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Gov. Phil Bredesen’s ability to balance his proposed $25 billion budget this year hinges on the state’s ability to prevail in federal court in its attempt to dismantle TennCare, the state’s beleaguered managed health care program for 1.3 million poor, disabled and uninsurable Tennesseans. Should the courts block Bredesen’s reform effort, the state faces a $575 million budget swing into the red.

Legislative approval of that proposed $25 billion budget would represent a 30% increase in state spending since adoption of the 2001-2002 state budget. Growth in state tax revenue, modest in recent years and projected at less than 4% in the coming year, won’t keep pace with that kind of government spending over the long haul.

Whether TennCare survives Bredesen’s ax, or the Tennessee General Assembly’s chronic lack of fiscal restraint finally breaks the bank, it’s just a matter of time before the state faces another fiscal crisis. And when that crisis arrives, two options will predictably dominate the political discussion—cutting state services or implementing a state income tax. It’s an all-or-nothing approach well framed by income tax supporters, now armed with fresh ammunition given the recent “independent” tax study commission report endorsing such a tax.

Once at the fiscal brink, though, lawmakers owe it to the citizenry to consider all options, including those de-emphasized in the report. There is a “third way,” though lawmakers bristle at the thought of it. Namely, taking action to increase the yield on existing revenue sources.

Tennessee law is chock full of self-interest-driven sales tax exemptions for which there is, at best, questionable justification. Admittedly, the state can’t balance its books by closing individual exemptions on goods like colostomy bags, taxidermy or bull sperm (yes, it’s in the code). Cumulatively speaking, however, the cornucopia of exemptions in Tennessee code will account for $5.7 billion in foregone state revenue on goods and services (not including another $1.7 billion in local tax revenue), according to 2005-2006 state budget estimates. That’s equal to half of the total state budget paid for with state taxpayer dollars.

A 1999 law required lawmakers to examine all sales tax exemptions, then reevaluate them every four years after they hit the books. Its intent was to keep lawmakers ever questioning if exemptions considered justifiable last year, or decades ago, remain justifiable today. Given Tennessee’s heavy dependence on the sales tax (40% of which is paid by businesses), and the state’s ongoing financial flux, it stands to reason lawmakers would be placing a heavy emphasis on that effort. To the contrary, lawmakers have snubbed their collective noses at the law. No hearings have been held. Special interests have not been called before a committee to defend exemptions. The failure of the current legislature to fulfill this statutory requirement is an obvious disservice to Tennesseans, particularly when talk of new state taxes is ever present on the horizon.

House Speaker Jimmy Naifeh, an outspoken proponent of the income tax, recently provided insight into why lawmakers would shun inspection of existing exemptions even though they know the questionable economic benefit of many of them. Asked in a February interview on WTVF-Nashville’s Inside this Week program if closing sales tax exemptions on items like farm equipment was a option for solving the state’s next fiscal crisis in lieu of an income tax, Naifeh replied, “It’s a possibility. But it won’t pass. I can’t vote to put the tax back on farm equipment. Every exemption in there was someone’s at that particular time, and it will continue to be.”

Naifeh’s frank admission makes clear that special interests run the state legislature. In that respect, all sales tax exemptions are equally egregious in that all reflect the same problem—the inordinate influence of lobbyists on Capitol Hill. (Terminating these exemptions would reduce lobbying at the Capitol by an order of magnitude, to say the least.)

Even if the political difficulties associated with paring back exemptions seem daunting, it’s useful to begin examining revenue opportunities before the next fiscal crisis emerges. Once the state again finds itself in the fiscal ditch, panic and emotions make thoughtful analysis rare. (And given current levels of state spending, another round of budgetary red ink is destined to flow.) Lobbyist influence is at its maximum when panic is afoot. So, whether or not an income tax is embraced or if exemptions are closed, this is a discussion best to begin now.

In that spirit, what follows is a glance at a handful of state sales tax exemptions that illuminate what’s at issue. They are not the biggest exemptions in the code. The elimination of any one of them wouldn’t insulate the state from future financial calamity. It would, however, constitute a significant victory against the powerful lobbies on Capitol Hill. And it might set the stage for a fresh look at larger exemptions on the books.

