The "Wyoming Tax Swap"

A blueprint for a workable, stable, efficient, and business-friendly Wyoming tax structure

by Brett Glass

[Slides from 9-20-2001 presentation to the Wyoming Legislature Interim Joint Revenue Committee are at http://www.brettglass.com/taxswap/slides/]


Executive Summary

This document proposes reforms of Wyoming's tax structure which are intended to accomplish the following:

The recommended changes include provisions intended to make the proposed reforms as fair, feasible, and politically palatable as is practicable in Wyoming's current political climate.


Motivation

While Wyoming's state government enjoyed a temporary surplus in the year 2000 due to a fortuitously timed energy "boomlet," the state's tax structure nonetheless lacks the stability it requires in the long term. Such stability is necessary to foster business development, induce businesses to relocate to Wyoming from outside the state, prepare for inevitable population growth, and allow the state to prosper in leaner times.

Were it not for the current (and temporary) surge in energy prices, our government would be roughly $160 million in the red for each two-year period for the forseeable future; perhaps more. While sheer happenstance has postponed the day when these deficits will arise, we must face facts: our state will not, in the long run, take in nearly enough in taxes to cover the expenses of even our minimalist state government.

As Governor Jim Geringer reported in his Y2K State of the State address, part of this deficit has been brought about by changes in the way we fund K-12 education. But in the future, the lion's share will be caused by unfunded or underfunded mandates -- many imposed by the Federal government -- over which our state has little control.

This paper presents a modest proposal which, if implemented, will benefit every citizen of the State of Wyoming financially while at the same time balancing our budget and promoting business development.

A State Tax on Services: The Wrong Choice

One proposal defeated by the legislature during its 2000 session was for a state tax on services. The Legislature correctly recognized that such a tax would be a poor choice for several reasons.

First, Wyoming's small businesses are already choked with paperwork. Companies that sell material goods already must serve as unpaid tax collectors for the State, and the process involves paperwork, audits, deposits, and other red tape which burdens our (mostly small) businesses. With the imposition of service taxes, even a local youngster who cut your lawn would be required to collect taxes from you, fill out complex forms, and remit money to the state government.

Second, because Wyoming's economy is largely service-based, imposing a service tax penalizes Wyoming businesses for doing what they already do best.

Third, and most importantly, a service tax is far more easily avoidable than a sales tax. Services aren't bulky or heavy, and can often be delivered by telephone, mail, FAX, or electronic mail. Service taxes will therefore drive business out of state instantly. Travel agents will be forced to shut down as service taxes, piled on top of fees recently imposed due to airline commission cuts, drive Wyoming residents to the Web. Investors will trade Wyoming stockbrokers for AmeriTrade or E*Trade. Even local businesses such as auto repair shops will suffer; unless it's an emergency, Wyoming residents will leave their cars at the Sears Auto Center in an out-of-state mall as they shop there for other goods. And even more than use tax on tangible items, a use tax on services would be infeasible to collect. Could you imagine posting police at the border to ask returning residents, "I see you have a new haircut. Did you get it out of state?"

The Rise of the Internet

Finally, the rise of the Internet has made service taxes -- like sales taxes -- an unreliable source of revenue. In Quill v. North Dakota, the US Supreme Court ruled that out-of-state merchants cannot be compelled to collect taxes on interstate sales without the approval of Congress. And that approval is not forthcoming. In fact, taxation of Internet transactions is strongly opposed by the majority of Federal legislators. The Republican Party's recently announced E-Contract 2000 calls for a ban on e-commerce taxes which would last 5 years and perhaps be made permanent thereafter.

Because the Internet makes it so easy to skirt taxes by shopping out of state, we can expect sales, use, and/or service tax revenue to decrease steadily as e-commerce becomes pervasive. An increase in sales taxes, or the imposition of service taxes, would accelerate this trend. "Although consumers seem nonchalant about online taxes," reports James L. McQuivey of Forrester Research, "they leave a trail of unpaid state and local taxes in their Web-shopping wake. In 1999, more than half a billion in sales taxes went uncollected." Jurisdictions throughout the country are already seeing substantial drops in revenue due to this growing trend. The city of Mountain View, California -- a small Silicon Valley suburb midway between San Jose and San Francisco -- estimates that its sales tax revenues fell by more than $500,000 in one year due to e-commerce. Because Wyoming residents have been slower to embrace the Internet than residents of the Silicon Valley, this effect is only beginning to be felt in our state. However, it will -- inevitably and inexorably -- make a substantial impact, as it already has elsewhere. This impact will likely be exacerbated by the limited variety of goods available at retail in many Wyoming cities.

