Big tax cut likely this session, but details still in debate

Stu Whitney and Bart Pfankuch, South Dakota News Watch

            A bipartisan consensus has emerged in the South Dakota Legislature that the time is right for some form of tax relief to be passed as part of budget negotiations in Pierre.

            But questions about which tax is reduced, and who will benefit, are still in debate and will be resolved largely on political inclinations and differing perceptions of whether the recent surplus of state revenues is temporary or a trend of continuous growth.

            On a basic level, three possible tax reduction proposals are in play in the 2023 legislative session, though lawmakers have said it is likely only one is affordable at this time without cutting programs or adding other taxes or revenue streams:

            • A full or partial removal of the 4.5% state sales tax on groceries, which would collectively save shoppers up to $120 million a year.

            • A reduction in the overall state sales tax from 4.5% to 4%, which would save residents and visitors an estimated $150 million a year.

            • A reduction in property taxes on single-family homes that would save homeowners an estimated $85 million a year.

            Of course, each measure that provides a savings for taxpayers would result in a corresponding reduction in government revenues – and that is where lawmakers face difficult choices. The GOP-led Legislature must also consider how a tax cut would fit into Republican Gov. Kristi Noem’s campaign promise to eliminate the South Dakota food tax.

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            Weeks before being re-elected in November 2022, Noem made a public pledge to preside over “the largest tax cut in state history,” a full repeal of the 4.5% grocery tax. The fiscal impact of that move is not written in stone, with the governor’s team saying the repeal would save taxpayers $102 million annually and the Legislative Research Council – in a fiscal note attached to a proposed ballot amendment – estimating that the state would lose $124 million in annual revenue by cutting the food tax.

Noem touted South Dakota’s favorable economic outlook in announcing the plan, pointing to double-digit increases in sales tax revenue in 2021 and 2022, a budget surplus last year of $115 million and $423 million in reserves.

            Some legislative leaders are more cautious, however, due to concerns that the state fiscal prospects are temporarily boosted by pandemic-related federal stimulus and infrastructure funds and by sales tax receipts augmented by record inflation. Other than federal revenues, South Dakota state government and programs are funded primarily by sales taxes.

            “When it comes to cutting tens or hundreds of millions of dollars in ongoing revenue that our hospitals, nursing homes and schools and state employees depend on, we don’t make those decisions easily,” said House Majority Leader Will Mortenson, R-Pierre. “Fools rush in … so we’re going to be taking our time and scrutinizing these proposals on the policy merits.”

            The grocery tax, which repeal supporters say has a disproportionate impact on low-income families because food expenditures represent a higher percentage of their household budget, has been a target of legislative reform for decades, mostly by Democrats. South Dakota is one of only three states that tax groceries without offering targeted credits or rebates for low-income residents to compensate for the added cost, though some low-income residents do qualify for the federal food stamps program.

            House Bill 1075, the Noem-supported food tax elimination sponsored by Rep. Mary Fitzgerald, R-Spearfish, and Sen. John Wiik, R-Big Stone City, passed out of the House Taxation Committee Jan. 26 and was referred to House Appropriations for further study. Jim Terwilliger, commissioner of the South Dakota Bureau of Finance and Management, echoed Noem’s sentiments about conditions being favorable for a significant tax reduction. Municipal food tax rates would not be affected by the House measure.

            “This tax cut allows more money to stay in the pockets of taxpayers, plain and simple,” Terwilliger said during committee testimony. “It does so in a fair and transparent way, with every trip to the grocery for every family in South Dakota. Even with this cut, there is still $208 million in new ongoing revenue for investment in other areas. We have not abandoned our conservative approach to how we manage our state budget.”

            While legislators have not yet received state revenue estimates, Terwilliger said that collections over the first six months of the current fiscal year were $146 million higher than projected in the legislative budget, or 13% above the estimate. 

            “This tax cut is affordable for us,” he told the committee, adding that there is no need for other taxes or revenue replacement to offset the repeal.

            Nathan Sanderson, executive director of the South Dakota Retailers Association and a former policy director under former Gov. Dennis Daugaard, testified against HB 1075 and expanded upon his testimony in an interview with News Watch. He said it is critical to determine whether South Dakota’s recent windfall is a one-time source of revenue – boosted by federal stimulus and inflation-impacted tax receipts – or an ongoing source.

            “We tend to believe that these are largely one-time sources of revenue,” said Sanderson. “If you think that they’re one time in nature, then it doesn’t make sense to cut the sales tax or reduce sales tax on food, because the chickens will come home to roost, and you’ll end up seeing tax increases in the future. Our interest is in ensuring that any tax reductions that we offer are more one time in nature than ongoing, because the last thing we want is a structural deficit.”

Sanderson points out that national inflation averaged 8.0% in 2022, twice as high as any inflationary year in the past two decades other than 2021, which was 4.7%. Higher prices mean more sales tax revenues for the state. South Dakota also received $3.5 billion in federal funds in 2021 and $2.6 billion in 2022 after averaging $1.4 billion a year from 2014-2019.

