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Politically Uncorrected: The Real Question About the Budget

pa-state-capitol-b175d9a07740ecf3People are asking lots of good questions lately about Pennsylvania’s proposed 2014/2015 budget. But few are raising what may be the most urgent question of all: why are state revenues down this year–more than a half billion dollars amid a national economic recovery?

Indeed, Pennsylvania’s revenue shortfall contrasts markedly with most other states. Revenues in 80 percent of the other 49 states will meet or beat budget projections this year.  Pennsylvania is one of only 11 that will not.

Pennsylvania’s revenue gap, along with projected spending, leaves a budget deficit of at least $1.4 billion. The problem is so severe that Gov. Tom Corbett and his notoriously tax-averse administration are furiously signaling they might consider new taxes, including a Marcellus Shale extraction tax.

Not surprisingly, the administration is already lining up the usual suspects, charging them with causing the looming deficit: former Gov. Ed Rendell for spending too much; the federal government for spending too little; and the economy for underperforming.

But, the blame game really doesn’t work here very well, even if others did drive state spending, and admittedly pension debt and other debt service are cost drivers. But spending is not the problem with this year’s budget. The problem instead is revenue: some $522 million in tax receipts, mostly in income and sales taxes, that didn’t show up.

Why not?

This is a simple question without a simple answer. In fact, Pennsylvania’s revenue shortfall stems from underperformance of the state’s revenue system. That revenue system was barely adequate in the mid-twentieth century when much of it was developed. It is now hopelessly outdated in the 21st-century Internet age.

To put it simply, Pennsylvania taxes are a mess.

The basics of the state’s tax system are straightforward. Pennsylvanians pay some $29 billion annually to state government from an array of taxes and fees, including a state sales tax, personal income tax, corporate income tax, motor vehicle taxes, sumptuary taxes including cigarettes and alcohol, and miscellaneous taxes.

The state sales and income tax produce the lion’s share of revenue with over 30 percent for sales and about 40 percent for income. And therein lays the problem — or most of it.  These two taxes as implemented in Pennsylvania provide textbook examples of how not to raise revenue.

The sales tax may be the worst problem, at 6 percent levied on retail sales and some services. Allegheny County adds 1 percent and Philadelphia 2 percent.

In principal, a sales tax can be a productive tax in a consumer economy such as ours. In practice, Pennsylvania has demonstrated how to render a productive tax not so productive.

The state has achieved this remarkable feat by littering the tax base with dozens of confusing exceptions to what is taxable. Food is exempt except when it is prepared. Clothing is exempt unless it is sports apparel. Some services are exempt, others are not. And so on. And, of course, in the Internet age, some retailers simply don’t collect the tax.

Pennsylvania has perversely transformed its “broad-based’’ sales tax into a “narrow-based” tax due to its multiple exemptions, favoring some while penalizing others. Narrow basing the sales tax costs the commonwealth at least a billion dollars a year.

Consider this: If 50 percent of the loopholes in Pennsylvania’s sales tax were closed, the revenue shortage this year would be reduced to zero. And if all of them were closed, the state would have a $500 million revenue surplus.

The state personal income tax gives the sales tax some competition for the worst state tax. Its problem is not its exemptions but its paucity of exemptions. Everyone receiving any of eight separate classes of income (salaries, interest, rents, etc.) pays it and pays it at the same fixed rate of 3.07 percent. That’s because it’s a “flat rate” income tax, with the lowest rate in the country. As a flat rate, its “elasticity” or growth is among the lowest of any tax. As the Pennsylvania economy grows, it lags behind and consequently can’t keep up with the demands on it over time. It’s bad in bad economies and worse in good economies.

The irony, not to be missed, is that the Corbett administration has adamantly opposed any kind of tax increase or reform. Yet much of his electoral problems have occurred because he has had to preside over successive draconian budgets and cuts in vital public services – all a consequence of a failing revenue system.

If taxes are the problem, they are also the solution. Clearly we must drag, pull or push the states antiquated revenue system into the 21st century, starting with the sales tax and the income tax. The sales tax can be fixed legislatively. The income tax will require a constitutional amendment to substitute for the flat rate tax. With a modern efficient tax system the state can begin to support the dangerously pent up demand in vital programs like education and infrastructure. Without a modern tax system, Pennsylvania faces a long painful decline.

It’s not a hard choice.

