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December 17, 2012
Transcript of Tax Analysts Panel on State Fiscal Cliffs

Full Text Published by Tax Analysts®

The transcript is available of Tax Analysts' December 14 roundtable discussion of state fiscal cliffs and state taxes, including Donald J. Boyd of the Task Force on the State Budget Crisis, Nicholas Johnson of the Center on Budget and Policy Priorities, Joseph Henchman of the Tax Foundation, and Cara Griffith of Tax Analysts.



Washington, D.C.
Friday, December 14, 2012



      President and Publisher
      Tax Analysts

      Co-Executive Director of the Task Force on the State Budget

      Vice President for State Fiscal Policy, Center on Budget and
      Policy Priorities

      Vice President for Legal & State Projects, Tax Foundation

      Legal Editor, State Tax Notes
* * * * *


(9:03 a.m.)

MR. BERGIN: Good morning. Thank you for coming. Welcome to the latest in the Tax Analysts series of discussions on key issues in tax policy and tax administration. Today's topic -- it's very important, is the fiscal cliffs in the states.

I'm Chris Bergin, the president of Tax Analysts, which is the nonprofit publisher of Tax Notes, Tax Notes Today, State Tax Notes, Tax Notes International, and many other fine print and online products on federal, state, and international taxation. We are in our 10th year of public discussions on tax policy. If you are new to our discussions, let me say it's great to have you here and you're most welcome.

Let me take just a moment to explain our process today. I will open things up with some brief remarks to introduce our topic. I will then introduce our distinguished panel of speakers. Each of them will address aspects of our topic. After that we will open up the discussion to all of you, and we encourage all of you to participate. Whether you are seated at the table or just a bit away from it, just wave and I'll find you. We are streaming audio of this event on our website, and we will post both the audiocast and a transcript there. We are also tweeting this event as we try to reach more people beyond this room through social media. So, for all media purposes, we are on the record. For that reason, when I recognize you, please tell us who you are. Also, please speak into a microphone. For those away from the table, we have handheld mics that we will quickly get to you. I will moderate the discussion, and I promise we will end by 11:00.

Now, onto the subject at hand, state budget challenges and their implications for state tax policy. I'm sure we've all heard the proverb, "May you live in interesting times." It's supposedly the English translation of a Chinese curse. The states probably think it's a curse. From California to New York and just about everywhere in between, states have been living in interesting times in recent years. And their experiences have not been a happy one. As I'm sure you will hear today, the Great Recession that began in late 2007 set state tax revenues plunging. By also sending unemployment way up, it greatly increased the burdens on state governments to respond in some serious way. But unlike the federal government, states don't have the luxury of simply borrowing to find the money they need. Instead, virtually every state faces a legal requirement to technically balance its budget each year. I say "technically" because that raises other issues and clever maneuvers, some that resemble a three-card Monte game.

This balanced budget requirement, however, not only makes budget planning much more difficult for those states, it also makes it harder for the economy to start growing again. Here's what can happen. The economy slips into recession. State revenues plunge because fewer people are working and paying taxes. State budgets fall into the red because of this plunging revenue. States respond by cutting spending, raising taxes, or both. These actions can make the economy worse, setting up a vicious cycle of more cuts, more taxes, and more problems for more states. Fortunately our economy is now recovering, although not nearly as quickly or as strongly as anyone would have hoped. State revenues have picked up, but they have not yet returned to their pre-recession levels after adjusting for inflation.

Meanwhile, states face a variety of serious challenges to their budgets, both now and in the future, and depending on how they are addressed, those challenges could have major implications for their future tax policies. For one thing, the continuing deadlock in Washington over the federal fiscal cliff could, if it leads to big tax increases and across-the-board spending cuts next month, send the economy back into recession in early 2013.

For another, states cover a sizable share of their budgets through what are known as grants-in-aid from Washington. That aid supports states and local government in such areas as education, transportation, public health, and law enforcement, and it could face very serious cuts because of the across-the-board cuts that are now scheduled to so-called sequestration, or because of an agreement that we hopefully will get to reduce federal deficits in the coming years.

When you hear the term "fiscal cliff" you obviously think about the debate we're having here in Washington today about what may or may not happen in early January. But as you know, we've named this conference "State 'Fiscal Cliffs' and State Taxes." We did so for a number of reasons. Not only do states face their own cliffs in their own fiscal turning points and obligations, both short and longterm, they also will be greatly affected by what happens in the coming weeks in Washington. That is, there's a real connection between the federal budget and state budgets that many people in Washington don't spend much time talking about. So, I'm glad that we're here today to think about it and talk about it, and if we're lucky, maybe even force others in Washington to think about it just a little bit.

To examine all of this from multiple sides, we have an absolutely terrific panel this morning. I will introduce them in the order in which they will speak. Donald J. Boyd is co-executive director of the Task Force on the State Budget Crisis, and he's also a senior fellow at the University of Albany's Nelson A. Rockefeller Institute of Government. Nicholas Johnson is vice president for State Fiscal Policy at the Center on Budget and Policy Priorities. Joseph Henchman is vice president for legal and state projects at the Tax Foundation. And Cara Griffith is the legal editor of State Tax Notes published by Tax Analysts, I'm proud to say.

So, without further ado, Don, could you start us off please.

MR. BOYD: I'd be happy to. Thank you for the invitation, and thank you, both for Tax Notes and State Tax Notes. They're great publications and I use them all the time. So then, about the Task Force on the State Budget Crisis. Richard Ravitch was New York's lieutenant governor in 2010. He was brought in when David Paterson moved up to be governor, and he was asked to develop a multiyear plan to help with New York state's budget gap and became deeply involved in budgeting in New York and ultimately in budgeting in the states and trying to understand it, and quite frankly became concerned when he saw the lack of long-term planning, the extensive reliance on nonrecurring resources, liabilities that were ill-disclosed, and several other features of New York's budget and potentially other state's budgets. And because of the things that states and localities do, meaning that they are the financers and/or providers of K-12 education and higher education for the most part, certainly public higher education, of course, and the major funders and implementers of infrastructure. We rely on them for public safety. Because of these things, he was concerned about the capacity of governments to do this in the future to be sustainable over the long run, so he established the State Budget Crisis Task Force with his friend and colleague, Paul Volcker, and assembled a very prestigious board including among others Alice Rivlin, whom I'm sure many of you know, and asked that we examine six states: California, Illinois, New York, New Jersey, Texas, and Virginia; and also think about the issues cutting across the states. So, that's what we did. We reported in July, and there are some individual state reports still coming out, including New Jersey yesterday.

The conclusions of the task force -- sometimes I talk about a freight train. I think in the fiscal cliff metaphor, we would probably talk about a fiscal slope as opposed to cliff for states, but in many respects that's really harder for state governments to deal with. That is, it's very difficult to deal with problems that accrete year by year by year. Not necessarily suggesting an immediate fiscal cliff would be good news, but it's very difficult to solve problems that no single year causes a calamity. And we identified what we called six major threats, and I'll just briefly address them. I want to make sure I stay -- keep my remarks short.

We talk about Medicaid growing faster than the economy and taxes, you know, decade after decade after decade. We talked about within five years, you know, the growth of Medicaid relative to taxes clearly could outstrip them by more than another $20 billion annually by the end of five years. The primary issues with regard to Medicaid we said were underlying healthcare costs and the difficulty of resolving them, as well as demographics in that while federal healthcare reform plays a small role, it's not a major role.

Federal deficit reduction is an absolutely major issue facing the states, and (inaudible 00:13:16) are the three main impacts. The impacts on the economy of individual states. That is, some states -- Virginia is a great example, of course, being extremely at risk of cuts in procurement and personnel. Federal grants to states are going to be an attractive target. Quite frankly, if states got out of this with sequestration cuts and nothing else, they probably ought to count themselves lucky. Medicaid, of course, is exempt from sequestration. It's hard for me to see how it's going to be exempt from longer-run federal deficit reduction efforts. It amounts to more than 40 percent of all grants.

And the third area we said is taxes, of course. Changes in federal tax policy could affect the capacity of states to provide services in finance infrastructure through changes in deductibility of state and local taxes against federal, and through changes related to exclusion of interest on municipal bonds. And, of course, there's both a threat and an opportunity for states if the federal government makes either substantial broadening to its own income tax base, which most income tax states conform to in some fashion or another or rely heavily upon. And should there be a federal value-added tax, of course, that creates, again, certainly substantial threats and maybe opportunity.

That was the second thread -- federal deficit reduction. The third we talked about was unfunded retirement or underfunded retirement promises. Pensions, as actuaries measure them, about $1 trillion underfunded, even now, even after some substantial market recovery from the declines from 2007 to 2009. And, quite frankly, the way economists value those liabilities, they're really underfunded closer to $3 to $4 trillion. Retiree healthcare promises, underfunded by probably more than $1 trillion, state and local combined. There's a difference because retiree healthcare -- those typically are contractual and more subject to change than pension promises which there's a huge gray legal area there as to whether states can change those, and that will vary state by state and will be litigated extensively.

We talked about narrow and eroding and volatile tax bases in our report. And quite frankly, if there was a fiscal cliff for states, the cliff part if you will, happened right in the recession and after the recession. It's extraordinary. I have these dramatic graphs that show the amazing drop-off in tax revenue. This particular recession, everyone knows it's the deepest since the Great Depression. Maybe a little less well understood is that the portions of the kind of measureable economy that most directly drive taxes have fallen farther and come up more slowly than the broader economy even since it's been recovering. And third, special features of the way states tax, and in particular, their taxation of income from financial assets, capital gains, for example. That has simply plummeted, and while there's been some recovery, it appears not a lot. So, we fell off a cliff. I have this graph. My title is "Limping up from the bottom of the cliff" because that's where we are. We are not back, as Chris noted, we're not back to where we were in inflation-adjusted terms. And even that, that's not really the measure of, if you will, returning to normalcy because service demands increase substantially, recession or not, and certainly because of the recession, even more than usual, so that we're well below where some sort of baseline revenue growth might have put us this far out from the recession.

