NASHVILLE — For the second straight year, Tennesseans have the unhappy distinction of paying the nation's highest average state and local sales tax rates, although Arkansans are giving them a hard run for the money this time.
According to mid-2019 estimates by the Tax Foundation, a Washington, D.C.-based think tank, the Volunteer State's combined sales tax rate was 9.469%. Arkansas came within a whisper at a combined 9.454% state and local sales tax rate.
Alabama held the No. 5 slot with a combined 9.16% rate, while Georgia's 7.33% combined rate made it No. 19.
From 2012 through 2015, Tennessee held the No. 1 ranking for highest average sales taxes until the state was unseated by Louisiana in 2016 and 2017.
Janelle Cammenga with the Tax Foundation's Center for State Tax Policy said the takeaway for Tennessee and other states is states "should be cautious about setting high rates — especially in comparison to their neighbors. Because if there's a large disparity in rates, people are going to be smart enough to shop where taxes are lower."
Still, Cammenga pointed out, it's important "to remember that Tennessee made the choice to forgo its income tax to give taxpayers relief on that front. And that's why the sales tax is carrying the extra weight. Which is not what Arkansas can say, because they still have an income tax."
Two governors here, Democrat Ned McWherter, and his successor, Republican Don Sundquist, broke their political teeth trying to push income taxes through the General Assembly, with McWherter failing in the early 1990s and Sundquist in the early 2000s. Voters settled the issue in 2014 when they approved a constitutional amendment taking a general income tax permanently off the table.
The Tax Foundation was founded in 1937 by a group of top national business leaders who agreed that a "new presence" was needed to "monitor the tax and spending policies of government agencies," according to a 1987 history on the nonprofit group's website.
But Tennessee state and local governments are heavily reliant on the sales tax. The levy was created in 1947 for education. It's now at 7%. But there are billions of dollars worth of exemptions. And the sales tax on groceries has been cut by lawmakers over recent years from 5.5 percent down to 4 percent.
FISCAL 2020 RECOMMENDED BUDGET
TOTAL STATE BUDGET
Source: State of Tennessee
Cities and counties can levy sales taxes of up to 2.75%. The city of Chattanooga's sales tax rate is 2.25%, which along with the state's levy brings it up to 9.25%. The same goes for the unincorporated areas of Hamilton County.
In the state's new Fiscal Year 2019-2020 budget that went into effect July 1, the state sales tax accounts for around $8.3 billion of the total estimated $38.55 billion Fiscal Year 2020 spending plan.
The state's total share of that is about $18.64 billion, while the federal government accounts for $13.94 billion. Nearly $6 billion comes from a category called "other," which includes bonds, higher education tuition and several other areas.
State Revenue Commissioner David Gerregano said in a statement that "in terms of the state's overall tax structure, Tennessee's sales and use tax serves as the primary source of state funding," noting it amounts to "roughly 60% of all taxes collected."
He did not address questions about the state's combined average rates being the highest in the U.S.
Multiple efforts last week to obtain Republican Gov. Bill Lee's views were unsuccessful. The governor was in Salt Lake City for most of the week, attending the Southern Governors Association's summer meeting.
Lee's budget says 55% of the taxes and fees in the total state portion of the budget, which includes gas and diesel taxes, come from the sales tax.
Sales taxes account for an even higher percentage — 60% — when looking at the state portion of revenues for Tennessee's general fund, according to the document. It pays for most functions of state government such as K-12 and higher education, TennCare, prisons and children's services.
'The Terrible 10'
While the sales tax is the workhorse of Tennessee's budget, it's also seen by critics as a "regressive tax" in that it takes a larger percentage of income from the pockets of lower-income and, some say, middle-income earners than those with higher incomes.
Heavy reliance on the sales tax has thrust Tennessee into the No. 6 slot in another Washington, D.C.-based think tank's rankings, the "Terrible 10" list, compiled by the Institute on Taxation and Economic Policy.
Noting that "you have to fund government somehow," ITEP Research Director Carl Davis said the fairest way is a "three-legged stool," which in addition to the sales tax and similar excise taxes includes income taxes and property taxes as the two other legs.
Most states rely on a variety of taxes and fees to get their revenue.
"It's pretty well established that sales taxes fall more heavily on the poor and middle class," Davis said. Most states, Davis said, also have a personal income tax "to balance it out" when it comes to wealthier residents.
