Michael Ferguson: Software tax exemption continues state's 'death spiral'


May 31, 2014 

In a recent Statesman article about the lowballed fiscal impact for Idaho's new software sales tax exemption, lobbyist Jay Larsen describes me as "holding on to old paradigms."

An interesting choice of words.

Would that be the old paradigm that says when you exempt virtually all of a major category of retail transaction - downloaded application software - you will lose a substantial amount of revenue? Application software sales are about 1 percent of GDP. They have been expressly taxed in Idaho, without regard to how they are delivered, for almost 30 years.

Or would it be the old paradigm that says when you depend on public investments in human capital (to populate the well-educated workforce your technology companies need), you should help pay for that investment?

Apparently Mr. Larsen's "new" paradigm goes something like this: "We really need a well-educated workforce, but we'd rather someone else pay for it." Because that's essentially what his new exemption implies.

Seriously, how is exempting sales tax on downloaded iPhone apps, Office applications, Photoshop, TurboTax (and the list goes on) supposed to attract or retain technology businesses? This year's first version of Mr. Larsen's exemption even exempted downloaded books, music and games - and claimed an even smaller fiscal impact. Was that really his intent, or just sloppy drafting?

The list of enterprise applications (SAP, Oracle, PeopleSoft, etc.) that are found throughout the business world is extensive, and they can be quite expensive. And now, thanks to Mr. Larsen, they will be completely tax-free.

That's a lot of currently taxable transactions that become exempt. That's the $40 million loss the Tax Commission presented. That's eight times the impact Mr. Larsen acknowledges.

Idaho is already near the bottom in tax effort compared to other states. With "innovative" legislation like Mr. Larsen's, we are pretty much guaranteed to stay there.

And that means we will continue to have major problems funding essential public services, including education.

Holes like the one Mr. Larsen punched in the sales tax reduce the amount of revenue for any particular size of the economy. All existing software sales (i.e., that were not induced by this new exemption) will be a pure loss of revenue.

Mr. Larsen suggests his sales tax exemption will attract more business to Idaho, thereby offsetting the large direct revenue loss. A claim we hear often, based on faulty logic.

First, it will take an enormous amount of economic expansion just to restore revenue losses from existing software sales that become exempt.

And we're talking about economic expansion induced by the exemption, not expansion that would occur anyway. By my reckoning, induced expansion would need to be in the neighborhood of $800 million of increased output.

Second, that expansion will place additional demands on public services without additional resources to fund them (see first point). Put simply, a larger economy places larger demands on public services such as education and public safety.

And finally, where does Mr. Larsen think the workforce will come from to staff these new technology firms? Idaho already comes up short finding the money to fund public and higher education. His exemption will just make it harder.

Mr. Larsen's own board member, Bob Lokken, probably put it best when he declared Idaho is in a "death spiral."

Here's how that works: Cut taxes (and therefore essential public services like education - they're just two sides of the same coin), lose good-paying jobs (but gain low-paying jobs in their place), lose more revenue, repeat.

The reality is we'll never know if any economic growth Idaho may experience in the future is because of this new exemption. But we can be sure that whatever the future size of Idaho's economy, it will produce less revenue courtesy of Mr. Larsen's exemption - much less.

Ferguson is the director of Idaho Center for Fiscal Policy.

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