Taxes and finance in the Alabama constitution by Keith J Ward, Ph.D. Center for Governmental Services, Auburn University
In an ideal world, finance would not be a part of the constitution. The power would be within the legislature to establish the necessary framework for taxation and debt and then left to the executive for implementation. But we do not live in an ideal world and that being the case some recommendations must be made as suggestions for a Finance Article for a constitution.    As the fundamental document of governance, the constitution should exhibit greater permanence than does statutory law and will require few changes. The function of the constitution is to protect the people in the exercise of their civil liberties, to define the powers of government, and to establish the permanent institution of government. The ideal constitution will be short and simple, reflecting citizen trust of government, and will vest broad powers in the governmental representatives of the people. These representatives will be held responsible for governance and the citizens will assume greater responsibility for the actions of government. Vagueness is one concern that will be troublesome if a fundamental document is strong on brevity and short on preserving current thinking. The idea is to avoid tying the hands of future generations through the provision of a flexible document. The Current Condition    The Alabama constitution is a litany of provisions limiting the power and flexibility of the executive and the legislature. With almost 90 percent of the state government revenues limited to restricted spending, the ability of the executive and legislative branches is severely limited in financial decision making. Even when a genuine general public need is evident, the revenues must be distributed to the purposes for which they are restricted. That becomes most obvious when the State's general fund is some $830 million, the education trust fund is 3.3 billion and a long list of other restricted funds are provided for by the constitution or by statute. (see appendix A). Earmarking    The argument for earmarking is that if people are specifically taxed they should be assured those funds will be expended for related services. The gasoline tax for public roads is an example where gasoline and related taxes are restricted to use for highway related expenditures. But Alabama far exceeds the concept of selective earmarking to assure expenditures for selected public services. The income and sales tax restrictions, for example, limit the legislature's ability to ascertain appropriate public needs funding.    A major fear is that if constitutional earmarking were removed, education and highways would suffer because the legislature would use those funds for general government. If the legislature chooses to earmark selected taxes for specific purposes that should be an acceptable prerogative. But that earmarking should be legislatively enacted, and therefore, changeable based on need. When the earmarking is placed into the constitution, current needs may be found wanting because of the limitations found written into the fabric of the basic document. As public needs change, flexibility is required to meet those needs. The United States Constitution is a vague document, but the flexibility found therein has allowed changes in areas that could not have been foreseen two hundred years ago. And the constitution should remain a classic, unfettered document, without amendments that shackle future decision making. The Income Tax    The income tax is the primary source of revenue for the State. In 1994, the tax raised $1.2 billion for the State Education Trust Fund. The Constitutional provisions of the tax are a maximum rate of 5 percent, a personal exemption of not less than $1500, and a definition of income. This tax is framed so that the legislature cannot change most of its provisions without a constitutional amendment. Among the limitations that might be considered for change are the maximum tax rate at 5 percent, the exemption limits and the federal income tax withholding exemption. The federal withholding exemption was adopted as amendment 225 in 1965. During the tax reform efforts of 1988 to 1992 that was one of the exemptions that found general disapproval because it skews the tax in favor of the higher income class. The Property Tax    The property tax provides some 2.4 percent of state revenues and is constitutionally distributed among education, civil war widows, and the general fund. Some states do not levy a property tax at the state level, leaving the tax for use by locally elected officials.    Education receives a majority of all property tax revenues, about 51 percent in Alabama. Even so the use of the tax by locally elected officials is heavily subject to constitutional limitations which inhibit the use of the tax for local education. Section 211 requires that "all taxes levied on property in this state shall be assessed in exact proportion to the value of the property..." This requirement is intended to insure fairness among all taxpayers. Since the adoption of Section 211, classes have been introduced and the current use provision has been created. Classification    Alabama is one of a handful of states that classify property, as authorized by section 217 (b). The effect of this classification is to place the heaviest burden on utilities and businesses and the least burden on residential, farm and forest properties. Assessment ratios on class I utilities are 30 percent and 10 percent on Class III residential, farm and forest properties.