The "Wyoming Tax Swap" takes a more forward-looking approach to the problem of taxation that anticipates this change. Instead of imposing new and potentially harmful taxes, or preserving taxes from which revenue is likely to decline, it reduces both the number and the dollar amount of taxes Wyoming residents pay while stablizing and broadening Wyoming's tax base. Finally, it has the advantage of insulating Wyoming from the nationwide debate over taxation of e-commerce. Whatever happens, Wyoming wins.

The Wyoming Tax Swap: Anticipating the Future

Under the Wyoming Tax Swap, sales tax, use tax, and business personal property tax are abolished and are replaced with a simple, flat income tax whose revenue is the same as that currently generated by those taxes.

What would be the consequences of this shift? First, income tax -- unlike sales tax -- is deductible from one's Federal income tax return. So, since the average Federal tax bracket in Wyoming is 15%, each Wyoming citizen would effectively get a rebate that averaged 15% (more, if he or she was in a higher bracket) of the state taxes he or she was paying before.

Consumers, given this extra cash, would be likely to spend those dollars in the state instead of elsewhere -- free of sales tax. The more each one bought locally, the more he or she would save; in short, the new tax structure would provide a reward, rather than a penalty, for patronizing Wyoming businesses. This would boost our state's retail economy dramatically.

Entities operating in the state but headquartered elsewhere -- such as large utility companies -- currently pay very little in state and local taxes because their offices and much of their equipment are elsewhere. With an income tax, these companies would pay their fair share for the privilege of operating within the state and for maintenance of the infrastructure that supports them, and in return would be assured of the quality of that infrastructure. A substantial portion of their state income tax liability would be offset by reductions in Federal income tax and by the abolition of the business personal property tax (see below).

A Boost for Wyoming Business

The "Wyoming Tax Swap" would also have other substantial benefits for Wyoming businesses and residents. The paperwork burden of sales taxes would be eliminated, allowing Wyoming businesses to spend less time serving as unpaid tax collectors and more time doing business. Since all Wyoming residents and businesses are already obliged to complete Federal tax returns, the paperwork burden of the Wyoming tax could be reduced virtually to zero by setting the tax at a flat percentage of a single line on one's Federal return. The state's "postcard" tax return could be filed at the same time as one's Federal return -- perhaps via a secure Web page. (Wyoming's recently passed electronic signature law already makes this legal.) The amount could be verified automatically with data obtained from the Federal government, making administration simple and requiring less manpower than the current state sales tax bureaucracy. Multi-state corporations, which already must apportion income by state and prepare tax returns for each one, would simply add one very short form to their accounting systems.

Eliminating the business personal property tax would likewise bring about immediate and substantial benefits. Like sales tax, this tax strongly discourages capital investment by burdening new and growing businesses before they can realize profits. It also imposes a penalty upon existing businesses which update their operations -- for example, by installing computers or purchasing state of the art equipment comparable to that used by competitors. Needless to say, taxes which discourage entrepreneurship, modernization and expansion are exactly the opposite of what Wyoming needs to promote business development.

Enforcement and administration of the business personal property tax are also problematic. Historically, Wyoming's county governments have had great difficulty collecting this tax or even identifying all the businesses who must pay it. Some have resorted to such tactics as scouring the membership rolls of local Chambers of Commerce, scanning advertisements in the Yellow Pages and local publications, searching for Web pages posted by small or home-based businesses, and/or following up newspaper profiles of promising local businesses with harsh letters or telephone calls demanding payment. Audits are time-consuming and difficult because they require a physical visit, which county assessors do not have sufficient staff to perform. And the unscrupulous can (and, alas, do!) remove personal property -- which by definition isn't permanently tied down -- before the tax assessor arrives.

The revenue lost by eliminating this tax would be made up via income taxes paid by businesses, which -- unlike the personal property tax -- would be levied on net income and therefore would not penalize new companies which had not yet made money. This could be a key factor in attracting, and fostering the development of, new knowledge-based businesses, many of which must forego short term profits to build market share.

