Colorado’s TABOR: Limit Tax Rates, Not Tax Revenues

H igh state tax rates cause taxpayers to earn less, change the location and timing of their income, and shelter their income through sub-optimal tax-preferenced allocation. Many taxpayers also hire lawyers, accountants, deferred-income specialists, favor-grabbers, and lobbyists — all to reduce tax payments. Tax-limitation initiatives, such as Colorado’s Taxpayer’s Bill of Rights, that focus on tax payments rather than tax rates totally miss the opportunity to address the damage done by high tax rates.

Such tax-avoidance activities, every one of them, leave taxpayers and the economy worse off, and they reduce tax revenues. A pro-growth and successful taxpayers’ bill of rights, which is what Colorado’s TABOR should be, must focus on tax rates, not on the amount of taxes collected.

The State of Colorado receives revenue directly from sales and income taxes, and indirectly from local property taxes that effectively reduce the required state share for funding public schools. Therefore, rate reductions in all three major forms of taxation in Colorado should be on the table to reduce the anti-growth overtaxation that results in TABOR surpluses.

Taxpayers aren’t the only people who change what they do when faced with Colorado’s TABOR. Knowing that TABOR focuses on tax collections, not on tax rates, legislators of both parties are enticed to increase their use of tax expenditures, such as increased deductions, tax credits, tax exemptions, and tax deferrals. There are more than 100 tax credits on the books in Colorado. Good, bad, or indifferent, they are revenue expenditures that are the economic equivalents of government outlays.

A taxpayers’ bill of rights should prevent bad things from happening to the taxpayer, not be a formula for redistributive payments that leads to a sub-optimal allocation of capital and to slower growth. In Colorado’s constitutional amendment that establishes TABOR, only once is the word “taxpayer” to be found, and that is in its title.

Tennessee, on the other hand, has explicitly prohibited an income tax in its state constitution. Now that’s a taxpayers’ bill of rights. California, in 1978, passed a constitutional amendment to limit property-tax rates to 1 percent of market value and the growth of property-tax payments to 2 percent per annum for any single property owner, which contains the growth of property taxes but also, unfortunately, reduces property transfers.

Colorado’s TABOR says that if tax collections increase by more than the percentage increase in population and inflation, the extra tax receipts have to be “refunded.” But TABOR’s definition of “refund” is far from being in taxpayers’ or the economy’s favor. In practice, tax-revenue surpluses (i.e., above the TABOR limit) have been “refunded” to Coloradans as a government spending program, such as transfer payments (rebates included) and housing subsidies to the elderly. This isn’t tax limitation at all.

Since 1992, when TABOR was adopted, there have been many refund mechanisms. As of today, there is no option available that reduces any tax rate. None of these tax expenditures and “refund” mechanisms makes taxpayers whole. Far from it. These mechanisms, in the context of the budget process, are no different than increases in state spending.

Legislators, once again, are incentivized to reduce state spending on TABOR-authorized “refund” mechanisms in lieu of other programs in the regular budget, only to use tax surpluses for those TABOR-authorized programs. Budget funds are fungible.

Even if Colorado could refund the money to the people who paid too much in taxes, which current “refund” mechanisms don’t even pretend to approximate, the damage already would have been done. Tax rates are all about incentives: When tax rates are high, your incentive to engage in a taxed activity is lower than it would’ve been if the tax rates were low or zero. When you work, produce, or employ other people, you do so with current tax rates in mind. The economic boost generated by a reduction in tax rates stems from the enhanced incentives you now face for engaging in taxed activities. No matter what you do with the TABOR refund money, you can’t change the amount of taxes paid last year. A tax refund won’t retroactively change what anyone did last year, and there is no incentive effect to offset the damage done. Even the best of cases, a hypothetical pro rata return of excessive taxes, as defined by TABOR, wouldn’t do what its proponents argue. No refund can retroactively make whole those taxpayers who overpaid because time has gone by, and the incentive impact is lost.

If there is an excess in tax revenues above population growth and inflation, as defined by TABOR, that means tax rates should have been lower but were not. The law serves as a signal that tax rates have been too high. The proper response to this signal is not to have it keep signaling, but to get the message and cut tax rates permanently. That’s why we both supported two permanent cuts in tax rates for the state income tax in Colorado, the first of which reduced the state income-tax rate from 4.63 percent to 4.55 percent in 2020, and the second of which, in 2022, permanently reduced the income-tax rate to 4.4 percent. And we both continue to call for additional income-tax-rate cuts. These tax-rate reductions generated less TABOR surplus to be redistributed, and that result has been good for Colorado’s economic growth.

A similar tax-rate reduction for property taxes, Proposition HH, failed on the ballot recently in Colorado. The expected opposition included the association of cities and the association of counties, entities traditionally funded by property taxes in Colorado, which naturally opposed a decrease in their revenue growth. This opposition was unfortunately joined by some elements of the populist right, who incorrectly view TABOR surpluses as refunds to be protected rather than as government revenue to be reduced through rate reductions in property tax, sales tax, and/or income tax.

To think any of this as a Democratic vs. Republican issue would be way off base. TABOR was adopted in 1992, when Colorado’s spending was a little over 6.5 percent of state GDP and the remaining 49 states each spent more than 9 percent of theirs. Since TABOR’s adoption and under Governors Roy Romer (D.) and Bill Owens (R.), Colorado state spending as a share of state GDP stayed low. But then, under Democratic governors Bill Ritter and John Hickenlooper, state spending soared to levels greater than the rest of the nation’s, in spite of TABOR.

Under Democratic governor Jared Polis (one of the authors), state spending as a share of state GDP has tumbled — in both absolute terms and relative to the rest of the U.S. At present, state spending in Colorado has fallen absolutely and relative to the rest of the nation and is at its lowest level since 2007. The current Colorado TABOR doesn’t help this governor or future governors maintain pro-growth economic conditions, but income-tax cuts and property-tax-rate reductions do.

Jared Polis is the governor of Colorado. Arthur B. Laffer, chairman of Laffer Associates, is the co-author, with Stephen Moore, of Return to Prosperity: How America Can Regain Its Economic Superpower Status.