CLASSIFICATION OF PROPERTY
Class	Assessment	Type	Lid Limit Percentage
Class I	30	Utilities	2
Class II	20	Business (All Other)	1.5
Class III	10	Residential, Farm, Forest	1
Class IV	15	Motor Vehicles	1.25
In addition to the classification assessment ratios, the constitution has a lid limit on each of the classes, fixing a maximum percent of value that a parcel may be taxed. The effect is an assurance that persons will not be taxed more than the lid limit percentage of market value. For example, a $100,000 residential parcel cannot be taxed at more than $1,000 per year. When we tie classification into this example, the taxable value of a $100,000 parcel becomes $10,000. With the homestead exemption the taxable value for state property taxes become $6,000 and $8,000 for local purposes. Then when the constitutionally restricted millage rates are applied, based on an average millage rate of 30 mills, the effective tax for a $100,000 parcel is only .25 percent. Such a parcel now pays about $250 per year, but could pay four times as much before the lid limit would come into effect and protect the property owner from the defined excessive rate of taxation. But the constitution has also been used to limit increases in millage rates, leaving in effect the 1978 rates. The 1995 rates are essentially the same as in 1978 when the constitutional amendment was passed.    The dilemma for Alabama has been the dissonance caused by the limits on property taxes and the lack of funding for schools. In a series of amendments, the schools have been assured of the ability to levy 15 mills but are not required to do so. Amendment 373 established a requirement for a referendum prior to any property tax rate increases. Recent referenda which proposed to increase the rates and levy additional local property taxes even for schools have typically met with failure. And one of the state's most severe problems is funding for k-12 education. Constitutional limitations hamper efforts to provide needed additional funding, especially at the local level. Current Use    Current use, as applied by any other state, protects agricultural values for purposes of taxation when urban market tax values would force persons off the land. In other states the application of current use provides that a farmer, located on an urban fringe,may continue his chosen occupation without fear of excessive taxation. His tax values are the tax values for other similar, rural land used for agricultural purposes.    In Alabama, amendment 373, provides for constitutional protection of urban fringe land. The constitution provides that farm and forest property "shall...be assessed at the ratio of assessed value to the current market value of such taxable property and not the fair and reasonable market value of such property." (amendment 373, found in section 217 b of the constitution of 1901.) The impacts of the implementation of this amendment per acre are that farm and forest tax values have not increased since 1982 and that the average per acre taxable value for such land is the same in every county in Alabama. Farm and forest land values have increased just as they have for business and residential property.    Perhaps the most egregious application of current use is that average values for cropland are the same in Baldwin and Madison counties as they are in Sumter and DeKalb counties. Constitutional Debt Limits    Limitations on debt are common to state constitutions. The Alabama Constitution limits the state expenditures to revenues expected for each year. Proration of funds is called for when during the year revenues received do not equal appropriations, assuring a balanced budget (required in amendment 26). At the local level, typically, the limits will be tied to some percentage of total assessed value of taxable property. The intent of debt limits has been to protect citizens from too much of a burden, but theintent has been abused. At the state level, authorities or corporations have been created to assume the burden of debt. At the local level public works exclusions render the limits relatively meaningless.    Other limits prohibit incurrance of debt for private purposes and provide an absolute restriction on debt for capital improvements. In a modern government, private purposes may mean limits on economic development activity. In practice financing for capital improvements has meant creating public authorities, granting them power to incur debt for public purposes, circumventing the constitutional restriction.    Local government debt limits are based on real property values. In Alabama the property tax is exceedingly low, and the revenues generated from these taxes constitute a declining percentage of total revenues generated, making other measures of ability to pay more logical. If a debt limit were considered necessary, perhaps some percentage of personal income would be more relevant.    With overlapping governments, cities and counties having constitutionally fixed limits based on appraised property values, 20 percent for cities and 5 percent for counties, and both tax the same property. The effect of the limit may be to provide some false reassurance that limits are actually protecting individual property owners from being overtaxed to repay debt issues. One authority on taxation and finance wrote, ...many students of local fiscal problems have concluded that percentage debt limits are of dubious value as a means of measuring local fiscal soundness. It is contended that such a system is basically negative in character and does little or nothing to promote sound local fiscal management. (Edward M. Kresky Salient Issues of Constitutional Revision. NML, 1961). Fiscal Affairs    As a rule, detail regarding fiscal affairs should be left to the statutes and not included in the constitution. Auditing, Accounting and Financial Reporting are rapidly changing, and should therefore be flexible enough to change with the requirements of the state of the art approaches still being developed.    