SC House GOP Sales Tax Plan Addresses only 8 % of Exempted Sales

Leaving the cap on sales taxes on cars untouched, the much ballyhooed elimination of “two-thirds of the special interest sales tax exemptions” in the SC House Republican Caucus’s comprehensive tax reform plan only effects 8 % of sales and use tax exemptions— $218 million of the $2.8 billion.  [All figures are from the BEA’s Sales and Use Tax Exemptions FY2008-09].  That’s not going to reduce overall rates very much.

This is not surprising.  The real money in sales tax exemptions is in prescription drugs purchased at pharmacies ($585 million), groceries ($354 million) and electricity or other fuel used for home heating ($188 million). That is not to mention the $253 million from sales to the Federal government that is not taxable under the US Constitution or the $500 million in highway fuel that is simply taxed another way. Altogether, that’s $1.88 billion of the $2.8 billion “sitting out there” in sales tax exemptions.

The House GOP left the most egregious exemption, a $300 cap on sales tax on cars, yachts, motorcycles  and airplanes despite earlier news reports that the cap would be phased out.  The elimination of a cap that taxes a $6,000 used car the same as a  $2.4 million Bugatti Vayron would have added $173 million to the exemptions eliminated, 80 % more.

So, who are the “special interests” whose exemptions are eliminated?  Telephone and ATM users lead the list at $74 million.  Next come Lottery ticket purchasers.  Of the $218 million eliminated, 22 % ($48 million) comes from taxing Lottery tickets.  The next special interest is students and libraries.  Books, textbooks, access to online services and other printed material used in schools (K-12 and higher ed) or for use in a school or publicly supported library would be taxed.  That’s $22 million.  Bible readers are apparently a special interest, too, since taxes would be added to purchases of “the Holy Bible,” newspapers, books, magazines and periodicals.  Twelve million dollars from the special interest group of readers.

An actual special interest, “radio and television stations, and cable television systems” would be liable for purchases used in producing, broadcasting, or distributing programs, an exemption which now saves them $9 million.

The next “special interest” is old people, really old people.  Elimination of the penny exemption for seniors 85 and older would add $5 million to eliminated exemptions.  Age-based tax preferences are bad public policy, but fixing this one won’t help much to lower the overall sales tax rate.

Two exemptions which have received press attention for their proposed elimination are the gun sales tax holiday over the Thanksgiving weekend and the back to school sales tax holiday in August.  Eliminating the gun holiday in the Code is only clean up.  The Supreme Court invalidated the law which enacted it.  It has continued, until this fiscal year, as a budget proviso.  The August sales tax holiday costs the state $3 million in tax revenues.  As the Tax Foundation notes, sales tax holidays are “Politically Expedient but Poor Tax Policy”.  It’s still not much money.

Every sales tax exemption has a lobbyist attached to it.  The $73 million proposed to come out of customers of phone companies and banks won’t go unchallenged.  Dry cleaners ($3.2 million), movie theatres ($2.8 million), hearing aid dealers ($2.1 million), amusement parks ($3.9 million), motor vehicle extended service or warranty peddlers ($1.2 million) and firms doing research and development ($2.6 million) won’t simply sit back and accept new taxes.  The retailers who will lose the $22 million reimbursement for collecting taxes in the form of a discount for taxes timely paid will be raising sand.  This proposal will not emerge unchanged.

In its report, the Taxation Realignment Commission (TRAC) proposed taxing a number of additional services and intangible goods, like digital goods, software and data processing, using the proceeds to reduce the overall tax rate. They recognized that we have moved from consuming goods to consuming services.  There are no such proposals here.

The  House Republicans had a real opportunity to fix serious issues in our sales and use tax code.  They passed on eliminating a car tax cap that only car dealers think makes sense.  They passed on taxing additional services and intangible goods.  Instead, they repeal numerous chump change exemptions making up only 8 % of the total currently exempted taxes.  That should lower sales taxes by half a penny—not the nearly three cents implied by the Caucus brag that it is eliminating two-thirds of those exemptions.

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SC House GOP Tax Package Does Little for Economic Development and Poses Long-term Threats to Fiscal Health

The South Carolina House Republican Caucus finally introduced its “comprehensive tax reform plan” this week.

