Revised May 8, 2010
Long-Term Economic Growth and Stability
This year, Tennessee is facing yet
another budget shortfall of up to a billion dollars.
trend in Tennessee has been
toward declining revenue and
chronic budget shortfalls.
This year, legislators and the
Governor have proposed severe budget cuts due to the lack of revenue. We need more revenue not budget cuts!
A well-balanced, reliable tax
system should, at a minimum,
raise sufficient funds over the long
term to meet the state’s needs. Tennessee’s tax system,
which depends heavily
on sales tax revenue,
fails to meet this criterion. This failure is the
prime cause of Tennessee’s
As a general rule,
the sales tax and property
tax are slow-growing
revenue sources over
the long-term. April 2010 was the 23rd consecutive month sales tax revenues have declined in Tennessee. Revenue
from these taxes grows
so slowly that it fails
to keep pace with the
economy as a whole. By some
estimates, sales tax revenue grows
by only 7 to 8% for every 10% of
economic growth we experience.
This dynamic is driven in part
by a shift to a more service-oriented
economy. The sales tax generally
applies only to tangible goods. The growth of Internet sales only exacerbates this problem, as does our high sales tax and cross-border shopping. The end
result is that the sales tax base is
shrinking over time (See Figure
11), along with the revenue we
raise at any particular rate.
At the other end of the spectrum
are personal income and
business taxes. These taxes, in
addition to being more fair, keep better pace with the overall economy.
In fact, revenue from a well designed,
personal income tax
would actually exceed economic
growth. Absent gross tax evasion,
business taxes have similar long-term
growth benefits since they
are tied to the growth of corporate
While income and business
taxes tend to grow faster over the
long term, they tend to fluctuate
more on a year-to-year basis, as
they are more closely tied to the
ups-and-downs of the economic
cycle. These year-to-year fluctuations
can be addressed with
wise use of rainy-day funds and
a diversified revenue stream that
includes a mix of both fast-growing
and slow-growing (but more
stable) revenue sources. That’s
what a balanced, common sense
tax system would look like.
While most states take a balanced
approach to funding state
services, Tennessee relies heavily
on the sales tax. Roughly 60%
of Tennessee’s state revenue is
comprised of sales tax revenue.
This number climbs to 70% when
selective sales taxes on gasoline, alcohol,
and cigarettes are included.
The result of this heavy dependence
on slow-growth revenue
sources is that the overall tax system
in Tennessee fails to keep pace
with economic growth, leading to
chronic budget shortfalls.
This may come as a surprise
to many, but even with the sales
tax increases of 1976, 1984, 1992,
and 2002, tax collections in Tennessee
have remained roughly 5 to
6% of total personal income (UT
Center for Business and Economic
Research, 2003. See Figure 10).
Without these legislated increases,
tax collections in Tennessee would
have dropped to near 3% of
personal income, with dramatic
implications for public infrastructures.
Creating a more balanced tax
system will better equip Tennessee
to make the kind of long-term
investments needed to maintain
healthy communities and a strong
economy. Ultimately, the state
must pass some kind of comprehensive
tax reform that would
include the elimination of the food
tax, reduction of the sales tax on
other items and creation of a progressive
state income tax.
While such reform remains
TFT’s long-term goal, there are
some short-term initiatives
that will move us in the right
direction. The Food and
Business Tax Fairness Act and Internet Parity Act is one of those initiatives.
Replacing a portion of the
slow-growing sales tax with
taxes will generate a sounder
and more reliable economic
base. A fiscally responsible
tax system will enable us to
meet tomorrow’s challenges.
Figures 10 & 11 are excerpts from The Structure of State Taxes in Tennessee: A Fiscal Primer. February 2003. A joint publication of the Tennessee Advisory Commission on Intergovernmental Relations (TACIR) and the University of Tennessee, Center for Business and Economic Research.