The well-respected Public Affairs Research Council of Alabama (PARCA), headquartered at Samford University in Birmingham, has issued its 25th anniversary report, How Alabama’s Taxes Compare, which discusses the sources and uses of taxes in Alabama. The somewhat controversial report reveals that the state collects fewer taxes per resident than any other state, which state economic developers view as a positive. It also shows that Alabama has the lowest per capita tax collections of any state.

In addition to the low per capita tax collections, the report highlights the unusual composition of tax revenue collected (outlined below), noting that Alabama’s budgeting process is especially daunting because of the state’s constitutional earmarking of almost 90% of its tax revenues. Tom Spencer, senior research associate at PARCA, summarizes the current regime, stating that “Alabama’s tax system is, to a large extent, frozen because of the scarcity of resources and because of earmarking.”

Alabama’s Per Capita Tax Collections are the Lowest in the United States

When the report was first issued in 1988, Alabama ranked 48th in taxes collected per resident. The state quickly moved into last (or first) place, depending on one’s perspective, and has held that spot ever since. According to PARCA, two primary factors — politics and economics — contribute to the state’s low tax collections.

Alabama has relatively low tax rates. Even during the more than 100 years of Democratic control of the state legislature, legislators were skeptical of raising taxes and risking the wrath of the electorate. That reign ended in 2010. However, despite the political popularity of “no new taxes” pledges in Alabama, the state isn’t at the bottom of the list when it comes to taxes as a percent of gross state product. While Alabama is still below average in the southeastern United States in that regard, it is actually fairly close to the middle of the pack regionally.

State’s Tax Revenues Have an Unusual Composition

According to the report and its predecessors, Alabama levies its taxes in a way that puts the burden more squarely on certain groups of people. The report concludes that Alabama has the lowest state and local property taxes per capita in the nation. Those low rates combine with extensive exemptions for homestead property and low assessment rates for farm and timberland property. Although property taxes generally tend to be progressive in nature, the report highlights the overall regressive nature of Alabama’s property tax regime.

PARCA Executive Director Jim Williams points out that Alabama’s income tax is essentially a flat tax and starts at one of the lowest income levels of any state in the country. That means low-income individuals and families start paying income taxes sooner than their counterparts in most other states. Additionally, Alabama is one of only three states that allow individuals to deduct on their state income tax return the full amount of federal income tax they paid during the year. Because the federal income tax tends to be more progressive than Alabama’s income tax, the benefit of the deduction is, by its nature, weighted toward upper-income individuals in the state. Thus, Alabama’s income tax, like its property tax, tends to be regressive.

Alabama’s sales tax collections rank 25th nationally, with rates that are among the highest in the nation. Despite that fact, the report finds that Alabama taxes a relatively narrow base, meaning that it excludes many services that are taxed by most states. Readers may recall the failed effort in 2003 to enact by referendum a package of tax reform bills — often referred to as “Amendment One” — that would have added a relatively narrow list of services to the sales tax.

Spencer sums it up, concluding that “high-income earners also benefit from features of the state income tax system like the full deductibility of federal income taxes. Meanwhile, poor households start paying income taxes at a lower threshold than anywhere else in the country. Those households also tend to feel the full brunt of high sales tax rates on the sale of goods, groceries and medication.”

Alabama’s Constitutionally Mandated Revenue Allocations Create Inefficiency

No other state constitutionally allocates, or “earmarks,” as much of its tax revenue as Alabama. The report finds that nearly 90% of state tax revenues are preassigned to a specific agency or to be spent on a particular program or purpose. In theory, that type of system should limit the discretion of legislators to send funds to pet projects or boondoggles. However, in practice, PARCA believes that it hampers government efficiency because state and local governments aren’t as free to spend the money in the areas in which it is most needed.

Low Revenues and Limited Flexibility are Tough on Good Government

Finally, the report highlights the impact that low tax revenues and strict allocation, which the report labels a “straitjacket,” have on good government and efficiency in Alabama. Specifically, it makes the case that state and local governments in Alabama don’t have sufficient resources. According to Spencer, the result is that “lawmakers don’t have a lot of flexibility with the resources they do have.”

Because of Alabama’s low tax revenue per capita, its state and local governments must be highly efficient and effective in order to maintain or exceed the level of government services that peer state and local governments deliver. Alabama often is faced with low revenue that is allocated away from its most pressing needs. Additionally, because the money comes in regardless of performance, Spencer notes that “agencies receiving earmarked funds don’t face much pressure to innovate. On the other hand, there isn’t extra money to reward good performance.”

To view a copy of the report, visit PARCA’s website at http://parca.samford.edu/parca2/newsletters/Fall2013.pdf.

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