62.2% of the state's general funds comes from sales and use taxes. When those revenues fall short of projections, emergency adjustments from lawmakers are required when crafting the state's budget. Kim Rubin is a senior fellow in the Urban Brookings Tax Policy Center at the Urban Institute. She directs the state and local finance initiative. She joins us now from Washington, DC, to talk about the state's tax policy in South Dakota.
Listen to the entire conversation here.
Let's start with what the State and Local Finance Initiative is. What can you tell us about that?
We basically are part of the Tax Policy Center that studies tax policy both at the federal government level and also across the 50 states. What we do--and what I do--is I direct the work that state and local governments are up to and what their taxes look like. Being in Washington, it's often funny, in that most people here kind of forget about states, and I try to remind them that there are 50 other governments out there that are trying to balance budgets and provide for their citizens.
You're looking at an overall report card, “hey, this is how South Dakota is doing”. Are you looking at key indicators of fiscal health and strong tax policy? Are you providing individual assistance to state governments as they have these conversations?
Some of all of that. We largely look at what state taxes look like overall, and then look at how if they choose to change certain policies what that would mean for both people in the state and their overall fiscal health.
When we look at the state of South Dakota, are there certain policies that stand out? How do those compare to our neighbors and other states?
On the positive side, if we think about the budget that just passed this year, your whole budget discussion was much more civilized than what we see in some of the other states, both in the region and overall in the country. So in the positive side, people are acting like grownups, and both Democrats and Republicans are talking about how much money needs to be raised and what needs to be cut if we don't have enough money going in. That's all to the positive. When we hear stories about what's going on in Illinois or the fact that Chris Christie's at the beach while they've closed the beaches for people because they can't pass a budget, South Dakota is doing pretty well.
What is unique about South Dakota, or what's different from most states, is the fact that it's one of seven states that doesn't have a personal income tax, meaning that it's more reliant on sales tax revenue to actually balance the budget.
What are the challenges of that and the advantages for us as a state, from not having a personal income tax? Challenges first.
The challenges include that, over time, the amount of economic activity that's covered by the sales tax has actually been eroding, so it's been falling over time. As people are buying less goods and spending less of their money on physical things, it means that how we tax things erodes and we don't have as much money coming in.
The other problem, is when you have more and more people buying things online, historically they're not paying sales taxes on that, so because of the change in how people are purchasing things and also the fact that we're buying different things, means that over time the sales tax actually raises less money than it, say, did in the 1950s and 1960s.
South Dakota is actually on the forefront of trying to challenge the rules on how internet sales are taxed or are not taxed. The argument had been, historically, that if you don't have physical presence in a place, a company doesn't have to remit or pay those sales taxes. South Dakota is basically saying if you have economic activity, you're responsible for it. It's not an undue burden, given technology and the fact that there are programs and there is software around where people and businesses can figure out what those taxes are and send them to the state.
That’s the big downfall, that we're getting less money from the sales tax over time. The advantage is, if you're a taxpayer or you live in South Dakota, often you like having one fewer tax, because it's seen that taxes overall don't need to be as high, but it does mean that if the sales tax runs short, there are harder decisions that have to be made.
People are buying things in a different way. Do you think that's a trend that continues? We're not buying goods in the same ways that we did, not just from where, but what, the ‘what’ we're buying has changed from the 1950s. How so?
That's right. If we just take something like books, right? We used to go to the bookstore down the street and buy some books and read it in a paper copy. Now, what people are more likely to do is they're downloading a file from a computer onto a reader or computer, and that's how they're reading, and those are typically not taxed, and so just as technology's changing, we actually have to think about how we raise money if we’re a state government. If [you] actually have to provide services for people who live somewhere, how do you raise money at the lowest rate you possibly can but still get as much money in, and you want to do it in generally in a way that doesn't bias activities in one way or another. If people are happy to either buy a physical book or download a file, you don't necessarily want them to have an eight percent penalty for going to the bookstore and buying the book and having a paper copy.