So, volatile taxes, frustrating planning, narrow and eroding tax bases, particularly the sales tax. Everybody's well familiar with a lot of issues related to the sales tax, but the base relative to the economy's decline by roughly a quarter over the last two decades, and it's state by state by state for the most part. And those are the major issues we talked about, most of which are continuing in some fashion. We also talked about local government fiscal stress which varies state by state and is not necessarily a budget buster for state budgets, but it's a substantial issue.

And the last thing we talked about was the sixth thread, if you will, was state's own budget laws and practices. The failure, quite frankly, to do any sort of longer-term planning, the inadequacy of rainyday funds. You have these volatile tax systems trying to fund services, the demand for which is either stable or rising. It certainly doesn't fall in recessions. And then, little capacity to manage through that, and while rainyday funds can be part of the solution, for the most part, they're not large enough and not useful enough.

The recommendations of the task force were greater transparency and accountability. Right? Who's not for that? Better disclosure of liabilities, multiyear planning and forecasting, better rainyday funds, pensions -- disclose the risks and fund them. One of the things -- it's not true for all plans in trouble, but for some of the plans in trouble, I have a list in one of my presentations called the "Billion Dollar Bad Boys Club" and in our studies, California, Illinois, and New Jersey were in the multi-billion, really, quite frankly, the 2-digit Billion Dollar Bad Boys Club. I mean, substantial underfunding of liabilities, so another recommendation was fund the obligations you take on, the promises you make. Seems like a simple recommendation, but it's certainly not broadly followed. Taxes, broader bases, to help both keep rates low and to help soften some of the volatility, and then the last major recommendation was that there needs to be a federal process that attempts to properly consider the impact on states. We're not suggesting (inaudible 00:20:05) a federal deficit reduction. We're not suggesting for a moment that there won't or shouldn't be federal deficit reduction or that it won't or shouldn't affect states, but they need to be part of the process in terms of Congress and the president being well informed, and there's a clear disconnect there. So, with that said, that's --

MR. BERGIN: That's one of the reasons we're here is because of that clear disconnect. Nick.

MR. JOHNSON: Thanks Chris, and thanks, Tax Analysts, and all of you from Tax Analysts for all of your work. I just want to echo what Don said, which is that State Tax Notes is really an indispensable tool for everything that we do. In a sense, it is the daily journal of the little community of those of us who focus on state and local taxes, and we really could not do our work without it. So thank you for all of your hard work on that.

And Don has done a great job of laying out a lot of the challenges that states face. I think I am going to focus on four particular challenges. And maybe we might want to think about them as not so much as cliffs, but as sinkholes on the road to where we want to go. And it is one of those things where you can maybe swerve around one of them. But if you are spending all your time swerving around the sinkholes, it makes it a lot harder to get where you do want to go. So then the question arises, "Well, where do we want to go? What is the point of having state and local taxes to begin with?" And as Don noted, state governments play what I think in Washington is an often unrecognized, underappreciated role in our nation's economic future, right? State and local governments educate billions of schoolchildren every day. State and local governments build and pave the roads; keep the streets safe; provide healthcare to children, senior citizens, people with disabilities; and a host of other functions -- you know, human services, perfecting the environment often, and partnership with the federal government, but it is the state governments that are at the front line of that.

So all the challenges that we are talking about today are not just sort of budgetary challenges, not just pen and paper spreadsheet kinds of challenges. They really raise into question the ability of our country to prosper and compete for decades to come. Because without a good workforce, without a good infrastructure, you know, we are sunk. So with that in mind, and with the priorities ahead -- and keeping in mind the state and local -- so transportation, healthcare, education, public safety -- that represents 80 percent of what state and local governments pay for.

So the four sinkholes that I want to talk about briefly, and then look forward to conversation are -- one is, what has happened as a result of the recession. How did states respond and where do they stand today? Two is what is going on with the federal government. I think Don laid it out well, although I want to disagree on one minor point with him. I want to talk briefly about the long-term structural challenges that I think many of us have been talking about for years, which certainly include what's happened to pension funds, which certainly include healthcare costs. I want to talk a little bit about structural challenges and state tax codes. And then, along the same lines as problems in state tax codes, talk about some of the political developments in some of the states that I think are really worth watching, and I think have been underreported and underappreciated here in Washington, although I am sure many of you in this room are aware of them.

So let's start with the legacy of the recession and just remind ourselves this was not just a recession, right? This was the Great Recession, the worst economic falloff in 70 years which led to the worst state budget problems in at least 70 years. The data actually don't go back that far, so I am comfortable saying the worst state budget problems on record. And states are still feeling those effects, right? Most states are still funding K through 12 education at levels below what they were funding them in 2008. Most states are continuing, as Chris said, to collect revenues at below pre-recession levels, well below pre-recession levels with really, given where the economy is, little prospect of getting even back up to those pre-recession levels for several more years, meanwhile, needing to educate a growing population, needing to provide services to a growing population.

Rainy day funds, reserve funds so critical. Here we are five years after the start of the last recession. You know, one would think at this point we would be starting to build back those rainy day funds back up. They are still just barely above where they were in 2008, 2009, and 2010 when they had been drained to help states close budget gaps.

So, you know, there is a lot of rebuilding work to go on in the states. So I think that is a huge challenge, and something federal policymakers need to keep in mind as they think about our own fiscal challenges here in Washington with the federal budget. I do agree with Don that there are huge threats from the whole deficit reduction process that costs will be shifted to states. Where I disagree slightly with Don is I am not sure it has to come out of Medicaid. Medicaid represents about half of what the federal government sends to the states. But Medicaid has a huge role to play in implementation of the Affordable Care Act, which is going forward. And I think there is every likelihood that that will be one of the places where this administration draws a very, very, very strong line against cost shifts to states. Because if you think about it, one of the red flags that governors are saying is, "Well, we don't want to do the Medicaid expansion because we don't trust the federal government to stand by its commitment to Medicaid." The answer from this administration, at least for the next four years, will be "No, no. We are really standing by that commitment to fully fund Medicaid."

But that means all the more pressure on the other half of what federal government sends to states, which is this illnamed category of spending that we call nondefense discretionary, which manages to - - you know, no marketing professional came up with that name, or if they did, they should be fired. I like to call it just important stuff the federal government does for our country. So it is just little things like K through 12 education. It is the FBI. It is the National Institutes of Health. It is a whole range of things. And a big chunk of that, about a third of that is in the form of grants to state and local governments.

So if Medicaid is largely off the table -- if benefits to current Social Security and Medicare retirees are largely off the table, if defense is largely off the table for additional cuts, I think this NDD category, including the grants and aid to states, is hugely threatened, which at a time, again, when states can ill-afford it.

Structural problems at the state level, tremendous, longstanding. Many of us here at the table have written about and thought about these challenges. They range from the sorry state of state sales taxes, the basis of which narrow every year. They are states tax goods, not services, do a lousy job of taxing stuff over the Internet -- state income taxes have failed to largely capture the tremendous income growth at the top end of the income scale -- heavy reliance on excise taxes, and so on. A slew of structural challenges in states, that mean the state revenue systems are not wellmatched to the cost of refunding pension funds, paying for growing healthcare costs, educating the future workforce, and so on.

And then the fourth of these sinkholes is some of the political developments in the states. What I am seeing in a lot of states is a high degree of political polarization, as has been pretty well documented by NCSL and others, fewer states under divided control than in many decades, divided party control, about half the states under one party Republican control, and many of the rest under one party Democratic control, and many of those Republican-controlled states under Veto proof majorities, and often it is a very conservative breed of Republicans sort of different from the heartland balance the budget fiscal responsibility sort of republicans that many of us have been accustomed to over the years. A result of this has been, I think, an assault on the idea of progressive taxation in the states that I am not sure we have seen ever before. And it is sweeping and it is surprising.

So let me give you one example of how this resulted, particularly in bad tax policy. There are three states that, over the last couple of years, have enacted full or partial exemption from state income taxation of all income from pass-through entities from Scorps, from LLCs, from partnerships.

Now it has long been argued that the way we tax pass-through entities at the states -- which is the same as how it works at the federal government -- it is taxed at the individual level -- is how all business income is taxed, right? So a lot of people say, "Well, we shouldn't do it the way we usually tax Ccorporation incomes. We should just tax it at the individual level." These states are going in a different direction and simply exempting all passthrough income. Now this is a tax break for some small businesses, and it is built entirely as a tax break for some small businesses. It is also a tax break for a lot of entities that aren't small businesses, that aren't job creators. And it is actually very, very few businesses that are actually small business job creators. So we are seeing those kinds of deep and very, very costly tax cuts in states.

Now one of the consequences of this is that, in some of these states it is not being paid for, and the cost is likely to be or is explicitly planned to be covered by broadening or increasing other taxes, sales taxes, other kinds of business taxes, and Kansas is a great example. Probably the largest tax cut ever passed by any state last year -- the income tax cut passed in Kansas -- now is being talked about by being covered by an increase in the state sales tax going forward.

So we are seeing big changes, big shifts, and I think challenging for the idea of the provision of and financing of education and transportation and healthcare in the states. Because I think this assault on progressive taxation in the states is being driven by forces that I am not sure we fully understand. It is not popular. We just had a major national election that had a lot to do with the idea about progressive taxation. I don't think people in this country are really opposed to progressive taxation. And in fact, state polling does not support these taxes most of the time. States like Oklahoma; I have seen polling that suggests that the vast majority of Oklahomans would rather restore some of the funding that has been cut for public schools than to go ahead with some of the sweeping tax proposals. So it is not being driven by public opinion, and it is an interesting question about where it is coming from, but it does present a lot of change going on in the states.

So a lot of interesting challenges happening at the state level. And I do think it also presents some opportunities to have some conversations about what do we want state taxes to look like in the future. So thanks very much for the opportunity to be here. I am really looking forward to a good conversation.

MR. BERGIN: Thanks, Nick. Joe?

MR. HENCHMAN: Thank you. Joe Henchman with the Tax Foundation. I also, of course, want to echo the excellent indispensable work that Tax Analysts does in keeping everybody in the country informed on what is going on. You know, we are also a subscriber. We don't have a lot of subscriptions, but Tax Analysts is one of those that we certainly could not live without. And we are certainly also very honored by State Tax Notes' recognition of our work in state and local tax policy this year, and we hope to continue to live up to those expectations.

