DEPARTMENTS:
The Tax Revolt Turns 20

By Steven Hayward

Steven Hayward bids happy 20th birthday to the tax revolt—and hopes for a long and prosperous life

This June marks the 20th anniversary of California’s Proposition 13, the property-tax-cut initiative that set off America’s tax revolt. Within two years of its adoption, 43 states implemented some kind of property-tax limitation or relief, 15 states lowered their income-tax rates, and 10 states indexed their state income taxes for inflation. The widespread public backlash against high taxes that began in California contributed to Ronald Reagan’s election to the White House in 1980 on a supply-side platform and pushed taxes to the top tier of national political issues.

As the prospect of significant tax cuts in Congress stalls, however, some observers think the tax revolt is a spent force. The media touts every local vote in favor of a bond measure or tax increase. Meanwhile, a liberal counterattack has been gaining momentum. Fans of bigger government like to point out that the tax burden on our economy is lower than that of European nations. (So is our unemployment rate, but no matter.) Even Proposition 13 has come under renewed attack as the cause of the "Mississippification" of California, as journalist Peter Schrag puts it in his new book, Paradise Lost.

The signal breakthroughs of the tax revolt have come mostly through citizen-led initiatives. No dynamic anti-tax activists, however, have stepped forward recently to succeed the likes of Howard Jarvis, who masterminded Prop 13, or Douglas Bruce, who wrote Colorado’s tough Amendment 1 in 1992. Governors rarely propose the kind of deep, across-the-board slashing of tax rates we saw in the heyday of the tax revolt; entrenched interests will make life miserable for anyone who tries. That is why state tax cuts recently proposed or enacted give back only a fraction of current state surpluses and tend to be narrowly targeted at middle- and lower-income groups.

Yet the tax revolt is far from spent. It’s more like a dormant, smoldering volcano, capable of erupting on short notice. The tax revolt seems less prominent right now in part because it has become institutionalized in many states and localities through constitutional tax and spending limits. Also, having succeeded in limiting property taxes or general taxes in many states, anti-tax activism has moved on to unpopular ad valorem levies, such as the car tax. Finally, although there are many reasons for concluding that the tax revolt has been an incomplete success, there are signs that it could erupt again.

The most prevalent institutionalization of the tax revolt is the supermajority requirement for tax increases (usually a two-thirds or three-fourths majority) adopted by voters or legislatures in 14 states (see table, page 10). Ten of these 14 states adopted their supermajority requirements within the last eight years. Although we cannot fully evaluate the effects of recent supermajority requirements until we’ve experienced a complete business cycle, the early evidence from the states with such requirements suggests that they have a restraining influence on the growth of taxes and spending.

Separate studies by Dan Mitchell of The Heritage Foundation and Dean Stansel of the Cato Institute found that taxes and spending grew slower in states with supermajority requirements than in states that did not. Mitchell found that, between 1980 and 1992, tax revenues grew about 20 percent less in supermajority states than in other states, while spending grew 9 percent less. Economic growth in supermajority states was 8 percent higher than other states, and job growth was 5 percent higher.

Stansel’s study was broader in scope, examining all tax and spending limitation features—not just supermajority requirements—during the five years preceding and following each state’s adoption of fiscal limits. Stansel found that states that adopted tax and spending limits experienced spending growth 0.8 percent higher than the U.S. average before adopting limits, while spending growth was 2.9 percent lower than the average following the adoption of limits. Stansel’s most significant finding, however, was that voter-designed tax and spending limits were more effective than those crafted by state legislatures.

Supermajority legislation is pending in 14 more states, including Pennsylvania, Illinois, and Minnesota. New Jersey governor Christine Todd Whitman and Michigan governor John Engler are the most recent statehouse executives to endorse a two-thirds supermajority. Americans for Tax Reform, a national anti-tax group, takes a different approach to institutionalizing the tax revolt. It is extending its "no tax" pledge—a promise by public officials to vote against any new taxes or tax increases—to the state level. As of June 1, ATR has obtained "no tax" pledge signatures from 1,017 state legislators and statewide elected officials.

By far the most prominent expression of the latent potency of the tax revolt is the instant energy generated by the car tax issue. Virginia Republican Jim Gilmore first brought the car tax to the fore in his successful gubernatorial campaign last fall. In early October, polls showed Gilmore in a dead heat with his Democratic opponent. After Gilmore unveiled his "no car tax" pledge, however, he rode a substantial lead to a 12-point win last November.

Virginia motorists pay an annual 4.5 percent tax on the value of their autos. Gilmore proposed to phase in an exemption of the first $20,000 in value on every car, which the Virginia legislature enacted after some initial handwringing. Thirty-one states have a car tax of some kind. Rates vary from locality to locality within states; the levy in some Rhode Island counties has reached 5.4 percent. "No car tax" boomlets have erupted in several states as a result of Gilmore’s visible success. In Washington state, activists are collecting signatures to put a car-tax initiative on the November ballot. California governor Pete Wilson came out in late May for a 75 percent cut in California’s car tax. Such a cut would be worth more than $2 billion, the largest tax cut (in nominal dollar terms) in California history—even larger than Proposition 13.

