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Tax Reform Letter to Senate President John McKay and House Speaker Tom Feeney

February 7, 2002
Source: The Executive Office of the Governor

The Honorable John McKay
President
The Florida Senate

The Honorable Tom Feeney
Speaker
Florida House of Representatives

Dear President McKay and Speaker Feeney:

In my State of the State Address, I pledged to facilitate full, honest and transparent dialogue on the Senate tax plan. To that end, I raised several important questions concerning the impact that a massive tax overhaul would have on Florida's business climate.

So far, the accelerated discussion of the reform plan has focused primarily on the tax collectors in Tallahassee, rather than the taxpayers throughout Florida. Government expansion has been the concern, not economic growth and job creation.

Now, as this tax plan moves to the House of Representatives, I believe it is appropriate to offer my specific thoughts and concerns based on testimony provided to the Florida Senate; research conducted by the Governor's Office; economic theory and principle; and my own experience as a businessman, a former Secretary of Commerce and Florida's chief economic development officer.

As Governor, I am also committed to represent all the people of the State of Florida, not just those who are most vocal about reform, whether they are business interests concerned about the impact of the proposal or others seeking growth in government. Seemingly left out of the debate are those Floridians who are busy raising their children, trying to support their families with dual incomes, and going about their everyday lives - Floridians who must shoulder the burden of tax reform either through higher prices, lower wages, or lost jobs. While I applaud the Senate's passion for debating Florida's system of taxation, I have come to the conclusion that I cannot support the proposal passed by the Senate. I cannot support a proposal that will lock into our Constitution any plan that does not embrace the fundamental principle that government should not grow faster than our ability to pay for it. I believe now more than ever before that the true issue lies not in how much the government takes, but in how much the government spends. Regardless of its intent, this tax reform is a government spending plan.

I will outline the specific reasons for my opposition in two ways: by refuting six premises that provide a shaky foundation for this proposal, and by answering critical questions as yet insufficiently answered about the impact of the proposal on Florida's personal and business taxpayers.

The Six Premises for Tax Reform

I believe that our tax structure is an asset, and not a liability as some have suggested. Just consider Florida's job growth compared to other states during the slow growth period of the last year. As the The New York Times reported, while the nation as a whole lost one million jobs in 2001, Florida increased employment by 138,000 jobs. Economists, entrepreneurs, small businesses, Florida's own State Tax Reform Task Force, and average Floridians alike believe our tax structure is fundamentally sound.

Premise 1: We are facing a revenue crisis. Revenues are meeting Florida's budget needs. During the 1990s, sales tax collections as a percent of personal income actually increased, from 3.3% in FY 1990 to 3.5% in FY 2000, even as total state collections declined as a percent of personal income over the last three years. Over the last 20 years, growth in government spending per person has outpaced Florida personal income per person by nearly 61 percent. Furthermore, current long-term forecasts of the Revenue Estimating Conference suggest that over the next ten years, sales tax collections will grow very closely in step with total personal income.

Our taxes are growing at the same rate as the economy, and we should not increase them. Floridians deserve a committed effort from the Legislature and the Governor to find better, smarter, more efficient ways to accomplish our priorities, rather than requiring our hard-working citizens to give an everincreasing portion of their income.

Premise 2: We will "lose" approximately $4 billion in revenues by 2006. First, I must refute this claim on principle. Those items and activities left untaxed do not represent a revenue "loss" for government. If they did, then the sales tax exemption on food, for example, would represent a significant revenue "loss." In theory, the state could tax almost anything or any activity, but the fact that we choose otherwise does not represent a revenue "loss" for Florida in each case.

Regarding the $4 billion figure, Congress passed legislation that will stop taxing people's property after they die. I support that decision. This will impact our revenue projections by a little less than $1 billion over the next four years.

The remaining $3 billion of the cited $4 billion is attributed to revenue losses from remote sales, via either mail order or the Internet. The University of Tennessee estimates cited by some reform proponents do not hold up well under close scrutiny. The attempt to project for every state forced the use of overly-simplistic methods, wholly inadequate in accounting for the idiosyncrasies of each state's economy and tax structure.

For example, approximately one-half of the $3 billion in 2006 is attributed by the study to "trend loss," which is defined as revenue losses due to broad cultural shifts in consumption away from goods to services. That estimate did not use numbers from Florida's Consensus Revenue Estimating Conference, which already accounts for this change in consumer behavior and projects virtually no trend loss.

The study also estimates the other half of the cited $3 billion to be the result of e-commerce losses. To generate these estimates, the study had to make numerous assumptions about how much of the national e-commerce estimate was taxable/non-taxable, business-to-business, and business-to-consumer, and how much of taxes owed would actually be paid. The heavy reliance on unverifiable assumptions to "estimate" the tax losses is a good reason for caution when basing decisions on the numbers.

