By Caleb Taylor

Should Arkansas approve a permanent 0.5 percent sales tax for road funding in November?

BTĚěĚĂAssistant Professor of Economics and ACRE Scholar Dr. Jeremy Horpedahl gave voters a few important points to consider in “,” in the Arkansas Democrat-Gazette on September 25.

The 0.5 percent sales tax on the ballot is currently scheduled to expire soon, once it raises enough revenue to retire the $1.3 billion on bonds issued (probably in 2023) if a permanent extension isn’t passed by voters. Horpedahl notes that Arkansas already has the in the nation behind Tennessee (which has no state income tax on wages and salaries).Ěý

Horpedahl also notes that Arkansas already spends more than most states on road funding.

Horpedahl writes:

Do we spend enough on roads? Arkansas has the 15th highest spending on roads per capita, or the 11th highest spending as a percentage of personal income in the state, according to the most recent data from the .ĚýEven if we look at 2012 data, before the temporary sales tax to fund roads was put in place, Arkansas had the 22nd highest spending on roads as a percentage of personal income, and was above the national average.”

Horpedahl mentions raising the gas tax, toll roads, and reducing state government spending as alternatives to raising the sales tax.

Horpedahl writes:

This November, voters must decide whether they want to make the sales tax increase permanent or not. These other funding methods aren’t on the ballot right now, but they are real options the Legislature could take up in the next session.ĚýThe current sales tax for roads doesn’t expire for a few more years. There’s plenty of time for our elected representatives to go back and find better ways to keep Arkansas moving.”

For a different perspective from a fellow BTĚěĚĂCollege of Business professor, check out “,” by BTĚěĚĂProfessor of Logistics and Supply Chain Management Dr. Doug Voss published in the Arkansas Democrat-Gazette on September 26.

You can find more of our research on taxes and spending here.

In an op-ed published in the Arkansas Democrat-Gazette on February 15 entitled “,” ACRE Scholar and BTĚěĚĂAssistant Professor of Economics Dr. Jeremy Horpedahl and National Taxpayer Union Foundation Economist  Nicole Kaeding say ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s sales taxes have generally increased, income taxes have decreased, and property taxes have generally stayed the same over the past decade.

Arkansas Sales Taxes

Horpedahl and Kaeding on sales taxes:

The statewide sales tax stood at 6 percent in 2010, but it is now 6.5 percent after voters approved a temporary increase dedicated to highway funding in 2012.ĚýCities and counties in Arkansas can also add their own sales taxes on top of the statewide rate. A decade ago these local sales taxes averaged about 2 percent across the state, while today they are closer to 3 percent.ĚýThat means the combined rate that Arkansans paid, on average, has increased from to , just slightly behind Tennessee and Louisiana.ĚýArkansas voters are being asked again to approve a permanent extension of that sales tax this fall. If voters approve the 0.5 percent tax for highways, and more local sales taxes increase (such as the proposed 1 percent tax in Little Rock), Arkansas could fight for the dishonor of the highest sales tax in the nation.”

One exception to this sales tax trend is the state sales tax rate on groceries which decreased from 2 percent a decade ago to â…› percent today, according to Horpedahl and Kaeding.

Arkansas Income Taxes

Horpedahl and Kaeding on income taxes:

Most visibly, the state’s top personal income-tax rate was 7 percent in 2010. This year it is being cut to 6.6 percent, and it will drop again next year to 5.9 percent. That’s a big improvement, along with the reduction in the corporate income-tax rate, which is being cut from 6.5 to 5.9 percent.ĚýBut it’s not just high-income earners that have had their income taxes cut, as the top rate cut was the third step in Gov. Asa Hutchinson’s plan to reduce income-tax rates across the board. Two previous tax cuts directly benefited middle- and low-income taxpayers.ĚýWhile Arkansas’ three sets of tax brackets are complex, all taxpayers are now paying less in taxes, boosting their after-tax income. We estimate that low-income taxpayers are saving between $100 and $200 per year, while the middle class is saving between $300 and $400 per year. That’s a few meals out, a car repair more easily covered, or a surprise for the kids.”

Horpedahl and Kaeding say further income tax rate decreases to Gov. Asa Hutchinson’s eventual goal of 5 percent is “feasible” and would be a “welcome improvement.”