We spoke with our lieutenant governor in an earlier conversation, and one of the things he encouraged all the listeners in the state was to think responsibly about where they're making their purchases and how. What's the role of personal choice in that? Is that something that you think could have traction, where people in the state are making a choice, saying, "Yeah, we don't want to have income tax, and therefore we're going to spend our money in a certain way," or is that wishful thinking?
I think it's a little bit of wishful thinking, in that people often will want to buy things in the cheapest possible way, or in the way that's most convenient for them. One downside of not having an income tax, and this is sort of albeit awkward thinking--so often when you do have a sales tax, people are in theory responsible for paying for things they haven't paid the tax on. Sales taxes are actually sales and use taxes, so in general you're supposed to be paying the state of South Dakota funds for things that you've purchased if you haven't paid sales taxes on that. That's actually an easier to do in states that have an income tax, because there's a line on the income tax where people can report those sales. In places where there isn't an income tax, it's really tough to try and figure out how you get to pay that money to your government, even if you want to. It becomes much tougher.
Figuring out ways that people might be able to pay their sales taxes or their use taxes if they don't want to change how they're purchasing things would be useful and helpful for the state.
Do you see traction in other states too? You said South Dakota's at the forefront of the conversation about online sales, such as Amazon collecting sales tax. Is that gaining traction to the point where that could affect us in the future in a positive way?
Yes. For the first thing, Amazon is actually collecting sales taxes on purchases that are bought through them, so not through third party sellers, but if you purchase something on Amazon, you'll sometimes see now that they actually collect sales tax, and that's because Amazon is counting on the fact that what they're trying to do is build their model so that they're delivering more things on the same day or quickly, and so they're going to have to have physical nexus or have capacity to fill those orders locally if they want to get things out that fast.
What we've been waiting for for the last 30 years from Congress, is passing something that makes it easier to tax internet sales or electronic sales or catalog sales. They've come close a couple of times, but it's never actually passed in Congress, where they would set the rules and actually set up some systems which would make it easier for business to be able to pay all of the fifty states. We need there to be some rules about if somebody's purchasing something, whose sales taxes are you going to pay? If you're a company that is in one place but you're sending it to a second place, and it's being bought by somebody who lives in a third place, who gets that sales tax, and that's something that the federal government could agree to and states have been coordinating to try and make that easier. I think there definitely is work going on, especially across states, trying to make it easier to figure out how those internet sales could be taxed.
The other thing that is tough is what people are buying is also changing, so instead of buying physical things, we're spending more of our money on services, and historically those things haven't been taxed. There are a couple of states that have been able, that have broadened their sales tax to tax more things, and so that's also something that South Dakota could do more of if it wanted to broaden the base.
How so?
There all sorts of services that could be taxed. New Mexico has a much broader tax system in place, so there's a question of do you tax things like gym memberships or yoga studios or dry cleaners. There are certain other activities that historically haven't been taxed that a state could go ahead and tax.
Let's talk a little bit more about this income tax. You said South Dakota is one of only seven states who still don't have one. Is an income tax for a state inevitable, or are their ways to hold that line if it's something that the state decides? Then, let's talk a little bit about what happens if a state transitions to that.
I don't think it's inevitable. I think there's a number of states, including you, that don't have one. There are also some states that have an income tax but don't have a sales tax, and so it is possible to keep it. It's just that if you only have one and not the other, the rates have to be higher.
I had this conversation with some people in New Hampshire, which is far away, but they don't have a sales tax or an income tax, and there they were complaining about the fact that their property taxes are really high. In part, if you don't have certain taxes, it means that what's left ends up picking up the slack.
Some of the places that don't have an income tax have been able to get away with it in large part because they have other types of economies that raise money. A place like Texas doesn't have an income tax, but they're getting a lot of money from oil and natural gas. So is Alaska. Alaska actually eliminated its income tax. It had an income tax, and they got rid of it. More recently, as the price of oil and natural gas has fallen, they've started talking about whether they have to reinstate it or not.
