Tax Analysts Blog

The Promise of Tax Stability

Posted on Dec 26, 2012

An interesting fight went on in Oregon this month. It was over a tax incentive of a different variety with no direct tax breaks, just the promise of a fixed tax code. The governor wanted to be able to assure Nike, which was considering a major expansion in the state, that the state wouldn't change its tax rules after the company made an investment in the state. Nike wouldn't commit to the expansion until it had that certainty. Of course, Oregon conceded to Nike's demands.

Nike's resistance to change struck me as noteworthy. Businesses will always take tax cuts if they can get them, but the move by Nike is significant in that it shows that businesses may be equally concerned (or perhaps even more concerned) about having a fixed tax code.

State legislatures are prone to changing tax policy mid-stream. But businesses want predictability. Businesses don’t want to adjust their financial plans every two or three years. They want to know what the factors are that will play into their tax liability. If they know the factors, they can determine their property tax liability and even their sales tax liability. They can work with the numbers to determine what makes sense and devise their business plans accordingly. If, however, the state changes the factors after a year, businesses are back to square one, devising new business plans in the hope of continued profitability.

Stability is likewise a good thing for state governments, though from a different standpoint. Volatility in state revenue streams is problematic for state governments. It is hard to budget and often means robbing from one program to pay for another.

The pending federal fiscal cliff has increased the level of uncertainty for states, but may result in something positive. There has been, talk of fundamental federal tax reform. State and local governments should jump on that band wagon and take a hard look at their own tax systems. Given that many states are still experiencing a slow recovery from the 2008 recession and the potential impact of the federal fiscal cliff on states, now may be the time to capitalize on any shred of momentum for tax reform.

If embarking on tax reform, a major feature states should strive for is stability. Having a diversified portfolio of taxes can improve the stability of states’ revenue streams. That means not relying on a single tax or a single industry to support the lion’s share of the tax burden. Instead, states should use several taxes, including property, sales, and selective excise taxes to achieve a diversified, stable base. The sales tax is among the most stable in that people buy in good times and in bad.

States should, however, question their reliance on less stable revenue sources, such as the corporate income tax. For state tax purposes, the corporate income tax is too cyclical to be a stable form of revenue. Individual income taxes can also be volatile at the state level, and while somewhat counterintuitive, states with highly progressive income tax systems tend to see more volatile revenue streams than those states with flatter rate structures.

Of course, this is all easier said than done. But a diversified tax base will produce a more stable revenue stream, which will, in turn, prevent states from riding the boom and bust roller coaster. Getting off of that roller coaster ride means the state will need to adjust its tax policy, which is attractive to businesses. Businesses like low taxes, but they crave certainty.

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