The seven planks of the plan include three aimed at encouraging economic development that will do little or nothing to bring new jobs or raise per capita income in our state.  One plank phases out the corporate income tax.  As we have discussed elsewhere,  the export businesses we are trying to recruit don’t pay corporate income taxes in any case because of how we apportion multistate income based on where sales are made rather than where products are made.  Eliminating a tax that new businesses won’t pay, or at least won’t pay much of, hardly helps entice new businesses.

Another cuts income taxes on the many small businesses that flow their profits through to the owner’s personal income taxes.  These untargeted cuts, aimed at “entrepreneurs” according to the release, will wind up often just padding profits for the many small businesses which are not growing and have no intention of growing or are so up against it that they have no profits yet.  The funds could be much better spent training new and existing employees of small businesses and providing support services through Small Business Development Centers.

The third effectively cuts the manufacturers property tax assessment ratio from 10.5 % to 6 %.  The reality is that any manufacturing business which is moving into South Carolina, expanding its employment or making significant capital investments can already cut a deal, a fee-in-lieu-of-taxes agreement, with counties that effectively cuts its assessment ratio to 6 % or, for really large investments, 4 %.  The 10.5 % ratio is only an economic development burden because it makes us look bad in unsophisticated national rankings that only look at nominal rates and not actual rates.

In reviewing effective tax policies for economic development, Timothy J. Bartik, a leading authority on the matter, notes:  “One policy option that is NOT cost effective is an across-the board cut in business taxes.”  The House has chosen the ineffective approach to economic development.

The economics research is pretty clear that the beneficial economic development effects of tax policy are fairly small and are quickly eliminated or turned negative if you pay for them by cutting the kinds of government services that businesses think help them in the long term—things like education, health care, infrastructure and quality of life.

As outlined in a Caucus press release Monday, will take no less than $220 million out of recurring General Fund revenues each year going forward despite the fact that the BEA projects revenue growth to slow in future years.  We go into the next Fiscal Year $600 million short of meeting our statutory obligations to fund local schools through the Education Finance Act.  Even with a strong rebound in revenues for this year, the House Ways & Means Budget funds only $2,012 of the formula requirement of $2,790 in Base Student Costs.  This $220 million is most likely to come out of education funding.

We will be analyzing the proposals to eliminate some of the sales tax exemptions and to collapse the bottom four individual income tax brackets into one at 3 %.  It’s clear that they have  taken all the real-money sales tax exemptions off the table—gasoline, groceries, prescription drugs, home electricity and water. That’s good because these would be very regressive taxes.  However,  they have not expanded the number of services which are taxed. Reviewing sales tax exemptions every five years is not a terrible idea, but it is unclear that a perpetual tax review will produce any more coherent policy than our episodic tax studies.

The House Caucus press release makes pretty clear that this plan is more about an anti-tax ideology, and filing deadlines, than about sound economic policy. The so-called economic development changes will, given the revenue-negative effects of the changes, end up suppressing economic development in our state.

Posted in SC Budget | 1 Comment

Funding Private Schools—Here We Go Again

State funding of well-off private school students and homeschoolers is back on the agenda with a South Carolina House subcommittee hearing Wednesday on the latest effort to subsidize private education with public dollars.  The design of the latest proposal will only transfer public dollars to higher income parents.

This legislation, whose chief sponsor is Ways & Means Chair Brian White, allows an income tax deduction for parents who send their kids to private schools ($4,000 per child), who home school ($2,000 per child) or who send their child to another public school district ($1,000).  But those subsidies are not available to the majority of South Carolinians who, although they pay sales taxes and property taxes, have no state income tax liability.

If the real driver of this legislation  were to ensure competition and better education for poor children, you would design the program differently.  You would create vouchers and allow families to choose which school works best for their kids.  That proponents instead create tax deductions to middle and upper class families which only benefit the wealthy and provide a limited amount of scholarship money for poor kids, tells us something.  This is about providing a relatively small subsidy to families already able to send their kids to private schools or home-schooling while taking $37 million out of constrained state resources.  This is not about low-income kids.

For instance, a family of four taking the standard deduction, the tax liability is zero until they reach $29,200 in income.   Because this is a deduction, rather than a credit, a $4,000 deduction would produce, at most, a savings of $273 per child for someone in the $200,000-$500,oo0 taxable (after all deductions) income.

