When the Pennsylvania House of Representatives re-convenes this week, all indications are that it will not pass the existing revenue bill — brokered in July in the Senate — as it stands.
Rather, the House will be looking to pass a no-new-taxes package that relies on pulling revenue from existing funds that have displayed continuous surpluses, as well as booking anticipated increases in revenue from online sales taxes, managed care organization fees, and some other sources.
These funds, according to House Republican leadership, should allow the state to back-fill the budget deficit carried over from last year, and square the math on the 2017-18 spending plan approved earlier this summer.
“We were trying to truly be fair and identify funds that have a genuine surplus capacity that can be used to prevent us from borrowing to cover last year’s deficit,” said Rep. Stephen Bloom, R-Cumberland, one of the GOP members behind the proposal.
At the very least, the proposal should give the more conservative House a starting point to negotiate with the Senate and Gov. Tom Wolf, particularly when it comes to the Senate’s shale tax package, a revenue solution that has left a bad taste in the mouths of both liberal and conservative analysts.
So how, in a budget year that started with bipartisan praise for Wolf’s budget promise of no new broad-based taxes, did the state end up twisting itself into such a pretzel, again?
Without reading the minds of all 253 state legislators, the likely answer is that Pennsylvania’s fiscal system has a number of issues that can’t be solved in an annual budget bill — issues that pose much deeper ideological questions.
Senate shale tax
The House counter-proposal is driven, at least in part, by an interest in not endorsing the Senate plan, which passed 26-24 amidst opposition from both Republican and Democratic senators.
“This is a compromised revenue package,” said Steve Herzenberg, an analyst with the left-leaning Keystone Research Center. “Both in terms of the severance tax being a beginning, but not an end, as well as the overall issue of who pays the revenues in this package.”
The Senate proposal would introduce a severance tax of between 1.5 and 3.5 cents per thousand cubic feet of gas drilled in the Marcellus Shale deposit. The rate would fluctuate with the total volume a company drills.
This severance tax, however, would not be enough to fully close the state’s revenue gap. Wolf had previously pushed for a tax of 6.5 percent of production value, which would generate much more income.
To supplement this smaller severance revenue, the Senate deal also involved a number of new gross receipts taxes on energy sales, including a 5.7 percent levy on natural gas. As with most sales taxes, it’s expected this charge would be billed to consumers.
“We would much rather get the revenue from a higher severance tax, which falls more on out-of-state consumers and the gas companies themselves, as opposed to in-state middle class consumers,” Herzenberg said.
And if there’s one thing liberal and conservative budget wonks agree on, it’s that broad consumer taxes should be a means of last resort.
“Gross receipts taxes are always a pass-through. You’re just making the utility companies the tax agent to tax the consumer,” said Elizabeth Stelle, an analyst with the libertarian Commonwealth Foundation.
“[The gross receipts tax] is about as broad-based as you can get, which is a 180-degree turn from where the Legislature was saying they wanted to go at the beginning of the year,” Stelle said. “The budget can be balanced without new taxes. It’s unnecessary to even be talking about a gas tax.”
Further, conservatives project that taxes on specific industries will create more economic hurt than they will benefit. In the case of the shale tax, Pennsylvania is competing with other states to attract capital investment from energy companies, who may be putting their capital in the Keystone State due to a better tax climate even though there are more promising natural gas deposits elsewhere.
“You have to take into account that there are a lot of very good shale areas in Ohio and West Virginia and a fair number further south as well,” Stelle said. “While companies can’t move the gas that’s here, they can certainly pursue the areas with better regulatory and tax climates for a long period of time before they’re forced to come back and invest in Pennsylvania.”
In order to avoid fire from both right and left on the shale tax, the House package unveiled this week relies on what the GOP has called the state’s “shadow budget.”
These are public funds into which the state pays, but which are controlled for a specific purpose, often environmental trusts or public transportation funds. Many of these accounts, House Republicans say, are maintaining balances far beyond what they need to cover their day-to-day operations.
There is some legal question as to who truly controls these funds, or if the Legislature can simply take funds out. But if they can, the state could realize roughly $1.2 billion in surplus cash that won’t impinge operations.
“We had a number of criteria when looking for this money, and the main thing is [the fund] has an ongoing surplus of funds that don’t get spent and sometimes grow,” Bloom said.
The organizations that use the funds that will be drawn down, however, disagree with the notion that the House proposal won’t impact their operations. PennDOT Secretary Leslie Richards issued a statement Friday arguing that withdrawals from transit funds would limit the ability of the state to assist local transit agencies.