            “What is abundantly clear is that we got a boatload of federal money over the last few years and we’re seeing extraordinarily high inflation,” Sanderson said. “You can’t just ignore that when you’re having this conversation.”

Family of four would save $600 a year with no food tax

            According to U.S. Department of Agriculture data, an average family of four in South Dakota spends roughly $1,100 a month on food purchased at a store and prepared at home. Eliminating the 4.5% tax on food would save that household $54 a month, or nearly $600 a year.

            Eric Figueroa, an analyst for the Center on Budget and Policy Priorities in Washington, said eliminating the grocery tax is a good way to advance racial and economic equity for low-income residents but that states should pursue full repeals of the tax with caution if they don’t have a plan to offset the revenue.

Figeroa noted that several states use refunded tax credits for low-income brackets in which consumers pay the full sales tax rate on food but recoup some of those added costs by claiming a credit when they file their taxes.

            “That’s sort of the safe route for a lot of states, to provide targeted relief without taking a huge hit to the general fund,” Figeroa told News Watch. “Tax credits are good, but there are barriers to filing for those refunds, and not every family sees the benefits, for all kinds of reasons. There’s more complexity to doing something proactively, checking the right box and knowing how to file properly, as opposed to taking a basket of goods to the cash register and getting the immediate benefit of a tax being removed.”

            Idaho Republican Gov. Brad Little pushed for a full food tax repeal in 2022 but couldn’t get it through the state Legislature. Lawmakers instead passed a $20 increase in the amount that Idaho residents can recover on taxes paid on food through the grocery sales tax credit, from $100 to $120 for people under 65 and from $120 to $140 for people 65 and older.

            Idaho’s sales tax rate is 6%, while South Dakota’s is 4.5%. South Dakota is also one of only eight states with no personal income tax. Sanderson said that’s an important distinction when considering long-term policy changes that impact budget revenues.

            “If you’re a state that has no sales tax on food but a 7% sales tax on everything else and an income tax, is that preferable to South Dakota’s approach? Maybe, maybe not,” he said. “Most South Dakotans don’t want an income tax, so if you take that off the table from a policy perspective, what is left? Sales tax. That’s why we’ve been supportive of a very low but broad-based sales tax for a long time; it’s not as volatile as other types of revenue. Our approach has been not to grant a whole bunch of exemption for the sales tax. It’s been to tax everyone relatively uniformly but keep that rate as low as possible. It’s simple for people to understand and has provided us with a reliable source of revenue for years and years.”

Failing to repeal food tax would be ‘failure’ for Noem

            The Cato Institute, a prominent Libertarian think tank, gave Noem a grade of ‘C’ in its Fiscal Policy Report Card for 2022, saying that the “middling grade” was based on “a lack of tax cuts during a period when many other states passed large tax cuts.”

            Neighboring Republican governors Kim Reynolds of Iowa and Pete Ricketts of Nebraska both received ‘A’ grades for their tax reduction policies, with Reynolds described as a “lean budgeter and dedicated tax reformer since entering office in 2017.”

            During his testimony for the food tax repeal, Terwilliger mentioned other states catching up to South Dakota in terms of livability by offering lower taxes. Noem’s status as a potential GOP presidential aspirant in 2024 made her “largest tax cut in state history” announcement at a Rapid City grocery store in September 2022 a potentially beneficial headline for political reasons as much as for policy purposes.

            The question is whether the political benefit is negated if the measure fails to pass. Though budget talks are still weeks away from resolution, Sen. Reynold Nesiba, D-Sioux Falls, said he has not seen much evidence of Noem actively trying to build support for the food tax repeal.

            “I’ve been a little frustrated that the governor announced her efforts at repealing this, but then she doesn’t seem to be using her staff or herself to be making phone calls to legislators to get this done,” said Nesiba, a member of the Appropriations Committee and an economics professor at Augustana University. “She used this as a campaign stunt and now she’s missing in action. Perhaps it’s going on behind closed doors, but my sense is that she’s not personally working this as aggressively as I had hoped.”

            Rick Weiland, founder of Dakotans for Health, which is proposing a 2024 ballot measure to repeal the food tax if it doesn’t happen during the 2023 legislative session, sounded incredulous that Noem was struggling to push through the most noteworthy plank from a campaign platform that saw her re-elected with 62% of the vote.

            “There are only 11 Democrats in the entire state Legislature, the rest are Republicans and she’s a Republican,” Weiland told News Watch. “She made the commitment and she’s the governor of the state of South Dakota, so you would think she’d be able to get this done – unless it was an empty promise.”

            Nesiba noted that there are “compromise” bills proposed to lower the food tax rate to 3.5% or 2.5%, depending on the pace of progress of the original legislation to fully repeal the tax. He noted that Democrats may actually help Noem if one of their compromise bills is able to pass after a full food tax repeal effort stalls.

            “I’m a Democrat in the South Dakota Senate who simply wants us to do something for state taxpayers this year,” Nesiba said. “If we can take off 1 cent or 2 cents, which amounts to $25 million or $50 million annually, and leave that in the pockets of South Dakota food buyers, I think that would be good stewardship of public resources. But make no mistake: If we do not get a full sales tax repeal on food, it will be a major political failure on the part of Gov. Noem.”