Freedom of the Press
Opponents of a proposed income tax often seethe when Tennessee newspapers editorialize in favor of an income tax. That’s because the sale of newspapers in Tennessee is exempt from sales tax. Imagine, opponents argue, how many people could be kept on TennCare’s rolls if the state collected five cents on the sale of every daily newspaper. The policy argument against a tax holds that taxation restricts freedom of the press. Essentially, the power to tax is the power to destroy, and the state shouldn’t be able to tax to silence commentary from the press. Though no constitutional argument supports that viewpoint, lawmakers are clearly averse to antagonizing those who buy ink by the barrel. Yet, just cross State Street in Bristol, Tenn., into Bristol, Va., and citizens pay a three-cent sales tax on newspapers purchased over the counter, including Tennessee newspapers. The same is true in Kentucky, where citizens pay a six-cent sales tax. Foregone 2005 revenue: $14.6 million.

Back to Basic
Like the Internet that followed it, cable TV fell through the cracks of state revenue collection. When cable television began, many folks in rural Tennessee needed it just to get reception of the few over-the-air broadcasts readily available in more urban areas with an antenna. In competition with free, as it were, lawmakers did not originally see a reason to tax cable. In the 1980s, through enactment of a broad-based amusement tax, the state began taxing premium channels, defined as enhanced entertainment options subscribers chose to buy. But in a testament to the effectiveness of the cable TV lobby—a consortium of “A” players on Capitol Hill—basic service remains tax-free even to this day. The policy question remains: Does basic cable fit either of the standard measures used to legitimize an exemption, as either a basic necessity of life or something that serves the state’s economy? Even under changes scheduled to take effect under the streamlined sales tax law, basic cable will remain exempted following its transfer to another section of code. Foregone 2005 revenue: $18.2 million.

Paper Clippings
With few exceptions, services are not taxed in Tennessee, or anywhere else. Were Tennessee to tax architectural services, for instance, all Tennessee architectural companies would promptly move to incorporate in Kentucky or Delaware or elsewhere, maintaining a nameplate in Tennessee but billing from a remote location. The mobility of services, then, makes taxing services difficult. Giving a haircut or styling hair is unquestionably a service rendered by a barber or beautician. The same is true of nail and skin care services. In the case of a service like a haircut, though, the question becomes, “Would a person go out of state to get one?” The answer, clearly, is no. Thus, even the most hawkish low-tax advocates concede hair cuts could and should be made taxable. Basic politics, perhaps, provides the unspoken logic behind the exemption’s origins. Particularly in small communities—where most legislators hail from—barbers see every member of the male species in their shops at least every three to four weeks. And if those barbers are bad-mouthing their elected lawmakers, that can’t be good for votes in the next election. Foregone 2005 revenue: $30.8 million.

How You Frame It
Prescription glasses and contacts are exempt. Frames, no matter how expensive, also are exempt as long as they’re purchased simultaneously with the lenses. The policy argument for the exemption is that anything a doctor prescribes is a medical necessity—needed to live life in a normal fashion. Similar exemptions include prescription medication and dental fillings and crowns. After all, should people be charged sales tax because doctors tell them they have to be on medication or wear a certain medical devices? Still, some view it as more cosmetic in nature (frames certainly are), or, at the least, an expense the citizenry should be expected to bear on its own. Of course, any argument in favor of the exemption as a basic necessity is moot in light of the fact that food, incontrovertibly a necessity, is taxed in Tennessee. Foregone 2005 revenue: $15.3 million.

Grabbing the Bull by the...
The artificial insemination of bulls was once an unusual procedure on Tennessee farms. Not anymore. When bull sperm and insemination service came under scrutiny as a taxable item, Tennessee’s cattle folk headed to Capitol Hill. In a sterling example of just how far a particular special interest will go to enhance the performance of a single business activity, livestock breeders descended on the Hill wearing buttons that read, “Don’t Tax the Climax.” The policy argument against taxing bull sperm, and the insemination service, is that should the state enact such a tax, Tennessee veterinarians would lose their ability to compete against traveling out-of-state vets or bull sperm banks erected just across the border in Kentucky. Indeed, like other services, the service of bull insemination doesn't lend itself well to taxation. Still, goods are goods, and even though the taxing of bull sperm wouldn't bring much money into state coffers, it's the principle of the thing that counts. Foregone 2005 revenue:Less than $100,000.

Streamlined Sales Tax Act

The Streamlined Sales Tax Act scheduled to take effect in Tennessee this July places Tennessee in a proposed multi-state pact to make sales tax rates uniform across jurisdictions. The national movement is intended to convince Congress that taxing Internet and catalog purchases would not burden industries exclusively reliant on those forms of commerce. But until Congress acts, if ever, some of the side effects of Streamlined will take a bite out of anticipated revenues for many cities and counties across the state.

