Tax Reform Task Force Looks at Federal Tax Changes (with Help from BLR and DFA)

The Arkansas Tax Reform Task Force met today to hear a variety of miscellaneous topics and also discuss the process going forward. This was the first meeting since last month's surprise termination of outside consultant PFM. The Task Force is now primarily assisted by the Bureau of Legislative Research (BLR) and the Department of Finance and Administration (DFA). BLR and DFA provided updates on the impact of federal tax reform, on revenue sources from miscellaneous taxes and fees, and on the landscape of online sales tax collection efforts.

This was the last educational meeting before the Task Force really digs in to consider specific policy proposals. At the end of the meeting, Task Force Co-Chair Senator Hendren explained the process going forward and the need for stakeholder participation in the next few meetings where the Task Force will hear specific policy proposals. Interested parties need to get ready for the process over the next few months.

BLR Looks Back at PFM's Report

The meeting kicked off with a presentation by Richard Wilson, Assistant Director of BLR, summarizing and critiquing PFM's report and correcting certain details therein. Task Force Co-Chair Senator Hendren expressed interest in simplifying the multiple individual income tax brackets. There also were questions about franchise tax collections, from which much of the proceeds go into the educational adequacy fund--thus reducing the burden on general revenue.

DFA Summarizes Federal Tax Changes and Impact on Arkansas

Next, DFA Commissioner Walter Anger, Assistant Commissioner Paul Gehring, and Senior Counsel Joel DiPippa addressed the impact of federal tax reform on Arkansas. Commissioner Gehring explained the nondelegation doctrine and Arkansas's standalone income tax that only borrows specific provisions from the Internal Revenue Code. Commissioner Gehring and Senior Counsel DiPippa provided general highlights of the federal tax reform law, which generally do not get picked up by the Arkansas income tax code.

There are a few exceptions where federal tax reform will directly impact the Arkansas tax system. One big change is that Arkansas will pick up the "chained CPI" methodology that would reduce inflation adjustments, thus causing individuals to move up in the brackets more quickly. This will increase revenue to the state (and tax burdens on Arkansans). On the other hand, Arkansas will pick up a federal expansion of the availability of the cash accounting method, which will cost the state about $10m of revenue per year.

DFA leadership downplayed the federal limitation of the SALT deduction and its impact on Arkansas. Senior Counsel DiPippa showed a slide comparing income levels to Arkansas tax paid, showing that basically no one making less than $150,000 would be impacted. This slide, however, failed to take into account that most such taxpayers would also be deducting property tax such that the actual impact of the cap would likely kick in at a lower income level. For higher earners who are capped out, the loss of the SALT deduction means a substantial increase in the effective marginal rate of taxation by the state.

DFA leadership also explained the new passthrough business deduction. DFA estimated that the fiscal impact of adopting a similar provision in Arkansas would be about $68 million annually. They also walked through the corporate income tax rate reductions, as well as accelerated expensing and depreciation. On NOLs, federal tax reform eliminates carrybacks and allows indefinite carryforwards. DFA projects that similar changes to Arkansas law would result in $4m-$5m revenue reduction initially but which would snowball to approximately $82m by 2028. (Query the modeling underpinning that high long-term estimate.)

DFA Explains Miscellaneous Revenue Sources 

DFA Budget Administrator Duncan Baird joined the aforementioned DFA leaders at the table for the next segment, looking at miscellaneous revenue sources. This overlapped somewhat with PFM's excise tax report from last fall.

Administrator Baird first gave an overview of "cash funds," which are fees that go to dedicated programs rather than general revenue. Assistant Commissioner Gehring and Senior Counsel DiPippa then followed up with coverage of the other revenue sources: telecom charges (911 fees, etc.), tobacco taxes and master settlement agreement monies, soft drink tax, franchise tax, premium tax, motor fuels taxes, gaming taxes, real property transfer tax, and severance tax. On the tobacco tax discussion, Co-Chair Senator Hendren expressed interest in extending an equivalent tax to e-cigarettes. The presentation wrapped with an overview of the Educational Excellence Trust Fund funding.

BLR and DFA Address E-Fairness / Online Sales Tax Collection

The final presentation to the Tax Commission was BLR addressing online sales and use tax collection efforts. George Ernst, a Legislative Attorney from BLR, took the lead with a detailed explanation of the Quill decision and the physical presence requirement. BLR Administrator Joi Leonard then gave an overview of Arkansas legislation proposed in 2017 and their comparisons to Colorado and South Dakota models. She also speculated on the potential outcomes from the United States Supreme Court hearing the South Dakota Wayfair case. After the presentation concluded, there was significant questioning by legislators about the impact of online sales and use tax collection on Arkansas consumers and local bricks-and-mortar retailers. Rep. Johnson, who is a practicing CPA, also noted the compliance burden on business consumers in self-assessing and remitting use tax where the vendor is not collecting tax under the current status quo.

After BLR presented, DFA leadership returned to the table to discuss the financial impact on the state. Assistant Commissioner Gehring and Senior Counsel DiPippa explained the practical difficulties in estimating revenue losses from remote sales tax noncollection and consumers' failure to self-assess use tax. They also highlighted the difficulty of identifying online sales tax revenue to dedicate to specific purposes.

Let the Stakeholder Input Begin

At the close of the meeting, Co-Chair Hendren announced the process for the Task Force going forward. There will be a series of two-day meetings. The first, March 19-20, will cover sales taxes. Day one (March 19th) will be informational reports from government in the morning and stakeholders in the afternoon. Then on day two (March 20th) Task Force members will identify and discuss policy changes they want to recommend. Senator Hendren also announced an intent to potentially engage outside consultants for dynamic revenue scoring on policy proposals after they are identified. Task Force members then would vote on the sales tax proposals at the next meeting in April. The process then would repeat for income tax (hear proposals in April and vote in May) and for property tax (hear proposals in May and vote in June). Meetings are tentatively scheduled for April 25-26, May 23-24, and June 20-21. With the final report due September 1, 2018, the Task Force will still have substantial work to do in its final stretch.

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