The Friday Alaska Landmine column: It's all about the base

The first question anyone should ask when presented with a revenue proposal is, “What’s the size of the base?” We explain why.

For some, the 2014 pop song “All About That Bass” is a long-forgotten “one-hit wonder.” For others, it’s an earworm – a recurring tune that occasionally pops up and sticks in your mind involuntarily.

But for us, it’s a way of remembering a key component of revenue policy: that the impact of a revenue approach is largely determined by the size and nature of its “base.”

We wrote about that some in last week’s column, explaining why the size of its base is a key factor in the attractiveness of Representative Ben Carpenter’s (R – Nikiski) proposed HB 142. But almost before the ink was dry on the column, we started receiving questions and seeing comments that “It’s ok, but wouldn’t it be better if we excluded this or exempted that.” That led us to realize that the importance of the key component of HB 142 – its ultra-broad base – isn’t well understood.

Let’s start with the simple math underlying the point. The “base” of any revenue approach is the scope, in dollars, of what it applies to. It is the divisor in the formula that calculates the rate used to raise a desired level of revenue. For example, let’s say the goal is to raise $100. If the base is $1,000, the average rate required to raise the $100 is 10% ($100 divided by $1,000). To raise the $100, on average, ten percent of each dollar must be diverted to the goal.

On the other hand, if the base is $10,000, the average rate required to raise the $100 is only 1% ($100 divided by $10,000). To raise the $100, on average, only one percent of each dollar must be diverted to the goal.

In short, the broader the base, the bigger the divisor, and the smaller the average percent required from each dollar in the base. When some start advocating for other approaches that exclude this or exempt that, what they are actually proposing is to narrow the base. While that may benefit those excluded or exempted, that benefit comes at the expense of the remainder. In the $10,000 example above, for instance, if $2,500 of the base is removed through exclusions or exemptions, the average rate required from those remaining to raise the same $100 is 1.3% ($100 divided by $7,500).

Essentially, those remaining in the base pay 0.3% more, on average, to subsidize the “free ride” realized by those excluded or exempted.

What we find attractive about HB 142 is that it has no exclusions or exemptions. At its core, it applies to all of the private sector portion of Alaska Gross State Product, the total value of the final private sector goods and services produced in Alaska, including the substantial portions exported either internationally (roughly 10% according to the most recent figures from the Office of the U.S. Trade Representative) or to other parts of the US, which counting oil alone, is at least another 10%. 

No component is excluded or exempted. No sector is used to subsidize the others.

Because it has the broadest base, HB 142 also produces the lowest rate compared to the alternatives. To provide a comparison, here is our effort to line up head-to-head those alternatives that have been analyzed the most on an apples-to-apples basis.

At the left is the HB 142 sales tax proposed by Carpenter. The fiscal note accompanying it provides a year-to-year projection of the amounts it would raise in the first five years following passage. Then, it concludes that “[a]t full implementation, revenue is estimated to be about $1.5 billion annually.” Using the growth factor used to calculate the projections made for the first five years, that appears to assume “full implementation” is achieved ten years after adoption or FY35.

To create an apples-to-apples comparison, we have scaled up the tax base for each of the other alternatives over the same time period. The base for the “flat tax,” for example, is calculated from Alaska adjusted gross income as reported by the Internal Revenue Service (IRS) for calendar year 2021, adjusted to add non-resident income from Alaska sources, estimated to equal 10% of resident income, plus the portion of the Permanent Fund Dividend (PFD) cut for that year. As with the sales tax base underlying HB 142, that amount is then escalated at an annual growth rate of 3% to reach a projected FY35 base of $49.8 billion.

Using that approach narrows down the base just to household income. It excludes corporate and business income not captured by the personal income tax. While it includes income received by non-residents from Alaska sources, it excludes from tax a share of the value of goods and services purchased in Alaska by tourists and other non-residents. It also largely excludes from tax a share of the value of goods exported from Alaska internationally or to other states.

While the remaining base is substantial, it is still only two-thirds the size of the HB 142 base. As a consequence, a flat tax requires a tax rate that is 50% higher (3%) than that needed under HB 142 (2%) to raise the same amount of money. Those portions of the economy not captured by the flat tax escape scot-free from the effort to close the fiscal gap, subsidized by the extra burden pushed to those portions that are.

To estimate the impact of the “South Dakota” and “Wyoming”-style sales tax approaches previously analyzed in the August 2021 presentation by the Department of Revenue (DOR) to the Legislative Fiscal Policy Working Group, we have started with the tax base for each calculated from that presentation and then scaled both up to a projected FY35 base applying the same annual growth rate of 3% used in the HB 142 fiscal note.

In DOR’s 2021 presentation, the “South Dakota-style” tax is described as:

A tax levied at 4% of purchase price on the sales of goods and services to consumers and businesses, taxing a range of activities similar to that of the South Dakota Sales & Use Tax. This is a very broad-based tax that extends to a wide range of services and business inputs. There are few exemptions, which includes prescriptions and medical equipment.

