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Income tax proposal sketchy, but may be compromise
By Andy Brack
SC Statehouse Report



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MARCH 30, 2003 - - Gov. Mark Sanford's proposal to tie a cigarette tax hike to an income tax reduction may end up being the compromise that funds a state Medicaid shortfall, but it's got a big problem:

Most lawmakers simply don't have any idea how the plan would work.

"They don't get it," one key Statehouse lawmaker said. "I'd like to see a bill; I'd like to see language."

Generally when a major legislative proposal is unveiled, proponents overload the media and potential supporters with piles of papers, detailed explanations, charts and more. Sanford and his team provided only a press release, three charts and a couple of other pages.

"That's pretty thin for something the governor campaigned on," observed a member of the House GOP leadership team. He added Sanford promised in his January State of the State address never to surprise lawmakers. "And it's been nothing but surprises since then."

Sanford's staff points out the income tax reduction plan, which was delivered two weeks ago shortly before a House vote on a Medicaid reform package, didn't have much of a chance to be aired in the House. Its leadership pushed hard to shore up a multi-million dollar Medicaid shortfall by reforming administrative practices, making slight service cuts and refinancing tobacco bonds. In other words, the House GOP leadership wanted no part of a cigarette tax increase.

Sanford, who vowed to veto a simple hike in the cigarette tax from 7 cents per pack to the national average of 60 cents per pack, may find more help in the Senate. But observers say a cigarette tax tied to cutting the income tax rate may not get much support from Senate Democrats. They believe it's not time to cut revenues when many state needs are unfunded or underfunded due to the economy. Meanwhile, many conservative Republican senators are opposed to any hikes in "sin taxes," such as the cigarette tax.

Sanford's plan calls for the state to generate $150 million in new revenue for Medicaid through a cigarette tax hike. The money would be dedicated to ever-increasing Medicaid costs and would have an extra benefit - - it would allow the state to grab about $450 million in matching federal funds.

But the tax is tied to a gradual reduction in the individual income tax rate, currently at 7 percent. Essentially, the state would fund an income tax credit to every South Carolinian who paid the tax with these caveats:

  • First, the state would set an individual income tax revenue baseline, which would increase 1.5 percent annually to adjust for population growth. The state then would have to collect all baseline revenues before any tax cut kicked in. In other words, any refund only would come from growth in income tax revenue collections above the baseline amount.

  • The state then would keep 20 percent of new individual income tax revenue growth. Refunds would be funded proportionally from funds leftover - - 80 percent of new revenue growth - - but only until the pool of money equaled the amount collected from the new cigarette tax.

  • At that threshold, the state would drop the individual income tax rate by a half percentage point. Then it would restart the cycle by collecting baseline revenues and using any growth to fuel another income tax refund. The cycle would continue annually over 15 years, with some other adjustments, until the overall income tax rate dropped to 5 percent.

Yes, it's complicated. And as Clemson economist Holley Ulbrich points out, it might not be the right time to talk about what essentially is a $7.6 billion state income tax cut because the effect of federal tax cuts on state revenues isn't yet known.

"I think it's premature to design an income tax program until you know what's coming out of Washington," she said.

But whatever happens, it's clear a showdown on state taxes in this tough budget year is coming soon. Put on your flak jackets.


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