Taxes

U.S. states flirt with major tax changes

(Reuters) - Hopes for overhauling the federal tax system are fading in Washington, but in some state capitals, tax reform experiments - some far-reaching - are fast taking shape.

Across the South and Midwest, Republicans have consolidated control of state legislatures and governorships, giving them the power to test long-debated tax ideas.

Louisiana Republican Governor Bobby Jindal, for instance, called on Thursday for ending the state's income tax and corporate taxes, with sales taxes compensating for lost revenue.

A similar plan is being pushed by Republicans in North Carolina. Kansas, which cut its income tax significantly last year, may trim further. Oklahoma, which tried to cut income taxes last year, is expected to try again.

"When it comes to getting pro-growth tax reform done this year, the only real opportunities are at the state level," said Patrick Gleason, director of state affairs for Americans for Tax Reform, the Washington-based anti-tax lobbying group headed by small-government conservative activist Grover Norquist.

His group and other conservative pressure organizations, such as Americans for Prosperity, have targeted state capitals for tax reform campaigns.

Cutting income taxes and shifting the overall tax burden to consumption through higher sales taxes is a long-standing goal of some tax theorists. Critics argue that approach is regressive and unfairly burdens the middle class and the poor, who spend more of their earnings on items subject to sales tax.

Nicholas Johnson, a state tax expert with the left-leaning Center on Budget and Policy Priorities, gave the chances of sweeping tax changes taking hold a low probability.

Still, he said he worried the efforts in the states could move the tax discussion in a direction harmful to middle- and low-income taxpayers and make balancing state budgets harder.

"Even if this is too radical, if it makes other radical schemes seem more reasonable, that's worrisome," he said.

SINGLE-PARTY CONTROL

But the political moment may have arrived for a test.

Thirty-seven of the 50 states now have single-party control of legislatures and governorships: 25 Republican, 12 Democratic. In those states, unlike Capitol Hill, partisan gridlock is not a big issue, making difficult projects such as tax reform easier.

In addition, new ideas look attractive in states that have suffered for years from high unemployment and tight revenue

"We have no choice but to make change," said Bob Rucho, a Republican state senator in solidly Republican North Carolina, who is leading a push in that state for major tax changes.

Rucho and other like-minded lawmakers have a plan to do away with all state individual and corporate income taxes. The plan would replace lost revenue with a new business license fee and a higher sales tax on goods and services not now taxed by the state, such as legal, accounting and spa services, and food.

In his inaugural address on Saturday, Republican North Carolina Governor Pat McCrory promised to work with business "as partners" to eliminate taxes and regulation that stifle growth.

Rucho's plan would remake the North Carolina budget, which now derives 65 percent of its $18.5 billion in total tax revenues from individual income and corporate taxes.

To make up for that much lost revenue, the state sales tax rate would have to rise to 6.53 percent from 4.75 percent, according to a supportive study done by a consulting firm run by Arthur Laffer, a former adviser to Republican President Ronald Reagan and one of the fathers of "trickle-down" economics.

SPURRING GROWTH?

U.S. states often test reforms too controversial for Washington to tackle. Although several states, including Texas and Florida, have no individual income tax, Alaska stands out in modern times for having repealed its personal income tax. It was able to replace the lost revenue with its huge state oil income.

The kind of basic shift to sales tax from income tax being eyed by Republicans is informed partly by "trickle-down" or supply-side economics - embraced by Republicans 30 years ago and still a powerful force in the party. Laffer has advised some of the states' activists.

North Carolina's Rucho acknowledged the argument that the poor would be hit disproportionately by higher sales taxes. But he said new sales taxes on services would also hit higher-income taxpayers.

He said low-income people got more government assistance that could help offset higher tax costs. Also, he added, cutting income taxes would spur economic growth, a key supply-side tenet, helping everyone.

In an interview with Reuters, Laffer said states with lower income tax burdens outperformed those with higher taxes.

Some studies, from liberal and non-partisan think tanks, say just the opposite and cite the relative economic strength of high-tax states such as New York.