I also want to extend a thanks to CBPP for one of the reports that you've put out this year, which I find very well done and essential reading for state officials, and that is your report on rainy day funds. I know, in the future, we are going to get out of this economic slump and states will re-enter that cycle of raising their spending up to unsustainable growth levels. And it is important that states have something to fall back on when the economy goes into a dip. States aren't doing that. You called them out on it, and it is the right thing to do, and states should build up their rainy day fund. So if you haven't read that report by CBPP, I strongly suggest it.

Of course, I also want to note that Mr. Boyd's report, the Ravitch-Volcker report, should take its place in the pantheon of essential reading for all state legislators because it somehow manages to summarize in six points, but extensively researched and explained pretty much all of the major pressure states are facing in the coming years. It is one, of course, we work with extensively ourselves, and I think you do a good job laying out the case of why there needs to be some significant changes in a lot of these policy areas.

Almost to the point where I am actually surprised where there's still so much denial about it, and there is at the state level on a lot of the points that you brought up. Public pensions, there's a lot of research that has come out recently on the unsustainability of public employee pensions. We at the Tax Foundation are actually in the middle of our strategic retreat. Yesterday was day one. This afternoon will be day two. And our archivist dug out a report that we did, I think in 1971, talking about the structure of public employee pensions. And we are like, "These aren't structured very well. And in the next couple of decades, these may cause problems for state and local governments if something is not done about it." Unfortunately, I guess not enough people read the report and nothing was done about it and it is a big problem.

The good people at the Pew Center on the States took every conservative assumption of "everything turns up roses from this point on" and found that it is over a trillion dollar shortfall between what states have promised and what they will actually be able to pay. And if you take away some of the assumptions -- if you assume the investment returns will not be percent (phonetic) a year, if you assume that maybe they will continue to promise more benefits, as they have in the past, there are other reports out there. The American Enterprise Institute has one, and you get into the trillions and trillions of dollars. And, you know, Nick mentioned the importance of infrastructure in healthcare and transportation. I am a big believer in all of that too. Everybody is. These are essential functions of state and local governments.

And I am originally a Californian and we often, in California, think wistfully back in the days of Pat Brown in the 1960s when state government built things. We built the California water project, built the interstate highway system, California roads, built the university system and the California State University system, got a lot of stuff done. And, you know, we don't do that kind of thing right now. It is kind of turning into a farcical tragedy, the effort to build a high-speed rail system in California, which just may be the one place outside of the Northeast where it makes the most sense to do it.

And the ongoing, well again, tragedy of the California state budgeting system, the California tax system, it pains me as a sixth-generation Californian, and at this point, a refugee from the state, what's going on in my home state. But the gist of it is, is that we don't spend on infrastructure and we don't spend all this stuff because the money is just going to salaries and retirement benefits, a lot of the resources that used to go to that. And, you know, there's graphs and charts that you can see that illustrate this point. They're going to hire a lot of people to work in state government and pay them a lot, a lot more than probably should be paid. This isn't just a California problem, but California, Illinois -- of course these are the states furthest along. Illinois at present is debating a proposal to borrow $7 billion to pay outstanding bills. California at least, when they ran out of money, they were nice enough to issue IOUs to people. Illinois is just not paying people.

And there was an expose on 60 Minutes a couple of months ago of some nursing homes and elder care facilities who rely on Medicaid payments, rely on state payments, and they are just not getting them, and they are having to close their doors, and that is the net result.

Nick mentioned that the administration is fully committed to fully fund Medicare, and I just think that is denial because we don't have the money. We have fully committed to fully fund a whole lot of things that we don't have the money to do, at least at present growth rates. And, you know, that is sort of the -- the big elephant in the room for me is how do we get our national growth rate up? It was great in the 50s and 60s. It was less good in the '70s. It was great again in the '80s, at the latter part of the 90s, and it is been anemic for the last 10 or 12 years or so.

And, you know, it is kind of in the background of the larger debate. Although, I think, in this most recent election it got sidetracked. We had a lot of discussion about distribution, a lot of discussion about the top 1 percent, but not really a lot of discussion about how we grow our economy, how we get it up to a level that we can actually afford to meet some of the commitments that we ought to meet, as well as provide, the good healthcare, good transportation, good infrastructure for everybody without breaking the bank, because if the pie is not growing and we are all fighting over the scraps that are left, it is not going to be very pretty, not for anybody.

We have passed out a couple of handouts. One of them is a map we posted on our website. We post a new map every week on federal aid to state budgets just because, even a lot of state legislators -- and I hesitate to say -- even governors aren't aware of how much of their budget comes from the federal government. In many cases, a third. One state is up to near 50 point, you know, the amount you raise yourself versus the amount you get in federal aid. And that is not going to last. I don't have any crystal ball or, you know, I haven't been invited to any secret White House meetings on what they are going to do about the fiscal cliff, but I have to agree with Mr. Boyd's, say, prediction or maybe anticipated prediction that that federal aid is going to get a cutback. And, you know, everybody's going to be fighting hard to make sure that Medicaid isn't cut, even though states use it, in many cases, the matching funds as a piggy bank to steal the money and use it for other things.

The transportation money is not going to get cut, even though we are raising like $30 billion a year from the federal gas tax and spending $70 billion on transportation, and that is not sustainable. And we have just made a whole lot of promises that -- I don't see how we can keep all of them. And I think that is a recognition going into the negotiations over this debate where, at the end of the day, I think we are all hoping that both sides will give a little. But, the White House and the Senate, give a little will be paring back some of the promises that have been made that we just can't afford.

So where do we go from here? You know, obviously I was most interested, Mr. Boyd, in the section you had on narrow eroding tax bases. It is an issue I work with a lot. I can do a little more than second a lot of your conclusions. The state corporate income tax is essentially extinct as a revenue source. It will be soon enough. The states have eroded away. They have either exempted all of their home state companies from the corporate income tax or they handed it away in targeted tax incentives. There's been some effort to reach beyond state borders and try to soak out-of-state companies that have run into some federal constitutional claims. But that is not going to make up for the fact that, if you are not willing to tax your own companies in your own state, you should just -- it is a hopeless cause. The tax itself, of course, cost far more in compliance and administration than it brings in in revenue. It is a big problem at the state and local levels.

The sales tax -- John Mikesell is a great friend of the Tax Foundation and his work which you cite out of Indiana University on the continual erosion of the sales tax base, a tax that was, by hook or by crook, designed in the Great Depression to tax goods. Now we are a service-based economy, and no state has successfully, yet, made the transition from taxing primarily goods to also taxing services. A couple of states do it but they have always done it. So I think that is something we may see in the coming years. A lot of states have tried. I think one state just has to do it right -- and we'll get the roadmap for how to do it -- and then other states will be able to follow to broaden the sales tax to services and reduce the rate overall.

I mean, there's a lot of discussion of course on online taxes and internet taxes. And states talk about this is the thing that is destroying our sales tax base, but it is a tiny portion of the lost revenue relative to what you don't get by taxing services, what you don't get by taxing groceries, which not only is a huge amount of consumption in the state, but also brings a lot of stability to the sales tax. When you tax groceries, your sales tax is much more stable than when it is not.

MR. HENCHMAN: But you know, all of these things are -- you know, Nick brought up some polls of, you know, things people don't want to tax or things people do want to tax. Well, I usually read a lot of those poll results. Do you want to tax yourself or do you want to tax someone else? And that's often how people answer these questions. So do you want to tax groceries? No, of course you don't want to tax groceries. Do you want to tax gasoline? No, of course you don't want to tax gasoline. Do you want to tax, you know, this faceless guy makes a whole lot more money than you who doesn't really work for a living?

Well, of course you want to tax that. And it's all in the freezing of things. There was a poll out earlier this week. The same poll, do you support cutting all government departments across the board? Three-quarters of people said, yes. Yes, let's do that. Do you support cutting the Department of Defense by one penny? No, no, don't do that. Three-quarters said don't cut the Department of Defense by one penny. Do you support taxing the high-income people? Two- thirds of people said yes, tax high-income people. Do you support taxing sole proprietors, small business owners? No, no. Two-thirds of people said don't tax those people.

Same respondents. So this is why, you know, we're a republic and not a democracy on a lot of these things. But I look forward to the conversation. There's some great materials that Mr. Boyd has prepared with his commission. And I look forward to hopefully rescuing the states and getting a lot of them implemented because they serve an important role. And I disagree with the case where Justice Brandeis said it, but he was right on the money when he called the states our laboratories of democracy because, you know, if anything, California and Illinois teach us what we shouldn't do. Thank you.

MR. BERGIN: Agreed.

MR. HENCHMAN: And I hope the world doesn't end next week, too.

MR. BERGIN: That's one of the ways to solve the problem.


MR. BERGIN: Not a good way. Cara?

MS. GRIFFITH: Cara Griffith, State Tax Notes. Well, thank you. I think we've heard some really interesting comments today and I'm going to do my best to keep my remarks as brief as possible so we can get to the discussion. And what I'm kind of going to try to do is sort of summarize in a way and hopefully that will lead us towards a really good discussion on this. So let's take a look first just at the relationship between the states and the fiscal cliff. And we're all obviously very aware of what it's going to do at the national level. But what might the potential tax increases -- if no compromise is reached, what might that do for states? And you know, one brief note is that it's not necessarily all bad news for the states.

There are at least some changes that could increase state revenue. And you know, whether it's going to have an indirect effect of hurting the economy is an entirely different thing, but from a state revenue standpoint -- thanks, Larry.


MS. GRIFFITH: I'm new to this. Some of the changes will actually result in an increase of state revenue. The Pew Center did a nice piece and a study on this and they showed that at least 25 states and the District of Columbia would see higher tax revenue because of federal deductions. That you know, changes in the estate tax could also result in an increase in revenue for states. And there are plenty of other provisions that would decrease state revenue. But just as sort of a note, it may not be all entirely bad news. The scheduled spending cuts, on the other hand, are decidedly worse news for the states as nearly all the panelists have mentioned.

