Why a flat tax …
By: Brad Keithley
Tags: Tax, Budget, Fiscal Policy, Alaska, Economics

Adapted from “Notes from the Alaska Fiscal Cliff: Why a Flat Tax” (originally published Sept. 7, 2017).

As regular readers of these pages will know, for the past few months we have periodically been including the following as a postscript in our fiscal policy posts.

As we have said repeatedly on these pages, we don’t believe any of these “tax and spend” programs are necessary. Instead, we believe using the Hammond 50/50 approach Alaska is well positioned to ride out the current low in the oil price cycle without self-inflicting any further damage on its economy. See “The Special Session version of “Implementing Governor Hammond’s 50/50 Plan” (June 7, 2017). But, as we also have said repeatedly if we nevertheless are headed down this [new revenue] road it should be done with the least damage and disproportionate effects possible. We believe that replacing both the Senate and House proposals (both the PFD cut and income tax components) with a single flat tax — a tax that imposes an equal distributional burden regardless of income class — does exactly that.

Some have criticized us for the latter paragraph, arguing that it concedes too much. But for the last two years, first the Governor and then, this session, the Legislature have raised so-called “new revenues” as part of the budget process; even worse yet, effectively they have started treating it as a foregone fact.

As a result, while we will continue to emphasize the point made in the first paragraph, it’s time also to give substantial emphasis to the second.

From an economic perspective, a PFD cut is the worst way to raise so-called “new revenue”

To date, the Governor and Legislature have raised the so-called “new revenues” entirely through PFD cuts. (We refer to them as “so-called new revenues” because, from an overall economic perspective, they aren’t “new” at all. Rather, they simply are revenues previously injected into the Alaska private sector that are being diverted instead to government. As a result, the more accurate term is “redirected revenues.”)

From the perspective of the overall Alaska economy and Alaska families, however, that approach has been the worst step for the state to take, especially during a recession. Why? Because according to ISER’s various economic analyses published over the past two years, cutting the PFD:

Has the “largest adverse impact on the economy [of all the new revenue options] per dollar of revenues raised,” https://bit.ly/3aylPmp at A-15;

Is “by far the costliest measure for Alaska families,” http://bit.ly/2GlFsPl at 1; and

“[L]ikely increase[s] the number of Alaskans below the poverty line by 12–15,000 (2% of Alaskans),” https://bit.ly/3rgDmFl at 14.

From an economic perspective, the approach also has discriminated severely against lower and middle income Alaskans.

For example, at the proposed level of PFD cuts endorsed by the Senate the income of the archetypical Alaska family of four in the lowest 20% (by income) is reduced by over 30%, in the next 20% by over 15%, in the next 20% by over 8% and even in the next 20%, the upper middle income bracket, by over 5%.

An archetypical Alaska family of four in the Top 20%, on the other hand, suffers less than a 2% reduction in income, less than half even of an upper middle income family and more than fifteen times less than the lowest 20%. See “Comparison of Senate and House Fiscal Plans on Family of Four by Income Group,” https://goo.gl/HVBGQx.

In short, no other so-called new revenue measure comes close to doing as much damage as PFD cuts to the overall Alaska economy, Alaska families and middle and lower income Alaskans. Going down that road has made Alaska’s recession worse for the overall economy and middle and lower income Alaska families than it should be, apparently solely so that it is easier on the Top 20%.

A progressive income tax isn’t far behind

Some propose that instead of (or worse yet, in addition to) PFD cuts, the state should consider progressive income taxes or a statewide sales tax. But both of those also have significant adverse economic side effects.

To some degree, a progressive income tax simply reverses the income level discrimination arising from the PFD cut. Under the House’s approach, for example, the proposed level of tax would reduce the income of the archetypical Alaska family of four in the top 20% (by income) by roughly 3%, the next 20% by 1.4% and the next 20% by roughly 0.7%. The bottom 40% would pay no income tax.

A progressive income tax also carries some risk for the overall Alaska economy. Alaska already is a high cost state. At the margin, increasing the cost of doing business even further for higher income businesses and individuals by allocating the cost of government disproportionately to them simply increases the incentive for them to relocate themselves and their related business activities to lower cost, more competitive locations elsewhere.

And a sales tax isn’t far behind that

A sales tax similarly has disproportionate effects and creates its own set of additional economic issues.

Like a PFD cut, a sales tax hits middle and lower income Alaskans harder than those in the Top 20%. As the Institute of Tax and Economic Policy concluded when looking earlier this year at the potential use of a sales tax in Alaska:

… sales taxes tend to be regressive, impacting low- and middle-income families more heavily than high-income families when measured as a percentage of household income. This effect comes about largely because low- and middle-income families spend a larger fraction of their earnings on items subject to sales tax, while high-income families direct a large share of their income into savings and investments. … [At a level of 3%,] the impact on the bottom 20 percent of earners … is more than three times as large as the impact faced by the top 20 percent ….

Comparing the Distributional Impact of Revenue Options in Alaska, https://goo.gl/N1sUUb.

Statewide sales taxes also are problematic from an overall economic perspective.

They would raise the cost of Alaska goods, lowering demand. A statewide sales tax also would adversely affect local governments, by using up a portion of the capacity of one of the major revenue tools on which they rely. If you assume, for example, that a given locality can tolerate a 7% sales tax before suffering significant competitive effects, imposing a 3% statewide sales tax would leave the locality with only the remaining 4% capacity, rather than the ability, if needed, to go up to the full 7%.

Why a flat tax?

A flat tax, on the other hand, compares favorably against those effects.

Under a flat tax, all Alaska families — upper, middle and lower income — would pay the same percent of income. (A flat tax of 2.75% of Adjusted Gross Income would raise roughly the same $700 million resulting from the Senate’s proposed PFD cuts).

Unlike under PFD cuts and sales taxes, upper income Alaskans would pay the same percent of their income toward government as middle and lower income Alaskans. Conversely, unlike progressive income taxes, middle and lower income Alaskans would bear the same proportionate share of the costs of government as upper income Alaskans, creating the same incentive for middle and lower income Alaskans to seek reductions in ongoing spending levels. See “Want to really control state spending? Use a flat tax” (Apr. 8, 2018).

Because a flat tax would be spread over all Alaska income, including that received by non-residents, the rates — and thus, the economic impact — would be lower than if concentrated mostly (or entirely) only on one income segment, or type (e.g., a sales tax). And unlike a statewide sales tax, a flat tax would leave the full capacity of a sales tax available to local government rather than diverting a portion of it to the state.

In short, especially in the midst of a recession, a flat tax would treat all Alaskans as fairly — and the overall Alaska economy as neutrally — as possible.

Fairness and economic neutrality are overriding factors anytime, but even more so during a recession. We hope those in government start coming to the same realization.