Republican lawmakers are lining up legislation to reduce or phase out Tennessee’s Hall income tax on investments, even though Gov. Bill Haslam is concerned about losing revenue amid the state’s economic ups and downs.

Such a move, even though supporters say it will benefit seniors and attract investment, could cost the state hundreds of millions in revenue while cutting into local government budgets and doing what most people hate – sending more money to the feds, about $60 million more, one study shows.

State Sen. Brian Kelsey, a Germantown Republican, is pushing legislation to phase out the 6 percent tax on interest, dividends and capital gains in three years, while Sen. Doug Overbey, R-Maryville, is sponsoring a bill to raise Hall tax exemptions based on the rate of inflation.

“The Hall tax hits seniors disproportionately because many seniors have saved their money and are now only receiving income through interest and dividends. That’s the main reason we need to abolish it,” Kelsey says.

Asked how Tennessee would be able to replace the Hall tax, Kelsey responds by saying the governor’s budget cuts $200 million and shows enough revenue growth to pay for it.

Two other bills, both sponsored by Sen. Ken Yager, R-Kingston, would increase the maximum income by $10,000 for seniors to be exempt from the Hall tax and reduce the Hall tax until it hits zero as state revenue grows by 3 percent. The latter one also would give local governments authority to levy tax increases up 2.25 percent to make up for the loss.

Lt. Gov. Ron Ramsey says the state is trying to eliminate the Hall tax one step at a time so the state and local governments don’t feel so much pain, but he notes it is important to replace the revenue.

“I think this year we’ll make some effort to reduce it again, as we have over the last three or four years, probably not as significantly as some people would like, but I’ve talked to the governor about this and [if we] just keep a good-faith effort of slowing chipping away at this where we can do away with it over time,” Ramsey says.

Haslam, meanwhile, says, “My concern is no different this year than last on the Hall tax. We have a very narrow base for revenue in this state. We saw what happened last year when we had revenue fall short, and then this year we’re in better condition.”

Because the state’s revenue reports are made of peaks and valleys, it’s difficult to base a Hall tax reduction on one year’s results, the governor contends.

He could be more amenable to Overbey’s legislation, which is a repeat from 2014.

“It seemed like a good step between doing nothing – and doing a repeal,” Overbey says, noting he believes Tennesseans want the Legislature to whittle away at the Hall tax.

The governor opposed Hall tax cuts last year, and his budget proposal for this year is based on not repealing the tax, Overbey points out.

“It’s a move in the right direction and not letting inflation eat into their savings,” he says.

What the numbers show

While Tennessee depends primarily on sales taxes for state revenue, the Hall tax was projected to bring $260 million into state coffers in fiscal 2014, about $98 million of which would go back to the local governments where those taxpayers live.

That revenue would disappear, and 63 percent of the tax cuts would go to Tennessee’s wealthiest 5 percent, while 23 percent would go to the federal government, according to a 2014 report by the Institute on Taxation and Economic Policy, a non-profit, non-partisan think tank.

The initial $2,500 of investments, $1,250 for single filers, is exempt from the Hall tax for all Tennesseans, and two years ago, the Legislature raised the maximum income to $59,000 annually ($33,000 for single filers) to provide exemptions for senior citizens who live off their investments.

If the Hall tax is repealed completely, nearly two-thirds of the tax breaks, about $163 million, would go to Tennessee’s wealthiest 5 percent, the study finds.

The bottom 95 percent of Tennesseans would receive only $37 million in tax cuts, while $60 million would go to the federal government because the state’s investors would no longer be able to write off Hall tax payments on the federal tax returns, the study points out.

“Eliminating the Hall tax would cause Tennesseans to lose any benefit from the federal deduction, and would essentially force them to claim the (generally less lucrative) deduction for state sales taxes instead,” the study states. “The end result of this ‘federal offset’ effect is to negate 23 percent of the tax savings that Tennesseans might have expected to result from Hall tax repeal.”

Tennessee has the sixth most regressive tax system in the nation with high-income residents paying between 2.8 and 4 percent of their income in state and local taxes compared to low-income residents who pay more than 11 percent, the study notes.

“Repealing the Hall tax would only exacerbate this regressivity,” the study states.

Asked about tax breaks for Tennessee’s residents, Kelsey says, “We want to incentivize investment in the Tennessee economy, and the Hall tax is the only tax left in Tennessee which disincentives investment in the Tennessee economy.”

But House Minority Leader Craig Fitzhugh says it makes no financial sense to cut $200 million, in part because of the impact it would have on local governments. He also raises questions about fairness.

“You want to cut taxes for those that are making a substantial amount of money, yet you want to raise taxes for folks who have to drive their car to work every day by raising fuel taxes. It just doesn’t make any sense to me,” Fitzhugh says.

Germantown, Kelsey’s hometown, reaps anywhere from $2 million to $2.8 million annually from the Hall tax and plows that back into capital improvement projects such as roads, bridges, drainage and parks, according to Mayor Mike Palazzolo.

By design, the city has no industrial or manufacturing areas, though it has a central business district. “About 82 percent of our property is residential, so when we look at revenue streams we’re dependent on, if we lose one, we would have to go to our core, and that would be the property tax,” Palazzolo says.

The Hall tax represents 12 to 15 cents on Germantown’s property tax of $1.935 per $100 of assessed value, according to the mayor.

“Losing the Hall, over time, would be pretty significant for us,” he says.

Saving the Hall income tax is part of Germantown’s legislative agenda this session, and city leaders presented it to their delegation, including Kelsey.

Palazzolo notes in the 10 years he’s served as an alderman and mayor, “No one has ever sent me an email or made a phone call with any kind of complaint on Hall, as it’s inappropriate or restrictive or it is inhibiting my personal income or my ability to be an entrepreneur or a business owner.”

Yet Kelsey says, “I think responsible communities like Germantown have understood that this tax revenue is inconsistent and they don’t count it as part of their yearly budget.”

Palazzolo says he will continue to lobby Kelsey and other legislators to keep the Hall tax.

Weighing in

Citizens for Fair Taxation, as it has for years, contends Tennessee’s taxation is “upside down” because it relies on consumption taxes that put a greater burden on poor families to pay for services.

When the income tax debate arose more than a decade ago, the group supported the move.

But the movement died, and passage of Amendment 3 last fall made a state income or payroll tax unconstitutional, the group’s leader, Dick Williams, points out.

The group isn’t fond of the Hall tax, either, because it can hit senior citizens pretty hard, he says.

“We really ought to be looking at raising additional revenue to fund some of the things that have been cut,” Williams says.

Closing sales tax loopholes would benefit Tennessee, Williams says, along with proposals such as the governor’s revenue modernization bill, which would raise more sales tax on out-of-state companies doing business in Tennessee.

Whatever route the General Assembly takes, lawmakers should recognize even if they wean state and local government off the Hall tax, the need for services such as higher education and local road and bridge work won’t vanish.

Gaps in state funding are increasing rapidly, especially for areas such as the University of Tennessee system, and that trend could escalate unless lost revenue is replaced.

Waiting for private enterprise to fill those coffers could prove fatal, because it’s not going to volunteer to pay more taxes.

Sam Stockard can be reached at [email protected].