In a classic bit of bad drafting, these deductions are inflated by growth in population plus growth in the Consumer Price Index (CPI).  Leaving aside the appropriateness of the CPI, the growth in population has nothing to do with increasing costs to educate one child.

Having been accused for years of ignoring the needs of low-income students, proponents of public funding of private schools have in recent years established a tax credit for contributions to private scholarship organizations.  They would pay tuition (tuition, transportation and textbooks) for low-income students and “exceptional needs” students to private schools.  For low-income students, the scholarships are limited to the lesser of $5,000 or seventy-five percent of costs – that means  that private schools would still be out of reach for most students, except those at the top of eligible income.

For poor kids, the total of scholarship-funding tax credits is limited to $15 million per year.  Only a moment scanning reports for schools on the Poverty Index (using the same standards as eligibility for scholarships, essentially being below 200 % of the Federal Poverty Level) would make clear that $15 million would be a drop in the bucket if this were a meaningful program.  Opponents would note that there are no private schools—at least none that is interested in poor students of color—in districts like Marion 7, Allendale and Bamberg 2 where just shy of 100 % of students would theoretically be eligible for scholarships.  Though proponents of the fund  would suggest that someone would rush in to create those schools, it is easy to see that this will not be the case if funds  are limited.

Clearly, immense challenges face our schools and our children.  Our long-term well-being depends upon ensuring that we address those challenges. Since poverty is a clear impediment to educational progress, we should also focus on eliminating poverty.  Continuing this side discussion about subsidizing private education while we are celebrating a budget that is still short $778 per weighted student unit  of recommended adequate funding clearly means one thing — we are still not taking steps toward real change.  Instead, we are entertaining proposals that bolster those who need it the least and dragging  us further to the failures of the past.

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Nikki Haley and Charlotte’s Web

In articulating her economic development strategy, Nikki Haley demonstrates that she learned much more from E.B. White’s Charlotte’s Web than from the large body of research literature on what works in economic development.  In this children’s story, Wilbur the pig is saved from Christmas slaughter by the spider Charlotte who spins webs extolling Wilbur—”some pig,” “terrific,” “radiant,” and “humble”.  Haley’s economic development strategy is the same.  We will weave a web of policies that convince business people that we are “some state,” “business friendly,” “low business taxes,” “anti-union,” “anti-regulation” and “anti-lawsuit”.

State and local governments have been trying to entice businesses for a long time and economists have been studying what works for nearly as long.

“One policy option that is NOT cost effective is an across-the board cut in business taxes” notes  Timothy Bartik, one of the foremost authorities on state and local economic development.  Our existing corporate income tax apportions multistate income solely on sales inside South Carolina.  Exporting companies, the ones we should be incentivizing to locate or expand here, are already exempt from income taxes on the bulk of their business.  These generalized cuts go largely to businesses either in no position to create new jobs or whose new jobs are driven by consumer demand rather than state taxes.

“Once one accounts for the opportunity costs of paying for business tax cuts through cuts in public spending or increases in household taxes, the economic development benefits of general business tax cuts are usually less than their costs and may even be negative.” (Emphasis added.)

In their summary of a 1997 symposium, Katherine Bradbury and her colleagues from the Boston Federal Reserve Bank note that tax incentives “… can also indirectly impede development if they reduce expenditures on public services that businesses value.”  Those things that businesses value include education, health care and infrastructure.

Broad-based tax cuts don’t work and cutting services like education and health care is counterproductive.  But there are things that work.  Bartik, in his 2011 book Investing in Kids, argues for well-designed tax incentives targeted at business that will increase per capita income. The average incentive only makes a difference in a branch plant location or expansion 3.6 % of the time. It’s important that there be clawbacks in place for failure to meet targets and that they be enforced.  A recent study by Good Jobs First suggests that monitoring and enforcement in South Carolina are lax.

Bartik tells us: “Two policies with rigorous evidence of cost-effectiveness are customized job-training and manufacturing extension services.” Our ReadySC program provides customized job training. Manufacturing extension services might include advice on improving productivity or product design or finding new markets. These are especially useful for small and medium size businesses. Infrastructure investments pay off.

Workforce development is important.  The Governor has announced her as- yet-undefined workforce development program in conjunction with ACT, the testing company.  Besides pushing ACT’s WorkKeys jobs skills assessments, we don’t yet know what it will look like in South Carolina.