Making the Internet Work For Us

Eliminating the sales tax would have the additional advantage of making the Internet work for us, not against us. Suddenly, there would be no advantage in shopping on the Internet rather than going to a local store. In fact, the local store would have an edge due to shipping costs! What's more, shoppers from neighboring states (all but one of the states which border Wyoming have sales taxes) will flock to Wyoming to shop, rather than the other way around. (Today, residents of northern Wyoming frequently travel to Montana, which has no sales tax, to buy big ticket items such as household appliances. And residents in all parts of Wyoming shop outside the state for food, since neighboring states either do not tax it or tax it at sharply reduced rates.) Shoppers from other states could learn what Wyoming retailers had to offer via the Internet and then come to Wyoming to patronize them. These "shopping tourists" would also patronize local restaurants and tourist attractions and increase local lodging tax revenue.

At the same time, Wyoming shoppers who now spend their money in Salt Lake City, Fort Collins, Rapid City, and Scottsbluff would reconsider due to the average 6.5% savings they would realize by shopping at home. Increased sales volumes would allow Wyoming merchants to broaden the range of products they carried, making them more attractive destinations for residents and non-residents alike. Increased revenues from lodging taxes and gasoline excise taxes, as well as increased income tax revenues from tourist-oriented and general retail businesses, will more than compensate for any loss of sales taxes paid by tourists.

In short, the Wyoming Tax Swap would keep local dollars local and bring in more from elsewhere, boosting Wyoming's entire economy without a commensurate increase in population. Two other Western states -- Montana and Oregon -- have leveraged this effect to realize substantial growth relative to surrounding states.

Income Taxes are Exportable

Another key advantage of an income tax, as compared to a sales tax, is that income taxes are exportable whereas sales taxes are not. Currently, Wyoming effectively imports the income taxes of other states when our residents and businesses buy products, at wholesale or retail, from elsewhere. However, because Wyoming has no income tax and cannot legally tax sales to out-of-state customers, we are not able to export an equivalent amount of our own taxes. As the Wyoming Taxpayers Association notes in its white paper Principles of a High-Quality State Revenue System, Wyoming's lack of personal and corporate income taxes represents a substantial lost opportunity to lower our overall tax burden. (The loss is especially great because, due to Wyoming's small population, an overwhelming majority of the goods and services produced in Wyoming are exported to out-of-state markets.) And, as mentioned earlier, the fact that one can deduct state income taxes (but not sales taxes) from one's Federal tax return also represents a missed opportunity to export taxes -- a tremendous benefit enjoyed by residents and businesses in states which levy an income tax.

Population and Income Elasticity

Under Wyoming's current tax regime, revenues are both population-inelastic (that is, they do not increase in direct proportion to population) and income-inelastic (that is, they do not rise at the same rate as net income). Both represent liabilities if the state becomes either more populous or more prosperous. A tax system which replaces sales taxes with income taxes helps to solve both of these problems. Only if revenues keep pace with population and with overall economic activity will state and local government be able to create and maintain the infrastructure that citizens and businesses require.

Tax revenue must track economic activity in all business sectors -- not merely retail sales -- to support activities such as manufacturing, which do not directly generate sales taxes but require substantial infrastructure. While increases in non-retail business activity indirectly generate some additional sales tax revenue when employees spend a portion of their wages in the retail sector, this revenue does not keep pace with demand for infrastructure and government services as would the revenue from an income tax. In Wyoming, sales tax revenues increase by only about 6% for every 10% increase in income [Ge1]. As incomes rise, residents spend a greater percentage of their incomes on items not subject to sales and use taxes -- as well as out-of-state, mail order, and Internet purchases. With the Wyoming Tax Swap, if the state becomes more prosperous -- that is, if the average wage increases -- tax revenues will rise slightly faster than population. This will provide funding for the enhanced services that citizens at higher income levels expect and/or provide an opportunity for tax rates to be cut.

Fairer to Ranchers and Other Agricultural Businesses

Wyoming's ranchers -- as well as others engaged in agriculture in our state -- must contend with dramatic boom and bust cycles and competition from large agribusiness concerns with deep pockets. A move to an income tax, rather than sales and business property taxes, would benefit these native businesses, which form an important part of Wyoming's cultural heritage as well as its economy. Besides reducing their overall tax burden due to decreased Federal taxes, it would help these businesses to survive lean times by reducing their taxes during especially difficult periods. It would also reward, rather than penalize, capital investment, allowing our native agricultural operations to modernize and become more competitive.