Other skirmishes are underway in various states. Arizona congressman Matt Salmon is spearheading a petition drive for a November initiative to abolish Arizona’s state income tax by the year 2004. Rhode Island’s Republican governor Lincoln Almond wants to phase in a modest, $175-a-year property tax cut over five years, but Democrats in the state legislature are blocking it.

Even tax-happy New York City suspended its 8.25 percent sales tax for one week last January. Retail sales soared between 40 and 100 percent at most stores in the Big Apple, prompting Mayor Rudolph Giuliani to call for a 50 percent cut in the sales tax for the next Christmas season. New York Assembly Speaker Sheldon Silver, meanwhile, has proposed abolishing the state’s 4.25 percent share of New York’s sales tax and giving New York City the option of abolishing its local sales tax on clothing.

There are lessons to be learned from the shortcomings of the tax revolt. Most important, although the tax revolt has slowed the growth of government spending in several states, it has not yet managed to roll back the size of state government. State spending has continued to climb faster than both population and personal income over the last decade (see chart, next page). Despite all of the froth about "reinventing government" at the state and local level in recent years, the tax revolt has not yet infused the public sector with the culture of the private sector, where gains in productivity drive down the cost of goods and services.

The chief reason for continued growth in spending is that state tax structures collect two-thirds of total revenue from personal-income, business, and sales taxes, which generate huge tax collections during economic booms and fall off when recessions hit. As large surpluses accumulate (the combined surplus of all 50 states may exceed $30 billion this year), state officials prefer to ratchet up the size of government rather than cut taxes or save the money in a "rainy day" reserve fund. When the business cycle turns down, states sock their citizens with tax hikes to cover the structural deficits they created during the good times. This was the story in California, where routine surpluses throughout the 1980s swiftly turned into a $14-billion deficit in 1991, requiring hikes in income and sales taxes. (Governor Pete Wilson managed to hold the line somewhat by making the income-tax hike temporary, but he has been unsuccessful in rolling back income taxes further as the state’s economy recovered.)

The next step for the tax revolt, therefore, needs to be more effective spending limits, so that budget surpluses in good times don’t inflate the size of government. As governor of California, Ronald Reagan proposed in 1973 to limit California’s state spending to 7 percent of personal income (it is currently about 9 percent), but the tax revolt had not gained sufficient traction by then. A few states, however, have taken some steps in this direction. Since 1978, Michigan has had a constitutional cap on state revenue of 9.49 percent of personal income. Washington and Colorado voters embraced measures to fight the ratchet effect by tying future spending growth to inflation and population growth in 1993 and 1992, respectively, while Connecticut voters adopted a measure in 1993 tying spending growth to growth in personal income.

Another downside of some tax limitation measures, especially property-tax cuts such as Proposition 13, is that they have often contributed to a greater centralization of power at the state level. In California, for example, the state government assumed the burden of funding public schools after Prop 13. Since state funding came with strings and conditions, Prop 13 had the effect of enhancing the power of the education bureaucracy and eroding local control. "The passage of Proposition 13," the Urban Institute’s Frank Levy wrote, "has caused almost the entire liberal agenda to be de facto adopted."

The flood of lawsuits (in 28 states at last count) to equalize education funding statewide will likely exacerbate this problem. In many states, the highest court has ruled that disparities between school districts in per-pupil funding based on local property taxes violates the state constitution. Many governors—especially Republicans—have flunked this challenge by moving to raise state income or sales taxes in place of the local property tax. (See "Low Profiles in Courage," Policy Review, March–April 1998.) In most cases, such as Ohio and Illinois, this "tax shift" would result in a net tax increase.

Michigan governor John Engler provides one example of how to finesse the issue successfully. After Engler campaigned for governor in 1990 on a pledge to cut the property tax, Democrats in the state legislature mischievously proposed to abolish the local property tax as a school funding source.

Engler called their bluff: He placed an initiative on the ballot that cut Michigan’s flat personal-income-tax rate and replaced the local property tax with a smaller, statewide property levy; a 2-point boost in the state sales tax, to 6 percent; and a hike in the cigarette tax. Engler’s Measure A garnered 69 percent of the vote in 1994, producing a net tax cut and allowing Engler to equalize public-school financing among school districts. (He mitigated the centralizing aspects of this fiscal shift with an array of education reforms aimed at curbing the clout of the teachers unions and the bureaucracy.)

The total tax burden in Michigan is about $500 million lower than it was before Engler took office in 1991, which the Mackinac Center’s Michael Lafaive credits with helping Michigan move out of recession in the early 1990s, before the rest of the country. Michigan’s fiscal reform, Mackinac’s Lawrence Reed believes, is a model other states should consider emulating.