The Florida Department of Revenue recently indicated that the estimates of e-commerce tax losses for Florida are certainly inflated. The University of Tennessee's estimate for 2001 is $932 million. DOR is suggests that the number is closer to $225 million, a 76 percent overestimate. The difference is due to disagreement on the assumptions about how much taxable business-to-business activity will be captured. Given the apparent error in the 2001 estimate, the 2006 estimate should suffer from a proportionate degree of inaccuracy.

Therefore, the most important reason expressed for the need for changes in our tax code, the $4 billion shortfall is not close to being correct.

Premise 3: The Senate Plan will raise enough revenues to make up the cited $4 billion. The goal of making the tax system more "adequate," suggests that the objective is to somehow raise more revenues than the current system provides. Based on numerous comments made during Senate hearing and floor debate, this certainly appears to be the expectation of some of the Senators who voted for the measure.

Even if one assumes the $4 billion "loss" projection, the Senate plan will not make up the difference. With revenue neutrality required in FY 2004-05, generating an additional $4 billion in the succeeding year or two from the base expansion would require annual growth rates in the newly taxed portion of the base in the range of 50 to 100 percent. Given that it took the proposed base-expansion sectors about 9 years to grow by 100 percent in the 1990's, the proposal cannot provide a revenue increase of that magnitude, even before accounting for the potential loss of jobs and economic activity that could result from enacting the Senate plan.

Premise 4: The Senate plan is "revenue neutral." This statement is clearly contradictory to the premise that the plan would raise more revenue than the current system. If the goal is to raise revenues, then proponents should be straightforward with Floridians and tell them that they think current revenues are simply inadequate and that we need to increase taxes, rather than hiding behind the veil of "revenue neutrality."

Premise 5: The tax structure is unstable and exaggerates economic fluctuations. Broadening the tax base, it is argued, will make tax revenues more stable and will render vital state services less vulnerable to disruption during economic downturns. Proponents, however, have not demonstrated that the proposal will provide any significant degree of state budget protection from the business cycle. If the additional goods and services proposed to be added to the tax base are more stable than the current tax base, all the old "less stable" elements will still be there during an economic downturn. At best, the plan can provide a marginal improvement in tax revenue stability. Based on past recessions, it will certainly not protect vital state programs from revenue shortfalls that inevitably occur in economic downturns for all state governments.

One does not have to look beyond this recession to see that there are many other states with broader tax structures experiencing even worse revenue shortfalls than Florida. For example, California's shortfall represents at least 7.7% of its total budget and Massachusetts anticipated a deficit equal to 5% of the state's total budget. By comparison, Florida's shortfall was 2.8%.

Premise 6: The current tax system is not fair and is illogical. It is argued that current exemptions protect special interests while Florida households must pay higher taxes -- that a "fair" tax system will spread the tax burden equitably across all segments of society (i.e. businesses should pay more taxes directly). This argument makes good intuitive sense, and it makes good economic sense if the goods and services taxed in "all segments of society" are subject to the same tax rate. But one of the reasons economists argue against levying sales taxes on business inputs, as the plan suggests, is that taxes will pyramid up through the cost structure. Consequently, the effective tax rate on the end product will differ among final goods and services, depending on the mix of taxable inputs that are used in their production/delivery. Economic theory suggests that extensive taxation of business inputs can result in inequities in the tax structure.

Questions About the Impact of Tax Reform on Florida's Economy and Families

Usually during the legislative process, questions raised about substantial reform are answered in committee hearings or in floor debate. However, in this particular case, many questions went unanswered, and those that were answered only raised more questions. The following are questions that I feel are of critical importance, but which upon our own study and reflection yield discomforting conclusions:

How will the plan really affect businesses and jobs in Florida? Will we be able to keep a competitive position that is the envy of many states? Testimony from manufacturing and agricultural representatives indicates that taxation of transportation services would increase the costs of those industries in Florida, potentially threatening their location in this state. Florida will be the only state in the nation to subject freight transportation to the sales tax. There was also testimony that taxation of transportation services could have a significant competitive impact on Florida's air and seaports.

Economist Dr. Hank Fishkind -- an advocate of the Senate Bill -- noted in his testimony that waterborne transportation would have difficulty passing the tax on, which means the tax would eat into wages, capital, and employment in that industry. As well, testimony was given that correctly stated that the bill is "anti-headquarters" legislation because of taxation of inputs used heavily by headquarters operations (e.g., accounting, legal, consulting, among others)

How will small businesses be impacted? Small businesses are the principal driver of our economy. These enterprises generally outsource much of their professional service needs because they cannot hire full-time employees to provide these services. They will pay a disproportionate amount of this new tax. While proponents claim through hypothetical examples that small businesses will not be adversely affected, they have not provided hard data to show that the new taxes will be offset by the 1.5% reduction in the overall sales tax rate.

