"Talk doesn't cook rice." -Chinese Proverb
Has anybody else noticed the new fad in tax policy? Whet the public's appetite and grab headlines with a lot of loud and happy talk about your intent to dramatically cut tax rates. And then mumble some vague notions about ways to pay for those cuts. Mitt Romney did it. President Obama did it. Paul Ryan did it. Bowles and Simpson did it. And so did the House's top taxwriter, Rep. Dave Camp.
Now a bunch of Republican governors (for example, Jindal in Louisiana, Heineman in Nebraska, and Brownback in Kansas)--many with an eye on appealing to Republican-primary voters in the 2016 presidential election--have announced their intentions to eliminate state income taxes and replace them with yet-to-be disclosed plans for expanding state sales taxes.
From an economic perspective the idea of replacing income taxes, especially particularly harmful corporate income taxes, with taxes on consumption is extremely sound. Income taxes create market-distorting disincentives to saving and investment--key drivers of economic growth and job creation. But this benefit of uncertain magnitude always has to be weighed against what is not included in most economic models: the redistribution of the tax burden to those least able to afford it. So we are in for another round of the age-old shouting match between conservatives claiming a switch from income to consumption taxes will increase growth a lot and hardly hurt the poor at all,and liberals claiming just the opposite.
The fact that I think has received far too little attention is that state income and sales taxes are only a shadow of the pure income and consumption taxes economists are thinking of when they recommend the switch. State income taxes are largely based on the federal income tax which--with all its tax incentives for savings (401k plans, preferential rates on capital gains, etc)--is a hybrid income-consumption tax. Perhaps more importantly, state sales taxes are a far cry from broad-based taxes on consumption. Many goods considered necessities and almost all services are exempt. And many items subject to tax are not taxes on final sales to consumers but on business-to-business sales. A 2005 study by Ernst & Young reported that 43 percent of sales taxes are on purchases by businesses. And the report observed:
- A sales tax on business inputs is an additional cost of doing business in the state, forcing companies to either attempt to pass on that cost to their customers or reduce their economic activity in the state. . . . As a consequence, these businesses may reduce their in-state investment in equipment and buildings and create fewer jobs for state residents.
So the economic benefits of a sales-for-income tax swap are probably less than they appear. And don't be surprised if some of the biggest opponents of the sales tax increases are businesses themselves.