Gov. Phil Bredesen appears inclined to freeze implementation of Streamlined until Congress acts. Should he take that action, many other elements of the proposed Streamlined law also would be suspended, including proposed changes to numerous existing sales tax exemptions in Tennessee.

Under Streamlined, a good must either be completely taxed or completely untaxed. So-called “threshold exemptions,” with few exceptions, would be eliminated. As a result, three of the most questionable sales tax exemptions on Tennessee’s books stand to be eliminated. They include the first $500 paid for a casket, burial vault or urn (one of a number of death care goods and services protected by a strong lobby), the first $150 of annual dues or fees paid for memberships to recreation clubs and the first 15% of the gross charge for the bathing of a pet.

The Next Batch

Each new session of the General Assembly is a time when lawmakers from both sides of the political aisle introduce pieces of legislation attempting to add to the list of goods and services exempt from sales tax in Tennessee. Though many are well-intentioned, they only increase the problem of foregone revenue under the state’s current tax structure.*

Below is a sampling of goods and services lawmakers would like to add this year to the exempted list and the amount of state revenues that would be lost.

Rep. Mike Turner (D-Old Hickory), Rep. Ben West (D-Hermitage) and Sen. Joe Haynes (D-Goodlettsville) to allow Ladies Hermitage Association to keep all sales tax applicable to admissions, food, drink, parking, goods and products sold at the Hermitage to be used exclusively to preserve and beautify the Hermitage. (no fiscal note)

Sen. Rosalind Kurita (D-Clarksville) to exempt gun safes ($157,000)

Sen. Jim Bryson (R-Franklin) to permit schools, churches and certain charitable organizations to raise funds six times annually through the sale of goods without paying sales tax ($1.9 million)

Sen. Steve Cohen (D-Memphis) to exempt residential utility bills when centrally metered ($2.3 million)

Rep. Gene Davidson (D-Adams) to exempt water when is used to aid the growth and development of seeds, seedlings or plants that will produce food or fiber (no fiscal note)

Sen. Jeff Miller (R-Cleveland) to exempt blood glucose monitors and test strips ($1 million)

Rep. Rob Briley (D-Nashville) and Sen. Steve Cohen (D-Memphis) to exempt hybrid electric vehicles and vehicles meeting California’s Air Resources Board standards (no fiscal note)

Sen. Rusty Crowe (R-Johnson City) and Rep. Matthew Hill (R-Jonesborough) to exempt bread and milk ($54.6 million)

Reps. Edith Langster (D-Nashville), Lois DeBerry (D-Memphis), Kathryn Bowers (D-Memphis), Ulysses Jones (D-Memphis), Joe Armstrong (D-Knoxville) and Larry Miller (D-Memphis) to reduce the state sales tax on food from 6% to 3% beginning in 2006 ($210 million)

Sen. Charlotte Burks (D-Monterey) to redefine the existing exemption for farm equipment and machinery to include flat bed trailers used for over-the-road transportation in the nursery or cattle business (no fiscal note)

In addition, Gov. Phil Bredesen has a stated goal of initiating a sales tax holiday in 2006 that would cost Tennessee an estimated $7 million to $12 million in revenue. Bredesen’s timetable would have the holiday fall in early August, just months before he stands for re-election.

*While it is highly unusual for a sales and use tax exemption to be repealed, it’s worth noting that at least one piece of legislation has been filed this year aimed at repealing a current exemption. Rep. Craig Fitzhugh (D-Ripley) and Sen. Roy Herron (D-Dresden) are sponsoring a bill to remove botox treatments for cosmetic reasons from the list of exempted medical procedures.

Reasonable Exemptions:

Contrasted with some of the more questionable sales tax exemptions in Tennessee code, there are a number that would seem to serve the societal greater good (or at least make logical sense).

•Services rendered
(or construction machinery transferred) between a parent corporation and its wholly owned subsidiaries

•Fabrication of computer software
for personal use

•Transfer of an automobile
between spouses following a divorce

•Human blood and plasma
handled by a 501C-3 organization

•Company expenditures
used to bring it into compliance with pollution control regulations

•Construction materials to build the Spallation Neutron source facility in Oak Ridge.
Passed in 2000, the tax relief bill freed the project of about $28 million in state sales tax. The break was one of many conditions set by the federal government to grant Tennessee approval for the $1.4 billion project.

•Aircraft and helicopter parts and repair bought or transported out of state.
This exemption was passed in response to concerns by Edwards & Associates, a Bristol-based company, which argued it was unable to stay competitive with similar companies nationally because of the sales tax burden on its goods and services.