Tax Analysts Blog

Tax Revolution in the Red States?

Posted on Feb 8, 2013

"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.

Read Comments (2)

Falstaff @ The Boar's HeadFeb 7, 2013

This post correctly asserts three critical points. First, the policy case for
taxing consumption is rock solid w/r/t efficiency, savings and growth. Second,
shifting away from income taxation toward consumption significantly inevitably
alters 'who' bears the tax burden. Even where the shift is revenue neutral, it
will never be distributionally neutral -- thus the need for corresponding
measures to address progressivity concerns. Finally, our current system of
taxing consumption at the sub-national level via a patchwork network of
inefficient retail sales taxes is utterly absurd. RSTs = epic failure. RSTs
don't reach services and don't relieve business inputs. They also don't reach
remote venders under current federal case law. RSTs are just plain horrible
taxes from a design perspective. The primary flaw in Jindal's plan is that he's
trading one bad tax for another bad tax. The rather obvious solution is a
modern VAT harmonized at the federal level that allows states rate-deviation
(an optional piggyback on the federal VAT) but denies them base-deviation. This
isn't rock science. Look at how the Canadians do it. Sullivan predicts that
some businesses may oppose Jindal's plan. That underscores just how backwards
RSTs are.

West Coast OffenseFeb 8, 2013

Regarding the E&Y study mentioned above. It reports that 43% of sales taxes
come from purchases of business inputs. That's really disturbing. Just to be
clear, the correct number there should be 0%. Why isn't the Chamber screaming
about this? Jindal needs to fix that if he's serious about killing Louisiana's
income tax. Not easily done.

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