There are hazards to this tax-shift strategy, however, as the experience of Texas governor George Bush shows. When Bush took office in 1995, Texas taxpayers were fed up with high property taxes. He proposed a wholesale tax shift that would have cut the property tax while raising a number of business taxes and excise taxes. The shift was designed to be revenue-neutral, but conservatives opposed the plan because they feared it would introduce a tax system that was inherently biased toward higher taxes in the future. Some conservatives would rather rely on direct taxes like the property tax, which are politically difficult to raise, than excise taxes and sales taxes, which officials may be tempted to raise perpetually because they are levied incrementally and in small amounts.

Moreover, tax shifts for the public schools are a dry run for a much more ambitious tax-shift agenda by the Left: substituting consumption taxes for income taxes in the name of the environment and public health. Think of it as the ultimate "sin" tax. Environmentalists are beginning to argue for wholesale tax reform to alleviate global warming by taxing "bads" (such as carbon dioxide emissions and gasoline use) in place of existing taxes on income and capital gains. Conservative tax reformers who are currently exploring the idea of a shift from the income tax to a simple broad-based sales tax should be careful not to get hijacked by the liberals’ version of consumption taxes.

Even if such a tax shift were revenue-neutral, there are grave problems with using tax policy to affect the quantities of resources used and byproducts produced in the marketplace. We could end up replacing the existing complex income tax code with an equally complex consumption tax code with bureaucrats deciding what was "good" and "bad" for us and fixing prices accordingly. Once the bureaucratic presumption in favor of such taxes was in place, it would be very hard to mount an effective revolt against taxes that are regarded as the primary bulwark against the coming apocalypse.

If the tax revolt has its weaknesses, it also has assets that must be assayed on the positive side of the ledger. Although some of the early tax-limitation measures, as noted above, resulted in increased centralization of government, several "second generation" tax measures have actually contributed to the cause of devolution.

Polls show that taxpayer confidence in government spending is inversely related to the proximity of the level of government doing the spending. According to a recent survey in American Demographics, only 42 percent of Americans think they get their money’s worth from federal taxes, 56 percent think that of state taxes, and more than 60 percent think that of local taxes.

Hence, tax limitations such as Colorado’s Amendment 1, which requires voter approval for all taxes at all levels, exploit the resistance to taxes at higher levels of government and effectively pushes government functions down to the local level. In Colorado, voters approve more than 90 percent of local revenue measures before them. Meanwhile, there has been no effort made to lift state tax limits. California has had a similar experience with local tax measures in the aftermath of Proposition 218, which closed some Prop 13 loopholes and tightened up voting requirements for local taxes.

What are the prospects for the tax revolt? Three themes come to mind. First, historical evidence suggests that public intolerance of federal taxes erupts whenever federal tax receipts begin to exceed 20 percent of GDP, as they do currently. Though state tax burdens vary widely between, for example, high-tax Connecticut and low-tax Florida, the same phenomena can be observed at the state level. In the early 1970s, California voters rejected several tax-limitation measures prior to Prop 13 until inflationary "bracket creep" pushed the total state and local tax burden from 11.5 percent of personal income to nearly 16 percent in just four years. Conditions are ripe for another taxpayer eruption.

Second, while the stalemate over revenue mainstays such as income and sales taxes may continue, the battle is shifting to new areas, such as the Internet. State revenue officials are drooling to get a piece of Internet commerce, whose annual value is expected to top $200 billion by the year 2000. The states were dramatically rebuffed in their attempt last year to impose sales taxes on interstate mail-order sales, a favorite means of tax avoidance among consumers these days. The Internet, however, allows tax hikers to hide new levies in the price of electronic transactions where the consumer won’t notice them. States with strong high-tech industries (including California, Massachusetts, and Washington) have passed laws specifically exempting Internet businesses from taxes, and a bill is pending in Congress that would impose an indefinite moratorium on state taxation of the Internet.

Internet taxation poses questions about the nature of goods and services in the Information Age that demonstrate the obsolescence of the current tax system. But attempts to "modernize" the tax code to tap the information economy are going to collide with the quality that makes the information revolution such a powerful and productive force: individual independence. Hence it will be very hard to impose many new taxes on the information economy.

The third tax revolt theme that is gradually surfacing was explained recently in the pages of the New Republic. The "seeds of what may be America’s next tax revolt" are the nation’s 25 million self-employed and independent contractors. The double taxation for Social Security, the disadvantageous tax treatment for health insurance, and the onerous tax compliance and filing requirements all give self-employed people a lot to complain about.

"You can almost hear the rumble of a tax rebellion in the making," said the New Republic. "The politician who finds a way to address the concerns of these new tax protesters may find himself the darling of a constituency whose allegiance is as yet unclaimed and whose numbers are large enough to sway elections." The author of this cogent critique was Daniel Pink, a former chief speechwriter for Vice President Al Gore—a sign, perhaps, that the next tax revolt might even be a more bipartisan affair.