Federal grants to states comprise on average a third of state revenue. So any reduction in that would directly affect states and state economies both directly and indirectly. It would have an indirect effect on depressing economic activity and would be compounded in states where federal spending is large as well as states that have large military installations for defense cuts. So there really is little question that the reduction in federal spending would have an impact on states. I think the question at this point would be the size of that effect.

The Federal Funds Information for States predicted that states would see a $7.5 billion funding reduction for programs subject to sequester, which is significant and certainly would be impactful. They note, however, that states receive 82 percent of their federal funding via grants that are exempt from sequestration and the largest federal grants, including Medicaid, would be included in those exempt. Another effect of the federal fiscal cliff on states may be on state credit ratings. I thought it was interesting on December 3, Fitch ratings came out and they released a special outlook warning that the fiscal cliff is the most significant risk to U.S. states in 2013.

While Fitch right now is saying they still expect slow economic and revenue growth, the fiscal cliff, they said, is the most significant near-term threat to that forecast because state revenues quickly change -- they quickly reflect change in economic conditions. The outlook cautions that cuts in federal spending would likely lower state funding, forcing states to cut programs or backfill certain programs with other sources of revenue. It says, "decisions that shift the costs of services from the federal to state governments while requiring states to provide the same level of services would be most concerning."

Another concern for states is that Congress may eliminate the federal deduction for state and local taxes. And all the fiscal cliff negotiations are still ongoing and we really have no idea or prediction at this point of what they're going to do. There has been at least some discussion of eliminating or reducing benefits from certain income tax deductions at least on higher-income taxpayers. And of the deductions that could be on a chopping block, the state and local tax deductions seems to be the most likely to gain any sort of political traction. Just under a third of all tax filers claimed that deduction in 2011.

And as expected, the amount of state and local taxes paid increases as taxpayers' income increases. So while only 25 percent of tax filers with income under $100,000 claimed the deduction, over 85 percent of tax filers with income over $100,000 claimed the deduction. State and local governments are protective of the deductions as everyone in here is obviously aware, because it provides an indirect federal subsidy to state and local governments. The Joint Committee on Taxation estimated that the tax subsidy provided to state and local governments through this deduction was $67 billion in 2011.

Now while the federal fiscal cliff has decided effects on states, most of the mainstream media is focused on what those effects would be on the national economy and not on the state economy as we've all mentioned today. The state economies are certainly in a very precarious position right now. We have the combination of the scheduled spending cuts pursuant to the fiscal cliff, the slow recovery from the 2008 recession, increased demand for public services, and already underfunded state programs, which has led to some analysts, and I certainly bought into it, to believe that states may be facing or have already faced their own fiscal cliff.

As we all know, the 2008 recession hit state budgets very hard and recovery from the recession has been slow and painful at best and is certainly still ongoing. And as the other panelists have noted, state tax revenues have actually grown recently. We're seeing -- in one report it was 3.2 percent in the second quarter of 2008. And while that is positive, we're still looking at certainly lower than peak levels reported and whether or not adjusted for inflation. We're still seeing revenue that is lower, which is clear evidence that states are still struggling to fully recover from the recession. And one reason for that, as everyone else has noted, is the increased demand for public services that occurred before and even because of the recession.

The states are already working on very tight budgets, had to shift funds around to backfill the increased demand for public service programs. And when this happens, two of the main areas that get shortchanged by this are state and local government pension and healthcare plans. And these plans are now as other panelists have noted, significantly underfunded and the underfunding is the result of not only the 2008 recession, but also the 2001 recession; both recessions which caused state trust funds to severely decline in value. So the combination of all of these sort of negative factors sort of paints a very bad picture, but there could be some positive action that comes out of it in the sense that states may actually be in the position to effectuate significant tax reform.

There's of course no single answer in terms of tax reform because the needs of each state and each state's tax system are different. But there are some guiding principles that should be followed when crafting major tax reform. And I read several reports and tax reform is often defined as a change in the tax system designed to improve equity, economic efficiency, and simplicity. And those are all very important factors, but I think with state tax reform, adequacy is also significantly important. If a state tax system is not designed to sufficiently fund the public services the state will have to provide, it simply cannot be good tax reform.

And states must also, I think, look ahead to the possibility that given the federal fiscal cliff, economic recovery may take years longer than initially expected. And that means that in order to fend off large tax increases which undoubtedly would not be good during a period in which economies are struggling to grow, states may have to consider cutting public services or, for government pension and healthcare plans increases in employee contributions or decreases in benefits. States cannot continue to use gimmickry to balance their budgets and state tax reform will not solve the problem of overspending.

As noted by Joe and by Don, one of the main problems for states right now is the eroded tax base. As the tax base gets narrower, states are forced to either see less revenue or to increase tax rates. Neither of the options seems politically palatable as voters tend not to want to see more taxes or see their services reduced. But states should (inaudible) on fundamental tax reform seek to reverse that trend by encouraging broad bases and lower rates. And one clear means of doing so is including services into the tax base and the sales tax base.

States should also seek sources of stable revenue. Having a diversified portfolio can help improve the stability of the state's revenue streams and this means not relying on any single tax or any single industry to support the lion's share of the tax burden. States should use several taxes, including property, sales, and selective excise, to achieve a diversified and stable base. And in terms of stability, the sales tax does rank very high as people tend to buy both in good times and in bad. States should, as Joe mentioned, question their reliance on the corporate income tax.

For state tax purposes, it's simply not sufficient. It is too cyclical, it is too eroded to be a reliable source of revenue. And individual income taxes can likewise be somewhat volatile at the state level. And while counterintuitive, states with highly progressive income tax systems tend to see more volatile revenue streams than those with a flatter rate structure. All of this is said with the backdrop that states should constantly address their budgetary outputs, including amounts that are put toward entitlement programs. Underfunding in state and local government pensions in healthcare plans can be addressed either by a decrease in plan's liabilities or increasing assets in plan's trust funds.

If states are unable to increase the amount of assets in the plan, the value of the benefits will have to be decreased. State and local government officials must educate the federal government and the public on the effect of the fiscal cliff on states, but state officials must also begin to address their own challenges. It's tough to predict what Congress will ultimately do with respect to the fiscal cliff, but states must begin exploring now how they will manage any potential changes. MR. BERGIN: Thank you, Cara.


MR. BERGIN: Well, lots to talk about. I would encourage the panelists to continue to engage each other as well as all of us. So I'll open the floor up to questions. Now just to remind everybody, please tell us who you are. I know most everybody in the room, but still tell us who you are and remember we're on the record.

MR. BRUNORI: My name is David Brunori. I'm with Tax Analysts. I have two quick points and a question for our panelists. One, I would commend everyone in this room and anyone listening the podcast to examine closely the work that Don has done and the work the center has done and the work the foundation has done on state fiscal issues in general. And in particular, the center's work on sales tax reform because it is really the best out there. I mean, they do some of the best work on identifying what the problems in the sales tax are and offering solutions to fix them. My second point is, Joe made a great point about the -- although he didn't make it strong enough, I think, and neither did Cara.

You're being much too subtle about the corporate income tax. I have long thought that corporate income tax should be repealed because it is ineffectual. But if you look at what's going on in Oregon right now with Nike, you'll see all of the problems with the corporate income tax because if a state -- a liberal bastion like Oregon cannot hold the line on its corporate income tax, all is lost. I mean, you just can't -- it really becomes a way to try to export tax burdens. So I happen to agree with Joe on this, probably disagree with Nick on it, but I think the corporate income tax is terrible.

Here's my question. Joe mentioned the (inaudible) of politics and I think he's absolutely right. And my question for him and Joe and maybe Don is, are there places -- I think there are places that liberals and conservatives can agree on good tax policy. I know there are because I read the liberals and conservatives in this room and throughout the country and I see places where there are intersections of agreement: a broad base, low rates, there's sale tax reform ideas, ending the insane incentive culture that we live in. So I would ask the panelists, where do you think, from a practical standpoint, there is a place for compromise on state tax reform? MR. BERGIN: Who wants it first?

MR. BRUNORI: This is like the fiscal cliff negotiations.

MR. BOYD: Well, Nick and I, we agree on incentives for the most part.

MR. JOHNSON: Yeah, but we're not state legislators or governors. I mean -- MR. BOYD: Yeah.

MR. JOHNSON: You know, a lot of times it's the reality of governing versus tax policy itself. So the stuff where the tax policy experts may agree are often the very places where -- and I think the incentives area is a great example. We just posted on our blog a piece about the Oregon -- the Nike -- the outrageous stuff that's happening in Oregon. I think that tells you more about whether Oregon really is a liberal bastion. Oregon's an interesting place in a lot of ways.

But it also tells you about the hold that a big corporate employer can have over a modest-size state and it also tells you something about sometimes the lack of backbone that legislators and governors have to a corporation who is playing an extreme level of hardball. But I think in theory, we have all long thought I think the incentives (inaudible) is somewhere where we ought to be able to find common ground. The first step to that would be better accountability, right. The first step would be if we could get measures in place to have better transparency, better disclosure, better requirements about exactly what are the corporations going to do in exchange for all of these incentives? Because that then takes you from a sort of partisan, is this good, is this bad kind of posture to, is it producing results?

Because the big question with a lot of these tax expenditures is are they producing results and if we can see in black and white that they're not, this certainly doesn't guarantee bipartisan agreement. But it can be a place for, say, a committee and state legislature to start. That would be my answer.

MR. BOYD: I guess I would agree that the disagreement is not much between left-leaning economists and right-leaning economists or you know, it really is between analysts, economists, and policymakers. And you know, we understand that their job is difficult. Two things. So I think there's a lot of agreement on broad base, low rates among the analysts and economists, there's a lot of agreement (inaudible). I mean you might -- if we put food in the sales tax and we had income tax credits for partial offsets, then you might think that's a good thing. (inaudible) right now, but I think that there are -- you know, there's room for agreement among people who don't make laws. But two things; one is states are copycats.

