People 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.
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 It is now hopelessly outdated in the 21st-century Internet age.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.