Tax reform is in the air, at least in Little Rock. The state’s Tax Reform and Relief task force is looking at ways to overhaul the state’s tax code. On March 19, Nicole Kaeding of the Tax Foundation gave the task force some ideas on how to fix the sales tax. She had some thought-provoking ideas that could prove very worthwhile if the state were to adopt them.
Here is what Kaeding wrote on the Tax Foundation blog regarding her testimony:
As detailed in our 2016 book, Arkansas: The Road Map to Reform, Arkansas’s sales tax structure is in need of broad reforms. The state has the third highest combined state-local sales tax rate in the country, but the real issues are with the state’s sales tax base. The state has a sales tax holiday, numerous blanket exemptions for goods, and limited taxation of services.
However, the state should proceed cautiously with the newfound revenue from sales tax base expansions. While the state’s sales tax rate is high, its high individual and corporate income tax rates are more problematic. The state should use any additional revenue from sales tax changes to help lower tax rates for these other taxes. Any excess revenue should be used to also repeal the state’s franchise and inventory taxes, along with a few other reforms detailed in our book.
In her slide presentation to the task force (which is posted on the blog), Kaeding points out that sales taxes should be aimed at final consumption, should not tax business inputs, and should not exempt services. Arkansas fares poorly using these criteria.
By taxing quite a few business inputs, Arkansas is distorting the economy by adding extra layers of taxation in the production process. Kaeding recommends doing away with sales taxes in this area. She also notes that there is no good policy reason why the state exempts groceries, prescription drugs, and many services from the sales tax. These are all final consumption goods, and the tax code should not discriminate. If lawmakers are worried about how ending these exemptions would affect lower-income households, Kaeding has a few ideas on better ways to address this concern. She also slams the state for its sales tax holiday, something that TAP has criticized, too.
A flatter, fairer sales tax makes a lot of sense. It would reduce government favoritism in the marketplace. The less that the state’s tax structure distorts the decisions of businesses and individuals, the better. There could also be positive revenue effects. As suggested by Kaeding, Arkansas should make a number of good policy changes to its sales tax structure, then use new revenue to offset cuts to the state’s high income and corporate tax rates. Less economic distortion by the sales tax, more revenue to be used to offset other tax cuts — sounds like a win-win scenario, right?
Of course, these recommendations ignore the fact that every sales tax exemption has an entrenched interest group to protect it. All too often, the pressure exerted by interest groups proves more powerful than the pull of sound public policy. Will that happen with Arkansas tax reform? Time will tell, but we will be watching.