The return on investment increases significantly the earlier the intervention. Additional learning time at early ages delivered by “reasonable quality programs,” Bartik’s research shows, “can be effective in dramatically changing the future earnings of many children from all income classes.”  At later ages, “the effectiveness of labor supply programs depend on targeting persons with good basic skills and focusing on the skills needed by employers.”

These are all long-term investments.   There are proven, short-term training programs providing wage subsidies to employers to add new jobs.  Bartik’s study of Minnesota’s 1980s MEED program shows a $6 increase in local earnings per capita for every dollar invested.

There is a lot of evidence on what works and what doesn’t work.  Clearly, Governor Haley’s plan to cut corporate income taxes won’t work and may be counterproductive if it’s combined with cuts in education, health care and infrastructure spending.  Every business-climate study out there, except those crafted to push a particular policy agenda, already says that we are a business-friendly state.  It would help if we were also known as a state making solid investments in our human capital, infrastructure and workforce development.

E.B. White was a great writer.  However, we should look elsewhere for guidance on economic development policy.  There are ways forward, but it will take more than spinning slogan-filled webs to improve the quality of life for all South Carolinians.

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Drowning South Carolina Government in a Bath Tub

In pushing for spending caps, Governor Haley and the South Carolina House of Representatives are pushing Grover Norquist talking points, part of a strategy “to shrink government to the size where we can drown it in a bathtub,” rather than good public policy.  Besides, we already have spending caps.

This past week, Representative Garry Smith of Greenville introduced another in a several year effort to limit the growth in state government spending.  He calls this one (H. 4709) The Cut , Cap, and Balance Act of 2012. It would limit spending growth to the growth in population and inflation in the cost of a market basket of household goods.

South Carolina already has two spending caps.  First, the South Carolina Constitution won’t allow us to spend more than we take in.  That cap led to substantial cuts in General Fund spending during the recent downturn.

We also have a spending limitation based on growth in personal income.  State spending (General Fund, highway funds and EIA) has been shrinking relative to personal income – the best measure of our ability to pay for public goods.  In FY95-96, we spent 7.5 percent of personal income.  In FY11-12, we are spending 4.8 percent. Even if you add in the faster-growing Other Funds and Federal Funds, FY2011-12 appropriations are the same proportion of state personal income as in FY1995-96—14.6 %.

We could quibble with the formula—using the Consumer Price Index, based on a market basket of consumer goods, is simply an inappropriate measure of inflation for state and local governments which necessarily shrinks government.  We could also take exception to the anti-democratic provisions allowing a minority of legislators to stop waivers of the limit.

But at core, the real problem with spending caps is that, at best, they are designed to freeze us in place.  At worst they make things much worse as Colorado found out when it imposed these limits.  Even if you use an appropriate inflation factor, the best you do is what you are doing today.  Governor Haley encourages  magical thinking by requiring Cabinet agency employees to tell callers “It’s a great day in South Carolina.”  Saying it doesn’t make it so.

The anti-government crowd repeatedly utters the mantra:  “We have to run government like a business.” They then proceed to propose running government like a poorly run business with no hopes of prosperity—a business that loses talented people because they won’t pay market rates; that lacks customers because they won’t advertise or invest in customer service; and that falls behind in productivity because they won’t buy better equipment.  Can you imagine a business that imposes spending caps based on some unrelated formula?  Where would Apple be if Jobs and Wozniak had said:  “Every year, we will only increase spending on people and equipment by the same proportion as population and inflation increase”?  Nowhere is where Apple would be.

What a smart business-person would say is:  “What are we trying to accomplish?  If we make additional investments, what  is the return on those investments? What is the return on alternative investments? What is the return on not investing?” If you want to run state government “like a business,” then run it like a smart business and not like a corner shop on the verge of bellying up because of poor decisions.

Spending caps confuse making a budget with figuring out what our state needs to improve the well-being of our people, including growing our economy.  At times we will figure out that those needs require us to raise taxes or to change spending priorities to reallocate resources.  At other times, they will require us to spend less.  But to assume that the only strategy is to spend less is to ensure that where we are today—in educating our children, improving our infrastructure, providing public safety, protecting abused and neglected children and seniors, the developmentally challenged and the mentally ill and ensuring a healthy population—is the best we will ever be.

If none of those things matters to you, then drowning  South Carolina  government in Norquist’s bath tub by imposing Governor Haley’s spending cap is the answer.

