Facing a $1.1 Billion Budget Shortfall, Louisiana Needs Tax Reform and Fast

Experts warn the State isn't collecting enough revenue to support its budget.

They say the only certainties in life are death and taxes, but if you're a Louisiana crawfish farmer, it's only the former.

That's because in Louisiana — where aspects of the tax code have been called irrational, the worst in the country and unparalleled in its complexity — all purchases related to the production of crawfish and catfish have enjoyed exemption from state sales tax. So have groceries, seeds, pesticides and dozens of other items, from livestock auctions to naval vessel renovations.

Louisiana slashed many of its taxes in the years leading up to the global financial crisis amid soaring oil prices and an influx of federal funding after Hurricane Katrina. But as that money stops flowing, experts warn the state is no longer collecting enough revenue to support its budget, with a shortfall of $1.1 billion expected at the end of fiscal 2018.

"They really have this sort of anvil hanging over the state budget," said Jan Moller, director of the nonpartisan Louisiana Budget Project."If it drops, it would require the kind of devastating cuts to services that no Republican or Democrat wants to see."

Short-Term Solutions

The state has taken some steps to alleviate the budget problem. For example, Louisiana's legislature tackled a historic state budget shortfall earlier this year by temporarily raising the state sales tax by 1 percent and cutting the number of items exempt from the levy. Although some items are still exempt, other items were taken off the tax-free list, including Mardi Gras beads, in an effort to raise more money. The state's 192 sales tax exemptions cost the state $2.9 billion in fiscal 2015, according to data from the Department of Revenue.

The state's short-term sales tax changes expire in mid-2018. Advocates for tax reform are hopeful that the budget crisis could encourage legislators to make more meaningful and long-lasting changes to the tax code in 2017.

Louisiana has faced budget deficits every year for the past eight years that ranged from about $31 million in fiscal 2014 to $1 billion in fiscal 2016, according to data from the Division of Administration, which oversees the budget. But reform has proven difficult for states due to anti-tax sentiment, lack of political consensus and the attraction of sticking with the status quo.

Former Governors Kathleen Blanco and Bobby Jindal each repealed parts of the Stelly Plan, an increase to the income tax passed by voters in 2002. These changes marked the largest income tax cuts in Louisiana history, according to the Louisiana Budget Project.

The state also allows for the deduction of the federal income tax and provides a high exemption from the property tax, said Steven Sheffrin, an economics professor at Tulane University.

"Once you start down a path like this, you develop a tax structure and people get to rely on it and that’s what they're expecting," he said. "It's very, very hard to change these things."

Louisiana's tax system is made more complicated by the fact that its 64 parishes have the ability to collect and administer sales tax. Experts say that's burdensome on businesses because they have to follow differing rates and exemptions across parishes.

"You don't want to be known as a state known for a really cumbersome tax administration system," said Scott Drenkard, director of state projects for the Tax Foundation. "It fits in with biases that Louisiana is backwards. That's not helpful to the state."

Party Lines

Some states have had successes enacting tax reform in the last decade, including North Carolina, Kansas, Rhode Island, Michigan and Utah, according to a report by George Mason University's Mercatus Center. Tax reform was defined in that study as cutting the tax rate, broadening the base of items taxed and simplifying the code.

Joseph Crosby, a tax policy expert for lobbying group MultiState Associates, said Louisiana may have a hard time tackling tax reform because its House and Senate are led by Republicans; Governor John Bel Edwards is a Democrat.

"There's disagreement over what reform means. If you look at successful reforms, they have occurred in states that are dominated by one political party," he said.

To make matters worse, Louisiana has been hit by widespread flooding this summer, which will exacerbate the state's cash flow constraints, said Jay Dardenne, commissioner of the Division of Administration.

Oil Settlement

In fiscal 2019, the state could see some budgetary relief from the nearly $9 billion in settlement money from BP Plc and other groups for the 2010 Deepwater Horizon oil spill, but that comes too late to help with the projected 2018 shortfall.

"That cliff is going to hit us a year before we resume receiving payments from Deepwater Horizon," he said. "We're going to face that cliff before we have any relief from one-time money."

Legislators like Republican Julie Stokes are starting to lose hope that the hard work of tax reform will be taken on next year. "We've done so much damage at this point," Stokes said. "If we don’t do something, we're going to turn a fiscal crisis into an economic crisis."

This story original ran in Bloomberg Brief: Municipal Market.

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