Legislative Testimony for LB433: Change the sales and use tax rate

Nebraska’s sales tax regime is in serious need of reform and broadening the sales tax base is considered by many to be the most critical issue facing Nebraska public finance. The sales tax structure violates fundamental principles of sound tax policy, the most notable being neutrality. Nebraska has an increasingly service dominated economy, yet most of the services remain untaxed. Failure to levy the sales tax broadly forces the rate to be higher than it would be otherwise. In addition, the state is deciding which industries and products should have a tax advantage, which creates government-engineered market distortions.

All personal consumption, including groceries, should be included in the sales tax base (prepared foods are already taxed). Many opponents will say this is regressive, however, research has shown that it is just the opposite. Federal law already exempts grocery purchases made using SNAP and WIC benefits from sales tax. Higher-income individuals tend to spend more on grocery purchases and are thus proportionally benefiting from the current exemption more than low-income taxpayers.

As part of the base expansion reform, the sales tax should never fall on business purchases. Taxing business inputs is among the most non-transparent ways to raise revenue because the tax is often passed on to customers in the form of higher prices. As a result, individuals are often paying the tax without knowing it. Taxing business inputs also leads to pyramiding where the tax is embedded multiple times into the final cost. Every public finance expert will confirm that a tax system including business inputs is unsound and has been proven to be a detriment to economic growth.

We believe the approach taken in Sen. Briese’s LB422 is an appropriate reform. Ideally, Nebraska’s sales tax base should include all personal consumption while excluding business purchases from the tax. But this committee will more than likely decide to draw the line somewhere short of that, so correcting the current imbalance between goods and services in the sales tax base is an excellent starting point.

Broadening the base has several advantages. The most notable are decreasing market distortions and raising substantially more revenue. A substantially broadened base would allow for reduced sales tax rates, in addition to other reform priorities. From rough estimated figures, we believe that the state sales tax rate can be reduced from 5.5% to 5%, while still having additional revenue to lower personal and corporate income tax rates and possibly also having enough revenue to reduce property taxes.

In addition, an expansion of the sales tax base will allow local governments to collect more revenue. We propose giving the counties a voter-approved local option sales tax. According to LB422’s fiscal note, a 1.5% local option would generate around $250 million by FY24-25. This should be enough to eliminate the economically harmful inheritance tax and tangible personal property tax while still allowing counties a reliable and sufficient revenue source in addition to real property tax.

Overall, any revenue neutral or revenue reducing tax reform package must include an expansion of the sales tax base. This technique is what has been the basis for many states’ reform packages, and it is also the key factor to making Nebraska’s tax modernization a success.