By: Kristen Cox, Executive Director, Utah Governor’s Office of Management and Budget (originally published in Utah Policy )
Utah is widely recognized as one of the best-managed states in the nation, and for good reason. Leaders and residents think ahead and tackle issues before they become a crisis. Tax reform is no different.
We need to make the necessary changes to Utah’s tax structure now to be able to meet the demands of the future. The situation is serious. If we don’t take corrective action, we will face a fiscal crisis where we will be unable to fund core government services like public safety, social services, and transportation in two to five years. It is not a matter of if it will happen, but when.
So, what exactly is the problem with Utah’s tax structure? Let’s delve in. The state’s revenue structure is comprised of income tax, sales tax, school property tax and user fees. This balanced tax structure helps Utah rebound from downturns and creates financial stability. But Utah’s balanced tax system, specifically the sales tax, is weakening.
The sales tax is the primary revenue source for the General Fund, which pays for state government services besides education, including public safety, courts, social services, elections, air quality and transportation.
One of the main issues with the sales tax is a narrowing base. This can be attributed to a shift over the years from a goods-based to a more service-based economy, as well as growth in sales tax exemptions. To put this in perspective, economic transactions covered by the sales tax constituted 70 percent of the economy as measured by personal income in the 1980s and have fallen to a little more than 40 percent today. This means fewer economic transactions are bearing the burden of paying for core government services than ever before. This inequity in the system needs to be fixed.
The next problem the state is facing is the fiscal cliff. This is a complicated facet of Utah’s sales tax structure, but one that is important to understand when discussing the need for tax reform.
Higher education used to be funded through the sales-tax-supported General Fund. This changed in 1996 when Utah voters approved a constitutional amendment allowing higher education to use funds from the income tax. Before this change, income tax, which is the funding source for the Education Fund, could only be used for K-12 education.
Over time, most higher education funding has shifted from the General Fund to the Education Fund because sales tax growth has been moderate while income tax growth has been strong. When higher education is fully funded from the Education Fund, this will reduce the state’s budget flexibility, forcing programs funded from the General Fund and sales tax earmarks to rely on sales tax growth rather than income tax growth.
At our current trajectory, higher education will be fully funded out of the Education Fund in two to five years. A significant restructuring of the state’s fiscal system will have to occur one way or another.
Improving Fairness by Lowering the Sales Tax Rate
Utah’s sales tax is regressive, meaning high-income households pay less in tax as a percentage of income than low-income households. Consumption patterns drive most of the regressivity, with lower-income households consuming much of their annual income to meet basic needs while higher-income households save more of their income having met basic needs. Broadening the tax base to include more services and lowering the overall sales tax rate reduces the regressivity and increases the overall fairness of the tax. This, combined with Gov. Herbert’s proposed tax cut, would create financial relief for low- and middle-income families.
The sales tax is an important part of a balanced revenue structure. Some advantages of a broad-based consumption tax are it does not discourage savings like an income tax and people have control over their consumption decisions.
Over the last several months many people have said tax reform is not for the faint of heart, and it is true. Anytime the conversation of broadening the sales tax base comes up, individuals or businesses who are not currently taxed are ready with a list of reasons why they should remain exempt. Any changes associated with tax reform must maintain Utah’s competitive and business friendly environment. The tax rate should remain low and the tax structure should be simple to reduce the cost of compliance for businesses.
That said, we must assume there are few, if any, exceptions. It is a fairness issue to businesses that already comply. The default should be that all consumption is taxed. Government should not pick winners and losers.
There is no better time to for tax modernization than now when 1) the economy is strong and 2) we have the luxury of preventing the problem rather than responding to it. The executive and legislative branches have forward-thinking leaders at their helms to guide this discussion, so the state is in good hands. If tax modernization is done correctly, it will leave a legacy of economic stability for generations to come.