Ryan H. Murphy offers a tantalizing idea:
In Texas, taxes on income are against the state constitution. However, Texans still pay the federal income tax.
In principle, the state could effectively end the federal income tax by using two surprisingly simple and straightforward legislative maneuvers—neither of which involves secession. Texas could choose to send its federal taxpayers a check in the form of a state tax credit equal to their federal income tax liability. It could then pay for the credit by increasing the state sales tax in a revenue neutral way. effectively, t hat would mean the end of all income taxes in the state while significantly raising sales taxes. This isn’t about cutting taxes per se; rather, this is the tax swap to end all tax swaps….
This would constitute a drastic policy shift, but why not do it? The superiority of consumption taxes to income taxes has long been argued by many neoclassical economists. The real difference between a consumption tax and an income tax is that a consumption tax encourages saving and thrift. We have good reason to believe that (relatively speaking) discouraging saving—and therefore investment—has significant negative effects on growth….
[Jens] Arnold’s work indicates that consumption taxes and property taxes are distinctly superior to income taxes, especially to an income tax with high progressivity. William McBride of the Tax Foundation summarizes this in a 2012 study, “What Is the Evidence on Taxes and Growth?” What is clear is that a U.S. state that is willing to move its tax environment strongly in this direction would attract investment, entrepreneurs, and workers from the other 49 states. [“How States Can Effectively End the Federal Income Tax — and Why They Should,” Regulation, Summer 2015]
Murphy doesn’t try to assess the legality of the maneuvers, nor will I. I’m interested in the arithmetic of Murphy’s proposal.
I dismiss Murphy’s emphasis on the supposed advantages to a particular State: attracting “investment, entrepreneurs, and workers from the other 49 states.” That just a kind of mercantilism. What’s critical is that sales taxes encourage saving and investment, while income taxes discourage them. (That’s a relative statement for a given level of tax revenue. In fact, saving and investment would be maximized when the sum of all tax receipts is just sufficient to maintain public order and national defense, and when those receipts come from sales and use taxes.)
As a resident of Texas — one of seven States that doesn’t levy an income tax — I’m keenly interested in Murphy’s scheme. But is it feasible for Texas to pay the federal income taxes of its residents, then collect the same amount through sales taxes? I think not.
In fiscal year 2008, for example, the residents of Texas owed $89 billion in federal income taxes. In the same fiscal year the State’s sale tax receipts were $22 billion. (The State’s sales-tax rate is 6.25 percent on taxable items. Cities, counties, and other jurisdictions are allowed to collect up to an additional 2 percent on taxable items, but there’s no need to include those taxes in this analysis, as you’ll see.)
Assuming that ratio of federal income taxes to State sales taxes hasn’t changed much since 2008, Texas would have to quintuple its sale-tax rate from 6.25 percent to more than 31 percent in order to pay the federal income taxes of Texas residents while netting its usual sales-tax income. How likely is that?
The nationwide picture looks much the same. All U.S. taxpayers owed the feds $1.1 trillion in fiscal year 2008. Sales tax receipts across the country came to $443 billion in the same period. (This amount includes receipts of local jurisdictions as well as States.) Sales-tax rates would have to be multipled by 3.5 if all States were to finance federal income-tax bills while they (and local governments) net their usual sales-tax income. How likely is that?
Partial subsidies might be feasible, though politically difficult. There’s always great resistance to increases in sales-tax rates because sales taxes are said to be regressive.
Murphy’s idea sounds good, but it’s not a practical one. Also, if adopted widely it would lighten the federal income-tax burden on high-income individuals. That’s a good thing and a bad thing. On the bad side, it would make high-income individuals less mindful of the need to fight for lower tax rates and the spending cuts that should go with lower tax rates. The proper objective — if you favor liberty and economic growth — isn’t to disguise the burden of federal spending, as Murphy’s scheme would do, but to reduce that burden, by a whole lot.
* * *
Income Inequality and Economic Growth
A Case for Redistribution, Not Made
McCloskey on Piketty
The Rahn Curve Revisited
The Slow-Motion Collapse of the Economy
How to Eradicate the Welfare State, and How Not to Do It
The Real Burden of Government
Diminishing Marginal Utility and the Redistributive Urge
Obamanomics in Action
Capitalism, Competition, Prosperity, and Happiness