2006 tax swap dug state into $866 million hole
Source: Greenville Online
March 2, 2015
COLUMBIA – Lawmakers crafted a plan in 2006 that slashed property taxes by roughly half for the owners of owner-occupied homes across the state.
Those homeowners would see the line for school operating funds vanish from their tax bills. School districts would get that money, instead, from Columbia by way of a new penny sales tax.
In the eight years since implementation of Act 388, the penny sales tax has never generated the amount of money needed to reimburse school districts for the lost tax revenue, according to revenue figures obtained by The Greenville News.
Not even close.
Instead, with little notice or debate, lawmakers have covered the $866 million shortfall with money principally from the General Fund that could have paid for road improvements, health care and other education needs.
Sen. Joel Lourie, a Columbia Democrat, said his vote for the bill remains one of his biggest regrets.
"I don't know of any vote I regret more than that for Act 388," he said. "I recognize it's done far more damage than good."
Lourie said the plan didn't offer comprehensive tax reform and missed an opportunity to address funding inequities for poor, rural school districts. "I think it was very short-sighted," he said. "It wasn't a well-thought-out plan."
Lawmakers interviewed by The News blamed what happened on a combination of factors that included the Great Recession, overly optimistic revenue projections and reliance on a revenue source that is not as stable as the one it replaced.
"We walked right into a perfect storm when we did that," said Sen. Larry Martin, a Pickens Republican and chairman of the Senate Judiciary Committee. "It was one of the worst possible times we could have done this, but we didn't know it at the time."
House Majority Leader Bruce Bannister of Greenville said lawmakers recognized there could be problems that might lead to needed adjustments.
"One of the things I've learned since then is that when you have a complicated bill that is very controversial and creates lots of ripple effects, you can't tweak it the next year or the year after that to work out those kinks," he said.
Former Rep. Ted Pitts, who was a co-sponsor of Act 388 and went on to serve on Gov. Nikki Haley's staff before becoming CEO and president of the SC Chamber of Commerce, said he has been surprised at the shortfalls.
"I don't think anybody foresaw the shortfalls that have occurred," Pitts said, adding that members of the General Assembly rely on statistical analysis done by professional staff.
"We usually expect those folks that run the numbers to be conservative," he said. "So when you have shortfalls, that is a concern and was never projected. You would never set up a system with projected shortfalls."
Many moving parts
Homeowners who lived in houses valued at more than $100,000 saw the line for school operating funds vanish from their tax bills. Owners of owner-occupied homes valued less than $100,000 already were exempt from the school operating portion of property taxes and got no benefit.
To pay for the tax break, the Legislature increased the state general sales tax by a penny. Because sales taxes have a proportionately larger impact on lower-income households that largely wouldn't benefit from the property tax break, lawmakers lowered the sales tax on food to 3 percent and abolished it altogether the following year.
Another part of Act 388 sought to constrain local governments from raising taxes by capping millage increases to inflation plus population growth and by limiting the impact of property reassessments to no more than 15 percent every five years.
The Legislature guaranteed to replace every penny of the property tax revenue lost by school districts and increase that amount each year to account for inflation and population growth. Counties were guaranteed to get a minimum of $2.5 million from the state.
All of that was predicated on projections at the time showing the new penny sales tax would generate the needed revenue each year, beginning with $582 million in fiscal year 2007-08.
But that didn't happen.
According to figures by the state Revenue Fiscal Affairs office, sales tax revenue generated $32 million less than projected the first year and the shortfalls only got worse as the recession wore on. Revenue has grown each year since 2010-11, but not enough to meet the growing cost of the program.
The shortfall between revenue generated by the penny sales tax and the amount spent on schools peaked at $116.9 million in 2012-13. The shortfall is projected to narrow slightly to $107 million for the fiscal year starting in July.
The original fiscal impact statement projected schools would be paid $526.6 million in 2007-08. Instead, the state needed $569.2 million to make good on the guarantee. Fiscal year 2015-16 projections estimate the payout to school districts will top $724 million.
Frank Rainwater, executive director of the RFA, said the formula accounting for inflation plus population growth is responsible for much of the expenditure increases.
Rainwater points to the recession that hit right as Act 388 rolled out.
"The legislation — and fiscal impact (projection) — was finalized in June 2006. The revenue and expenditures did not start until a year later in July 2007," Rainwater said. "Sales tax revenue did not experience a downturn until October or November 2007."
By way of comparison, Rainwater said the General Fund sales tax revenue fell about 17 percent during the recession.
Some lawmakers said they were confident the sales tax revenue would cover the cost of paying the schools. Others said they had their doubts at the time but believed shortfalls would not be great.
Sen. Mike Fair, a Greenville Republican who serves on the Senate Finance Committee, said he was unaware shortfalls have been that large.
"Not a clue. It hasn't been discussed," he said, noting that the law "passed at a time when things looked really rosy."
Rep. Bill Sandifer, a Seneca Republican who chairs the House Labor, Commerce and Industry Committee, said he wondered at the time the law was passed how long it could sustain itself. He said he's bothered by the amount of the shortfall.
"When we originally passed 388, we fully believed that the funding would come from the penny sales tax. And that's how we all voted for it," he said. "But as a caveat, we put in (that) the school districts would be held harmless and that any shortfall would be made up of general revenue funds. It hasn't worked."
To that point, Rep. Gary Simrill, a Rock Hill Republican, is quick to point out that the Legislature has kept its promise to school districts — something he thinks should be noted by local government officials opposing Simrill's push to accept local roads from the state inventory with the promise of more state money.
Don Weaver, president of the South Carolina Association of Taxpayers, said his organization has supported Act 388 because it gave relief to property owners facing rising property taxes they could not afford, especially the elderly.
"Our group thinks Act 388 is extremely important to protect especially (for) elderly homeowners who saw a tremendous rise in property taxes," he said. "So we remain steadfast in our support of Act 388."
Weaver's comments point to one reason lawmakers are hesitant to revamp or repeal the law. Some lawmakers say they are afraid of unintended consequences due to the law's many moving parts.
Repealing the law, they say, would hike property taxes substantially — something no lawmaker wants to do. But they also believe the law has myriad problems, not the least of which has been the drain on the General Fund.
Fair said he believes that while the law will not be reviewed this year, legislators should attempt to revise it next year so as to make it more flexible to fluctuations in sales tax revenues that rise and fall with the economy.
Sandifer believes the Legislature needs to revisit it. He said sales tax revenues have not rebounded as quickly as they dropped off. "I believe it's imperative, whether it's this year or when, that we re-think this whole thing and determine a different formula," he said.
Bannister said some House members are studying the law and possible changes that could be made.
"The constitutional amendments part of it are going to be very difficult to adjust," he said. "There are folks that are looking at the pieces of it that we can adjust and are trying to determine if that's the direction we want to go."
Senate Majority Leader Harvey Peeler said politically he does not think lawmakers can make any substantive change to the law. Instead, he said, lawmakers can try to hand groups left out of the law additional tax breaks.
Martin said he struggled with voting for Act 388 in 2006 because of questions he had about the sales tax covering the costs to the schools.
"I certainly don't advocate going back in and trying to unravel it. It would create a whole new set of problems that I don't think we could work our way out of," Martin said.
"Whatever way we tweak it going forward we're going to have to be real careful that we don't exasperate the outcome and walk into another hornet's nest that we're not anticipating."