State Budgets

Taxpayers Score Win as Pennsylvania House Squashes Proposed Tax Hikes

As legislators and Gov. Tom Wolf contemplate whether to consider the House alternative to damaging tax increases, an overview of the dilemma is helpful.

Late Wednesday night, members of the Pennsylvania House of Representatives passed a budget that is free of the onerous tax increases included in previous budgets passed by the Senate. This represents an initial victory for fiscal responsibility in a prolonged budget battle that threatens to resurrect taxation ideas that have long since been proven to be economically destructive. As Governor Tom Wolf (D.) and legislators contemplate whether to consider the House alternative to damaging tax increases, an overview of the dilemma is helpful.

Not all taxes are created equal. The economic distortion caused by an array of tax types, structures, and rates varies wildly based on the specific tax implemented. Distortion represents the opportunity cost of diverting a dollar from its most productive use. One example is a municipality using tax revenue from a local business owner to provide tax credits for electric vehicle purchases. Those siphoned profits could have enabled business and employment expansion rather than incentivized a particular type of consumer activity. In other words, two distinct taxes yielding identical amounts of revenue may impact economic growth in far different ways.

A well-designed tax code should minimize—rather than exacerbate—this distortion. Broad based, flat, low rate taxes with few—or no— deductions, credits, and exemptions can achieve this goal. Income taxes are some of the most destructive because they discourage work, savings, and investment. In recognition of this, most developed countries have moved away from income taxes due in part to the perverse incentives.  In addition, the highly progressive nature of many incomes generates revenue instability by relying on relatively few people for a greater portion of revenue compared to consumption and property tax bases.

Pennsylvania already has the 2nd highest corporate income tax rate in the country, a combined state and local rate of 17.02 percent, and the 17th highest combined personal income tax rate, 6.97 percent. In response to uncompetitive taxes, people and their businesses are “voting with their feet,” taking the tax base with them. Between 2006 and 2015, 128,000 residents left Pennsylvania, primarily to low or no income tax states. The severance and energy taxes proposed by Gov. Tom Wolf and the legislature over the past two months would only worsen the problem.

Policymakers should take heed to the sound of Pennsylvanians peeling out of their driveways for the last time, rather than pursue creative and destructive ways to raise revenue. The state senate passed a budget bill July 27th which would impose a severance tax on natural gas extraction, heighten energy costs for consumers and businesses by levying a gross receipts tax (GRT) on natural gas purchases and increasing the existing GRT on electricity bills, increase the GRT on phone bills, and impose unconstitutional tax collection requirements on out-of-state online retailers. What is particularly troubling is the possible expansion of the gross receipts tax, a structure which has been condemned by economists for more than two centuries.

The severance tax is also economically problematic. Imposing a severance tax on natural gas production on top of Pennsylvania’s already high corporate income tax will place the state at a further economic disadvantage to numerous other natural gas producing states. Although several leading energy producing states impose severance taxes, such as Texas and Wyoming, these competitors refrain from levying the egregious corporate tax rates of the Keystone State (2.56 percent and zero percent, respectively). According to the Commonwealth Foundation, the severance tax proposal would result in one of the highest effective tax rates on natural gas production companies in the country.

Natural gas production possibilities have grown exponentially thanks to technological advancement. The Marcellus Shale region, which spans Ohio, Pennsylvania, and West Virginia, provides opportunity for prosperity not only for Pennsylvania, but for two other states in the region. This would make production artificially more expensive in Pennsylvania through additional taxation and creates an incentive to devote limited exploration and production capital—and the related jobs—elsewhere. Ironically, the severance tax could result in a net loss of tax revenue compared to projections due to forfeited corporate and individual income tax revenue from relatively less natural gas business activity.

Additionally, revenue from the severance tax would be an unstable component of the budget due to swings in price and production levels. Energy economy based states typically develop large reserves to anticipate shifts in global oil prices. But according to the Pew Charitable Trust, Pennsylvania has the lowest reserves in the nation.

Implementing poor ideas with good intentions does nothing to mitigate the negative results. Instead, tax reform utilizing sound tax principles will minimize the damage from each dollar of tax revenue on the opportunities and prosperity of Pennsylvania’s residents.

In Depth: State Budgets

Smart budgeting is vital to a state’s financial health. The ALEC State Budget Reform Toolkit offers more than 20 policy ideas for addressing today’s shortfalls in a forthright manner, without resorting to budget gimmicks or damaging tax increases. One way to stabilize budgets over time is to embrace…

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