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Arkansas: A tax myth-maker, too

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Arkansas is not quite the laboratory that the government of the United States has afforded us for testing supply-side economics and other popular tax myths, but our experiment is much older.

The central supply-side tenet is that low or non-existent taxes are the key to unlocking growth, jobs and general prosperity, including plenteous government treasuries, but long before President Ronald Reagan unwittingly shot that idea full of holes, we had tested it in Arkansas for something like a hundred years.

If low taxes were the key, Arkansas would have been an industrial juggernaut by World War II instead of the poorest, most undeveloped state in the land.

President Roosevelt singled out Arkansas in the Great Depression because, alone among the states, it would not raise enough taxes to pay school teachers and other public servants or help the federal government supply the desperate needs of people. Governor Futrell and the legislature had greeted the Depression by slashing spending 51 percent, stopping payment on government bonds, cutting teacher pay and then not paying them at all. When the federal government punished the state's delinquency in 1935 by halting all federal assistance to the people of Arkansas, the governor called the legislature into an emergency session and passed a sales tax and some liquor taxes to avoid what the governor expected to be an overthrow of the government by mobs of the hungry and jobless. Still, no one could touch our low taxes.

Until Gov. Dale Bumpers raised income-tax rates and other taxes in 1971, Arkansas had by far the lowest per-capita state and local taxes in the United States. Afterward, we were still 50th but within shouting distance of 49th.

What happened then? Lo and behold, for three years from the month that Bumpers's taxes took effect, Arkansas attracted more industry and created more jobs than any time since World War II. Frank White and Bill Clinton raised state and local sales taxes and a variety of excise taxes, which earned Clinton the Republican epithet of "the taxing governor." For a while in the late 1980s Arkansas led the country in the percentage growth of industrial jobs.

Then came Mike Huckabee, who raised more taxes by far than any governor in history (practically all of which he now disavows having anything to do with).

History is so perverse. Each round of tax increases was followed by a spurt of economic growth, which is not how Milton Friedman and Arthur Laffer said it would happen.

Huckabee's time is most instructive. In 1999, he slashed taxes on investment profits (30 percent of capital gains would be exempt from income taxes), which he and the chamber of commerce said would unleash investment capital and create thousands of jobs. But it was followed instead by a period of economic stagnation. For 4 years, employment would not return to the level of the month when the tax cut took effect. At the trough of that decline, in 2003, Huckabee had the legislature at two special sessions raise a variety of taxes, including a two-year surcharge on income taxes, a substantial increase in the corporate franchise tax, and new sales and cigarette taxes. In the next three years total employment grew by 94,000.

A simple conclusion would be that raising taxes compels growth and tax cuts depress it. But that is as nonsensical as the opposite theory. A more logical one is that taxes, at least at the relatively inconsequential rates levied by the state and local governments, do not drive investment decisions and that business expansion and job creation depend on all sorts of factors: the quality of the work force, proximity to markets, energy costs, supply, demand, a supportive infrastructure and, well, personal whims.

The other myth, same as the national one, is that rich people and corporations bear an undue share of the cost of government at all levels. That is even less the case in Arkansas—and in most other states as well—than at the federal level. Like most states and the city and county governments in those states, Arkansas relies heavily on sales and excise taxes, which fall most heavily on people with low to modest incomes. Millionaires may pay more taxes on goods and services but a far smaller fraction of their income and assets.

Arkansas has a graduated income tax but it stops at 7 percent, and neither the rates nor the brackets were changed from 1971 to 1999, when the brackets were indexed to the cost of living. A family with a modest income—say, $70,000 a year—pays almost the same share of their income in income taxes as a billionaire. The value of the federal deduction for state income taxes, of course, increases dramatically for the wealthy.

Arkansas also is one of only eight states that exclude a substantial portion of the income of its wealthiest citizens from income taxes by exempting 30 percent of capital gains. The legislature this year wanted to remove taxes entirely on profits from Arkansas-based investments, but Governor Beebe scotched it.

The chart nearby shows the relative impact of state and local taxes on segments of the population. The poorest fifth of the population pays 12.1 percent of their income from all sources on state and local taxes, the next fifth pays 12.6 percent, and the top 1 percent — those with average net incomes of $911,500 a year — pay only 5.9 percent in taxes.

Arkansas is not the most regressive state. It falls somewhere in the middle. Washington taxes away 17.3 percent of its poorest people's incomes while taking only 2.6 percent from the richest 1 percent. Vermont, the fair tax state, taxes its poorest at 8.2 percent and its richest at 8.4 percent. (If you are curious, Vermont's unemployment rate is 5.5 percent, Washington's 9.2 percent. And Nevada and Florida, which do not tax incomes at all, have the highest and third highest jobless rates in the country. But Florida did bag Mike Huckabee.)

Arkansas has both a corporate income and a corporate franchise tax that compare favorably with other states, but despite the immense growth of the corporate sector and rising profits, the corporate income tax has borne a shrinking part of the state budget for 30 years.

One reason is that many of the most profitable corporations have found ways to sequester their Arkansas profits in subsidiaries in tax havens like Delaware and Nevada and avoid paying much Arkansas tax. Big oil companies like Exxon and Chevron expense their profit to subsidiaries out of state as do many other multistate businesses.

Most states with corporate income taxes have resorted to an accounting rule known as combined reporting for multistate corporations, and other states are adopting it. The state will compute the parent corporation's total profits and the share of the revenue generated in that state and assess the income tax on that amount. But the Arkansas legislature regularly defeats bills to apply the unitary reporting in Arkansas. The bill is always killed in the Revenue and Taxation Committee of the House or Senate. Lobbyists say it would send the message that Arkansas is anti-business.

The Arkansas corporate franchise tax is little more than a nuisance tax. The tax is supposed to be computed on the basis of a company's assets in Arkansas. The tax, about three-tenths of one percent, applies to the par value of a company's capital stock, which usually has little to do with the real value of its assets. Corporations are structured so that the franchise tax will be minimal. Collecting it is so pesky that the state Revenue Division surrendered the job years ago to the secretary of state.

Over the years, corporations have won exemption from excise and sales taxes that others have to pay. This month, the legislature reduced the amount of sales taxes that manufacturers and energy companies have to pay for their power and fuel. The legislature never meets in regular session without granting a tax exemption to some company or corporate sector.

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