Arkansas Property Taxes

Horpedahl and Kaeding on property taxes:

Not too much has changed here. While some tax rates may have increased, on average these have been in line with increases in home value: Average tax rates for owner-occupied homes were about 0.6 percent in both 2010 and in the latest available data, but the homestead tax credit was increased by $25, which will lower property-tax bills slightly in future years.”

You can read the entire op-ed .

For more of ACRE’s work on taxes, check out the below links:

The Road Map to Tax Reform in Arkansas

Lessons From Other States Tax Reform Attempts

More on State Taxes and Spending

On February 13th, Rep. Justin Gonzales, R-Okolona, presented House Bill 1402 in front the House State Agencies Committee, which would limit special elections to just two dates a year – either at a primary or general election, or their corresponding dates in off years. Dr. Jeremy Horpedahl was invited to testify to the committee about his research on special elections. He explained how low voter turnout is during special elections (19%) compared to general elections (44%), and how the pass rate is much higher during special elections. He’s quoted in Jeannie Roberts’ article, “” in the Arkansas-Democrat Gazette about the committee meeting.

Arkansas has the in the nation at 9.43%. One reason for that is special elections. In 1981, the Arkansas legislature began allowing cities and counties to increase their sales tax rate and many did. 83% of the time, these increases are voted on during special elections. Special elections are usually single issue elections that happen outside of regular voting at a primary or general election. How important are special elections to the increases in taxes? In 2016, BTĚěĚĂassistant professor of economics and ACRE Scholar Dr. Jeremy Horpedahl and Alexandria Tatem, a BTĚěĚĂSchedler Honor’s College student and an ACRE student worker (who has now graduated), began gathering data on all sales tax elections in Arkansas since 1981, including ones at both special elections and normal elections.

What they found was interesting. Special elections to increase the sales tax have much lower turnouts and much higher pass rates than votes held at a primary or general election. Specifically, they found that voter turnout was 44% in general elections, 26% in primary elections, and 19% in special elections. The pass rate for these increases in the sales tax rate was 45% in general elections, 56% in primary elections, and 77% in special elections. It’s easy to see why ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s sales tax rate is so high, since 82% of all sales tax votes they collected occurred in a special election. Dr. Horpedahl also conducted statistical analysis with the data and found that turnout has an independent effect on the outcome. That means that even within special elections, higher turnout increases the share of “no” votes.

Dr. Horpedahl and I have updated the data to include elections through 2018. We collected data on 30 more elections, and the results still hold. The percent of special elections in the entire dataset increased to 83%, voter turnout stayed the same for general elections and special elections and decreased by 2% for primary elections, dropping to 24%. The pass rate for each election shifted slightly, moving general elections to a pass rate of 46%, primary elections to a pass rate of 61%, and special elections down to a pass rate of 76%. Please download our one page summary of the data to see more.

We have also mapped where the highest sales taxes are in the state. Below you’ll see a weighted average sales tax (which includes both county and city sales tax) for each county using county and city populations.

We have also updated the total estimated cost for hosting each election, based on data we obtained directly from local government statements for a sample of elections. Previously, the costs of all the special elections was $7.4 million, but after adding the new elections and updating the numbers for inflation, the total cost to taxpayers is $9.8 million for holding these elections. This is not just the cost of doing business or the cost of democracy – this is money that could be completely saved if the elections were to be held at the same time as primary or general elections.

The cost of allowing these special elections is high. It is part of the reason that Arkansas has the third highest sales tax burden in the country. 83% of sales tax increase ballot issues have been held at a special election, and since these elections have low voter turnout and a high pass rate, ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s sales tax burden has been creeping upward and upward. In addition to the cost a high tax burden imposes, taxpayers have also paid nearly $10 million for elections to increase their taxes.

Currently, cities and counties have a great deal of discretion when deciding when to hold special elections. Arkansas lawmakers considered a bill in 2017 that would change the timing of special elections. was designed to increase voter turnout by requiring that all special elections must be held at a primary or general election in even years, and in May or November in years without a primary or general election. Arkansas lawmakers considering similar legislation should understand the costs and benefits of allowing these special elections when considering changing the law concerning special elections. Limiting the timing of special elections to general and primary election dates would increase voter turnout, lower sales taxes in the long run, and save money by eliminating the need to pay for separate elections.

You can find a video of Dr. Horpedahl’s , starting at 10.25.55
You can find more of Dr. Horpedahls’ research here
You can find more of ACRE’s research on taxes and spending here

The Arkansas Legislative Tax Reform and Relief Task Force cited BTĚěĚĂAssistant Professor and ACRE Scholar Dr. Jeremy Horpedahl’s work on property and sales taxes in its interim report released on December 18th.