Will the state's economic growth be adversely affected? Based on testimony, there would be an adverse impact. Numerous repealed exemptions are in areas that are sensitive to interstate and international competition, and could pose a threat to the viability of those activities in this state. Included in this group are investment offices, consulting services of various types, motion picture/TV production, some transportation services, research, development and testing services, and our emerging technology companies to name but a few.

How will this affect the size and scope of the tax bureaucracy? How much bigger will it have to get? The Department of Revenue will increase in size to fully implement the Senate tax plan. In order to audit and enforce compliance of the new businesses required to file taxes, the Department's preliminary estimates project that over 200 new employees will be needed, a 10% increase in the general tax administration personnel. Most of the new positions will be auditors and enforcement/collection specialists. The funding for these new positions will require an additional $10-11 million in general revenue.

How much more complicated will the tax code become? How difficult will it be for both taxpayers and the Department of Revenue to fall into compliance? The tax code will get bigger and more complex in order to accommodate the taxation of a new set of heretofore- untaxed activities. This means there will be new definitions, new rules for determining where taxable services actually occur for taxation purposes, and new rules for distributing taxable services among different jurisdictions, to name but a few.

  • In 1987 the Dept. of Revenue Emergency Rules for implementing the services tax took130 pages (single-spaced) to explain.

  • In 1987, the portion of the Florida Statutes pertaining to the sales tax grew by 19 pages (46%) from 41 to 60, as a result of the services tax.

  • There will be a 34% increase in the number of businesses (from 500,000 to 670,000) that will have to register as tax dealers and learn how to collect taxes for the state. The complexity they each face will depend on the activity being taxed and the specific rules, not yet developed, that define how they are to be taxed.

  • Public testimony, particularly from small business groups highlighted concerns about the additional cost, in money and time, of having to undertake this task for the state. The maximum of $30 per month that businesses can get as a dealer collection allowance hardly serves as adequate compensation.


Will this plan result in more tax pyramiding-or taxing taxes? The plan will result in more tax pyramiding because it is shifting sales taxation away from final consumption of goods and services by households to consumption by businesses. To the extent that businesses build the cost of the new taxes into their own prices, and those prices are in turn subject to sales tax, pyramiding would occur. Dr. Fishkind even testified that the taxation of transportation services would result in pyramiding.

How will consumers really be affected? Will households actually save money? Or will businesses just pass the taxes on so consumers end up paying anyway? The full effects cannot be quantified with much accuracy. Dr. Fishkind presented estimates that the average Florida family will save $250 annually under the Senate tax plan. By Dr. Fishkind's own admission, this is an estimate of the direct savings and does not account for the increased business taxes that will be passed on in price increases to consumers. Businesses will pass on the increased taxes if they are able. Otherwise, there will be adverse effects on wage or business income if businesses cannot pass the taxes on to consumers. Either way, our people will pay.

Will tourists pay less and Floridians pay more? It is clear tourists will pay less, since only some of the goods and activities that tourists buy will continue to be taxed at 6 percent. If the plan is revenue neutral and tourists will pay less, then Florida residents will certainly make up the difference. In addition, in viewing the list of services to be newly taxed, it becomes clear that most of these services are rendered for the benefit of Floridians. Legal, consulting, engineering, employment, accounting, banking, freight transportation are all services provided primarily to Floridians, not tourists. Despite Senate efforts to retain tax levels that apply to tourists, Floridians will still be paying for the new taxes enacted, not our seasonal visitors.

What of investment climate uncertainty? I am concerned about the impact that passage of the Senate bills would have on our ability to continue to attract job-creating business investment to Florida. While the implementing bill is very prescriptive in what is exempted, there will still be much leeway for the next Legislature to change what is exempted and what is not. Using history as a guide, the uncertainty will have a chilling effect on the economic development efforts of our state. Adding an uncertain tax code to already difficult economic times will hurt our chances to continue to recruit and retain higher wage jobs for Florida families.

In sum, while the Senate tax plan is the product of a sincere effort, it is clear that its flaws are in no way grounded in intent, but in faulty premises and adverse consequences. Again, I have appreciated the opportunity to follow the discussion on tax reform, and restate that my conclusions are based solely on principle and experience. They should not be interpreted as anything more than that. History may prove me wrong on these conclusions. But, as Florida's Governor, I have an obligation to weigh in on issues of significance to the state, and this well-meaning reform certainly rises to that occasion. Thank you again for affording me the opportunity to share my perspective on this important issue.

Sincerely,

Jeb Bush

 

Cc: Sen. Jim King, Senate Majority Leader
Rep. Johnnie Byrd, House Speaker Designate
Rep. Jerry Maygarden, House Majority Leader
Sen. Tom Rossin, Senate Minority Leader
Rep. Lois Frankel, House Minority Leader