While there may be “few” exemptions, the net effect is to reduce the projected FY35 base to a level significantly (39%) below the level projected for HB 142 and below even that for projected adjusted gross income. As a consequence, the “South Dakota-style” tax requires a rate that is 65% higher (3.3%) than that needed under HB 142 to raise the same amount of money. As with the “flat tax,” those portions of the economy not captured by the “South Dakota-style” tax receive a free ride from the effort to close the fiscal gap, subsidized by the extra burden pushed to those portions that are.

In DOR’s 2021 presentation, the Wyoming tax is described as:

A tax levied at 4% of purchase price on the sales of goods and services to consumers and businesses, taxing a range of activities similar to that of the Wyoming Sales & Use Tax. This is a broad-based tax that extends to many, but not all, services and business purchases. Exemptions include groceries, prescriptions, and medical equipment.

The net effect of the exemptions is to reduce the projected FY35 base to a level less than half the size of even the “South Dakota-style” approach and, as a consequence, even further (71%) below the level projected for HB 142. Because of that, the “Wyoming-style” tax requires a rate that is 3.5 times higher (7%) than that needed under HB 142 to raise the same amount of money. As with the other alternative approaches, those portions of the economy not captured by the “Wyoming-style” tax are shielded from the effort to close the fiscal gap, subsidized by the extra burden pushed to those portions that are.

We have estimated the size of the base of the “Broader Base Sales Tax” included in DOR’s May 29, 2020, “Review of Tax Options” using the data provided in that presentation and again, scaling that up to a projected FY35 base using the same annual growth rate of 3% used in the HB 142 fiscal note. Positioning the scope of the tax between the “South Dakota” and “Wyoming”- style approaches, in its 2020 presentation, DOR described the tax as:

A tax levied at 4% of purchase price on the sales of goods and services to consumers and businesses, taxing a broad range of activities. This is a very broad based tax that extends to a wide range of services and business inputs, including groceries and medical sales, but excluding all business-to-business sales and services.

As anticipated, the net effect of the exemptions is to reduce the projected FY35 base to a level falling between the “South Dakota” and “Wyoming” – style approaches, significantly (51%) below the level projected for HB 142. Consequently, the “Broader Base” approach requires a rate of a little over two times higher (4.1%) than that needed under HB 142 to raise the same amount of revenue. As with the other alternatives, those portions of the economy not captured by the “Broader Base” tax escape scot-free from the effort to close the fiscal gap, subsidized by the extra burden pushed to those portions that are.

We have estimated the size of the sales tax analyzed in the 2017 study for the then-legislature by the Institute on Taxation and Economic Policy (ITEP) using the data included in that study, and again, scaling that up to a projected FY35 base using the same annual growth rate of 3% used in the HB 142 fiscal note. The result falls between DOR’s “Broader Base” approach included in its 2020 presentation and the “Wyoming-style” approach analyzed in DOR’s 2021 analysis. In its presentation, ITEP described the tax as:

This tax would include exemptions for various necessities such as groceries, health care, prescription drugs, shelter, and child care.

The net effect of the exemptions is to reduce the projected FY35 base for the approach to a level 61% below the level projected for HB 142, requiring a rate that is a little over 2.5 times higher (5.1%) than that needed under HB 142 to raise the same amount of money. As with the others, those portions of the economy not captured by the sales tax analyzed by ITEP receive a free ride from the effort to close the fiscal gap, subsidized by the extra burden pushed to those portions that are.

Finally, we have estimated the size of the Permanent Fund Dividend base by using the projected FY35 amount (equal to 50% of the then-year percent of market value draw). The resulting base represents about 5% of total household income and is barely 3% the size of the HB 142 base. Because of the extremely narrow base, the effective tax rate to produce the same $1.5 billion in revenue (61%) is over 30 times higher than that needed under HB 142. 

As with the others, those portions of the economy not captured by the approach – in other words, the remaining 97% of Alaska GSP, including not only the remainder of household income but all of the income derived from international and interstate trade, sales to tourists and other non-residents, and other sources – escape scot-free from the effort to close the fiscal gap, subsidized by the nearly overwhelming extra burden pushed to the, relatively speaking, almost minuscule portion that is.

In short, while Meghan Trainor likely did not realize she was writing about revenue policy when she penned the chorus line of “It’s All About That Bass,” she was. As in the song, when it comes to revenue policy, it’s “all about that bas(e), ’bout that bas(e), no treble.”

For the reasons we have explained above, the first question anyone should ask when presented with a revenue proposal is, “What’s the size of the base?” The answer to that question alone will quickly tell you whether the approach is being narrowly targeted at a given segment of the state’s economy – so that the remainder can avoid any responsibility – or is broadly spread to limit the burden on any one group.