Fairer to the Mineral Industry

Currently, mineral severance taxes are the largest single source of Wyoming tax revenue. According to data compiled by University of Wyoming professor Shelby Gerking [Ge2], Wyoming residents pay far less in state and local taxes than the value of the public services they receive. (The gap ranges from about $4800 per household  per year in Rock River to approxmiately $15,000 in Gillette.) Mineral taxes currently make up the shortfall, and if they are expected to continue to do so the industry's tax burden will increase linearly with population. This author takes no particular position as to the most appropriate rates for mineral severance taxes. However, it is clear that under the current tax regime, the politically powerful mineral industry has a strong economic motivation to oppose economic growth, business development, or any other change which might cause Wyoming's population to increase and place upward pressure on mineral taxes. This, in turn, hinders the development of new sources of tax revenue, creating a vicious cycle.

The Wyoming Tax Swap provides a way out of this conundrum. By fostering the development of other industries, and gradually shifting a fair share of the tax burden to them as they begin to generate revenue, the Wyoming Tax Swap will allow Wyoming to tax the mineral industry fairly but not excessively and to accommodate a reasonable pace of population growth. Perhaps even more importantly, it will align the interests of the mineral industry with those of Wyoming residents and small businesses instead of setting them at odds with one another. The state will also be able to save more money in the Permanent Wyoming Mineral Trust Fund (PWMTF) toward the day -- hopefully far in the future -- when key non-renewable resources are exhausted or no longer economical to extract. Finally, Wyoming will be less at the mercy of outside forces as energy and commodity prices move through "boom and bust" cycles.

Better for the Trucking, Railroad, and Telecommunications Industries

Wyoming's shipping-related industries would also benefit from the Wyoming Tax Swap, because increased economic activity would stimulate demand for both interstate and intrastate transport of goods. Demand for rail freight services would increase, as would demand for "dark fiber" and telecommunications right of way along railway corridors.

Increased business development fostered by tax reform would likewisecreate greater demand for telecommunications services. (E-commerce firms, in particular, prefer to locate in states without sales taxes, since by doing so they can avoid altogether the costly and tedious logistics of collecting sales and use taxes.) Wyoming's location near the center of the continent, with three major interstate highway corridors traversing the state and a fourth just to the west, makes it an ideal location for e-commerce companies which must ship goods throughout the United States. A stable and business-friendly tax structure, a healthy economy, and a high quality of life are key to attracting such businesses to Wyoming and keeping them here.

More Attractive to Relocating Businesses

Economic development officials, seeking to lure existing businesses to Wyoming, often tout our state's lack of an income tax as a positive factor. Yet, they routinely watch as these businesses choose to relocate to other states instead. Why? One key reason is that, due to accounting practices and the ways in which taxes are levied, sales taxes and business property taxes are actually far less favorable to businesses than an income tax. Sales taxes (which, unlike state income taxes, cannot be deducted from income when computing Federal taxes) and personal property taxes must be paid upfront, often before benefits from the purchase can be realized. Income taxes, by contrast, defer the tax burden until a profit is made. In fact, they provide an upfront incentive for business spending and growth by making purchases subject to either direct expensing (in the case of day-to-day supplies) or depreciation (in the case of capital equipment). In either case, expenses are deducted from gross income and lower the income tax paid. From the perspective of a business, a state with an income tax is a far better choice than one which levies an equivalent amount (or even a lower amount) of sales and personal property taxes. This is reflected in companies' choices to locate elsewhere.

Businesses also seek locations with a stable tax structure. Because Wyoming's current tax system lacks stability due to fluctutations in mineral prices and consumer spending, businesses are justifiably concerned that rates may change, or that new taxes may be imposed to balance state, county, and municipal budgets.