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A Foolish Inconsistency, SC Leaders on Military and State Spending

Recent articles in South Carolina papers point to the growing concern that military spending cuts evidenced by base closings and slow-downs in spending on F-35 fighters destined for South Carolina will have a negative impact on our state’s economy.  James Rosen writes for McClatchy Newspapers: “Those [SC] bases employ thousands with an economic impact on the state in the billions of dollars annually. Securing new airplanes for the bases … is vital to their continued operation. Otherwise, they could face closing, an economic disaster for a state with an unemployment rate above 9 percent.”  A report on Saturday tells us:  “Communities already are mobilizing in South Carolina, which has an unemployment rate of 9.5 percent. The economic impact of military installations in the state is more than $13 billion, said Ike McLeese, president of the Columbia Chamber of Commerce in the state’s capital.” And Governor Haley “’is now focused on this issue, energized.’”

We have no doubt that losing these bases would have an effect on these communities. A 2011 Congressional Research Service study concludes: “However, while base closures and realignments often create socioeconomic distress in communities initially, research has shown that they generally have not had the dire effects that many communities expected.”

However, the more significant policy issue is why state and local officials crank up the machinery to keep the economic benefit of federal military jobs while bragging about cutting state and local government jobs.  From December 2007 through December 2010, South Carolina state government employment, according to the labor statisticians at the SC Department of Employment and Workforce, dropped by 4,100 employees while local government employment dropped by 8,100 employees. Would any state leader not stand on her head to bring in 12,200 new jobs?  Why then blithely give up those jobs?

Economist Jared Bernstein of the Center on Budget & Policy Priorities in a pair of posts on his blog notes, first, the steep decline in the contribution of state and local government to total GDP.  “[States] haven’t done much on the tax side, so they’ve been laying off teachers, cops, maintenance workers; practically every month over the past few years we’ve been adding private sector jobs and shedding public sector jobs.”  As he notes, “ You squeeze [state] budgets, it shows up quickly and directly in growth and jobs.”

State tax and budget expert Nick Johnson of the Center observed on Friday: “State and local government spending on goods and services fell at a faster rate — and hence had a bigger negative impact on economic growth — in 2011 than in any year in the last six decades, Commerce Department data released [Friday, January 27, 2012] show.” It’s not just that you cut FTEs at state agencies, a point of pride with South Carolina leadership.  You also “cancel contracts with vendors, eliminate or cut payments to businesses and nonprofits that provide services, and slash benefit payments to individuals.” In doing that you remove money from the non-governmental economy as well and reduce demand.

When looking at military base closings, our political and economic leadership clothes itself in Keynesian rhetoric about jobs.  When faced with their responsibilities to fund adequately state government, they retreat into Hayekian rhetoric about free markets and counter-factual arguments about the drag that government places on our economy.

A foolish consistency may be the hobgoblin of small minds as Emerson told us.  But a foolish inconsistency is not the sign of a great mind.

Posted in Economy, SC Budget | 1 Comment

Haley Budget Priorities: Savings and Tax Cuts but Not Schools

Although state funding for our local schools is $600 million short of what our funding formula (the Education Finance Act) calls for and state economists project nearly a billion dollars in available additional revenue , Governor Nikki Haley’s first Executive Budget includes no increase in EFA dollars for local schools.  Haley directs an additional $10 million to the 1 % of public school students in the Public Charter School District.

Like a homeowner who puts money aside for a rainy day while it’s raining and the roof still needs replacing, Haley proposes moving $219 million of “excess” revenues into reserves on top of the $98 million transferred to the General Reserve Fund.

Haley also “returns to the taxpayers” (well, some of the taxpayers) $78 million in an income tax cut achieved by collapsing the middle tax brackets into one 3.75 % bracket.  The top 45 % of income tax filers (with incomes over $32,700 for a family of four taking the standard deduction) could buy an additional fast food lunch with the $7 per month cut.  The majority of us don’t even get a lunch.  This cut will continue to reduce revenues through the years.

Haley also proposes to phase out the corporate income tax, costing another $62 million in this budget and much more in future years.  Cutting corporate income taxes has a very small effect on economic development—a much smaller effect than not investing in our workforce.   A fuller discussion is here.

