Stephen Slivinski

State Taxation Must be Simpler, Less Confiscatory

Posted on June 05, 2003 | Type: Op-Ed | Author: Stephen Slivinski
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The ancient Greek physician Hippocrates wrote that the most important rule for doctors is to "do no harm" to their patients. This is also a good rule for policymakers hoping to reform the Arizona tax code. In January, Governor Napolitano convened a Citizens Finance Review Commission to find a cure for our ailing tax system. But if the commission misdiagnoses the problem, its proposed remedies could end up harming the patient in the long run.

One popular diagnosis of Arizona's tax troubles is that the tax system does not collect enough revenue. The Morrison Institute, for example, likens the system to a "sieve." But the numbers tell a different story.

The sales tax, which critics claim is riddled with too many loopholes, is actually robust, growing apace with personal income growth. The 10-year average growth rate for personal income was 7.4% each year, while the average growth rate for sales tax revenue was 7.8% each year.

The personal income tax dips during economic downturns, but grows faster than personal income growth in boom periods. The 10-year average growth rate per year in income tax revenue over this time frame was 8.2%, while the average growth rate of personal income was 7.4%.

In fact, the only tax that shows strong volatility is the corporate income tax. That volatility is due to the fact that the taxable base of the corporate income tax profit margins  is always subject to big swings.

Those results are consistent with decades of data for all 50 states. A comprehensive study undertaken by economists Russell Sobel and Randall Holcombe found that between 1951 and 1991 personal income taxes were, on average, about as stable as sales taxes, while corporate income taxes tended to fluctuate greatly. In other words, the Arizona state tax system works exactly the way economic theory predicts it would.

So if Arizona's tax system isn't leaky, what's wrong with it? The real problem is that the system is not as simple, fair, neutral, or regionally competitive as it should be.

A simple tax system would reduce the time and capital consumed in complying with taxes or devoted to tax planning, and it would redirect those resources toward more productive uses. A fair tax system would treat all taxpayers equally, rather than punishing higher-earning families with higher statutory tax rates.

A neutral tax system would not discourage saving and investment-the building blocks of the economy-or tax any dollar more than once. Finally, a regionally competitive tax system would give Arizona a more favorable climate for economic growth than that of its neighbor and competitor states.

How can Arizona create a tax system that would meet all of these criteria? By replacing the current system with a simple consumption-based tax. By taxing what people buy, rather than what they earn as income, a consumption-based tax would eliminate the double taxation of savings and remove the tax code's bias against investment.

In a new report for the Goldwater Institute, I offer Arizona policymakers three different consumption-based tax reforms: a 3-percent flat tax, a 3-percent consumed-income tax, and a broad-based 3-percent retail sales tax. Which of those taxes is best is a matter for debate, but each would have the effect of decreasing the tax burden on Arizonans, while greatly simplifying the tax code.

According to projections, a 3-percent flat tax could save taxpayers $3 billion, a 3-percent consumed income tax $3.3 billion, and a 3-percent retail sales tax at least $2.4 billion. If phased in over a five- to ten-year period, those static losses to state government revenue could be easily offset by increased economic growth and modest fiscal restraint.

Those who seek progressivity in the tax code should note that the flat tax and the consumed-income tax both contain generous standard deductions, meaning that the rich would still pay a larger share of their income in taxes than the poor. And the retail sales tax can retain the current exemption for food. But the most important thing is for Arizona to increase economic growth by lowering taxes.

There's no shortage of good cures for Arizona's tax-code malaise. Let's hope that the Governor's commission issues a good prescription.

--Stephen Slivinski is director of tax and budget studies for the Goldwater Institute.

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