The budget and appropriations process, too, is rapidly changing. In Alabama, budget isolation is the constitutional venture in budgetary planning (Amendment 448). This amendment was intended to "force early consideration of the budget bills", leaving ample legislative time for other important bills. In practice the legislative process is slowed by frequent votes on budget isolation, that evade the intent of the amendment. The Constitutional Fix    Among the taxes with constitutional limits are the Property Taxes, Hunting and Fishing Licenses, corporation taxes on agent's Occupational License Tax, the Franchise Tax, Alabama Trust Fund, Alabama Heritage Trust Fund, Gasoline and Motor Fuels Taxes and Motor Carrier Milage Tax, Income Taxes, and Motor Vehicle Registrations. All of these revenues must be placed in special funds. The budget process is hampered by the budget isolation, amendment 448, income tax restrictions and the extensive number of restrictions on the property tax. These types of restrictions affect flexibility. More important, because of these restrictions, the state and, especially, local governments have an undue reliance on consumption taxes. For municipalities consumption taxes are about the only mechanism with which to meet increasing responsibilities to provide services. Counties traditionally relied on the property tax for funding of the basic services. As new fiscal requirements arise, more and more often counties are turning to the same consumption taxes relied upon by the cities. For example, in 1994 the five counties over 100,000 population derived 62 percent of their local revenues from sales and use taxes. The net effect of this overreliance on consumption taxes causes bond ratings to be lower than necessary, and that increases costs to both state and local levels of government. State bond ratings are affected by a lack of diversity among the tax bases.    The natural solution to the above problems is to change the way we tax ourselves. In 1995, a tax structure with simple, fair, broad-based, low rate taxes would significantly improve the fiscal integrity of the state. In particular, abolishing exemptions would contribute to a more fair tax structure. In addition, a balanced tax system is desirable. The balance would be chiefly among the big three taxes, property, sales and income. Because the current limitations on property and income taxes restrict balance, constitutional revision becomes at least desirable. One mechanism would be to abolish constitutional restrictions one by one. At the other end of the spectrum, another mechanism would be to completely rewrite the taxation and finance article during a constitutional convention. Rewriting The Finance Article    One approach to rewriting the finance article would be to use the Proposed 1979 Constitution for the state of Alabama. Article VIII, Taxation and Debt Limitation in the proposed Constitution of 1979 contains provisions which prohibit the state from assisting the private sector from delegating taxing authority to private parties. It establishes an income tax (but keeps the current maximum rate and the federal income tax exemption). Earmarking is removed from the constitution. Property taxation is left intact (current use was not yet an issue). State debt is to be approved by an extra majority of the legislature. Municipal debt limits are raised to 35 percent of assessed value and county debt is left at 5 percent. Public works is included in the municipal debt but county exceptions for public works are continued. The use of local taxing authority for industrial or commercial development is prohibited.    A second approach is found in the model state constitution. Section 7.01. State Debt. No debt shall be contracted by or in behalf of this state unless such debt shall be authorized by law for projects or objects distinctly specified therein. Section 7.02. The Budget. The governor shall submit to the legislature, at a time fixed by law, a budget estimate for the next fiscal year setting forth all proposed expenditures and anticipated income of all departments and agencies of the state, as well as a general appropriation bill to authorize the proposed expenditures and a bill or bills covering recommendations in the budget of new or additional revenues. Section 7.03. Expenditure of Money. (a) No money shall be withdrawn from the treasury except in accordance with appropriations made by law, nor shall any obligation for the payment of money be incurred except as authorized by law. The appropriation for each department, office or agency of the state, for which appropriation is made, shall be for a specific sum of money and no appropriation shall allocate to any object the proceeds of any particular tax or fund or a part or percentage thereof, except when required by the federal government for participation in federal programs. (b) All state and local expenditures, including salaries paid by the legislative, executive and judicial branches of government, shall be matters of public record. Source: The Model State Constitution    These provisions assume a level of confidence in representative democracy and depend on the executive and legislative branches to assume the responsibility for conducting the affairs of state. Trusting the governor and the legislature to act responsibly can be no worse than evasion of constitutional responsibility. And that is what we do with the budget process. The budget is of primary efficacy in establishing "good", "responsible" government and the model constitution recommends an executive budget, a process already in place in Alabama. The recommended line item veto for appropriations is a tool to balance executive power with the legislature. The section on making all salaries a matter of public record has gradually become standard practice for both state and local government. The greatest change from current practice is the prohibition against earmarking, "...no appropriation shall allocate to any object the proceeds of any particular tax or fund..."    