14 Responses

  1. There is no single solution to the question, why are state revenues down this year–more than a half billion dollars amid a national economic recovery? One simple answer that covers much from taxes to purchasing ability to drive our economy is this: PENNSYLVANIA JOB GROWTH REMAINS WEAK COMPARED TO THE REST OF THE US. Pennsylvania ranks 42nd in job growth over the last 12 months. Pennsylvania ranks 49th in job growth since 2011. With a Republican Governor, a Republican majority in the Senate, and a Republican majority in the House, it is crystal clear that the policies and/or abilities of this Administration to implement them have failed our state. While I don’t believe it is always appropriate to label every problem as partisan, the truth is that Republicans had carte blanche to legislate an improved economy. Instead we had a focus on voter ID and ultrasounds and liquor sales when we should have had focus on jobs and economic development. Sometimes the phrase, “It’s the Economy, Stupid,” really does apply. Pennsylvania had opportunity for solid growth and what the citizens received was smoke and mirrors. The good news is there is an election this year. The citizens who have had to pay dearly for the failure of this administration and the majorities of the Senate and House can vote these people out of office…now, if they would just register and show up at the polls. Unfortunately getting them to care enough to do so seems impossible.

  2. Isaac L-

    Bob doesn’t need to “read” the article. He won’t be happy until the state has no taxes, no spending and no services. Bob fundamentally does not understand the role of government and what services are necessary (or better) run by government.

    Many of his ilk are opposed to publicly funded education and claim it’s not a role of government. They fail to see the value of public transportation and the saving/stimulus it provides to the overall economy (as well as the saving in road/traffic problems).

    Bob’s statement here shows his complete lack of understanding of the article as well as how anything works: “Taxes are one very reliable measure of commercial activity and it appears that commercial activity has, in fact, declined in last year.”

    1) Terry has pointed out that Pennsylvania’s system of tax collection is flawed and is not directly correlated to commercial activity as Bob claims.
    2) I think it’s been posted elsewhere that the Corbett administration implemented various tax breaks or “incentives” for businesses as part of trickle down voodoo-economics that lower tax rates generate more business, and more revenue. Utter nonsense.
    3) Bob’s anti-tax mantra prevents him from understanding that there should be extraction taxes on natural resources in a Commonwealth, such as PA.

    People like Bob don’t seem to understand that people get VALUE for their tax dollars (police, fire dept, roads, schools, street/traffic lights, civil engineering, waste management, etc).

    I haven’t seen any jokers like Bob actually produce a budget to show what they would actually cut/keep.

    For this, and many other reasons, Bob and his bogus ideas will never be taken seriously.

  3. A credible analyst does not use “In principal” for “In principle,” or “lays the problem” for “lies the problem.” (Sex, anyone?) Street-corner jargon isn’t appropriate in a mature written exchange of views. The credibility of the argument declines along with the literary paucity of the writer. Words do matter.

  4. Bob – Did you even bother reading the article? We have the lowest income tax in the country and relying on income and sales taxes leaves the state budget vulnerable to economic fluctuations. Clearly, this is a revenue issue and not a spending issue.

    Frankly, one point Dr. Madonna did not address is the $2.1 billion in corporate tax breaks Gov. Corbett and the Republican General Assembly gave away. I just checked the math on a napkin and I came to the conclusion that $2.1 billion is bigger than the $1.4 billion budget gap. Shocking!

  5. Terry Madonna is advocating bigger and more expensive government. Many do not think this in our best interest. The Statists and Collectivists do. So far the Big Government advocates are winning. Let us see what happens.

  6. Terry Madonna seems to be saying that Pennsylvania is not collecting enough taxes to pay for government services that the public need or that special interests, crony businesses and crony unions, demand.

    If government spending were less, then the government would not have to take so much of Pennsylvania taxpayers money.

    The problem is government spending. Less government spending means less taxes.

    Taxes are one very reliable measure of commercial activity and it appears that commercial activity has, in fact, declined in last year.

    Why did this not happen in 2013 or 2014. Why is only happening this year? Why didn’t Corbett have this problem in first three budgets? Why didn’t Ed Rendell have this problem?

  7. So, the “loopholes” in the sales tax need to be addressed? Ivory tower is right. How about people are simply not BUYING they way they used to because 1.) they simply do not have the expendable income they used to have; and 2) the price of everything is unbelievable.
    taxing clothes is not PA’s answer. Now, those gum sales…

  8. Terry Madonna is clearly one of the brightest, if not the brightest, political scientists in Pennsylvania. To say he is a Republican lapdog is insulting. Everyone, Republican and Democrat, has to quit blaming each other there’s, plenty of blame to go around. Until people realize that it is the collision of ideology and reality then nothing will get done.

  9. Here’s two very quick answers: Corbett’s party blocked the Unemployment Compensation extensions – ALL of which would have ended up directly in the PA Commerce stream (since unemployed people spend EVERY dime of their benefits), and, Corbett himself blocked Medicaid Expansion that 20-some other states accepted, which again, ALL of which would have entered the PA commerce stream – sveral hundred million already this year. One-Term Tommie has only himself to blame, because those two factors caused $400,000,000 of the budget shortfall. Not surprisingly, Ivory Tower Madonna blames it all on tax loopholes, like the good Republican lapdog that he is. Never even considers the obvious reasons why we are different from other states.

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