The ’94 Tax Trend: A Throwback to the ‘70s

The trend in taxes this year is to avoid trouble--with voters that is--as states and the federal government scramble to find ways of raising revenue that will be the least displeasing to middle-class taxpayers.

Michigan set the tone last month by voting to use sales taxes and a hefty levy on cigarettes, rather than property taxes, to finance public schools. Wisconsin followed two weeks ago by scheduling a $1-billion cut in property taxes by 1996 and promising to come up with alternative sources of revenue before then. In all, some 20 states are making changes in their tax systems.

The trend is strong at the federal level too. President Clinton proposed a 75-cent-a-pack cigarette tax to help finance health care reform, and Congress hiked the suggestion to $1.25 a pack. Clinton also nodded at the idea of a tax on gambling to raise $3 billion toward the cost of welfare reform.

Politically, it’s easy to target smokers and gamblers, but politicians and voters should understand that economically, such “sin” taxes might bring in less revenue than anticipated.

A more important trend is a widespread shift to consumption taxes, such as sales taxes, rather than property or income and business taxes. “It’s not a bad idea,” says Lawrence Stone, tax expert at Irell & Manella, a Los Angeles law firm. “Consumption taxes are less disruptive to the economy than taxes on labor or capital.”

But there are pitfalls as well as advantages in sales taxes. And the more we understand them, the more we can make intelligent choices about public finance.

Today’s trend is a throwback to the anti-tax sentiments of the late 1970s that produced Proposition 13 in California, which curbed property taxes and reined in government, and Proposition 2 1/2 in Massachusetts. In the present revolt, Colorado voters, seeking to harness government, have passed an amendment requiring ballot approval for any tax change.

But there are no easy fixes. A study released Tuesday says California is suffering a worrisome erosion in education and public services--a fall to 14% below the national average in school funding--because of structural distortions in its sales and property taxes. Other states are likely to run into similar unintended consequences.

The currently popular idea of heavily taxing cigarettes, for example, could prove disappointing in two ways. In the past, tax hikes of pennies to a nickel a pack reduced cigarette sales by about 5%, several studies show. The new steep taxes--the city of Detroit is already moving toward 75 cents a pack--will cause more smokers to quit, which will be a boon for their health but not for school budgets.

Also, higher taxes spark illegal activity. Canada last year levied $2.69 a pack in taxes and watched in horror as smuggling and black markets erupted. It has since rescinded the tax.

As for gambling, “no reason why it shouldn’t be taxed,” says economist Henry Aaron of the Brookings Institution. But economically, gambling revenues are too unpredictable to be a satisfactory source for public finance--as lotteries have proved.

Volatility is a drawback of sales taxes also; tax revenues jump around with consumer spending. “Surpluses pile up in good times, leading to calls for tax cuts, then fall in bad times, producing deficits,” says Ron Snell of the National Conference of State Legislatures in Denver.

And many sales tax systems are out of date. The American people are spending more on services--medical, legal, dental, all sorts of consulting. Yet sales taxes in most states focus on goods. Thus, the buyer of a lawn mower pays a tax but the probably wealthier person who hires a gardener does not.

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The Center for Budget Priorities, a Washington think tank, estimates that California forgoes $1.7 billion a year in tax revenue by not taxing services. But doing so may not be easy. “There are fierce arguments in many states about extending sales taxes to services,” says Carol Douglas, state editor of “Tax Notes,” an Arlington, Va., research publication.

To be sure, property taxes also have their drawbacks: In areas of sharply rising land and house values, such as Montana today and California in the ‘70s, they threaten family homes and farms.

And politically, notes one tax expert, “property taxes tend to fall on articulate people who vote,” which probably explains why they have been declining as a source of states’ revenue for almost a decade.

So what’s the solution? “There should be a balance among sales and property and income or other taxes,” says Steven Gold, director of the Center for the Study of the States in Albany, N.Y.

In a sense, Michigan is creating such a balance. The state’s sales tax was only 4%--below the national average--before voters last month hiked it to 6%. But in property taxes per resident, Michigan ranked high--8th in the country. So voters rebelled.

Also, Michigan had to balance school funding between rich and poor districts, a major need for most states. And sales taxes offer the flexibility that allow this to be done more easily.

California’s system since Proposition 13 qualifies as balanced, with property and sales taxes contributing roughly equal percentages of state and local funding, and income taxes accounting for 45% of state revenue.

The political arguments as the state tries to move ahead revolve around two poles. One is the recommendation of the liberal Center for Budget Priorities to increase revenues by enlarging the scope of sales taxes and loosening the strictures of Prop. 13. The other is the forthcoming recommendations of a governor’s commission headed by former Treasury Secretary George Schultz to spur the economy by cutting taxes on business.

It’s a worthy argument, and as the state pursues it, we should remind ourselves--particularly in the week of April 15--that tax changes come and go but that the average percentage of income most Americans end up paying in taxes, about 25%, has not varied in 16 years, according to the Congressional Budget Office.

And we should also keep in mind a quotation from Justice Oliver Wendell Holmes Jr.: “Taxes are what we pay for civilized society.”