I mean there's clear evidence of that. So that if and when some states successfully scale back tax expenditures, others will be watching and you know, there's a possibility of a movement. The other thing is that if you look across 30 or 40 years for episodes of widespread state tax reform, you find one and that was after 1986 when the federal government substantially broadened the base of the income tax. And so you know, we don't know. I mean, it's not going to happen in the fiscal cliff, but it might happen beyond. The federal government's need for revenue is not going to go away in the next couple of weeks or next couple of months.

So should there be another episode of substantial federal base broadening or other ways in which they drastically change the tax bases upon which states themselves get their taxes? And then there's another opportunity for widespread tax reform. But to me those are the two things; a successful state triggering copycat actions or the federal government taking the lead.

MR. HENCHMAN: States are copycats, and they mimic success; and not only do I think a lot of the analysis and ideas that we promote at the Tax Foundation are good policy, but they also lead to good economic outcomes. So, I think over time you'll see states with good tax systems continue to get the jobs and the investments; states with bad tax systems continue to have people fleeing, although -- because the IRS won't be able to measure it anymore. But they're no longer going to be measuring interstate migration of tax returns, which is very unfortunate. But I think we will see that over time.

There is a point I want to hone in on, and that's volatility. Don, your report says states should try not to have volatile tax systems. Cara, you mentioned it also. States should try not to have volatile tax systems. And I talk about it a lot.

And it didn't, because a lot of the policies the center promotes promote volatile tax systems -- taxes on high-income earners, taxes on corporations, capital gains, and so forth. You know, there's a chart in Don's report about the crazy ups and downs you get from relying heavily on taxes on very high-income people, and we have our report on, once again, my home state of California, which, Cara, you mentioned adequacy, the so-called three-legged stool argument, which I'm not a fan of actually, because to me what matters more is that you have a broad-based, low-rate system, not how many different taxes you have.

California has all the major taxes, believe me. (Laughter) But they are all narrow based and high rate, and it leads to a terrible tax system.

A state like South Dakota -- it doesn't have most of the major taxes, but the sales tax that they do have in (inaudible) services. It's broad, it's low rate, and it works for the state of South Dakota. And that's the other constraint, of course, on what happens in the states.

We have different states with different strengths and different weaknesses, and they'll have different policies, which is something of course we try to be respectful of when we talk to state officials. I know the center does, too. But generally -- I mean, there's a reason our organization focuses on the principles of good tax policy, because they are timeless. They do apply in a lot of places, and they're primarily accepted by a lot of fiscal policy experts.

And, Cara, you did a masterful job running through them pretty well.

MR. BERGIN: Yes. I'll get a mic to you.

MS. KISSEL: My name is -- hello? My name is Detta Kissel. I'm a citizen, and I just would like to hear some discussion about Internet taxes just among the panelists.

And the other thing -- the other comment I have is that it's interesting. I'm hearing that for some reason because corporations are not paying their state taxes we should eliminate the corporate tax, which is an interesting solution to the problem. But, you know, just reading The New York Times series over the last, you know, week or so on, you know, on the incentives to move corporations to your state, and realizing that there's a tremendous amount of competition -- I think destructive competition -- to the -- you know, it's very destructive to the collection of state taxes. Why not eliminate the -- this is just today's thought -- why not eliminate the state corporate tax and raise the federal rate and have the federal rate apply, you know, across the board, and then have the money distributed by the federal government to the states to eliminate the state competition?

MR. HENCHMAN: I'm a big federalist. I'm a strong believer in, you know, limited federal government and the defined role for the states, and I think you'll get a lot of federal objection to an idea like that. It's an interesting idea, and I've actually posited it. I've thrown out maybe five or six different ideas with respect to the Internet tax issue, which is the first part of your question. And that was one of them, which hasn't gotten any traction from anybody, and, you know, I just kind of threw it out there to offer the whole spectrum of possible solutions. They had kind of federal-level tax that applied when we couldn't figure out, you know, who gets to tax this transaction, then the federal government distributes that money.

Your question on the Internet taxes -- of course it's a hot issue right now. There is no economic reason why buying something online, you should not pay a tax, buying something in a store, you should pay a tax. Economically, they should be treated the same. Like everything else, it's a question of jurisdiction and compliance in administration.

We provide state services on a geographical basis. If you are within this line on the map, you are eligible for in-state tuition or healthcare by your state or so forth. And so, because of that historically, we've provided -- we've assessed tax obligations based on geographic jurisdiction. And when we get into this question of, you know, I buy something sitting in a chair in one state that's sent from a warehouse in another state that travels through all these other states, surprisingly, states often end up, all of them, saying well, that happened in our state; therefore, we have to tax, and there's a role for the federal government, an anticipated role by our Founders through the commerce clause, through the compact clause, through a lot of other provisions to develop overarching rules, and that's the debate happening in Congress right now -- is what will that overarching rule be to facilitate the appropriate level of taxation on Internet commerce. And we want to make sure we're not punitively taxing it as states often do for things that are happening outside of their state. And so that's obviously a risk that needs to be avoided.

We have 9,600 different sales tax jurisdictions in the United States. Right now if you are a brick-and-mortar retailer, you collect the tax wherever you have a physical location. So, if you're a sole proprietor, you only have to worry about one sales tax with its crazy rules and exemptions. And there's a circular out of Illinois on how you tax ice cream cakes. They offer nine examples -- five taxable, four nontaxable. I mean the rules are pretty insane, and we have trouble keeping track of them, and we do this full time. We're not trying to make a profit running a business, providing goods and services. So, it's a complex issue.

You know, we hear a lot about leveling the playing the field and, you know, fostering Internet commerce, and those are good slogans, but it's a really dicey issue of how we resolve it.

MR. BERGIN: So, over here.

MR. DONLAN: Tom Donlan from Barron's magazine. Regarding the fiscal cliff, which I tend to refer to as the fiscal curbstone, it shouldn't be a surprise, I think, that the states have managed to learn the lessons that the federal government is teaching. But to ask a question, I would -- I'd like to know -- since all of the panelists said about something or other, "This can't go on," I would ask them to imagine a situation that would cause this, whether it's, you know, pension underfunding or Medicaid growth or whatever, imagine a situation in which it actually stops. And can you speculate, can you even concoct a situation in which state legislators would actually stop doing any of the things which you personally have identified as crazy? (Laughter)

And I used to cover a state legislature, so I ask that question in complete ignorance of a possible answer.

MR. JOHNSON: Right. So, there's, what, 7,000 -- 7,500, 8,000 state legislators in the country? And I don't think any of us is going to propose any kind of solution that would stop any of them from doing crazy stuff. (Laughter) And a lot of them are brand new. I think a majority of state legislators are new either as of this election or the last election. So, there is a -- you know, there's certainly a learning curve. I think we've also flagged instances where states are doing the right things. There are states that broaden their sales tax base to include more services in recent years. There are states that are maintaining and keeping their corporate income tax strong. I actually think it's a pretty important source of revenue in a lot of states. It's going to continue to be, and it's also hard for me to imagine legislators ever getting rid of it as long as they have a personal income tax, because people really don't understand why Corporation X shouldn't pay income tax when they have to, and that's a pretty big threshold challenge.

I think there have been -- we talked about rainyday funds. I think rainyday funds -- I mean, I guess I would say we have a volatile economy. We have had this -- one of the costs of tremendous income growth at the top end of the scale, the amazing accumulation of wealth by a relatively small number of people, is that wealth is held in very volatile forms, and that translates into volatility in a lot of revenue streams. The answer is do I agree is better reserve funds, rainy day for at least one of the answers. And that is an area where we've seen some improvement by states in recent years. If they're not refilling their rainyday funds, they're at least making structural changes that would allow them to have more adequate rainyday funds that better utilize rainyday funds in the future.

So, I don't know. I mean, to some extent it's a political question. To a large extent maybe it's an entirely political question -- to what extent can we get state legislators to agree that these are the right solutions, short of electing smarter state officials?

I guess the other part of it is putting it in place with the budget process changes that Don mentioned. So, I'm thinking a bit further ahead. Most states -- all states budget either for one year at a time or for two years at a time. And even those that budget for a whopping two years at a time redo their budget mostly every year. So, you know, better -- I would put one structural process change out there -- would be much better long-term information, long-term planning both on the revenue side and on the spending side.

What are the costs of providing the same level of healthcare and education and transportation services? What's that really going to cost five years now? Ten years from now?

MR. DONLAN: Just parenthetically, do you think that doing that has helped federal budgeting at all?

MR. JOHNSON: Well, you know, it's interesting. I mean, certainly we can -- one of the fun things about these kinds of panels, right -- is you can just make a lot of cracks about who is worse off, the federal government or the state government. That's a race to the bottom right there. (Laughter) You know, it is -- but if you think about it, think about the conversation we're having about deficit reduction. It's all about 10-year deficit reduction. Every number that's -- all the numbers that are at the top of our fingertips, whether it's 4 trillion or 2 trillion, we talk in 10-year terms. Does anyone do that at the state level? Do we ever have a conversation about the 10-year forecast? I mean, that's some of the pension numbers that are changing a little bit. But, in general, that's a conversation you don't have at the state level. I think there's potential to have a different kind of conversation if you had some different kinds of numbers on the table.

MR. DONLAN: So, you really think it has helped?

MR. JOHNSON: You know, it's as baseline question, right? What would have happened in the alternative, I don't know. I'm just saying I think it could help at the state level.

MR. HENCHMAN: You asked a great question on, you know, how do we get legislators to implement some of these things and do better.

MR. DONLAN: Well, really -- with all due respect to Nick, I didn't really ask that question.

MR. JOHNSON: I didn't know the answer to your question, so I answered a different one. (Laughter) Isn't that we're supposed to do?

MR. DONLAN: Oh, I see, so you gave me the answer to the question you did know the answer to.

MR. JOHNSON: Yeah, yeah.

MR. DONLAN: But what I was trying to ask was not how you change the minds of state legislators and get them to stop being as crazy as they have historically been. My question was at what point does some force -- for example, municipal bond investors -- simply -- you know, somehow bring the -- bring bad policies to an end by refusing to fund them anymore? Taxpayer revolt? Do you think that a taxpayer revolt is possible? Do you think a bond investors, strike is possible? Maybe I should have been more specific to begin with.

MR. JOHNSON: Right. MR. DONLAN: Or can you think of something that would actually force change, even real bad ugly change?

