Playing Tax Shell Games

By John S. DeMott

While Washington cuts rates, many states and localities are raising them

Most wage-earning Americans will see increases in their take-home pay after next week, when the second round of the Reagan Administration personal income tax reductions goes into effect. The cut trims the federal withholding bite by another 10% on top of the 5% reduction of last October, pumping an additional $39 billion into the depressed economy. To millions of Americans, though, actual buying power after July 1 may turn out to be only microscopically greater than before.

That is because many states and cities have been partially offsetting the federal cut by raising a broad range of other taxes. They are doing this to make up for revenue lost to the recession and reduced handouts from Washington. Says Stephen Meyer, an economist with the Federal Reserve Bank of Philadelphia: "It looks like rising state and other taxes will virtually undo the federal tax benefit." Adds Robert Rossana, an economics professor at Pennsylvania State University: "The net benefit of the federal tax cut will be very small for the large majority of U.S. taxpayers. It would take only a little bit of action by state and local bodies to wipe it out."

The Tax Foundation, a Washington-based organization that monitors tax trends, estimates that tax increases of all sorts enacted by state governments last year equal $4 billion, and so far this year taxes have gone up by another $3 billion. Since December of last year, 20 states have raised one sort of tax or another. Six states have boosted individual income taxes. In January, the Joint Economic Committee of Congress put out a report showing that 40% of large U.S. cities surveyed were raising taxes to increase revenues by some $500 million.

While those increases on the whole are nowhere near enough to offset the federal cut, there is sufficient nibbling and chipping at the state and local levels to mitigate the hoped-for economic stimulus from the tax cut. This is especially true in the industrial states of the Midwest, where local governments are particularly hard pressed for revenue. Their once sturdy tax bases, proudly rooted in steel, autos, coal and muscle, have been eroded by the migration of people and companies to the Sunbelt, and by competition from more cost-efficient manufacturing operations in Japan and Europe. Most of them are simply running out of new sources of revenue and have to keep putting higher and higher taxes on the people and companies that remain.

Michigan, for example, has been particularly hard hit by the recession. Unemployment in the depressed auto industry has pushed the state's joblessness up to 14.3%, the highest in the U.S., and profits from the car industry are naturally way down. The effect is at once higher social-welfare spending and smaller tax revenues. Harried state-government officials in Lansing are faced with the worst revenue crunch since the Great Depression.

Now, just as Washington is taking a little less from taxpayers, the state of Michigan and the city of Detroit are collecting more. Detroit's resident income tax has gone from 1.5% to 2%. On July 1 a "temporary" increase in state income taxes will push the rate from 4.6% to 5.6%. Local residents are fearful that the tax hike, which is due to expire at the end of September, will soon become permanent. Cigarette taxes have increased 10-c- a pack, to 21-c-, the highest in the U.S. All of those tax hikes mean that an unmarried taxpayer with a 1 1/2-pack-a-day cigarette habit, who lives in Detroit and earns $38,500 a year, will wind up with $1.08 a week more to spend after the July 1 federal tax cut. That might be a good reason to quit smoking, but it is hardly enough to get Michigan's or America's economy moving again.

Conditions are much the same in Ohio. Says Matthew Filipic, assistant director of the state's office of budget and management: "Ohioans will lose half the benefit of their federal tax cut through an increase in state income taxes." Wisconsin, facing a $450 million budget deficit, has hiked its sales tax and extended it to new areas such as landscaping, lawn maintenance and interstate telephone calls. Minnesota now taxes sales on soft drinks and candy, and has instituted a 7% income tax surcharge for 1982. Indiana raised corporate income taxes 1% to help cover a loss of $25 million that resulted from federal budget cuts.

Other regions are also beset. In Vermont, lawmakers increased the state income tax from 23% of a. taxpayer's federal tax bill to 24%, increased the sales tax from 3% to 4%, and clamped an additional 14-c--per-gal. tax on diesel fuel. Florida has hiked the state sales tax from 4% to 5%, a measure that state officials hope will raise $600 million in revenues. New Jersey Governor Thomas Kean campaigned last year on a Reagan-like tax-cut platform, but this year he is proposing to increase cigarette taxes from 19-c- to 24-c- per pack and gasoline taxes from 8-c- to 13-c- per gal. Colorado has found the most unusual new tax. It will put a levy on the carbon dioxide gas produced from its wells.

Some state officials are trying to hold the line on new local taxes. In Connecticut, which could lose $166 million because of federal funding cuts, a law was passed in November barring any increase in state taxes because of Washington's action. Nonetheless, the legislature accelerated corporate tax payments and passed a new commuter tax applicable only to New York State residents who work in southern Connecticut. Last week, though, Governor William O'Neill vetoed the commuter tax.

Pennsylvania, too, has held firm. Republican Governor Dick Thornburgh forged ahead and cut the state's budget across the board by 1% last year to" help make up for a $267 million revenue short fall, and has chopped 5,000 workers from the state payroll. But some of Pennsylvania's cities have been forced to raise their taxes. Philadelphia increased the mercan tile tax on city shopkeepers by 20% in an effort to make up for a $21 million cut back in funds it no longer receives from Harrisburg.

Through its own special brand of metropolitan metaphysics, New York City has calculated that about one-third of its revenue gap of $800 million is due to reduced federal largesse. To compensate for that, the city will impose several new taxes, among them a two-year 10% in come tax surcharge on incomes above $20,000. In addition, Mayor Ed Koch has ordered a freeze on all new city hiring. This will result in the elimination of 7,700 jobs.

Reagan Administration economists profess to be unconcerned that new revenue-raising measures on the local and state levels could offset the effects of the federal cut. Says an official of the Office of Management and Budget: "The state increases are a few minuscule billions. The federal cut is $400 billion over three years. The two numbers just aren't in the same league."

Moreover, shifting both the tax bur den and public services away from Washington and toward state and local authorities has always been one of Reagan's long-term political goals. Says Manuel Johnson, acting Assistant Treasury Secretary for Economic Policy: "The state in creases are in line with the President's new federalism. One of the purposes of lowering federal taxes was to give states more taxing room."

Reagan Administration officials continue to hope that American consumers will spend a large part of the money from the federal tax cut. Increased consumer spending is now seen as the best hope for pulling the economy out of recession. There were some signs last week that this might be happening. The Commerce Department reported that May retail sales were up a modestly healthy 1.5%. It will take several more months like that, though, before the recession ends, and the state and local tax increases may be slowing down the spending even before it starts. it Starts. -- John S. DeMott.

Reported by Patricia Delaney/Chicago and Paul A. Witteman/Detroit

With reporting by Patricia Delaney/Chicago, Paul A. Witteman/Detroit

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