This article first appeared in the St. Louis Beacon, Feb. 15, 2010 - Bills before the Missouri General Assembly -- (HJR) 56 , HJR 71, (SJR) 29 and SJR 37 -- would radically alter the state's tax structure by doing away with the state's individual and corporate income taxes and the earnings tax in St. Louis and Kansas City.
In their place, the bills propose to expand the number of goods and services whose sales are taxed and increase sales tax rates. Furthermore, despite proponents' claims that the state's sales tax rate would be 5.11 percent, most objective analysis puts the new rate much higher. Because of the increase in the coverage and probable increase in the tax rate, the proposed bills would offer a tax rebate to low-income households to offset their higher taxes.
In this article I offer a set of economic criteria to measure what a good tax system is supposed to do so a reader can make up his/her own mind on this complex subject. For the sake of brevity, I will focus on two key criteria: Fairness and efficiency.
A Good Tax System Should Be Fair
Fairness can be measured many ways. Fundamentally, however, "a tax system ought to be fair in its relative treatment of different individuals." This definition, by Joseph Stiglitz, says that a fair tax system treats those in similar circumstances similarly and imposes a higher tax burden on those who are better off rather than those who are less well off.
The income tax is the one form of tax that takes into account individual circumstances of the taxpayer. The income tax, with its many exemptions and deductions, is designed to allow taxpayers to reduce their tax burden according to their family's financial situation. Furthermore, the income tax is progressive, which means that the more income you make the sooner you get bumped into a higher tax bracket. As many in the current economic downturn have learned, moreover, the principle also works in reverse: If you make less income, your tax burden is reduced.
Sales taxes do not take into account the consumer's financial condition. A gallon of milk will cost the same in tax whether you are a Fortune 500 CEO or homeless. Obviously, a bigger proportion of your pocketbook gets consumed by sales taxes if you are at the lower-end of the income scale than at the higher. As the scope of taxed goods and services widens, the tax becomes even more difficult for low-income people to avoid. Rich people, however, can avoid the tax by doing most of their consuming out-of-state or online.
A Good Tax System Should Be Efficient
What this means is that the tax system should not interfere with people's economic choices. Interference by a tax would lead to market distortions, which ultimately means those markets operate less efficiently. Hypothetically, income taxes could interfere with an individual's decision to work, particularly at higher tax rates. The question becomes at what point does the income tax discourage personal productivity?
A look at the per capita individual income tax for Missouri and its neighboring states for a recent year, compiled by the Missouri Budget Project, indicates that Missouri's average per capita tax ($822) is not out of line with its neighbors, Illinois ($734), Iowa ($894), Arkansas ($766) and Kansas ($988).
Furthermore, in terms of personal income growth, Missouri experienced a 44 percent increase from 1998 to 2008, while over the same period, Illinois experienced a 42.3 percent increase, Iowa a 50.2 percent increase, Arkansas a 55.7 percent increase, and Kansas a 49.1 percent increase. Therefore, there does not seem to be a correlation between higher per capita income taxes and declining personal productivity.
Sales taxes act to dampen consumer demand for the goods and services being taxed. This is more so the case when there are sufficient non-taxed alternatives available for consumers. Similarly, consumers can be tempted to purchase their goods and services in nearby states with lower sales tax rates. Increasing sales tax rates and expanding coverage to include items not currently taxed would have the potential to distort consumer choices, which could lead to greater inefficiencies for the state's economy.
For example, Missouri residents who live near other states would have a strong incentive to shop across the borders. This would decrease overall commercial activity on the Missouri side, leading to more small business bankruptcies and lower employment rates. Other negative effects might include fewer firms deciding to relocate to Missouri, a larger number of businesses moving elsewhere, increased fiscal pressures on municipalities, not just St. Louis and Kansas City, which have the most to lose from the proposals, but all other municipalities in the state as well.
A good state tax system should be both fair and efficient. The state's taxpayers should have significant input regarding dramatic changes in the way state revenues are currently collected. Those changes will have a tremendous impact on the state's economy for many years to come. Missouri's lawmakers do a great disservice to the state's residents if they enact poorly thought-through legislation driven by narrow self-interest. It is up to us to make sure this does not happen.
Robert Cropf chairs the Department of Public Policy Studies at St. Louis University.