MR. HENCHMAN: It's tough to rely on those things. Illinois is borrowing at 3.6 percent right now, and if federal law permitted states to be bankrupt, they would be bankrupt. So, you know, I am not putting my 401(k) into Illinois state government bonds, but somebody is. So, you know, what do I know, I guess.

You know, this is my job. It's the mission of the Tax Foundation's state program to find good policy and find ways of getting legislators to hear about it and learn about it and promote it. I mean, Nick's right. A lot of these people -- legislators are new. For many of them, this is their night job. I mean, they've got real jobs and then they go work in the legislature. They don't have staff. They have the whole portfolio of issues in front of them. So, it's tough. They rely on organizations like us to hear about what's going on in other states, because they're so overwhelmed with what's going on in their state that they can't think about trends -- national trends -- or, you know, what's going on down the line in 5 or 10 years from now. So, we've had some success with that. I'll pick again in the interest of Kumbaya film tax credits, which is a horrific trend at the state level. Something like over 40 states ended up adopting them over a 10-year period, providing tax incentives to perhaps one of the most financially successful industries in America without really doing any analysis of whether they promote economic growth or whether they're successful primarily because people are upset when a movie is set in their state and not filmed there. Some states have pared back those incentives recently. They've dropped them. They've cut back. And I'd like to take a little bit of credit for the work that we've done to raise awareness on this issue. But, quite frankly, the argument that's worked most is there are a couple of states -- Louisiana and New York -- that are pouring their treasure into these incentives, writing checks to filmmakers essentially at this point. Why try to compete with that? Compete on something else. And that's our argument that's worked.

So, with a lot of these things, it's finding the argument that works that also promotes good tax policy. And, you know, I think the bond traders will -- they're kind of often the last ones to figure out what the bad investment was. I mean, not all of them. You know, there's somebody that's going to make a billion dollars on Illinois's defaults on its bonds. But I don't think everybody is.

MR. BOYD: Just a quick -- I mean, one of the few sources of external discipline on state governments and local governments is the municipal bond market. And we saw -- we've seen examples of it at the local government level. Clearly, New York City in the 1970s is an example where it imposed discipline on a process out of control. I do not think -- certainly I'm sure 45 or more states are not at the point where the municipal bond interest -- bond market could impose discipline. Whether we ever get there for any of the other truly basket-case states I don't know. They have broader economies than cities. They're less susceptible to being battered by income external forces. They have far greater revenue-raising capacity, and I think that's really what it came down to with what Joe said, is that the ability to tax with relatively little constitutional limitation in most states means they have great capacity to pay off bonds, and somebody other than bond holders is going to pay the price for lack of discipline. And those people are, you know, folks in nursing homes and kids getting educated and people relying on public transportation or the roads and bridges. You know, those are the kinds of things that are at greater risk.

MS. THORNTON: My name is Joanne Thornton and I'm with Guggenheim Securities and in defense of bond investors. I wanted to followup on the bond question mainly for Cara but for anyone on the panel to answer. I'm more interested in another force on the bond market and that is the prospect that the deficit reduction talks will result in curbing or eliminating these exclusion of interest on the state and local bonds. Cara, you mentioned the subsidy involved with state and local sales tax deduction. Has anyone measured the subsidy with respect to the bond interest exclusion? Is it bigger? Smaller? Is there a greater or lesser risk that that particular tax expenditure will be eliminated versus the sales tax or income tax deduction? There are myriad proposals it seems out there with respect to limiting that particular tax expenditure, to eliminate it, eliminate it for new issues, limit it, replace it with some sort of credit for issuers. Is there anything that is gaining traction at the state level that would be more attractive or less attractive? Finally, the second prong of the question is longer term. When we get into the discussion of federal tax reform, which I guess we will after the immediate crisis is over, will state governments become proponents of that given that there are some elements that many of you have mentioned in tax reform, lower rates, a broader base, on the corporate side reducing the preference for debt financing, all of these things could provide more head room for the states to raise revenues? So will we have the state as a force behind tax reform do you think?

MS. GRIFFITH: Very, very good questions. I will have to admit that I don't know about the deduction for interest on bonds. I don't know. I haven't heard any proposals in terms of whether that is more or less likely in the sorts of things our reporters are hearing indicating the deduction for state and local taxes was among the most likely if the deduction is going to go, but again there are no firm proposals that are sitting on the table so we just don't know at this point. In terms of whether states would drive federal tax reform, I tend to say, no, I don't think the federal government has any history of looking at what states do. I think they like to give the money and then forget that they're there. In a lot of ways it would be nice. States are laboratories. They try a myriad of different ideas and concepts some of which are good, some of which are not, but I would hesitate to say that the federal government would follow the states.

MR. BERGIN: Anybody else?

MR. SULLIVAN: Marty Sullivan, Tax Analysts. On your question about immunity interest, I think it's very interesting the president's budget does include this provision that would limit tax benefits to 28 percent and most people don't realize how broad this provision is. It includes a lot of things including, for example, employer-provided health care, but it also -- if you read between the lines -- includes immunity interest and that sort of dovetails on the idea of converting the exclusion to a tax credit. Also the administration is very interested in this idea, both the tax credit as a substitution for the exclusion and then the idea of this type of limitation so that it's a real possibility given -- everything is impossible, but among the impossible things, it's really possible that there might be some limitation. But having worked on the Hill, I think there is no way in the world it would ever be retroactive, it would only apply on a going forward basis. On the state and local tax deduction, that is exactly right. Among the usual suspects that would be on the tip of the list, but in 1985 President Reagan proposed complete elimination of that deduction. Chairman Rostenkowski even took a portion of that and included in his first mark for tax reform and then he was almost publicly embarrassed because the committee rejected it and it wasn't just the high tax states, the low-tax states didn't like it. It's something that probably will get a lot of attention but is unlikely to be sustained because of the political problem. Going back to David's point, it's not a partisan issue once you get down to these levels because there are Republicans in California who say this is going to hurt the blue states, but there's not one Republican member of Congress in California who is going to vote to repeal the state and local tax deduction. So the politics is different than the usual partisan setup and will make any type of tax reform very difficult.

MR. BERGIN: If I could jump in here a quick second, the expenditures, all this fantasy that they're talking about in this town, it's really hard and I would refer people to an article by John Buckley on reforming the federal tax expenditure budget that's available for free on The politicians talk about this like we'll just get rid of these expenditures. It's $1.1 trillion. I double-dog dare you to get $1.1 trillion out of this exercise in futility, but I would recommend the article.

MR. DRENKARD: I'm Scott Drenkard and I'm an economist at the Tax Foundation. We've talked and I think three people have mentioned problems with getting rid of the corporate income tax at the state level at least and David has said they're badly run so let's get rid of them, and indeed that's pretty well chronicled. In the states I've looked at recently, Virginia and North Carolina give away about a dollar in handouts for each dollar that they collect in revenue from the corporate income tax and this is all at very high compliance costs associated with these taxes, all to collect only 2 to 3 percent of state and local revenues in those states so that there are a lot of problems with the way that they're orchestrated but that does not give you an answer as to why you should get rid of them. The main answer you should get rid of a corporate income tax is that economists agree generally that they're just passed on. They're passed on to workers in the form of lower wages. They're passed on to shareholders in the form of lower payouts and dividends. Or they're passed on to consumers in the form of higher prices. The argument here is not that businesses deserve special treatment but, rather, if you're going to get at that base, is it best to do so through a corporate income tax or through other means?

MR. DUNCAN: I'm Harley Duncan with KPMG and I have a question and then a comment that hopefully explains why the question is important. I want to followup on the woman in the front row. The thrust of her question which I think is spot on is do the panelists think that there is any significant federal role in trying to strengthen tax bases? The reason I think it's an important question and more important than perhaps in the past is when I was a younger person I worked on a little noted and long forgotten report called "Financing State and Local Governments in the 1990s." The general thrust of that report was state tax bases were narrow, state tax bases were high, the tax bases were out of sync with the economy and we were all going to go to hell in a hand basket before the 21st century, and now 20 years later we're still talking about the same thing and the issues are still there. I think if you go down the list of taxes, David Brunori is beginning to win the battle on whether there ought to be a corporate income tax, but I think when you've got small open economies trying to levy a tax on multinational interstate businesses when capital is as mobile as it is is extremely difficult. The sales, yes, is within the purview of states but there are some federal issues associated there. There is some salvation in services, but I think we need to be very careful about saying let's take today's sales tax structure and impose it on service transactions because we will compound issues that we already have so that a well-designed sales tax might get back to where we are in revenues if we are concerned about taxing business inputs. We've got to strangle the property tax in many states by moving away from any semblance of fair market value for a base. We've put limits on local governments. Sometimes we've supplanted that with state money. Sometimes we have not. Which brings us back to the income tax as the main lever it seems to me to begin to resolve some of these issues. The federal government dominates that. There's as much sensitivity as Nick pointed out and Joe has pointed out to direct taxes on individuals. And it seems to me that the ability of states to deal with all of these issues on their own and resurrect and reform their bases in a fashion that enables them to play the role they traditionally have is difficult, and therefore is there a federal role, and if so, what do you think it is?

MR. BERGIN: Panelists?

MR. BOYD: I think there's a clear national interest in the stability and adequacy of state finances. The national interest comes from the things that state and local governments do, that is, that we care about how kids are educated in Mississippi if for no other reason than they're going to move somewhere else in the country. There are spillovers in many things states do. We care about the interstate highway system. We care about other kinds of infrastructure that states build. We care about the economic well-being of people which states finance through Medicaid and other mechanisms so that there is a big national interest in this. The federal is a different question and a little bit harder to address. The first question, I think quite, frankly comes from the question of deductibility of state and local taxes and that is a major potential interest on the federal impact on the capacity of states to do what they do. When you get into the details of individual taxes themselves, I believe the biggest thing the federal government can do is have a broad-based income tax that the states can rely upon, to not impose restrictions on the capacity to levy sales taxes where we were very clear on our report that the physical presence ought not be limited in such a way that you can collect taxes, impose transactions -- I think those are the big things the federal government can do. I don't believe there ought to be some sort of new form. We are a federal system and I think it's important to have the ability for states to have their own variations in taxes. MR. BERGIN: Maybe the first rule is do no harm.

