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Texas Politics - Political Economy
sunset review
4.2    Limitations of the Sales Tax

Beyond concerns about the regressive nature of sales taxes, the reliance on such revenue sources (and license and user fees) raises critical issues. It restricts the capacity of a country-sized state like Texas to respond to short-term fiscal shortfalls. It also slowly debilitates the state over the long run.

Though Texas is much more diversified than it was just a decade or two ago, short term economic recessions can cause considerable mischief to state fiscal policy. The revenue shortfalls in the 2003-2004 budget cycle, as we saw in the discussion of the Texas Enterprise Fund near the beginning of this chapter, forced painful cuts on a wide range of programs that are critical to the well being of Texas citizens and the broader Texas economy.

The core problem is that sales taxes, licenses and fees can only be raised so much. Advocates of this approach to taxation argue that limiting the flexibility of the government to raise revenue forces it to stay lean and resist "program creep" (incremental expansion of government programs) in good times as well as bad. But taking this approach to taxation also means that critical programs must be cut in bad times. It also means that cutting state expenditures carries with it even greater losses to the state because of diminished matching federal funds for many programs.

Successive legislatures and governors have been forced to face the possibility that reliance on these limited sources of revenue reduces the capacity of state government in the long run. Revenue from sales taxes, licenses and fees grows far less rapidly than total personal income in the state. Yet the growth in personal income reflects a growing, increasingly diverse population and a more complex economy that requires new and expanded public programs in education, health, transportation, and regulation. As the Center for Public Policy Priorities (CPPP) states:

Our basic problem is that state and local tax revenue does not keep up with the growth of the Texas economy [if we are] measuring economic growth by growth in personal income, which shows the ability of Texans to pay taxes. The growth in personal income also generally reflects the need for public services, tracking the growth in population and inflation. In addition, higher personal income mirrors changes in the nature of the economy, which now demands higher skills from workers, requiring more students to continue their education through high-school graduation to post-secondary institutions. [4]

As the CPPP notes, the state sales tax in Texas was adopted in 1961 when most sales involved goods - tangible items - as opposed to services. Consequently, many services were excluded from taxation. But as the state economy has grown and become more diversified, services have come to represent a much larger share of economic transactions. In other words, "Over time, the sales tax has applied to a shrinking percentage of all sales transactions in the state. Sales volume has grown faster than sales tax receipts." [5]

A significant source of the decline in the share of transactions subject to taxation is the growth in the value of professional services not taxed, including: legal services, architecture and engineering, accounting, advertising, financial services, construction labor and personal services, among others. In the modern Texas economy these professions and services account for a substantial and growing percentage of all commercial transactions. More generally, they represent large sectors of the economy that remain essentially untaxed. Taxing these sectors would broaden the base of the state's primary means of raising revenue, while achieving some measure of increased fairness in the distribution of the tax burden.

Short of introducing an income tax in the state, the CPPP report recommends "sunsetting" the tax code - that is, mandating a periodic review and updating of the tax code. Each department of the state's executive branch is reviewed every twelve years to justify its continuation and current functioning. So should each tax exemption, exclusion, and discount. The reason sales of many services continue untaxed is, in part, because there is currently no such regular review.

4 Center for Public Policy Priorities, link: "Testimony before the Joint Select Committee on Public School Finance," May 9, 2002.
5 Ibid.

Texas Politics:
© 2009, Liberal Arts Instructional Technology Services
University of Texas at Austin
3rd Edition - Revision 115
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