Business Giveaways-- or Smart Tax Policy?

"Economic development" was one of the main topics Louisiana Governor Kathleen Blanco wanted to put on the state legislature's agenda when she called the just-ended December special legislative session. But throughout the session, the media focused its attention primarily on Blanco's proposal to set aside $300 million in incentives to attract a new steel mill to the state.

This is too bad, because there were a couple of other state tax reforms on the agenda that made a lot of sense-- with a couple of caveats.

House Bill 67 was, on its face, a sales tax cut for business. In particular, the bill would have accelerated the implementation of a sales tax cut that was enacted in 2004. The 2004 tax cut (House Bill 2 of the 2004 special legislative session) gradually eliminated the state sales tax on the machinery that manufacturers buy for use in, well, manufacturing things.

There's a pretty straightforward reason why manufacturers shouldn't pay sales tax on machinery used in the manufacturing process. The sales tax is supposed to apply only to retail sales-- purchases of finished product for personal consumption by the purchaser, like furniture, a book or a DVD. When the tax applies to sales of products that aren't being purchased for purposes of consumption-- like the lathing equipment that a furniture manufacturer uses to make a chair-- the manufacturer pays the sales tax initially. But when it sells the chair to a wholesaler, it passes the sales tax on to the wholesaler in the form of a higher sales price. The wholesaler passes that higher price on to retailers, who in turn charge consumers more for the chairs they buy. And the final consumer-- a Louisiana resident who buys a chair-- is effectively paying sales tax twice (once for the actual retail sales tax on his purchase, and once for the manufacturer's sales tax that is embedded in the sales price).

It could get worse. Suppose the Louisiana sales tax applied to furniture wholesalers too. Then the Louisiana resident would end up paying sales tax three times when he buys a chair.

This process-- where a sales tax levied on different stages of production gets passed through to final consumers-- is called pyramiding. Pyramiding affects different industries (and different retail products) differently, in unpredictable and unfair ways. The more stages of production in a good are taxed, the more pyramiding there is, and the higher the sales tax on the final consumer.

So when the state legislature moved in 2004 to gradually exempt the manufacturing machinery bought by manufacturers, they were taking a good step toward eliminating pyramiding, and making the sales tax more rational and fair.

They were also taking a very expensive step, which is why the 2004 legislation phased in this exemption very gradually-- between 2005 and 2010. So when it became clear this fall that the state was facing budget surpluses (at least in the short run), lawmakers sensibly decided to try and accelerate the phasein. As the special session dissolved into partisan chaos, the sales tax bill fell by the wayside (as did almost all of Blanco's goals for the session).

And that's mostly too bad. But here are two caveats:
1) Using surpluses to fund tax cuts only makes sense when you've got a long-term, recurring surplus. Paying for a permanent tax cut with temporary money is a recipe for fiscal disaster--and no one in state government is saying that the state is permanently awash in funds. So there are real questions about whether the accelerated cuts would have been affordable.
2) Accelerating the tax cut for all manufacturers is a fine thing, if it's affordable. But one bill that was floated during the special session would have basically accelerated the tax cut for one company: General Motors. House Bill 15 would have immediately exempted "certain machinery and equipment of motor vehicle manufacturers with an NAICS Code beginning with 3361." The official fiscal note for HB 15 notes that "Proponents of the bill have indicated that it is intended to provide a full tax reduction to the General Motors facility in Shreveport."

This is the wrong way to tackle this problem. GM shouldn't get special treatment simply because it's got more effective lobbyists than other Louisiana industries affected by the sales tax. Carving out special preferences for particular companies heightens the perception that legislation, and tax legislation in particular, is being bought and paid for by moneyed interests. This perception (which is unfortunately correct all too often) undermines public support for adequate and fair taxation.

There's a lot of unfairness in the Louisiana tax system, and eliminating pyramiding in the sales tax base is only part of the answer. But let's hope that when lawmakers return this spring to deal with important questions of tax fairness and adequacy, they attack the pyramiding problem in an even-handed and affordable way.