I think in general, places that don't have taxes, don't necessarily want to introduce it, but it depends what else is happening within your state and whether you can raise the money you need to provide the services you want. If it's a trade-off between introducing an income tax and funding your schools, you might decide that it's worth introducing the income tax, but it also might be possible just to raise your sales tax or broaden the base of the sales tax.
How consistent is income tax? Is that a more reliable stream of income? Is it more consistent, or is it unpredictable?
This is where it gets a little complicated. In general, because South Dakota doesn't have an income tax, you actually have much more stable or less volatile taxes than in other places, but it means that the tax rates would have to be higher, so just having an income tax is a more volatile, or it moves around more, because it depends on things, especially if you have a tax on things like capital gains and stock options that vary a lot over a business cycle. In that way, having a sales tax is just more constant.
The problem is that if you have two taxes and changes in the economy, especially if downturns in the economy hit them in different ways, by having those two taxes in place, it sort of insures you against some types of risk.
By diversifying things, it makes it, you're less vulnerable to downturns or sudden shocks. That's less of an issue for something like sales tax than for some of the other states. North Dakota and some of the oil and natural gas states that have seen big hits to their budgets because they were so reliant on those extraction taxes.
All right, so here's a magic question that might be unanswerable. Are we more civilized in our discourse in South Dakota just because we're good people, or is that evidence of the stability and the constancy of the sales tax, of how we're structured? Does that promote a calmer conversation, when you don't have those big swings, or are we just nice?
That is an interesting question. I would not discount the fact that you are nice ...
Me either.
... but I think in part you're grown-ups in a way that some other states are not necessarily acting. Part of the problem you're seeing this year in the budget process, and again, it was much more civilized than in a lot of other states in that you actually had a budget passed much before your deadline, and the fact that we have seven or eight states that still don't have a budget finalized, even though they were due on Friday, is a problem.
I also think that, last year, the sales tax was increased is [an example] that people in South Dakota are going beyond the rhetoric and actually thinking about and looking hard at what's needed, and so that sales tax increase didn't raise as much money as what was originally predicted, which has made for some tough decisions this year going forward. I think there's going to be some questions about what your next step is. Is it the case that if the money is not coming in, is that because farm prices were down, or does it just mean that there's more erosion than we thought in sales taxes? I would say it's a little bit of both, but there have been other states where I thought people had historically been good government types, where the conversation had been pretty civilized, and that's sort of fallen apart, if we think about places like Minnesota and Wisconsin.
Check out South Dakota's Budget in Brief here.
Let's wrap up with this. It's all online. We can go and look at what the state budget is. When we look at that and then [when] I went online to some of your website and compared different states, per capita, what are the smart questions we need to ask as citizens, as voters, about how our budget is structured and the spending is concerned? Do we look at those per capita numbers and say, “oh, we're spending fifteen hundred dollars per South Dakota resident on K through 12 education”. How do I put that in perspective? How do I know if that's positive? Do I compare it to Minnesota? Do I compare it to other line items in the state budget? What are the smart questions to ask?
I think part of it is thinking about what it is measuring. In some ways looking at per capita is an overall number, but then you have to think about the fact that if you're a big state with a lot of land but relatively low density, so you have few people and where they are, figuring out what that means for those costs is really important. You might need more money for transportation and for roads and highways than a state that's smaller, than say Rhode Island.
I think in general, starting with those per capita numbers but then digging into sort of what's driving those numbers and asking the questions of “what level of service do you want to provide?”. If you have fewer children than another state, it means that you could have higher spending per pupil for less money per capita just because there are fewer kids to have to pay for things for.
Of course, if you have fewer children, it also means that the amount you’re spending per student might be higher, because there are just fewer of them, and if you want the schools locally, you need that money.
There’s no easy number, always dig deeper and find out what’s behind the ‘what’ and the ‘why’. That’s the take-away.
Understanding what it is that you're buying. Mostly what state governments are paying for, state and local governments are paying for are often right now education, healthcare, and police and fire. It's not just that they're sort of raising this money for a lot of state employees or something.
