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Central to all tax reform proposals are the changes required to compensate for decreased revenue created by a tax cut. The most simple and obvious solution is to reduce spending in direct proportion to the amount of any tax cuts. Another approach is to restrict the growth rate of spending, with the expectation that growth of the tax base will exceed the rate of spending, allowing for a reduction in the tax rate.
None of the current tax reform proposals currently being discussed publicly take either approach. Rather, they divert revenue from one form of tax to cover reductions in another tax. In order to fill the hole created by the diversion, the amount of diverted tax collected is increased. For example, one proposal would provide an income tax credit equal to 50 percent of the K-12 education portion of your property tax bill. No taxes are actually reduced. Rather, revenue collected by the state in the form of income and sales taxes would be credited to taxpayers in proportion to their property tax bill collected by local schools. The credit would be applied when taxpayers file their state income tax return. In order to cover over $1 Billion of credits that amount of additional sales or income taxes would be collected by the state.
Two revenue sources frequently targeted to increase state tax revenue to cover the cost of large scale tax shifts are tax incentives and tax expenditures. Tax incentives are specific reductions, credits, and exemptions paid to companies who enroll in programs intended to promote economic growth and development. I have discussed them at length in previous columns this fall. (If you missed them, you can read them on my legislative website, http://news.legislature.ne.gov/dist38/.)
Tax expenditures are reductions to the base tax rate. An exemption of an item from sales tax, such as food or agricultural seeds, are considered a tax expenditure. Some organizations are exempt from all taxes, such as certain nonprofit, religious, or charitable organizations. They pay no property, sales, or income taxes. Any tax deduction, exclusion, tax deferral, or credit also falls under the category of a tax expenditure.
Put simply, “tax expenditures” represent income not collected by the government because a law has specifically identified that good, service, or property as exempt. Generally accepted tax policy recognizes that a product should be taxed only once. Thus, components used in production of a good should not be subject to sales or property tax, only the final product. Other exemptions are intended to promote growth in certain industries, such as the exemptions on agricultural machinery and parts.
In even numbered years the Department of Revenue prepares a comprehensive “Tax Expenditures Report” that uses economic data to estimate how much revenue was not collected, categorized by each exemption created by statute. Smaller, more focused reports are produced annually that provide a closer detail of specific exemptions on a four year rotation.
Tax exemptions vary in their size, importance to the Nebraska economy, and purpose. Some are textbook examples of political rent seeking, such as sales tax exemptions for purchases made by zoos. Others represent a broad policy goal, such as exemptions on machinery, which promote agriculture and manufacturing, Nebraska’s two largest industries. Exemptions for charitable activities reflect our collect belief in rewarding altruism.
Lawmakers have different perspectives on who is “first in right” to the money not collected by tax exemptions. I believe the money belongs to the taxpayer, and the government should take only what is necessary. Others refer to tax exemptions as revenue owed the state, operating from the perspective the government is entitled to your money. Taxpayers need to carefully study tax reform proposals to insure that while additional money may be left in one pocket, the proposal may take even more money out of another pocket. In the end, you may have less net dollars than you had before.