The Myth of the Tax Swap

STATE HOUSE ECONOMICS, CHAPTER II

Following the governor’s lead on tax swaps, more than 20 Senate Republicans unveiled the outline of a compromise amendment to the Senate Finance gas tax bill.

The heart of the proposal is the swap of a 1 percent cut to all income tax brackets for a variety of tax and fee increases, including a 12 cent increase in the gas tax, an increase in driver’s license fees, increasing the cap on vehicle sales tax from $300 to $600, increasing vehicle registration fees, and imposing new fees on hybrid and electric vehicles.

This policy should sound questionable to advocates of tax reform on these facts alone. But – as is almost always the case with tax swap proposals – the devil is in the details.

Tax swaps are designed to help spare politicians the political pain of raising taxes and shifting revenue from one “priority” to another. The newly announced gas tax compromise is no different. Politicians refuse to prioritize road maintenance and repair by taking funds away from other agencies, projects, and programs, and repurposing them for our infrastructure needs. But since road maintenance and repair is a real thing about which actual citizens demand action, they can’t do nothing – so they merely raise revenue in the general area of roads (car taxes, license fees, gas taxes) and claim it will be used to meet maintenance and repair needs.

Swaps don’t ‘save’ you money

Tax swaps deceive, first, by claiming that the swap in question produces either a net savings, or at worst no new costs for all taxpayers. This is the idea of “revenue neutrality.” In reality tax swaps will always produce winners and losers. The governor’s and Senate Republicans’ tax swap plans are no different.

The compromise amendment proposes to raise the gas tax (a tax paid by virtually all consumers) and several other fees that fall on a large number of South Carolinians, while cutting the income tax, a tax paid by far smaller numbers of individuals. According to the governor’s own numbers, as reported by The Nerve, over 1 million state tax filers (nearly 46 percent of all filers) will owe no income tax in 2016. That means these individuals will feel the sting of a gas tax increase with no offsetting relief. They are the tax “losers” in this plan. Middle class families may range from seeing a slight increase to a slight decrease in their tax burden. Nor will the proposal save money in the aggregate. In a press release promoting their plan, Senate Republicans admit they expect the plan to generate $800 million while providing only $709 million in tax cuts. The only guaranteed savers from this plan will be the wealthiest South Carolinians.

In short, the tax swap proposed by Senate Republicans would make South Carolina’s tax system more regressive and more burdensome as a whole.

The hike is guaranteed … the cut isn’t

Second, tax swaps are almost always designed so that the tax increase component is guaranteed, while the tax cut is only a promise. The reason for this isn’t complicated: the tax hike is always the true reason for the policy, while the cut is only included to ensure the hike becomes law. As Sen. Ray Cleary (R-Georgetown) said about an earlier gas tax bill, “the purpose of this bill is to raise revenue, anything else it does is just icing to make it more palatable to voters.”

That’s well said, and it’s true of the Senate Republican tax swap plan, too, which guarantees a 12 cent increase in the gas tax over three years while promising a 1 percent cut to income tax brackets phased in over five years. The annual 0.2 percent reduction in the tax bracket will only be realized if state revenue growth exceeds 4 percent each year. For reference, from 2003 to 2013 South Carolina’s compound annual growth rate (an average of economic growth) averaged less than 2 percent.

Swaps distract from the real issue … intentionally

Third, a tax swap involving dedicated revenues is a more complicated, less efficient way to reprioritize a budget. Because the tax swap proposed by the Republican compromise amendment raises a dedicated revenue tax (all gas tax proceeds are directed by state law to DOT and a few other agencies) in exchange for lowering a tax that provides revenue to the General Fund, it will necessitate a reduction in General Fund money (at least in the short run). When looked at this way, it’s easy to see that lawmakers could achieve the same effect – more funds for DOT at the expense of other programs – by simply cutting back on existing budget items and directing the savings to DOT. Shifting existing budget resources wouldn’t require any change to state law, and would have the further advantage of not giving politicians the authority to choose tax winners and losers.

The tax swap method allows lawmakers and the governor to delay these spending reductions and the accompanying backlash. By reducing future revenue instead of shifting existing resources, lawmakers can plead necessity when they have to cutback spending on programs in the future. The swap method even gives lawmakers the opportunity to avoid making any spending cuts whatsoever, since they can always rescind their promised tax cuts.

In the final analysis, the purpose of tax swaps (especially those involving dedicated revenue taxes) is not to reform the tax code or to lower taxes; the purpose is to raise revenue for a desired state expenditure while provoking the fewest objections from influential constituencies. Tax swaps are a manifestation of the principles of taxation laid out by former French Minister of Finances Jean-Baptiste Colbert, who said that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

Tax swaps are pursued not for their soundness as policy, but for political reasons. As a result, taxpayers should be naturally wary of them. This is true in general, and it is especially true for a plan whose principle purpose is to raise money for a wasteful and inefficient transportation governance system in dire need of major reform before it receives new revenues.

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