March 22, 2016

Want to Lower Tax Rates? Get Rid of These Loopholes

John A. Dove


Change won't occur overnight, but with wiser policies, Alabama will indeed have a bright and prosperous future to look forward to.

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Even as leaders in Montgomery have been hammering out a new budget, rumors that we may need a special legislative session have been widespread in recent weeks. During last year's session, Alabama faced a major General Fund shortfall of roughly $200 million dollars. This led to two special sessions and heated debates as to how to go about closing that gap. How do we avoid this going forward?

Unfortunately, the "solutions" passed during the last go-around will only prove to be temporary patches, since none solves the long-run issue: The state has a spending problem, not a revenue problem. Without structural changes, we will always have budget problems, and our economy will continue to languish.

My colleague Daniel J. Smith and I explore these structural problems in a comprehensive new economic and fiscal study entitled "Alabama at the Crossroads: An Economic Guide to a Fiscally Sustainable Future." In it, we lay out the problems at hand and provide some sensible solutions which would put Alabama on a path toward greater well-being and prosperity.

One of Alabama's largest problems is excessive spending. In 1975, the state spent about $2800 per person. Today, that has grown to almost $6000. Although this spending may be buying us more services, it has grown faster than personal incomes. Over the past ten years, state spending has increased 21 percent higher than inflation and population growth (a basic measure to gauge how much public spending should increase each year).

This money is being squeezed more and more from hard-working Alabamians, and over time, it depresses the state's economy and discourages entrepreneurship.

The state should immediately impose a binding expenditure limit. Many states do this, with Colorado being the best known example. There, the state may only increase spending at the rate of population growth plus inflation growth. So if the state's population grows by two percent, and inflation increases by one percent, state spending can only grow by three percent.

This has gone a long way in stabilizing Colorado's budget—and would certainly do the same in Alabama—by better aligning public funds with the needs of citizens, and better aligning state spending to true economic conditions. 

Another problem plaguing Alabama is a burdensome, complicated tax structure. We have the largest effective tax rate in the region, beating out Tennessee, Florida, Louisiana, and even Mississippi. This slows economic growth and hampers business growth and entrepreneurship.

Texas—which has no state personal or corporate income tax—saw its economy grow by 5.2 percent last year, compared to 0.7 percent in Alabama.  At the current pace, personal incomes in Texas would double in roughly 14 years, while in Alabama, it would take 103 years.

Adding to the problem are the well-intended—yet harmful—tax subsidies and other tax benefits the state hands out to attract major corporations every year. Businesses and individuals who don't receive them are placed at a competitive disadvantage, even as they must help pick up the tax bill.

The jobs these subsidies bring to Alabama generally cost us far more than should be justified. After we spent hundreds of millions to lure ThyssenKrupp, the cost per job created was estimated to be $370,000—a salary most of its local employees were most assuredly not making.

A better approach would be to remove special subsidies, incentive packages, and other loopholes for big businesses and major corporations, and instead create a level playing field for everyone—including smaller businesses and entrepreneurs—in Alabama. Not only would this promote competition, innovation, and entrepreneurship, it would also allow the state to lower tax rates and increase our tax base. This in-turn increases tax revenue and helps stimulate economic activity.

These are just a few of the more pressing fiscal issues we should address now. There are a multitude of others—such as pensions, K-12 education, and corruption (each of which is discussed in our study)—that we must also address. Change won't occur overnight, but with wiser policies, Alabama will indeed have a bright and prosperous future to look forward to.