While Tennessee has no general personal income tax, it does have the Hall Tax, a limited income tax imposed on individuals who receive interest from bonds and notes, as well as dividends from stock.
The state is phasing out the tax.
Davis noted that Arkansas, which has a personal income tax, didn't make the group's "Terrible 10" list.
Watson: Tennessee system works well
"Since we don't have an income tax, we rely on a consumption tax [sales tax] as a primary source of revenue," Senate Finance Committee Chairman Bo Watson, R-Hixson said.
The state's sales tax and the corporate franchise and excise taxes represent the state's "two largest revenue streams," he added.
He noted the state is in the process of eliminating the limited Hall Tax and emphasized voters' 2014 two-to-one approval on any general personal income tax.
"Obviously, a consumption tax is the choice Tennesseans have made to fund their tax base."
And Republicans, the chairman said, have sought to "address the regressive nature" of the sales tax through cuts over time to the tax on groceries.
"I assume every tax, unless a graduated income tax, is regressive to some" extent, he said.
Revenue Commissioner Gerregano did not address the issue.
The Tax Foundation's sales tax data only looks at states' top rates. They don't take into account factors such as Tennessee's sales tax on groceries having been cut to 4 percent. Doing so would make trying to make any sort of comparison confusing, Cammenga said.
ITEP's Davis said that in an economic downturn, sales taxes are "one of the first taxes to take a hit because as folks get laid off, hours cut back, they cut back on their expenses."
Watson pushed back, saying sales tax revenues are also quicker to recover from a recession. With lawmakers having socked away just over $1 billion into the state's Rainy Day emergency reserve fund, he said the state is well set to weather a mild to moderate recession.
Each quarter percent reduction in the state's tax on food purchased in grocery stores decreases state revenue by about $23 million to $25 million. So taking it down in stages from 5.5% to 4% has led to an annual revenue reduction now of about $150 million.
The state sales tax also doesn't include many services and other items. It amounts to several billion dollars. Female Democratic lawmakers have unsuccessfully tried to put the GOP majority on the defensive by trying to lift the sales tax on feminine hygiene products.
Watson, meanwhile, said that because of Tennessee's favorable tax treatment of businesses, major companies have flocked to the state, generating millions of new dollars for state coffers.
Haslam's gas tax
When then-Gov. Bill Haslam in 2017 sought to boost gas and diesel taxes for the first time in decades, he ran into a major problem from Republican lawmakers. They said they would agree to the increase only if the governor was willing to cut other taxes by an amount larger than the increase on motorists.
He did and the list included the 1-cent cut in the sales tax on groceries, a change in corporate tax formulas for manufacturers, the decision to phase out the Hall Income Tax entirely in Fiscal Year 2022 and other measures.
Add them all up and the $410 million in cuts outweighed the fuel tax increases.
Former House Minority Leader Craig Fitzhugh, D-Ripley, who once headed the lower chamber's finance committee when Democrats held power, said Tennessee having the highest combined average state and local sales tax rate "is a problem. I mean, you don't ever want to be in taxing situations with one extreme or another."
The high sales tax hits poorer Tennesseans harder as well as those on fixed incomes, Fitzhugh said. And while local governments in theory can raise their rates to 2.75 percent, many can't, he said. Small counties and towns are struggling, he said.
While taxes here are generally low, Fitzhugh said it impacts Tennesseans in areas ranging from the quality of public education to providing health care.
Another tax ranking
Working with Tax Foundation data, 24/7 Wall St. in 2017 found taxes paid by Tennesseans as a percentage of income was 7.3%. It was the 47th lowest in the nation.
Income per capita was $45,517, the nation's 18th lowest. Income tax collections per capita was $49, the eighth lowest. Tennessee local governments do have property taxes. The 24/7 Wall St. examination found per capita property taxes here were $863, the nation's seventh lowest. General sales tax collections per capita? They were pegged at $1,054, the 13th highest in the country.
While Tennessee has the highest combined state and local average sales taxes nationally, Davis with ITEP thinks the measurement is missing something.
He believes Hawaii may actually be No. 1 despite having about a 4% levy because the state has few sales tax exemptions.
Or as Kiplinger Personal Finance Magazine put it in a dire 2018 warning to readers:
"Don't be fooled by Hawaii's 4.35% average sales tax rate. Since it's due on virtually all transactions, the pocketbook effect is severe."
Contact Andy Sher at email@example.com or 615-255-0550. Follow him on Twitter @AndySher1.