This budget includes no pay raises for state employees, who have already gone three years with no increase. The plan increases state contributions to health coverage and retirement.  A 1 % state employee pay increase would only take an additional $14 million in General Fund dollars.

The Haley budget does some good things, like paying for the health care for 80,000 children already eligible for coverage and attempting to keep up with enrollment growth and health care inflation. The proposal puts more money into a mental health system that had suffered deeper state cuts than any in the nation.

Governor Haley keep saying that her goal is economic development.  This budget undermines investments in a trained, educated and healthy workforce.  Without that employers won’t come here regardless of what tax breaks you give them. That starts with funding our schools and for Governor Haley, the only schools with priority are charter schools.

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Another Bad Idea: Axing the SC Corporate Income Tax

In 2011, we will again see proposals to repeal the corporate income tax to “encourage economic development”.  The only real effects will be to further reduce revenue and make it harder to make the long-term investments that will produce sustained economic health.

South Carolina collected $216 million in corporate income taxes and an additional $89 million in corporate license fees in FY10-11.  That $305 million (a 37 % increase over FY09-10) represented 5 % of gross General Fund revenue.  Improving economic conditions make further growth in FY11-12 highly likely.  The Board of Economic Advisers’ November 2011 estimate placed corporate income taxes at $242 million and corporate license fees at $92 million for FY11-12.

South Carolina charges a flat 5 % corporate income tax.  For in-state companies not doing business outside South Carolina, that is a 5 % tax on net income.   For multistate corporations, income is apportioned among the states in which the corporation operates.  As of 2011, that South Carolina apportionment is done solely on the basis of sales.  If 1 % of your sales are in South Carolina, you pay South Carolina tax on 1 % of your net income nationwide.

Although Governor Haley has argued that eliminating the corporate income tax will have the effect of encouraging small businesses, very few South Carolina “C” corporations, those entities which pay corporate income taxes,  are small businesses.  Most South Carolina businesses are pass through entities, sole proprietorships, partnerships or “S” corporations and LLCs taxed as such.  The income passes through to the individual income tax returns of their owners. Under legislation passed a few years ago, those entities are eligible to elect to pay the corporate income tax rate or the existing individual income tax rates.

The SC Department of Revenue does not publish good data on corporate income taxes.  The SC Department of Commerce has put out data on 2008.  According to that information, 80,866 corporations filed in 2008.  About 89 % of them had no tax liability.  About 68 % of the revenue came from foreign (non-South Carolina) firms.  Although they had dipped some, 2008 profits and revenues were better than in 2009 and 2010.

Then State Economist Bill Gillespie told Senate Finance Committee the last time it considered eliminating corporate income taxes that the state corporate income tax had no particular impact 0n business location decisions.  That is doubtless especially true now that we have transitioned to the Single Sales Factor to allocate taxes for multistate corporations based entirely on sales.

I asked and none of my neighbors plans to buy a Boeing 787.  None of Boeing’s profits from sales of the 787 will be allocated to South Carolina.  Similarly, any new manufacturers with significant sales beyond the state will not be paying much, if any, corporate income tax to South Carolina.  The same is largely true for most large South Carolina manufacturers who sell the bulk of their product outside the state.

The only potential business recruits that might be impacted in any way are foreign businesses with significant South Carolina sales but no current presence in the state creating the nexus that triggers South Carolina’s ability to tax the corporation.  Distribution facilities don’t trigger that nexus in any case. It’s hard to think who might bring a manufacturing plant to the state making them suddenly liable for much new tax.  In any case, as the Department of Commerce notes, “SC has one of the lowest corporate income tax rates.”

The research on tax reduction effects on economic development pretty clearly show effects which, as economist Timothy J. Bartik, one of the leading authorities on the issue notes, “are not huge.”  Further, Bartik notes:  “If the state and local tax cuts are financed by cutting public services, the result may be lower business activity.”  (“Solving the Problems of Economic Development Incentives,” Growth and Change, 36(2), Spring 2005, 139-166, 142.)

All of this suggests that eliminating the corporate income tax in South Carolina carries with it a large price tag and precious little return.  Not taxing corporations a little bit is not enough to attract them to our state if we don’t invest in human capital (education and health care), infrastructure and quality of life.  We can’t do that without tax revenues.