The tax structure and financing mechanisms based on the Constitution of 1901 are worthy of debate as to their usefulness in the 21 first century. Some change is justified. How much change is framed by the approach one takes to government's role in framing policy. If we assume that government is a necessary function and we move from that perspective, the opportunities for change are myriad. Some of the obvious questions that need to be addressed follow: • Does the state need a more balanced tax structure? Or is the current reliance on sales taxes appropriate for today? • If a greater reliance were placed on property taxes, how much freedom should be given to local units to determine tax rates? Today, that freedom is strongly curtailed by the constitution which expresses the will of the majority of the population. Are we prepared to determine what is "best" for today? • Should the question of financing government be a subject for the constitution? Or should the constitution be silent and leave this question to the elected representatives of the people? • Should debt be limited in some way for both the state and local units of government, or should debt be limited only for the local units? And if limited, what should be the limiting measure, assessed value of property, personal income, or some other measure? • Earmarking is a limiting factor in flexible planning. Is extensive earmarking desirable, or should we abolish earmarking ala' the model constitution? Would Alabama be better served if earmarking were removed from the constitution but left to the legislature to enact as "necessary". Or, should the constitution provide that all funds be legislatively appropriated without benefit of earmarking? • Should public money be used for private purposes, either in the area of jobs development or charity? Whole books are written on the usefulness of government's role in industrial recruitment but conclusions are usually based on personal preferences. If public money is not to be used for private purposes, what about the use of welfare funds to sustain individuals or to promote industrial location?    Many other questions remain to be framed in the debate about the role of government and the area of taxation and finance. The answers to these and other questions will frame an article for Finance and Taxation in the Alabama Constitution. Appendix A Special Revenue Funds Special revenue funds account for specific revenue sources that are restricted to finance particular functions and activities of the State. The individual Special Revenue Funds of the State are combined on a functional basis according to the type of activity. Alabama Special Educational trust Fund (ASETF) accounts for the revenues and expenditures associated with public education. Public Road and Bridge Fund accounts for the revenues and expenditures associated with highway construction, maintenance, and operations. Medicaid Fund accounts for revenues and expenditures associated with the provision of nursing home care, hospital care, and physician services for those eligible for Medicaid benefits. Human Resources Fund accounts for revenues and expenditures associated with the administration of programs to provide financial assistance, such as the Aid to Dependent Children program, and a broad range of social and protective services. Public School Fund accounts for revenues and expenditures which are located to local boards of education for support of educational programs. Education Department-Federal Programs accounts for federal monies received by the State to support educational programs for elementary and secondary education and rehabilitation and crippled children services. Economic and Community Affairs Fund accounts for revenues and expenditures related to energy management, skills enhancement and employment opportunities, traffic control and accident prevention, and state and regional planning. Corrections Fund accounts for revenues and expenditures associated with the administration of penal and correctional institutions and related activities in the State. Mental Health Fund accounts for revenues and expenditures related to the provision and care of those who suffer from mentalillness, mental retardation, and substance abuse. Public Health Fund accounts for resources used in the promotion of general physical health. This includes the enforcement of laws relating to public health as well as programs providing preventive and treatment services to the public. Revenues Allocated to Local Governments accounts for revenues from gasoline taxes, motor vehicle licenses, TVA payments, and other revenue sources which are shared with local governments. Other Special Revenue Funds account for various resources used to provide a wide variety of services, the largest of which are: Revenue Administrative administers the collection of almost all state taxes and licenses. Industrial Relations administers the unemployment compensation and industrial safety and accident prevention programs. Conservation and Natural Resources is responsible for the management of the state's game and wildlife resources as well as the management of the state parks system. Forestry Commission is responsible for the management, protection and development of the state's forest resources. Environmental Management protects the state's citizens from pollution of the water, land and air. Agriculture and Industries inspects agricultural products to ensure compliance with state and federal standards. Commission on Aging administers federal and state programs which provides services for the elderly. Indigent Mothers and Babies Trust provides funds for the care of indigent mothers and their children. Professional and Occupational Boards provide professional and occupational licensing and regulation. ASETF Proration Prevention is a "rainy day" fund intended to prevent budgetary shortfalls in the Alabama Special Educational Trust Fund (ASETF). Guaranteed Student Loan Program provides for the administration and coordination of the Alabama Guaranteed Student Loan Program. Miscellaneous Special Revenue Funds are aggregated for reporting purposes and account various other revenues which must be specific purposes. Source: Comprehensive Annual Financial Report. State of Alabama, 1991.
Alabama Citizens for Constitutional Reform Foundation, Inc. P.O. Box 34 Montgomery, Alabama 36101-0034 E-mail: accr@constitutionalreform.org
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