It doesn't shrink as much as income taxes do in tough years," he said.

When the economy slows down and income-tax revenue dives, those states face larger deficits because they over-spent - and over-committed for the long-term - during the fat years.

By relying instead on the sales tax, Tennessee is less susceptible to over-spending in the fat years, and less susceptible to massive shortfalls in the lean years.

Gov. Bredesen has explained, in two sentences, why it would be fiscal suicide to reform Tennessee's tax code by adding an income tax.

Ironically, just before Bredesen's statement in the same article, state government's top economic adviser continues to spout the untruth:

Sales tax exemptions have proliferated nationally, but because Tennessee relies heavily on its sales taxes, the state can be harder hit when the economy sours and sales flatten, according to University of Tennessee economics professor Bill Fox, who advises the state on financial matters.

That shortfall is directly tied to how Gov. Bredesen dealt with last year's $1.5 billion revenue shortfall. Instead of saving most of it, Bredesen sought and got a budget that spent almost all of it, and started new programs and expanded existing programs as if the one-year revenue surge was going to be an annual event.

Bredesen's budget even included $723 million in spending that exceeded the state constitution's limit on the year-over-year growth of the state budget.

Now, that over-spending has combined with the economic slowdown to create the fiscal crisis Tennessee now faces.

It's just a good thing that Tennessee Republicans fought to stop the income tax six years ago - else this year's revenue shortfall might be twice as large.