Don’t Fund Income Tax Stimulus with Corporate Tax Hikes

Don’t Fund Income Tax Stimulus with Corporate Tax Hikes

By Burnet Maybank


I was very pleased to read Governor Sanfords recent call for $205 million in income tax reductions. The Governor is to be applauded for his continued devotion to the cause of tax cuts as a significant economic development stimulus.

I was concerned, however, to read the Governor planned to fund the cuts with an increase on cigarette taxes. This tax hike is projected to fund slightly over half of the cost of the income tax cuts. Clearly, last years billion dollar state government surplus, combined with another projected one billion dollar surplus this year, should be enough money to fund virtually any new government program without a tax hike. In spite of the surplus, there are many tax advocates who propose raising the cigarette tax not to provide relief, but to fund a growing government or to discourage smoking. If a combined 2 billion surplus over the past two years isnt enough to quiet talks of tax hikes, the mind reels at how large the surplus would have to be. After all, it was only several years ago when the entire General Fund was $8 billion!

Last summer I wrote an op-ed pointing out that while cigarette taxes in South Carolina may be low compared to the national average, we have quite a few taxes that are among the highest in the nation (including our individual income tax rates.) Indeed, if you just look at sin taxes, our taxes on beer (3rd highest), liquor (8th highest) and wine (10th highest) are among the highest in the nation. Our real property taxes on manufacturers are the absolute highest in the nation. I urged our General Assembly to spend as much time and energy lowering extremely high taxes as they do raising low ones.

One of the comments I got back from that op-ed was that increased cigarette taxes will have the salutary affect of lowering cigarette consumption, particularly among youth smokers. If accurate, this will surely depress cigarette tax revenue even at the higher tax rate. Experience teaches that raising a consumption tax will produce short term gains in tax revenue followed almost invariably by reductions as people change behavior (for example, by purchasing cigarettes tax free over the internet or at military bases.) Indeed, the flight from premium cigarette brands (which pay tax-equivalents under the Master Settlement Agreement) to off brands (which do not) is already so strong that last year the payments which go to make South Carolinas bond payments were endangered.

We need to look no further than the debate last year over property taxes. While researching this issue, I discovered the Michigan experience. Michigan raised cigarette taxes in 1996 to fund property tax relief. Prior to the hike, from 1993 to 1995, tax collections from cigarette sales rose from $244 million to $620 million. After the tax hike, collections had dropped to $525 million by 1998. Michigan is hardly alone.

My research of some months ago indicate some 18 states plus Cook County, Illinois raised cigarette taxes from 2004 through early 2006. In every instance, there was a decline in sales. In a plan very similar to that of Governor Sanford, Pennsylvania raised taxes by 35 cents. The result was a 13 percent decline in sales over the prior 12 months. Overall sales declined from a low of 4 percent to a high of 28 percent. If that was entirely the result of consumers quitting smoking, then certainly that sales decline is a plus from a health standpoint. But from a tax policy standpoint, that decline proves that a higher cigarette tax is an unreliable way to fund income tax cuts. Virtually every state which has raised a consumption tax has gone through the same experience. Proof of this comes from the example of one of the few tax cuts that Senator Ted Kennedy has supported. In the 1980s, the U.S. Congress enacted a luxury tax on yachts (among other items). The result was a short term hike in tax collections, followed by a sharp decline in yacht sales that resulted in a serious recession in the American yacht building industry, which was then located in Maine and Massachusetts. Congress admitted the error in its ways and repealed the tax.

My point is simple. By all means lower the income tax rate just dont tie the fate of permanent income tax relief to a revenue source that is certain to decline. Focus instead on lowering tax rates in instances where South Carolina has the nations highest.

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