Less Intrusive than Enforcing Current Taxes

Some Wyoming residents have traditionally objected to the notion of a state income tax because they feel it might be intrusive. However, states already have the ability to access Federal tax return data, so an income tax would not give state government access to any information it could not already obtain easily and at will. If a state tax were based on one line of one's Federal return, the state would normally need to know only the amount on that line. On the other hand, full enforcement of the use tax laws which are now on the books would require far more Draconian measures -- including auditing of citizens' checkbooks, credit card statements, and mail order purchases. In short, an income tax would actually be less intrusive than enforcement of existing sales and use taxes. The Wyoming Tax Swap would, likewise, eliminate potentially intrusive inspections for the purpose of assessing the business personal property tax.

Citizens have also expressed concern that a state income tax would create a large tax bureaucracy. However, if a Wyoming income tax were based on a single line of citizens' and corporations' Federal returns, bureaucracy would be minimized and the paperwork burden would likewise be negligible. (Similar systems have been implemented successfully in other states. According to the Federation of Tax Administrators, six of the 50 states have flat individual income taxes, and of these, five use Federal adjusted gross income, or AGI, as the starting point for the calcuation of those taxes.) Because Wyoming's government is small compared to those of other states, the flat personal income tax rate required to replace revenues from sales, use, and business personal property taxes would be modest -- most likely between 2 and 3 percent. Corporate tax rates, which are flat in nearly all states, would be similar.

Another concern about an income tax is that it might foster a "tax-and-spend" mentality in state government. Fortunately, Wyoming's citizen legislature has historically shown a strong and healthy resistance to increases in the size of government. Fears that Wyoming could wind up with both an income tax and a sales tax could be allayed by replacing Article 15, Section 18 of the Wyoming Constitution (which, in its current form, would make an income tax both fiscally infeasible and extremely regressive) with a provision that prohibits the simultaneous imposition of a general sales or use tax and a general income tax.

An income tax  was strongly recommended by Wyoming's Tax Reform 2000 Committee -- a committee consisting of Wyoming legislators, businesspeople, and taxpayers -- as a means of stabilizing and broadening Wyoming's tax base. Unfortunately, the committee's recommendations proved unpalatable to the Legislature because they did not recommend the concurrent elimination of other taxes. A "swap" which results in fewer and lower taxes -- rather than an added tax -- is key to public acceptance of any serious reform of Wyoming's tax structure..

Keeping our Young People

Wyoming residents often bemoan the fact that our young people -- high school, vocational school, and college graduates -- virtually all flee the state upon graduation in search of greener economic pastures. Unfortunately, by discouraging capital investment and business development, Wyoming's current tax regime has inhibited the creation of career-oriented, entry-level jobs which might allow us to retain them.

This "Wyoming Brain Drain," as it is sometimes called, is exacerbated by the lack of progressivity in our tax system. Unlike most other states, we tax young families and entry level workers, who will naturally start out at the lower rungs of the income ladder, at a far higher percentage of income than those who are farther along in their lives and careers. This, in turn, creates a dearth of such workers, creating difficulties for both new and established businesses.

To encourage our sons and daughters to stay in the state, we must adopt a tax system which rewards them -- or at least does not penalize them --for making that decision. A flat tax on adjusted gross income, while not particularly progressive,  would nonetheless be less regressive than sales taxes on goods or services because, unlike a sales tax, it is subject to some deductions and therefore does not tax the first dollar. (Governor Jim Geringer, recognizing the extreme regressiveness of sales taxes on food, proposed in his Wyoming 2000 Budget Presentation that they be eliminated. The Wyoming Taxpayers Association's Fiscal Researcher newsletter likewise notes that Wyoming is one of a very few states whose tax structure is so strongly regressive.) If we penalize our young for remaining in Wyoming, they will leave. But if staying has clear economic advantages, more will do so.

What About Cities and Counties?

Today, many of Wyoming's cities and counties derive vital revenue from local sales taxes, which consist of "points" added to the state's base sales tax rate of 4%. What would substitute for these revenues once the swap was implemented? While many solutions are possible, the simplest way -- and the one that would require the least change to the ways in which counties and cities did business -- would be to do exactly what is now done with sales tax. The state, which would collect the income tax, would send some percentage of revenues back to the cities and counties. As with current sales taxes, the percentage collected from and returned to local communities could be determined locally, within constraints set by state law. Since a community's income tax  revenue would more accurately reflect the overall level of economic activity than a sales tax (which only measures activity in the retail sector), the amounts of revenue returned to local governments would correlate more closely with their monetary needs. There would be fewer "surprise" shortfalls. Counties and cities -- especially those in which the primary industries are manufacturing, mining, or high tech -- would find that their tax revenues more accurately tracked demand for their services. In short, local government would fare better than before under the new plan.