The 180 page report produced by Public Financial Management (PFM) summarizes the task force’s work so far to modernize and improve ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s taxation. PFM had been assisting the task force in its tax reform efforts since September 2017.Ěý

Sales Taxes

In its section on local option sales taxes, PFM cites Horpedahl’s work on the variability of county sales tax rates across Arkansas. You can read ACRE’s one-page summary of data related to this issue here.

PFM writes in the interim report:

“When possible, the ability of local governments to set (or not set) a local option rate and/or set a varying rate can lead to significant uncertainty related to overall sales tax rates in a state.”

Property Taxes

The report also cites Horpedahl and the Tax Foundation’s Nicole Kaeding blog post published on December 5, 2017 entitled

PFM writes that the U.S. Census Bureau, Horpedahl, and Kaeding agree that some property taxes in Arkansas should be considered as part of ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s overall state tax burden despite property taxes being levied at the local level.

Horpedahl and Kaeding write:

“While property taxes in Arkansas are primarily a local function, there are good reasons to think of some real property taxes as state-level taxes, even though legally they are local taxes. Specifically, Amendment 74 to the Arkansas Constitution (narrowly approved by voters in 1996) requires all school districts to set a minimum 25 mills property tax. (Because Arkansas taxes based on 20 percent of assessed value, 25 mills is essentially equivalent to 0.5 percent of property’s value.) The proceeds of this minimum property tax for school districts are then redistributed from the state to local school districts. Since local governments (school districts) are required by state law to collect this tax, it makes sense to think of it as a state-level tax.”

To Learn More

The task force will meet next at 9 a.m. February 5th in Room B of the MAC Building in the State Capitol. Their final report on improving ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s tax code is due by September 1, 2018.

For more of ACRE’s work on tax reform, read authored by ACRE Scholar and BTĚěĚĂAssistant Professor of Economics Jeremy Horpedahl and Tax Foundation experts. The rest of ACRE’s work on tax policy can be found here.

[Also posted at the ]

´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s will continue its job of working to improve ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s tax system next week. Now that the process of choosing and hearing from the consultant, PFM Group, is done the Task Force is now really getting down to business. The tentative plan for the November meetings is to discuss the sales and use tax in Arkansas.

As coauthors of a major book of ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s tax system, , we have also studied and thought deeply about how the sales and use tax in Arkansas could be improved. Chapter 6 of our book examined the sales tax in detail, and we will summarize some of our main findings and suggestions here.

General Recommendations

One major issue with sales taxes across the country is the eroding . The base erosion is partially due to conscious policy changes, such as exemptions for groceries as we discuss below. But another source of sales tax base erosion is the changing structure of the economy, moving from a goods-based economy to one dominated by services. This change is essential to understanding sales tax base erosion, since nearly all states include goods in the tax base by default (unless exempted) and exclude services by default (unless specifically enumerated).

Arkansas fits well within this national trend. Services are usually exempt from the sales tax (with a few exceptions), while goods are generally included in the sales tax base. In 1977, we estimate that Arkansas was accurately capturing about 77 percent of the logical sales tax base using the basic principles of public finance economics. By 2015, the sales tax base had gradually shrunk to about 43 percent of the appropriate implicit tax base. That 43 percent figure actually places Arkansas in a position of strength, with the eighth broadest sales tax base in the country, and well above the national median of 23 percent. But from that position of strength, Arkansas has much work to do to improve the breadth of its sales tax.

In addition to having one of the broader sales tax bases in the country, Arkansas also has the third highest average sales tax rate in the country (including local sales tax rates). Together, these mean that Arkansas is heavily reliant on the sales tax for funding state and local government services. For example, even though Arkansas is by most measures in the bottom five states in terms of income (and thus consumption) per capita, it has the 10th highest general sales tax collections per capita, more than high-tax, high-income states such as New York and California (the 11th and 15th highest on this measure).

Arkansas also derives about 37.5 percent of all revenue (state and local combined) from the general sales tax, the eighth highest in the nation (or the fourth highest if we exclude states with no general income tax). The national median is around 24 percent for states that have a sales tax. Arkansas relies heavily on the sales tax as changes to the sales tax only require a majority vote of the General Assembly under Amendment 19 to the Arkansas Constitution; increases to income taxes require super-majorities.