MR. DUBIN: Elliott Dubin, Multistate Tax Commission. There's a few things. We talked about reforming the sales tax base which would include services. A good tax policy also recommends not taxing business inputs as Harley mentioned. I'm not so sure you would get a more stable tax, but obviously it would raise that much more revenue because about 40 percent of the tax revenue now comes from business inputs. Another point is there is some discussion of changing new issues of state and local debt into Build America type funds in which the interest is taxable but the federal government gives the states some sort of grant to pay the additional interest costs. This way if you remember, the alternative minimum tax also is starting to limit the usefulness of the state and local tax deduction, the nontaxability of muni interest, so that would seem to have been forgotten in this discussion. You're already limiting those deductions. I may be a liberal, but I don't believe the states should have that progressive taxation. That I learned in graduate school -- redistribution primarily as a federal function and not a state function.

MR. JOHNSON: What I would say to that is most states you'll be glad to know do not have regressive tax systems. Most states have highly regressive tax systems, upside down tax systems where low-income and low- and moderate-income families are paying a larger share of their income than high-income families. That's a result of the mix. When I said an assault on progressive taxation of the states, I didn't mean that there was a great overwhelming preponderance of progressive taxation in the states that was now under assault. Probably the more accurate way to say it is what little progressive taxation there is in the states, about half of them have gotten rid of their estate taxes, about half have expanded the use of consumption taxes. What little progressive taxation there is in the states that offsets the more regressive elements is under assault. I agree that a lot of the income transfers need to be rooted in federal financing, but I think states have a role there too. To the extent that states, the governors, and state legislatures are concerned about their state's economies and the prosperity of the families in their states, they should be concerned about income inequality in their states. They should be concerned about the concentration within each of their states even in rural smaller states that you wouldn't think have a ton of concentration of wealth. The volume of literature is stunning on the cost of inequality and it's not just for countries, it's for states too. So I think some degree of progressive taxation in the states is well warranted.

MR. BERGIN: I'm not sure we answered your question, Harley.

MR. DUNCAN: There is a particularly good answer. I keep going back and forth or maybe around three parts of the triangle as to, yes, we're all federalists and there's lots of value in our current system and we just continue to struggle through to another that would say that there is more room for a more integrated tax system and that fiscal federalism is an important thing and we ought to look at structural arrangements, to a third leg that says maybe we should go back to discussions that we used to have about sorting out, and remember when the federal government was going to be responsible for all services to individuals, people related services and state and local governments can take care of the things, the parks, the roads, those sorts of things and they might be even a little more suited to the tax base that each of them has. My main concern is that we don't even talk about those things very much and certainly not in this town.

MR. BRUNORI: I wanted to followup on something Nick said. The center did a terrific piece many years ago, I'm dating myself now, probably in the early 1990s or mid-1990s, on the political opposition to personal income taxes. And you guys did a study and you showed that budgets run surpluses, the first thing that would be cut is personal income taxes, when states run deficits, the last thing to be raised tend to be income taxes. They looked at sales taxes first. That was a long time ago, but it seems like that has continued which adds to the regressivity of the overall system. You're looking for the sales tax for revenue and you're looking to decrease the income tax. Would you think that those politics are still in place right now? Part of it, I think, had a lot to do with the perception of harmful effects on economic development was really what motivated legislators. I was wondering if you could talk about that for a minute.

MR. JOHNSON: I think I wrote that study. Others should weigh in. I don't feel like I saw so much in the way of sales tax increases. One of the interesting things that happened in this last recession is there were widespread measures to increase revenues by states in this last recession. There were maybe a dozen states that did big tax packages that included a lot of temporary taxes. But based on what we had seen in previous recessions, you would have expected probably more revenue-raising measures in 2008, 2009, and 2010 than probably we did. Probably that's because the federal government came with aid to states as part of the Recovery Act that alleviated the need for tax increases. The question that I think is really interesting and I don't have an answer to this is back in our old friend of fees and increasing reliance on fees rather than either sales taxes or income taxes. I think for a lot of on tax policy, those have been a little bit of an afterthought, they're just big enough to make a mark in the aggregate data or in families' pocketbooks. But anyone who has gotten a speeding ticket lately from going through one of those cameras, I feel fortunate that I'm able to afford maybe one or two of those checks, a lot of families aren't, and it's an interesting question that there is more investigation, I think, about when do we get to the tipping point where reliance on fees and fines and license fees which may or may not be classed as taxes, when do those become enough to really merit some serious study, and it's hard to do because there are so many of them and individually they're so small. That may or may not be an answer to your question.

MR. BRUNORI: I was wondering if you saw that perception among legislators that personal income taxes in particular have a detrimental effect on economic development so that they're always hesitant. Despite the couple of millionaires' taxes sprinkled around during the last recession, there wasn't a lot of broad-based income tax raising and I was wondering if you thought that was connected to it.

MR. JOHNSON: To the perception of economic development? I don't know. I think it's more along the lines of doing any kind of broad-based tax increase during recessions seems to hit the hardest other than you have millionaires' taxes when clearly that's a source of revenue. It's hard to answer. The other thing I would say is it's always nice to imagine that people would learn from experience. We did a little bit of looking at the states that had done the income tax cuts in the 1990s of which there were a ton and found that they were hammered harder in the ensuing years than other states which has probably more to do with economic cycles than anything else, so that maybe there was some learning that the big income tax cuts in the 1990s really didn't pay off.

MR. BOYD: I'd just like to give you a slightly different interpretation of history. Income taxes, by their nature, you have to cut them to stay even. That is, they typically -- the typical state income tax is going to grow faster than income over the long haul. And throughout the late 1990s, states were cutting income taxes year after year and incomes taxes as a share of personal income were rising. And it's because of the relatively substantial elasticity in that particular kind of economic environment.

Excise taxes, not so much sales taxes, but excise taxes, you have to raise them just to stay even. The typical excise tax is based on quantity. Prices go up, the revenue doesn't go up. Unless you raise the rate, you don't raise the revenue. So I think that's part of the explanation for those kinds of trends.

MR. BERGIN: Thank you, Don. Martin?

MR. LOBEL: I'm Martin Lobel. I'm chairman of the board of directors of Tax Analysts, but I'd like to talk to you about my role as member of the Maryland Business Tax Reform Commission, which the governor appointed, and we spent a little over a year examining the Maryland business tax form, and it became quite obvious to me fairly early in the process that every member of the business community that had been appointed there was there to lower his or her company's taxes and not to raise taxes for the state of Maryland. There was one major problem. It was lack of data.

A lot of the academic papers that we looked for were not available except in Tax Notes and State Tax Notes. And that became an invaluable asset for us. A little plug for our publication. But the problem was that nobody really wanted to talk about income redistribution, fairness, equity, or any other long-term concern outside of protecting their own self-interests. And they were very high-power individuals on the board. The governor gave it its full support. We examined a whole range of options and came up with essentially kicking the can down the road because of the political pressure that was applied.

My own takeout from this is there were two things that I thought would help: One is what the state of Oklahoma has done, which is before you can put a tax provision into the code, you have to estimate how much it's going to cost. As a result, there were very few tax provisions that are going to cost -- or tax giveaways that are going to cost a lot of money. And the second is that until you have campaign finance reform, you're not going to have any real political reform or tax reform in this country.

MR. BERGIN: OK, one and two, right?

MS. KISSEL: Yeah, I just wanted to follow up on the corporate tax issue. I've got a couple questions, but one is if the corporations were paying state tax, what would the effect on all these budget problems be?

The second thing is I wanted to respond to the gentleman about, you know, eliminating the corporate tax and how it's a tax on, you know, the shareholders or consumers. I doubt that you're saying just eliminate it and just leave it at that because you've got income being generated and it's either accruing to the shareholders -- so, I mean, I guess you're talking about an integration system where it's taxed at one level or the other. And so I'm assuming that that's the case, otherwise you wouldn't have parity with passthrough businesses, so that's got to be taxed at one level or the other.

And I guess I'm still sort of toying with that idea of having it taxed, you know, eliminating it at the state level, having it taxed by the feds at the shareholder level. And basically, since this is an integrated system, it's kind of a separate tax system. And you can actually raise that rate a little bit and rebate it based on the activity attributable to individual -- you know, the business activity attributable to individual states. And it just seems like the problem is tax competition in terms of the corporate tax. And that would kind of eliminate that tax competition and give states additional revenue.

And I guess that brings me to the first question which is how much would that help the states' conditions?

MR. HENCHMAN: Well, if I could defend the competition a little bit, states compete not only over taxes, but over services, over the different infrastructures that they have. States compete on a lot of things, so to say that they shouldn't compete over taxes, I think that implies that they shouldn't compete over other things, too, and I don't want that. I mean, we have a lot of foreign delegations visiting and get to hear how we do things in America, and they always leave a little surprised. But, you know, the Japanese and the Germans, a lot of other countries in the world have much more unified structures than we do. I don't know, I guess I'm just a flag-waving American patriot on that. You know, I don't really care what they do. In the federal government, we have states and that's the way I want to do it.

But, yeah, I think recognition that the corporate income tax is, in many ways, a passthrough tax is -- once you've got that, you're 80 percent there. And the last 20 percent is just deciding how should we do it to make sure that there's equity and that people aren't escaping taxes that they ought to be paying. And states are trying different things with that.

Michigan had a really awful tax and they repealed it and replaced it with an even worse tax. They tried to do this and they've just repealed that and gotten back to a straight corporate income tax with very few credits and deductions. They got rid of their film program. They got rid of a lot of other economic development incentive stuff which was -- I think they were spending more on that than they were bringing in revenue. We'll see how that works. Texas has their margin tax, which I think is awful. I don't know if anyone disagrees with me on that, but the states are trying different things and we'll see what works.

And the whole difference between how you tax S corps, how you tax corporations, that's a big part of this thing, too, because there are a -- most business activity is not occurring by corporations. Most business activity is occurring by S corps, by partnerships, by sole proprietors, who are all taxed under the individual code, federal and state. So, you know, it's like we're chasing a phantom here and trying to stick it to businesses by raising the corporate income tax in a time of highly immobile capital and especially when the economic evidence is suggesting that workers get a lot of it in the neck because it'd passed forward.