Supporters say property tax relief plan won’t hurt schools

            In Sanderson’s estimation, there is more support in the House for food tax reform and more appetite in the Senate for property tax relief, but there’s a long way to go. Most legislators want more information on economic forecasts before sharpening their stance on major issues that will stretch into the final days of the session.

            “Overall, I think most of us would love to do a tax cut; which one, that’s got to be weighed out through the process,” said Senate Majority Leader Casey Crabtree, R-Madison. “We have to know what this thing looks like in the future, before we can make those decisions before we lay out the obligations, the priorities and the tax cuts. We’re going to be conservative and prudent in our decision-making. I know that’s not a flashy headline, but that’s how South Dakota has been governed for years, and we don’t want to make a mistake now.”

            House Bill 1043 would create an exemption from property taxes on the first $100,000 of the value of an owner-occupied, single-family home. The concept originated in a summer taxation study completed by the Legislature last year, according to Rep. Mike Derby, R-Rapid City, who chairs the House Appropriations Committee.

            “Most of us legislators, when we’re on the campaign trail, the No. 1 issue we hear about is skyrocketing property taxes,” Derby said.

            School districts, which rely largely on local property taxes for revenue, “would be held harmless” under the bill, Derby said. The idea is to reduce the taxes homeowners pay, and then use ongoing general fund revenues to “backfill” the money school districts need to operate, he said.

            The benefit of the property tax reduction compared to eliminating another sales tax revenue category is that lawmakers could readdress the property tax reduction and change it if financial conditions changed from year to year, Derby said.

            At this point, there is no mechanism in place to determine what impact such a tax reduction would have on school districts, or a method to ensure schools receive the funding they would lose in property tax collections. Also, unlike a reduction in the food tax, a property tax cut does not benefit renters or other residents who do not own a home.

            Nesiba said it would be difficult and unwieldy and require significant new programming to determine how to redistribute state general funds back to school districts that see reduced property tax revenues.

            “The state is going to set up a brand-new government bureaucracy to redistribute sales tax and other general fund revenue and backfill these things forever?” Nesiba said. “For somebody who is in favor of efficient government, just starting up a whole new program to do that is a non-starter.”

If lawmakers don’t repeal food tax, voters might

            Adding to the political calculus in Pierre is the fact that if the governor falls short in her public bid to repeal the food tax, South Dakota voters might do it themselves.

            Dakotans for Health, the grassroots organization pushing for policy change through citizen initiatives, plans to gather signatures for both an initiated measure and a constitutional amendment on the 2024 ballot to mandate that the state “may not tax the sale of anything sold for human consumption, except alcoholic beverages and prepared food.”

            The group re-submitted language for the ballot proposals Dec. 7, 2022, after a conflict in interpretation of the food tax measures between the Legislative Research Council and then-Attorney General Mark Vargo. The new language clarifies that the measure applies only to the state grocery tax and has no impact on the taxing authority of municipalities.

            Weiland said re-submitting the language set his group back “a good three months” and that he never received an explanation from Vargo as to why municipalities were included in the attorney general’s ballot explanation despite not being mentioned by Dakotans for Health or by the LRC.

            Dakotans for Health requested an expedited process with its second submission due to “the delay in our ability to begin collecting signatures caused by the attorney general’s misinterpretation of our previous submission on this subject.” The LRC submitted a new fiscal note to Secretary of State Monae Johnson on Jan. 5, 2023, estimating that the state could lose $123.9 million in annual revenue by eliminating the state grocery tax if the measure passed. The attorney general’s office, now occupied by Marty Jackley, has noted that under state law it has until Feb. 7, 2023, to file a draft title and explanation with the secretary of state.

            Under current law, the deadline to submit petition signatures is six months prior to an election for initiated measures and a year before the election for constitutional amendments. The number of verified signatures needed for initiated measures to make the ballot is 5% of the total vote in the last gubernatorial election (17,508 based on the 2022 turnout of 350,166), while constitutional amendments require 10% (35,016).

            “They’ve made it very difficult for us with this timeline,” said Weiland, “but someone needs to hold (Noem and the Legislature) accountable.” Even if the food tax is repealed in the state Legislature, he said, there is the “gnawing question” of past statutory changes – such as minimum wage or ethics reform – passing through initiated measures or the Legislature and then being altered or reversed by lawmakers.

            Initiated measures can be repealed by the state Legislature or referred to the statewide ballot for reconsideration, while constitutional amendments are entrenched in the state constitution and can only be addressed through court challenges or a superseding amendment on a subsequent ballot.

            “That’s why a lot of us in the citizen initiative process have been forced to look at constitutional amendments, because of the Legislature’s inclination to want to come in and thwart the will of the voters and change it,” Weiland said. “You could make the argument that there’s a reason regardless of what happens in Pierre that we get this in the constitution, not just in the law books. The question is whether we have time to collect enough signatures to get it on the ballot, because they’re running the clock out.”

— This article was produced by South Dakota News Watch, a non-profit journalism organization located online at SDNewsWatch.org.