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VOL. 7 | NO. 45 | Saturday, November 1, 2014

Why are Tennesseans So Afraid of an Income Tax?

SAM STOCKARD | The Ledger

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The odds of an income tax becoming a reality in Tennessee – one of the nation’s lowest-taxed states – are slim to none.

And, yet there is an amendment on the Nov. 4 ballot that would change Tennessee’s constitution by giving the Legislature authority to prohibit passage of an income tax or payroll tax in the state.

State Sen. Brian Kelsey, a Memphis Republican, sponsored Amendment 3, and contends Tennessee’s stance against an income tax is good economic policy.

“Not having an income tax has already brought jobs to Tennessee, and Amendment 3 will bring even more jobs,” he says.

State Sen. Doug Overbey, a Maryville Republican, agrees. He supported Kelsey’s resolution for Amendment 3 and says Tennessee’s Constitution already prohibits an income tax and points out that this amendment was created to strengthen that.

“Not having an income tax has been good for us economically in terms of companies deciding to bring their employees here,” Overbey says. “I think it’s led to helping Tennessee in terms of economic development and job creation.”

Overbey points toward Beretta USA’s decision to build a firearms manufacturing plant in Gallatin, a $45 million investment that will create 300 jobs in Tennessee.

However, Tennessee’s jobless rate was 7.3 percent in September, compared to the national rate of 5.9 percent.

Six of the nine state states without a state income tax – Tennessee, Texas, Florida, Washington, Alaska and Nevada – have had higher than average annual unemployment rates over the last decade, according to the Institute on Taxation and Economic Policy.

Five of the nine – Tennessee, Florida, New Hampshire, Alaska and Nevada – are doing worse than average in terms of median income growth, ITEP research shows.

The $100,000-and-less factor

The state debated adding a state income tax about 12 years ago. The proposal targeted those making $100,000 a year pay, rolled back the state sales tax and eliminated food taxes.

Tennessee’s sales tax rate is 7 percent, but jumps to between 8.5 and 9.75 percent when local taxes are added. Food is taxed at 5 percent plus local taxes.

When income tax supporters brought the matter to the fore in the early 2000s, they proposed ending the food tax, cutting the sales tax to 5 percent and instituting a 5 to 5.5 percent income tax. A $30,000 personal exemption was part of the package as well, according to Bill Howell, of the group, Citizens for Fiscal Sanity.

Determining the impact of an income tax depends on a number of variables, according to Citizens for Fiscal Sanity.

But under that structure, low-income Tennesseans “got immediate relief,” Howell says, and 70 percent of Tennesseans would have paid less when property, sales and income tax were taken into account.

“Everyone earning $100,000 or less in Tennessee would experience a savings,” Howell says.

A look at Tennessee’s fairness

Make no mistake, Tennessee is a low-tax state, ranking 45th in the nation – and lowest in the Southeast – in 2012 at 7.6 percent for the state-local tax burden as a share of state income, according to the Tax Foundation.

The state’s per-capita income was $36,525 that year. Taxes paid in Tennessee on that income were $1,835, and taxes paid to other states were $942 for a total state-local tax burden of $2,777.

In addition to sales taxes, Tennessee has a Hall Tax, a 6 percent levy on interest and dividend income. So Tennessee is not completely void of income taxes, though legislators are trying to phase it out.

Yet, because it depends primarily on the sales tax for revenue, Tennessee’s tax structure is regressive in that people with low incomes pay a greater percentage of their income in taxes than high-income earners, says John Gnuschke, director of the University of Memphis Sparks Bureau of Business and Economic Research. In a progressive structure, taxes would rise as income increases.

The lowest 20 percent of Tennessee earners (making less than $17,000) pay 11.2 percent of their income in state and local taxes, according to the Institute on Taxation and Economic Policy.

The top 1 percent (making at least $372,000 with an average income of $945,900) pay 2.8 percent.

Here's how the effective tax rate breaks down for other income brackets:

  • Second lowest 20 percent (earning $17,000 to $29,000): 10.1 percent.
  • Middle 20 percent ($29,000 to $46,000): 8.8 percent.
  • Fourth 20 percent ($46,000 to $74,000): 6.8 percent.
  • Next 15 percent ($74,000 to $146,000): 5.4 percent.
  • Next 4 percent ($146,000 to $372,000): 4 percent.

Gnuschke notes that, in absolute terms, higher-income groups spend more on taxable items than low-income groups, but not as a percentage of their income.

Tennessee’s main problem is that it’s a “one-trick pony” in its dependence on sales tax as the primary base of the economy, and that makes it difficult to support a growing state economy, Gnuschke says, though he adds that an income tax never has gained traction statewide.

“I don’t think we would consider an income tax whether we prohibited it or not. I think we’re going to continue to depend on sales taxes,” he says.

Maryville’s Overbey says he’s never put much stock in the terms “regressive” and “progressive” as far as taxes go. He points out that people can avoid paying taxes by saving their money. On the other hand, an income tax would tax them automatically, in addition to their savings accounts.

