The right ap­proach

Cut Texarkana’s tax ex­emp­tion

Northwest Arkansas Democrat-Gazette - - VOICES - NI­COLE KAEDING AND JEREMY HORPEDAHL Ni­cole Kaeding is an econ­o­mist at the Cen­ter for State Tax Pol­icy at the Tax Foun­da­tion. Jeremy Horpedahl is a pro­fes­sor at the Uni­ver­sity of Cen­tral Arkansas and a scholar at the Arkansas Cen­ter for Re­search in Econom

As the task force of Arkansas law­mak­ers con­tem­plates how to over­haul the state’s tax code, one sen­a­tor is al­ready jock­ey­ing to pro­tect a lo­cal ex­emp­tion. State Sen. Jimmy Hickey rep­re­sents a district en­com­pass­ing Texarkana, and some of his con­stituents have a spe­cial deal: They are ex­empt from the state’s in­come tax.

Sen­a­tor Hickey ar­gues that re­peal­ing the Texarkana ex­emp­tion would cause res­i­dents to move to the in­cometax-free Texas side. But that ig­nores the big­ger pic­ture. His com­men­tary doesn’t ac­count for the bur­den from other lo­cal taxes, nor does it jus­tify keep­ing the ex­emp­tion in place. In­stead, it’s a symp­tom of much larger prob­lems with Arkansas’ tax sys­tem, which is lit­tered with spe­cial pro­vi­sions that cre­ate an im­bal­ance in how Arkansans are taxed.

Un­der Act 28 of 1977, Texarkana res­i­dents were given an op­tion to ex­empt them­selves from the state’s in­di­vid­ual in­come tax, now top­ping at 6.9 per­cent. The res­i­dents, ob­vi­ously, chose this path, and in ex­change they pay an ad­di­tional 1 per­cent­age point in state sales tax. This trade saves tax­pay­ers in the city a great deal, but costs the rest of the state mil­lions. In 2016, the lack of an in­come tax in Texarkana cost the state $16.6 mil­lion in net rev­enue.

That means all other Arkansans pay more in taxes.

A closer look at the data also calls into ques­tion whether the tax break pro­vides much of a ben­e­fit. Elim­i­nat­ing the ex­emp­tion doesn’t im­me­di­ately spell tax flight from Texarkana. While Texas has no in­di­vid­ual in­come tax, Tex­ans face an ef­fec­tive prop­erty tax rate that is 2½ times higher than Arkansans. For the me­dian tax­payer, that amounts to an ex­tra $1,149 in an­nual real es­tate taxes, ac­cord­ing to the Cen­sus Bu­reau. In­stead of elim­i­nat­ing the tax dis­par­ity be­tween Texas and Arkansas, the ex­emp­tion sim­ply shifts the dis­par­ity to the city lim­its.

Those con­cerned about what might hap­pen to Texarkana with­out the ex­emp­tion can take a look at an­other bor­der city in Arkansas with a sim­i­lar di­vide. The metro area of Mem­phis also strad­dles our state’s bor­der, with West Mem­phis fall­ing in Arkansas and Mem­phis fall­ing in Ten­nessee.

Like Texas, Ten­nessee does not have a per­sonal in­come tax. West Mem­phis res­i­dents, how­ever, do not re­ceive an in­come-tax ex­emp­tion like their Texarkana coun­ter­parts.

Fol­low­ing Sen­a­tor Hickey’s rea­son­ing, West Mem­phis should be de­pop­u­lated from tax-avoid­ance mi­gra­tion. Yet, West Mem­phis is still home to more than 25,000 res­i­dents, just a few thou­sand less than Texarkana. And there are at least six other met­ro­pol­i­tan ar­eas in the United States with some por­tions in noin­come-tax states. None get in­come-tax ex­emp­tions, and none are com­pletely de­pop­u­lated.

One pos­si­ble ex­pla­na­tion is that there is a large dif­fer­ence in ef­fec­tive prop­erty-tax rates be­tween Mem­phis and West Mem­phis. The ef­fec­tive rate in West Mem­phis was just 0.59 per­cent, com­pared to an ef­fec­tive rate of 1.60 per­cent in Mem­phis. Res­i­dents of West Mem­phis could be at­tracted to the lower prop­erty-tax rates, among other ben­e­fits of Arkansas.

The rate dif­fer­ence in Texarkana is even larger. In 2015, Tex­ans paid 1.77 per­cent in ef­fec­tive prop­erty taxes com­pared to the 0.67 per­cent paid in ef­fec­tive prop­erty taxes by Arkansans in Texarkana. To ig­nore this, along with nu­mer­ous other con­sid­er­a­tions, misses the nu­ances in why in­di­vid­u­als choose to live where they do.

Now, Sen­a­tor Hickey has a point: To­tal taxes are higher in Arkansas than Texas. The Tax Foun­da­tion’s “State-Lo­cal Tax Bur­den” re­port finds that Arkansans have the 17th high­est tax bur­den in the coun­try, while Tex­ans have the 46th high­est. But even given that, the in­come-tax ex­emp­tion still isn’t good pol­icy. Ideally, the state would seek to pro­vide tax re­lief for all res­i­dents, not just those in Texarkana. Ex­emp­tions like this make real, com­pre­hen­sive tax re­form more dif­fi­cult.

The Arkansas tax code needs re­form. The state’s last com­pre­hen­sive tax re­form came in 1971. An al­most 50-year-old tax code does not serve the state well and harms its com­pet­i­tive­ness.

As we wrote in our book last year, Arkansas: The Road Map to Tax Re­form, the Texarkana ex­emp­tion is an ex­plicit ac­knowl­edg­ment of the state’s in­fe­rior tax code. Try­ing to fix the is­sues within just the city lim­its of Texarkana does noth­ing to im­prove the tax cli­mate for the al­most 3 mil­lion Arkansans who don’t live in Texarkana. The leg­is­la­ture should fo­cus on im­prov­ing the tax code for all Arkansans, not just the few in one bor­der city.

At a time when leg­is­la­tors are con­sid­er­ing elim­i­nat­ing ex­emp­tions in the state’s tax code, the Texarkana ex­emp­tion should be at the top of the list. Tak­ing ex­emp­tions off the list be­fore the process even be­gins is a sure way to kill good tax re­form. Pur­su­ing broad and equal re­forms makes for bet­ter pol­icy than keep­ing an in­ef­fi­cient ex­emp­tion in place.

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