MR. BERGIN: David, you want to get in here?

MR. BRUNORI: David Brunori. I just wanted to mention one thing about competition, a shameless plug for State Tax Notes. The single best, I think, article ever written in State Tax Notes was written by a guy named Harley Duncan. If you can find it in the early '90s. It's called "The Good, the Bad, and the Ugly". It talks about good state competition and bad state competition and ugly state competition. And there really is a lot of variations. I think Joe is a fan of good state competition. I think most of us are fans of good state competition, and there are ways. I'm a fan of state competition in the sense that not only do states compete on tax burdens, but they compete on things like universities and good infrastructure, and there's a lot of other things that drive people to either live or start businesses and stay. So if you get a chance, you should read this article. It's in the archives of State Tax Notes.

MR. BERGIN: And we'll make it easier by putting it up on --

MR. BRUNORI: I think that's a great idea.

MR. BERGIN: -- When we get back home this afternoon, available for free.

MR. BRUNORI: Dig it out of the archives.

MR. BERGIN: You want to respond?

MS. KISSEL: I just wanted to ask that question again, though. If corporations were paying their full income tax, state income tax, what would be the result on the budgets? I guess the comment was made that there are so few operating in corporate form these days that it might not be that great of an impact on the schools.

MR. JOHNSON: Yeah, I mean, if you -- so one way to think about it is if corporations are paying the same share of taxes now as they were 20 years, 30 years, 35 years ago, what would it be? I don't have the numbers in front of me, but it's a pretty significant falloff --

MR. HENCHMAN: It was like 10 percent of state revenues at the time.

MR. JOHNSON: -- Yeah, the loss of revenues to states and, to a lesser extent the federal government, that has resulted from the erosion of the corporation income tax, which has happened for lots of different reasons: policy changes, economic changes, the interaction of the two, really great lobbying by corporate lobbyists, all of the above. You know, it's a good chunk of money. States would really like to have that money back.

MS. SULLIVAN: Do your revenue estimate on top of the head. The federal tax raises 400 billion. The best the states could hope for is a quarter of that, which would be 100 billion.

MR. JOHNSON: Is that right?

MS. SULLIVAN: Yeah. And so --

MR. HENCHMAN: They have about 50 now, so.

MS. SULLIVAN: So 50 billion. MR. BERGIN: Fifty billion across the states?

MS. SULLIVAN: Across all 50 states.

MR. BERGIN: Which isn't going to get even close.

MS. SULLIVAN: So I think the point is it would -- you know, 50 billion is a lot of money, but it's not going to solve all the state's budget crises.

MR. BERGIN: Fifty billion's a lot of money? Well, then 16 trillion must be really a lot of money.

MR. HENCHMAN: Nick, in your annual budget shortfalls report what was the peak number?

MR. JOHNSON: What was it?

MR. HENCHMAN: Like 300 or something like that?

MR. JOHNSON: Yeah. You know, depending -- it's been so long ago I can't to 150 billion. So it would have closed a good chunk of the state budget shortfalls, but not close it all by itself.

MR. BERGIN: There's somebody over here? MR. DE JONG: Hi. This is Dan De Jong from Tax Executives Institute. And I just have a question.

We talked a lot about different ways states have of raising revenues. We've got the corporate income tax, which people seem to agree is fairly broken. We've got a sales tax, which only applies to goods and not services. We've got the property tax that is now applied on values that don't reflect fair market value. Well over 100 countries around the world employ a valueadded tax. I just didn't know if there was room in the discussion for maybe a state-level valueadded tax in some states. I just wanted to get some thoughts on that.

SPEAKER: (inaudible) countries.

MR. DE JONG: So a lot of countries, yes.

MR. HENCHMAN: It's tough to implement a VAT at the state level because of the need to tax imports and credit exports. It's difficult under our constitutional structure to do that. The Constitution was partly written because states were doing things like that and we wanted to stop them from doing that.

I spent a week in North Carolina a couple of months ago, and there were people there who -- this Fairtax thing, if you've read the book. And, you know, that's not quite of that, but it's close. And there is some support for that out there, but I bet Nick wouldn't be a fan of shifting from income taxes to consumption taxes, although there's, you know, economic evidence that it's better for long-term growth.

MR. BERGIN: Good morning.

MS. SULLIVAN: Well, if you want to talk about state and federal VATs, Canada -- I mean, it doesn't make sense to do it state by state. It would have to piggyback on the federal system. Canada has setup this system like this. It's very complicated, but basically the federal government collects a big chunk and the states have some flexibility within that system to (inaudible).

MR. HENCHMAN: Provinces.

MS. SULLIVAN: Pardon me?

MR. HENCHMAN: Provinces.

MS. SULLIVAN: Provinces, yeah. Thank you.

MR. BERGIN: Robert?

MR. GOULDER: Oh, yes, Bob Goulder with Tax Analysts. I was just going to add the case for the VAT here. Yes, Canada is the example. Last time I checked, the provinces were rolling in cash. So this whole issue about how are the states going to find revenue, this is a uniquely American problem. It isn't happening in Canada. What they do, they've got a harmonized VAT at the federal level. It's about 5 percent. They establish the base, so when the states sign on to it they piggyback. They compete on the rate, not on the base. So the competitive aspect is sort of satisfied because the rate that a consumer pays is different in Ontario than it would be in Quebec. It satisfies the concern about growth that we heard at the beginning of the discussion because most economists would tell you that in terms of debt wage loss and so forth you're better off taxing consumption than income.

It also addresses the problem of, what is it, 40 percent of the retail sales tax, its business inputs. That goes to about zero with the VAT because you have a dollar-for-dollar credit for business inputs. And now, the states do have to give up some sovereignty, which -- yes, the provinces have to give up -- states, provinces, we're Americans, they're Canadians. I'm going to use our term and call them states anyways. But so many of the problems just seem to go away. They have all the revenue they want. It's a -

MS. SULLIVAN: Less administrative costs.

MR. GOULDER: Yeah, you know, yeah.

MS. SULLIVAN: Less compliance. And also, the federal -- the corporate tax in Canada is coordinated in a similar manner. And I think this goes to -- I think what Harley was trying to get to, which is if we would sacrifice a little bit on the sovereignty, we can go a long way on increasing these compliance issues on.

MR. BERGIN: So the answer to the question of the federal involvement in helping the states is when we figure out that the citizens of this country want more government they're willing to pay for, when they finally realize that we'll have a VAT, the federal government will collect it and help distribute it to the states. I'm with Joe on this one.

MR. HENCHMAN: Well, it's all dependent on the federal government designing the base properly.

MR. BERGIN: Right. Right, and we've seen what they did with the individual income tax on that, so.

MR. LOBEL: I have to dissent on the fact. That is probably the most regressive tax outside of Social Security I can think of for the middle class --

SPEAKER: Cigarette tax.

MR. LOBEL: -- which has lost ground for the last 30 years while the top 1 percent did all the GDP growth we've had. It is just going to compound felony we've been under.

MR. BRUNORI: How about the fact that if you adopt a VAT you turn into Greece? (Laughter)

MR. LOBEL: Well, I mean, one of the conservative arguments or libertarian arguments against the VAT is it's a spigot of revenue that never turns off and you've got to spend the revenue and it will feed a growing government. Now, our problem right now in America is we want this much government and we're willing to pay much taxes, so Chris is right, we've got to balance that somehow. We want much more government than we're willing to pay for.

MR. BRUNORI: I don't disagree with that. But the problem is the VAT will be so much more regressive than any other proposal on the --

MR. LOBEL: I agree.

MR. BERGIN: Oh, it's totally regressive, yeah. We're almost out of time here. I wanted to give the panelists an opportunity to -- first of all, thank you guys for being here. This has been an excellent conversation. Anybody want to get a word in here before I close up? Don? Nick? Somebody?

MR. HENCHMAN: I'm glad growth came up a fair amount because, you know, I don't see growth a lot in some publications and from some arguments I see out there, and that's the big question. It's not really something -- I mean, states can nibble around the edges on growth, but a lot of it comes from our national policy and what happens in the secret negotiations going on right now, which I don't understand either. I mean, I've learned this in government where the House passes a bill, the Senate passes a bill, a conference committee negotiates it out, and then it goes to the president. And somehow, I don't know, I guess that's an arcane process now. We've got to have secret meetings and phone calls and everything.

MR. BERGIN: And there's this messy thing of transparency --


MR. BERGIN: -- and published (inaudible).

MR. HENCHMAN: So, you know, I don't know what's going to come out of that, but I think the vibrancy of our states is a testament to our national identity and we're going to see which systems work. I mean, California's got a pretty volatile system, narrow bases, high rates. They've got all the major taxes. They soaked their corporations. They soak their high-income people who will be paying 13.3 percent. We'll see if this is the recipe for economic growth that some people say it is.

MR. BERGIN: That's a good way to end it. Message to Washington: Pay attention to what's going on in the states.

MR. JOHNSON: And let me just say we actually have a really interesting new study out, out of California, about what happened when the last time they raised their top income tax rate, and the answer is not a whole heck of a lot except for the state got a lot of revenue from that. So we will look forward to getting more evidence.

MR. HENCHMAN: Excellent.

MR. BERGIN: Excellent. Thank you, panelists. This was a great discussion. Thanks all of you who were here and thanks to the Tax Analysts folks. (Applause)

(Whereupon, at 11:00 a.m., the
PROCEEDINGS were adjourned.)

* * * * *


I, Irene Gray, notary public in and for the District of Columbia, do hereby certify that the forgoing PROCEEDING was duly recorded and thereafter reduced to print under my direction; that the witnesses were sworn to tell the truth under penalty of perjury; that said transcript is a true record of the testimony given by witnesses; that I am neither counsel for, related to, nor employed by any of the parties to the action in which this proceeding was called; and, furthermore, that I am not a relative or employee of any attorney or counsel employed by the parties hereto, nor financially or otherwise interested in the outcome of this action.

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