Posted in SC Budget, Taxes | Tagged , | 1 Comment

SC Health Insurance Consumers pay $250 per Year in Agent Commissions

Wonder why health insurance is unaffordable?  South Carolina’s health insurance companies pay insurance producers (agents and brokers) on average $20.85 per member per month ($250 and change per year) for individual policies, the second highest in the country.  See On small group policies, it’s a more middling $17.52 per member per month.

Broker compensation has been a big issue of late in the health care arena.  One of the big advances of the Affordable Care Act (ACA) is to put a floor on the amount of premium that actually pays for health care—called the Medical Loss Ratio (MLR)— set at 85 % for large group policies and 80 % for individual and small policies.  That compares with South Carolina’s regulatory standard of 55 % going to health care for individual policies.  [A PowerPoint in which I explain this is at]

When initially faced with these new standards, South Carolina insurance regulators (and we use the term in its loosest sense) sought a waiver, claiming that the new limits would work a hardship on insurers because they compete for producers (the new name for agents and brokers) with other insurers by offering higher commissions.  The smaller, less efficient, companies would be run out of South Carolina.

In other words, the real competition in health insurance inSouth Carolinais not in providing better benefits at a better price, but in competing for producers, sellers, through increased levels of commissions.  Those commissions are simply transaction costs which add friction to the system and not efficiency.  Paying producers more provides no benefit to the health insurance consumer; rather, it incentivizes producers to push products which pay them more rather than those delivering value (better benefits for a better price) to consumers.

The National Association of Insurance Commissioners (NAIC) was tasked to determine precisely what makes up the MLR under the ACA.  Brokers and agents tried repeatedly to advance the absurd proposition that their commissions should be counted as part of the 80 % dedicated to health care and not the 20 % to cover overhead.  In the end, they lost that argument.

In 2014 the Health Benefits Exchange comes online.  That will be a marketplace through which individuals and small groups will purchase insurance and access premium and out of pocket subsidies.  Historically, agents and brokers were needed because health insurance policies are always written in legalese, a dialect of Greek, and explained in Vietnamese.  You needed a translator.  However, new requirements for plain English policy explanations and better decision support tools should make producers redundant.  In addition, producers have a fundamental conflict of interest with their customers.  They are paid by the insurer … and not for getting you a better deal.  The more you pay, the more the producer makes.  Consumers are better off if Exchanges and the entryways to them are producer-free zones.

However, the requirement in SC insurance laws that you be a licensed producer to “sell, solicit, or negotiate insurance” may well force anyone buying through the Exchange to fork over money to a producer to buy insurance through that Exchange.

Governor Haley decries “government picking winners and losers”.  However, laws such as ours requiring an agent to peddle you health insurance—whether you need one or not—do exactly that.  The winner is the agent and the losers are consumers.

This would be bad enough if we were talking chump change.  But $250 a year is not chump change.  SC should change its insurance law and the feds, in designing our new Exchange, should ensure that state producer-protection laws don’t apply to consumers purchasing through the Exchange.

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Building a Better Gas Tax for South Carolina

South Carolina could generate an additional $407 million in transportation revenues by updating its gas tax to reflect changes in the cost of transportation construction according to a report out today from the Institute on Taxation and Economic Policy (ITEP).

Revenues for highway construction, the state share of which is funded largely out of our 16 cent per gallon gasoline tax, face two challenges.  Our gas tax was last raised in 1989.  Because our gas tax is based on volume rather than cost, revenues do not increase as the price of gas goes up nor do they increase as the cost of highway construction and maintenance increases.  Had the tax kept pace with the costs of highway construction, our gas tax today would be 28 cents. And, as cars and trucks are made more fuel efficient, the per-mile revenue decreases.

As the report notes: “The chronic under-funding of state transportation networks should be addressed in the short-term with  gas tax increases, and in the longer-term  by reforming state gas taxes so their revenues can keep pace with the rising cost of building and maintaining a transportation network.”

In introducing legislation to reduce the SC gas tax, Rep. Bakari Sellers attacked it as a regressive tax.  No doubt the gas tax hits more heavily on low-income than upper-income South Carolinians.  But there are way to address that regressivity through a refundable, low-income tax credit that would make low-income families whole in the face of increased gas taxes.

The gas tax can be improved by raising it, but also making it more like a sales tax so that as prices go up revenues go up.  As South Carolina tries to develop economically a critical factor will be whether we have the infrastructure to attract and support that development.  Crumbling bridges and roads will undermine that development.

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