Do we need an 'insurance policy' for tax reform?

Mar. 30, 2013  |  Comments
Barry Erwin
Barry Erwin
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The Revenue Estimating Conference has been in place for almost 25 years. It's the mechanism state government uses to project revenues for budgeting purposes and it has proven to be a good reform that has greatly benefited the state. The process is pretty straightforward. An economist from the Division of Administration and another one from the Legislative Fiscal Office work independent of each other to develop forecasts of how much revenue state government will take in each year.

They don't collude on the numbers and they use different modeling techniques to arrive at their conclusions. They also revise their estimates through the course of the budget year and they present all their data to the four-member Revenue Estimating Conference which picks one of the forecasts to be the state's official forecast for that time period.

Generally, most would agree that the Revenue Estimating Conference process has been a good one, and as a result the state has experienced very few real deficits over the years and those that have occurred have been relatively small. But longtime watchers of the Revenue Estimating Conference also note that throughout the course of a budget year, the revenue forecasts can often swing, sometimes significantly.

As one of the economists for the Revenue Estimating Conference notes in an assessment of the Conference's performance, variations like that are to be expected as more data becomes available and legislative actions are taken into account. But there is no doubt that initial forecasts have proven less accurate than later forecasts.

The assessment also notes that historically large errors have been associated with economic cycles, such as the one the country is going though now. "The forecasting process is expected to deal with economic cycles," the report notes, "although, forecasting will rarely deal with these cycles accurately."

So what does this have to do with the tax reform proposal? Simply that in Louisiana our own experience with revenue forecasting indicates it's not an exact science, certain things are unpredictable and accuracy improves with additional data, particularly data from actual tax collections. But even with all that, sometimes we get it wrong. This is a critical point as we embark on the tax reform debate.

Margin of error

In the revenue forecasting business no one gets it right all the time and accuracy depends on many factors. Given that reality, it would seem prudent as we go through the tax reform process to 1) allow ourselves some margin of error in our predictions and 2) develop a mechanism to make adjustments if the increases in sales tax revenues generated under the plan don't fully cover the losses of revenue triggered by the elimination of income taxes. There are a couple of reasons why CABL believes this makes sense.

In predicting the revenues generated by the proposed increased sales tax rate there is a great deal of room for uncertainty. For one thing, there's the question of how a higher rate will impact consumer behavior. Will consumers buy less if products or services cost more? To what degree will businesses use perfectly legal and totally expected tax avoidance measures to limit their

sales tax liability on the goods and services they purchase? And, perhaps most importantly, while economic modeling will no doubt be used to predict various consumer responses, how confident are we that they will capture them accurately? Particularly, with regard to myriad services that have never been taxed before.

We should probably anticipate the need for some type of transition from the old system to the new one. The governor's plan indicates the tax change will occur all at once on Jan. 1, 2014. As PAR and others have indicated, that's a short time frame and a lot of rules and regulations will have to be promulgated and approved to spell out more clearly which kinds of new services will be taxed and which ones will not. As past experience with the Stelly tax swap indicates, even a relatively simple change like eliminating the sales tax on food for home consumption can cause considerable confusion in the marketplace for a time. This tax swap would be vastly more complicated, particularly for businesses, and they will need time to understand the new rules and implement them properly. In the meantime, errors and mistakes are to be expected.

There are a number of other observations that could be made, but the point is there is a tremendous amount riding on the ability of the revenue forecasters, whoever they may be, to get the numbers right. And there's ample reason to expect that with the complexity involved in this type of restructuring there will be mistakes.

If the revenue predictions err on the side of bringing in more revenue than expected, that doesn't create much of a problem for the state as lawmakers could always reduce taxes if they choose to bring things back to revenue neutrality. But if they don't bring in as much revenue as expected, that could create a self-inflicted budget crisis that would be hard to repair.

Louisiana is now in the midst of five years of state budget cuts. The chairman of the House Appropriations Committee recently warned that we haven't hit bottom yet and future budget cuts can be expected. Consider for a moment what would happen if after the tax swap revenues fall short of expectations. That would mean that a reduction in revenues due to the loss of expected taxes would be compounded on top of budget cuts we're already anticipating. Higher education and health care would most likely be the most dramatically impacted if recent history is any indication. No one wants to see that happen.

So what do we do? As mentioned before, if revenues come in too high, lawmakers can cut taxes if they choose. If they come in too low, will they raise taxes to make up for it? They may have little choice. If so, which taxes? We won't have an income tax and we have to recognize politically that if we ever do eliminate that tax it will likely never be re-instated. So that's not an option. That pretty much leaves just a handful of other alternatives to consider.

We could again raise sales taxes, but if we do, we would be adding that on top of what would already be the highest sales tax rate in the country. That doesn't seem like a good option. We could perhaps further broaden the sales tax base, but that would skew the winners and losers from the original plan and could make the tax even more regressive depending on how it would be implemented. Or we could create some kind of new business tax, but that would seem to defeat part of the purpose of enacting the tax swap in the first place.

Barry Erwin is president of the Council for a Better Louisiana in Baton Rouge.

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