Anti-income tax philosophy

Even as the Tennessee unemployment rate exceeded 7 percent in September, Kelsey says the anti-income tax philosophy has helped increase employment and draw jobs in recent years.

Tennessee’s jobless rate was 7.3 percent a month ago, compared to the national rate of 5.9 percent. Both showed improvement over September 2013 rates, when Tennessee’s unemployment mark hit 8.2 percent and the national rate was at 7.2 percent.

Tennessee’s tax collections were $293 million short of projections last year, and Gov. Bill Haslam has asked state agencies to prepare for 7 percent cuts when preparing next year’s budget.

Despite that, Kelsey argues Tennessee has increased revenue in the last three years while cutting four different taxes, the food tax, gift tax, inheritance tax and Hall Tax.

Kelsey says he isn’t concerned about locking Tennessee into dependence on the sales tax, nor is he worried about the greater burden economists say it places on low-income residents.

“I’m most concerned that people of all economic levels will have jobs, and that’s what Amendment 3 will provide,” Kelsey says.

Gov. Bill Haslam says Amendment 3 clearly rules out one source for revenue, but he doesn’t see Tennessee moving toward an income tax in the near future, so amending the Constitution won’t change anything in the state over the next several years.

“I just think there’s such a sentiment that not having an income tax is good for the state,” Haslam says.

And while he understands the argument that sales taxes put a greater burden on low-income Tennesseans, he points out that the Hall Tax hits people on the upper end.

“I think the one thing to keep in mind on this is, hopefully, not having an income tax is a source of overall growth for us as a state,” Haslam says. “It really does help us recruit and attract businesses here, which ultimately brings more revenue into the state.”

Citizens for Fiscal Sanity isn’t emphasizing the need for an income tax immediately, according to Howell.

“The amendment is really about locking us into the current tax structure and protecting very high-income earners,” Howell says.

An income tax can offer flexibility in how it’s structured to fit a population by income level, in conjunction with sales taxes and other consumption taxes, Howell adds.

He points out, however, that no state in the nation has a truly progression tax structure. Instead, they all tax low-income people at higher rates than high-income people.

Even for small retail businesses, sales taxes can prove to be a stumbling block because high sales taxes make items more expensive, Howell contends.

“Since the sales tax affects low-income people, it affects their spending power,” Howell says. “If you tax something, people are going to do less of it.”

Seventy percent of economic activity is consumer spending, demand for goods and services, which creates more jobs than tax breaks for the wealthy, he says.

What the people say

Ethel Hawkins, 58, of Murfreesboro, says she would like to see a better effort to implement a state income tax.

(The Ledger/Michelle Morrow)

Murfreesboro resident Ethel Hawkins says she plans to vote against Amendment 3.

Hawkins, 58, remembers well the debate surrounding the suggestion of an income tax some 12 years ago, including a proposal that would have made only those making $100,000 a year pay more in taxes.

“It hasn’t ever been done right,” Hawkins says of Tennessee’s tax structure, speaking after shopping recently at Jr’s Foodland on East Main Street in Murfreesboro.

George Jones, 79, retired from General Electric and also a Murfreesboro resident, says those with higher incomes should pay more in state taxes.

(The Ledger/Michelle Morrow)

Hawkins contends a state income tax would benefit the state and taxpayers.

“It’s good,” she says, pointing toward withholding allowances. “You get your money back at the end of the year.” With the state’s reliance on sales taxes, she continues, “you’re not getting what you’re supposed to be getting back.”

Another Jr’s Foodland shopper, George Jones, agrees with Hawkins to an extent.

Troy Hord, 42, of Murfreesboro, says a state income tax “wouldn’t bother me at all.”

(The Ledger/Michelle Morrow)

“I’m not for punishing the guy that’s successful,” says Jones, 79, a General Electric retiree living on a small pension and Social Security. But he adds, “The guy who don’t make nothing, you can’t tax him too heavy.”

Jones says he understands that people on the low end of the economic scale pay a greater percentage of their income in sales taxes than the wealthy.

“I don’t think it ought to be. I think the man making big bucks ought to pay a bigger percentage than the poor boy.” Still, he notes, “These people who don’t work at all, I’m not for them.”

 “I believe we’re probably taxed enough myself,” says Rick Hitsman, 56, a construction worker.

(The Ledger/Michelle Morrow)

Whatever decision is reached on the matter should come only after extensive research, Jones says. “Every decision you make carries consequences, either good or bad,” he notes.

Troy Hord, 42, of Murfreesboro, wasn’t aware of Amendment 3 when he was about to enter Jr’s Foodland. But even though he says he’s near the $100,000 income mark, an income tax “wouldn’t bother me at all.”

Money raised from any increase in taxes could go toward adding jobs, improving schools and helping young people attend college, Hord says.

Rick Hitsman, on the other hand, says “prohibit it” when asked about a state income tax.

“I believe we’re probably taxed enough myself,” says the 56-year-old construction worker.

Even with the $100,000 mark attached to the 2002 proposal, Hitsman remains skeptical of an income tax.

“I’m a single man, so I’m probably taxed a little more than most,” he says, adding he already pays plenty in federal income taxes.

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