The most basic reform that Arkansas can enact is to broaden the sales tax base to include more services. One way to do this is by gradually including more services in the sales tax base. An easy place to start would be service industries that are already taxed in neighboring states, but that Arkansas does not tax. A much more dramatic, though also more economically sound change, would be to include services in the sales tax base by default, unless there are good economic reasons for exempting the service. In other words, treat services the same way goods are treated. Finally, Arkansas could consider including some goods in the sales tax base that are currently excluded, such as groceries (discussed below).

At the same time that Arkansas is broadening the sales tax base, the new revenue should be used to lower existing tax rates. As mentioned above, Arkansas has one of the highest sales tax rates in the country. But other tax rates are high, and may be even better ones to lower with the new revenue. For example, at 6.9 percent Arkansas has the highest personal income tax rate among its neighbors, and the second highest in the South (South Carolina is slightly higher at 7 percent). And the top corporate income tax rate is tied with two other states for second highest in the South at 6.5 percent (only Louisiana is higher at 8 percent).

At the same time Arkansas is broadening its sales tax base, one caution must be kept in mind: don’t make it too broad. Specifically, business purchases should be exempt from the general sales tax. Many business purchases are exempt, though some are taxed, and caution must be exercised to not include any new business services.

The reason for exempting business purchases of goods and services from the sales tax base is not to give preferential treatment to businesses. Instead, it is to avoid the practice of tax pyramiding, where taxes are placed on multiple stages of production. Not only does this practice lead to higher taxes than the stated rate suggests, it can lead to distortions across industries. For example, some industries may only have two stages of production, while others have six stages. The six-stage industry would be paying over three times as much in sales taxes as the two-stage industry, which is not only unfair, it may distort business investment decisions. A good sales tax base treats all industries equally.

Lower Sales Tax Rate for Groceries

One major example of an exemption that narrows ´ˇ°ů°ě˛ą˛Ô˛ő˛ą˛ő’s tax base is the lower rate imposed on groceries (technically food and food ingredients). The normal statewide sales tax rate of 6.5 percent is reduced to 1.5 percent for items that qualify under this exemption, though local sales tax rates still fully apply to groceries. In an April 2012 , the state’s Department of Finance and Administration estimated that this lower rate costs Arkansas about $197 million annually, compared to taxing groceries at the full sales tax rate.

The current lower rate for groceries is part of a series of changes, starting with a 3 percent rate in 2007, which was a campaign promise of then-Governor Mike Beebe (D). While the bill passed both houses of the General Assembly unanimously, support was not universal across the state. For example, the Arkansas Advocates for Children and Families (AACF) that the cut in the grocery tax was a poor way to assist low-income families, since it also benefits millionaires and non-Arkansans. Their preference was the establishment of an Earned Income Tax Credit, a much cheaper way to provide the same level of benefits to low-income Arkansans. Many members of the governor’s own party also initially supported measures more directly targeted at low- and middle-income families, such as income tax credits.

The debate over the grocery tax between left-leaning AACF and then-Governor Beebe highlights an important difference between arguments for exempting groceries from the sales tax. The first is that groceries are a necessity, and therefore it may be a good idea to exempt them for purchase by both rich and poor alike. The second argument is that the poor spend a disproportionate amount of their income on consumption generally, but especially necessities such as groceries.

While the two arguments are similar, they have . If taxing necessities is generally a poor policy choice, exempting groceries from the sales tax is a good idea. But if the primary goal is to help those families who are struggling to make ends meet, it may not be the best policy. First, because it is an expensive way to help a targeted group as all individuals benefit, and second, because it may not actually help many poor families. Those at the very bottom of the income distribution who purchase their food with government benefits such as Supplemental Nutrition Assistance Program (SNAP, known colloquially as food stamps) and Women, Infants, and Children (WIC) already enjoy tax-free purchases, and there is no additional benefit to lowering the sales tax rate on groceries for them.

There are better ways to help Arkansans make ends meet than by partially exempting groceries from the sales tax. For the lowest-income Arkansans, grocery tax credits or an earned-income tax credit would be a more effective and targeted way to provide them with additional income support. For all Arkansans, lowering one of their tax rates, such as the personal income tax, would also be a better way of helping them. Instead of saying “we’ll only give you a tax break on your groceries,” Arkansas could say “we’ll give you a general tax break, and you can then choose where you spend your income.”

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 Economics. They are the lead authors of .