A Call for Leadership

Implementation of the Wyoming Tax Swap would mean fewer and lower taxes, a balanced budget, a more stable tax base, less bureaucracy, a healthier state economy, and an improved climate for business development. The reduction in the number of taxes, the elimination of taxes that might hinder e-commerce, the potential for radical improvement in Wyoming's business climate, and the elimination of current taxes which would be particulary onerous if enforced are all potent selling points for the proposed changes.  The Tax Swap will also encourage new business development (and the relocation of existing businesses to Wyoming) by creating a predictable, stable tax system with three sturdy, independent "legs:" mineral severance taxes, income taxes, and property and excise taxes.

The key element in making all of these things happen is leadership. A Constitutional amendment will be required to effect the change. Our leaders will need to address citizens' concerns, explain the rationale for this new plan, and show them that it would benefit them personally. While the notion of an income tax will at first seem unpalatable to some, our leaders will be able to point out to constituents that three other taxes -- all less desirable! -- will be repealed, that they will pay less in taxes and endure less paperwork than before, and that they and other Wyoming residents will all prosper as a result.

In presenting this proposal to the public, our leaders must stress that the time to make these changes is now -- at the peak of the energy boom/bust cycle. Economic development takes time, and only if we begin to diversify our tax base while our government is temporarily flush with cash will we be prepared against the next precipitous decline in energy prices.

The outcome, when all is said and done, will be well worth the effort. Not only will Wyoming be solvent and secure, but it will be able to claim bragging rights as the state best positioned to benefit from the Internet and the Digital Age.


A Closing Note from the Author

When I began to ponder the issue of tax options for Wyoming, I -- like many of my fellow Wyomingites -- was skeptical of the notion that any tax plan that included an income tax could be beneficial.  It was only when I learned more about taxes, did the math, and researched our possible courses of action that I found compelling evidence that this plan is demonstrably what we need. Yes, it's daring. Yes, it's controversial. However, if one really considers what would most benefit our state and every one of its citizens, it quickly becomes apparent that it's our best choice.

Wyoming cannot hope to take on future challenges -- from within or from without -- if powerful interests within the state are at odds with one another. The Wyoming Tax Swap will help to align these interests so that progress benefits everyone.

At the same time, the Wyoming Tax Swap will help us to benefit from, rather than becoming victims of, nationwide and worldwide trends. We in Wyoming -- being possessed of a fiercely independent spirit -- are sometimes loathe to admit it, but due to our small numbers our economic climate is strongly influenced by forces beyond our control. Our representation in Congress is limited, and we could never hope to derail or even slow down the runaway train that is the Internet. (Nor would we want to! The Internet, used properly, can provide great benefits to Wyoming and other rural states.) The Wyoming Tax Swap is, in this sense, a sort of "judo." While we cannot hope to oppose overwhelming external forces directly, we can -- being small and agile -- turn their momentum to our advantage.

While this paper sets forth all of the key elements of the Wyoming Tax Swap, it does not address every fine point of implementation. (For example, it is unclear whether it would be more beneficial for Wyoming to adopt a "3-factor" or "double-weighted sales" approach to corporate income apportionment, or whether it should adopt UDITPA -- the Uniform Division of Income for Tax Purposes Act.) I therefore welcome continued discussion of these issues, and am available via e-mail (and, with reasonable notice, in person) to talk about how we can best structure our tax policies to ensure Wyoming's future solvency, prosperity, and quality of life.

Brett Glass
Laramie, Wyoming



Footnotes

[Ge1] "Income, Revenue from Personal Taxes, and Public Service Costs in Wyoming," Gerking, Shelby [Unpublished report]
[Ge2] “State Fiscal Structure and Economic Development Policy,” Gerking, Shelby and W. Morgan, Growth and Change, 29:131-145, Spring 1998.



Additional References

Tax Reform 2000 Committee final report
Governor's Wyoming 2000 Budget Presentation
Wyoming State Constitution
Principles of a High Quality State Revenue System (WTA)
Analysis of the Internet Tax Freedom Act, passed by Congress in 1998