“Moving $357 million from the Pennsylvania Public Transit Trust Fund would mean a 35 percent reduction in operating subsidies this fiscal year for the state’s 37 fixed-route transit agencies,” Richards said.
Spending vs. revenue
The common refrain is that Pennsylvania has a spending problem, an assertion that can be true, depending on one’s political persuasion, but comes with a number of caveats.
The state’s recurring budget deficits are not due to spending increases per se, but rather to the fact that state revenue packages, while they cover spending increases on paper, rarely actually do so. The income Pennsylvania realizes throughout the year is habitually below legislative projections.
So far this year, however, revenue has actually been coming in ahead of projections, indicating that Pennsylvania may be saved from adding any more to its deficit in the current fiscal year, Bloom said.
It is true that state spending has increased, a fact decried by conservatives. The Commonwealth Foundation points out that Pennsylvania’s total budget has grown 183 percent, adjusted for inflation, since 1970. If the state were to have pegged its spending to the rate of inflation since 2000, it would require $15.3 billion less in taxes that it currently does.
On the other hand, the state’s budget has actually contracted relative to GDP.The state’s general fund, as a percentage of the overall economy, dropped from 5.10 percent in 1997 to 4.36 percent in 2015.
Liberal observers have pointed out that this corresponds with poor outcomes for the working class, particularly when it comes to education. Funding for the state higher education system has been cut 26 percent since 2007-08, with a corresponding tuition hike of 21 percent, and a 5.1 percent decline in college system enrollment.
This decline is much stronger at schools with a higher proportion of students from families in the bottom 60 percent in incomes, a recent KRC study found. It also correlates to Pennsylvania lagging behind its neighbors in wage growth. The 60th percentile of earners in Pennsylvania took a 0.7 percent pay cut since 2007, while the average of Pennsylvania’s neighboring states was a 4.8 percent raise.
“The reality is that the state budget as a percent of GDP has been dropping for 20 years, and cuts to public initiatives like state universities are killing our middle-class economic growth,” Herzenberg said.
While any of the above debates — be they natural gas taxes, fund depletions, education cuts, or any other budget-correcting maneuvers — are difficult, they are relatively fast to enact. Some other issues with Pennsylvania’s financial structure are not.
The most obvious is the flat tax rate. Pennsylvania’s constitution specifies that taxes “shall be uniform upon the same class of subjects.” This is why the state levies a 3.07 percent tax on all personal income, regardless if one made $1 or $1 million in a given year. Most states in the nation, in contrast, charge higher rates on higher brackets of income.
Thus, raising money through income tax hikes is difficult in Pennsylvania, since it will hit working families as well as the wealthy. Changing this would require a constitutional amendment, although a bill by Sen. Art Haywood, D-Montgomery/Philadelphia, would create different rates for different types of earnings, with a lower rate for wages and a higher tax rate for capital gains and other sources of income that tend to be used by wealthier people.
The proposal has gained some support, although it is unclear if it would meet the constitutional test if challenged in the courts.
The state also faces a struggle with corporate tax rates. Pennsylvania’s 9.99 percent corporate net income rate is nominally one of the highest in the country, but three-quarters of C-corporations operating in Pennsylvania show zero or negative net income in the state in any given year, creating an effective rate that is much lower.
Corporate net income tax revenue, as a percentage of the state’s GDP, has actually declined about 20 percent in the last 20 years. Proposals have been floated, including by Wolf, to crack down on corporate accounting and fix the system. However, these proposals would involve combined reporting, which requires corporations to list profits of out-of-state subsidiaries and has received considerable pushback.
“In the previous times this has come up, it’s viewed as almost confiscatory by the business community to go with mandatory combined reporting,” Bloom said. “It can be a penalty against certain companies rather than just neutralizing their out-of-state advantage.”
At the same time that multistate corporations may have an advantage, small corporations that book their profits as owners’ income (S-corporations) are at a relative disadvantage in PA.
A number of small business advantages, such as tax-exempt like-kind exchanges, exist in other states and at the federal level, but not in Pennsylvania. Bloom has introduced bills for the past several years to correct the problem, but they have gone nowhere amidst budget impasses that make legislators reluctant to meddle with the tax code.
“It doesn’t mean that it can’t be done, but it’s not easy to coordinate,” Bloom said.
He said, however, that the Legislature has created a bipartisan Select Subcommittee on Tax Modernization and Reform.
“We’ve only just begun — we had our organizational meeting over the summer and have not started hearings,” Bloom said. “It will be a long process, but I’m hopeful we’ll get somewhere.”