Alternatives to the Earnings Tax are not Fiscally Sufficient, Politically Feasible, or Economically Desirable…According to a Study Paid for by Rex Sinquefeld

The idea at the core of efforts to phase out the city’s 1% earnings tax is the assumption that there are preferable alternatives. All things being held equal, there is no doubt that the earnings tax, or for that matter every other tax, makes the city less competitive. The problem is that cutting one third of the city’s revenue has real consequences, and the city would be forced to respond by either raising other taxes and fees, or cutting services, each of which would make the city less competitive.

With that in mind, I decided to turn to a study conducted by Public Financial Management (PFM) in 2011 which explores the implementation of a 10-year phase-out of the Earnings Tax. The study was commissioned by the Missouri Council for a Better Economy (MCBE), a group wholly funded by Rex Sinquefeld, and is occasionally biased or misleading. None-the-less, it does not recommend phasing out the earnings tax. Instead, it lays out how best to phase out the earnings tax in the case we were forced to do so.

This study lays out the most optimistic vision for an earnings tax phase out, and it still doesn’t look good. I encourage anyone who believes there are feasible and responsible alternatives to the earnings tax to read this study, which demonstrates that alternative revenue sources are not sufficient to replace the earnings tax, and may well have worse economic effects than the earnings tax.

Despite assuming that the people of St. Louis approve 10 different tax hikes (pg. 81), any one of which would be a big political win, the study was only able to find $91.4 million in new revenue by 2021 to fill the gap created by eliminating the earnings tax (pg. 98). Critically, the study itself acknowledges that these alternatives may well have worse economic effects than the earnings tax. On the expenditure side, the study was only able to identify $28.2 Million worth of cuts, roughly half of which the city has already implemented (pg. 64–79). The total budgetary impact of Rex’s plan is $119.6 Million, that’s $36 Million less than the $155.9 Million gap it projects in 2021 (pg. 98). In the meantime, it turns out Earnings tax revenue is growing much faster than the study anticipated, the study projected $142.6 Million in earnings tax revenue in 2015 (pg. 53), instead, we collected $161 Million. That is great for the city, but bad for efforts to eliminate the earnings tax, since it makes finding alternatives even harder. Further complicating the picture, the study projects that even if the city does retain its earnings tax, it will face a $75.3 Million structural budget deficit by 2021 (pg. 56).

When you factor these key pieces into the projected gap if the city loses earnings tax revenue, the hole grows from $155.9 million to roughly $250 Million — the study only shows us how we could cut and raise $120 Million. Even setting aside political constraints, alternative revenue sources are not sufficient to replace earnings tax revenue.

The most surprising part of the study, however, is what it has to say about the other revenue sources. Even if passing 10 big tax increases were politically feasible, it turns out that the revenue sources the study proposes may well have worse economic impacts than the earnings tax, the study speaks for itself:

Property Tax

• According to the study: “There is no perfect tax, and any change will have some negative impacts” (pg. 13), in fact, “high property taxes can have a dampening effect on development and economic growth, when the differential with surrounding jurisdictions and competing cities is high. … Overreliance on the property tax can leave a city overly vulnerable to periodic declines in real property values. Given the frequency of reassessment in the state of Missouri, this would be a significant concern for St. Louis. For example, over the past 30 years, New York City has moved away from reliance on property and sales taxes and toward individual and corporate income taxes.” (pg. 36)
• This is supported by empirics, according to a December 2015 study by economists out of the bipartisan Brookings Institution, “We show that different sources of tax revenues have dramatically different impacts on growth, with property taxes exerting consistently negative effects, and income and corporate taxes usually exerting positive effects” (pg. 920)

Sales Tax

• According to the study, “St. Louis already has one of the highest total sales tax rates in the region; an increase in this rate would inevitably generate some of these cross-border effects. For example, studies have shown that a 1 percent rate differential in local sales tax can lead to a 3 to 7 percent decrease in retail sales.” (pg. 37)

Miscellaneous Taxes and Fees

• The study also relies on raising miscellaneous taxes and fees, most of which are targeted at specific industries and consumption, and many of which have regressive economic impacts. As the study notes, one strength of St. Louis’ existing revenue structure is its broad base,(pg. 28) yet the study recommends increasing the city’s reliance on narrow taxes and fees, like the hotel and restaurant tax, which wind up extracting a lot of money from a small subset of people. (pg. 81)

Earnings Tax

• As for the earnings tax, the study commends it as: “broad based without exemptions” (pg. 9) and seems skeptical of the notion that cutting the earnings tax will result in significant positive economic effects for St. Louis. Specifically, it explains that “Small increases in [earnings] tax [are] not likely to increase unemployment” (pg. 40). Which calls the entire negative relationship between the earnings tax and economic activity into question.
• Unlike most of the alternatives, the incidence of the earnings tax does not fall predominantly on city residents, as the study notes, “An unscientific examination of the percentage of nonresidents working for the city’s twenty largest employers by the Collector of Revenue found that 70 percent of earnings tax revenue was generated by nonresidents” (pg 11). The study goes on to point out that, “this is appropriate, given the significant influx of non-residents into the City during normal working hours — for whom the City provides police and fire protection, maintains city streets and other infrastructure and provides parks and other amenities” (pg. 85).

Expenditures

• The options aren’t any better on the expenditure side of equation. The study points out that, “the City has made extensive budget and personnel cuts in recent years; it is unlikely that the budget contains significant additional personnel-related reductions that will not have a material impact on provision of service” (pg 86). It is also worth noting that the city has already implemented roughly half of the study’s suggestions.

Maybe this is why the very same firm (and many of the same individuals) that conducted Rex’s study has cited re-authorizing the earnings tax as the city’s number one economic priority, and a pre-requisite for financial stability and long term growth. (City of St. Louis Long-Range Financial Plan, 2015, Comptroller’s Office).