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PAR Says Keep Stelly Plan on Track

Efforts to derail the Stelly Plan are building steam for the legislative session. While there has been no ground swell of public opinion against the plan, some legislators are attempting to create one. Others apparently feel compelled to respond to the complaints of a vocal few among the small minority of taxpayers who experienced a net tax increase under the plan. Those attacking the plan, however, are condemning it for doing exactly what it promised to do.

In 2002, voters approved the constitutional amendment enacting the tax swap plan named for its author. The plan permanently exempted from the state sales tax purchases of food and utilities for home use and prescription drugs. To make up for the lost revenue, the plan increased the state personal income tax collections. Tax brackets were changed to increase taxes on higher incomes while giving a small break at the lower end. However, more than half of the increase in 2003 came from eliminating the 65% deduction that would otherwise have been allowed that year for excess itemized deductions. (Excess itemized deductions are the itemized deductions on the federal return that exceed the standard deduction.) The loss of this deduction affects only the 20% of taxpayers, primarily in higher income levels, that itemize their deductions.

While the sales tax and income tax bracket changes were made in the constitution, the deduction for excess itemized deductions was removed statutorily. Bills to restore the deduction have been filed with numerous co-authors. Removing the deduction would undo the tax swap, reduce revenues by roughly $240 million and deny the state a relatively small annual revenue growth. A proposed 10-year phase-in of the deduction would ease the transition but still effectively unravel the plan.

The objectives of the Stelly Plan were four-fold. One was to greatly reduce the use of temporary taxes, the bane of the budgeting process since 1986. Another was to reduce reliance on the regressive sales tax and give low income families some tax relief. The third objective was to shift that tax burden to the more progressive income tax. And finally, the tax swap was designed to make the overall state tax structure slightly more growth-oriented. According to a recent Legislative Fiscal Office (LFO) analysis of the first full year impact, the plan appears to be meeting all of these objectives.

The LFO analyzed the Stelly impacts on three basic types of filers in 30 income classes. Most notable was the finding that 79.3% of all tax filers were in income classes where the average filer received a net tax reduction. This supports the earlier predictions that the vast majority of taxpayers would benefit from the plan.

Opponents of the Stelly Plan continue to make a number of arguments that legislators should examine very closely before rushing to judgment.

Argument: voters were misled into believing the tax swap was revenue neutral while it is really a $1 billion tax increase over 10 years.

Stelly Plan backers said the tax swap would be revenue neutral to the state initially, and it was. However, the plan was always intended to increase revenues in the future. Proponents explained very clearly that by swapping an income tax that was growing at about 7.5% per year for a sales tax growing at 1.8%, the state would experience some net revenue growth over time. This was an expected and openly discussed outcome of the proposal. As a result, net revenue collections will grow a modest $15 to $20 million each year over the next decade due to the growth in personal income. This relatively small extra growth, however, will help somewhat to offset those major state revenues that fail to grow with the economy.

Argument: the Stelly Plan hits the middle-class working family the hardest. An example often given is a teacher married to a policeman with a combined income of $100,000.

Most families consider themselves middle class, but the term has little real meaning. A family with a $100,000 income would rank among the top 15% highest income joint filing families in Louisiana. An interpolation based on the LFO analysis indicates that the typical non-itemizing family with $100,000 in income would have paid about $515 extra in income taxes in 2003 due to Stelly. However, a $258 sales tax savings reduced the net tax increase to $257. The typical $100,000-income family that itemized would have paid $880 more in income tax, but a $271 sales tax savings and a $224 federal tax savings reduced the net tax increase to about $385.

The problem is that while these taxpayers might easily recognize the increase in their state income tax bill, they would not fully or immediately appreciate the offsetting savings in sales and federal income taxes. The net tax increases for families at this income level were not, by any means, draconian. More importantly, the average non-itemizing joint filer with an income below $80,000 would have had a net tax reduction as would the average itemizing joint filer with an income below $65,000.

Argument: eliminating the itemizers’ excess deductions is a tax on charitable contributions and medical payments while penalizing home buyers.

Itemized deductions are primarily for home mortgage interest and charitable contributions. Occasionally, taxpayers’ medical costs can exceed the high threshold to be included. It must be remembered that the taxpayer gets credit against his federal tax for all itemized deductions and still gets to credit deductions up to the amount of the federal standard deduction (currently $9,600 for joint filers) on his state form. The high federal standard deduction means that losing the excess itemized deductions primarily affects higher income families. Furthermore, Louisiana taxpayers deduct federal taxes from their taxable income–something only a few other states allow.

Prior to adoption of the Stelly Plan, some argued that it would not have a positive impact on the state’s bond rating and that local governments would seize the opportunity to pass sales taxes to replace those the plan would remove. However, the bond rating was raised, and the Stelly Plan was noted as a contributing factor. Also, while 31 local sales tax increases were passed in the 14 months following passage of Stelly, there were actually 37 tax increases in the preceding 14 months. Most of the increases, both pre- and post-Stelly, were in small jurisdictions whose rates had not yet reached the limits or the levels commonly levied in the more urban areas.

The Stelly Plan was no one’s idea of the perfect tax reform; however it was an important first step toward a more rational tax structure by providing greater equity and stability. Undercutting the plan now to placate a small minority of primarily higher income taxpayers who experienced tax increases would be a significant step backwards.

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