A way to end the flat v. sales tax debate

Irrational Knowledge ^ | 10/14/2005 | Justin

[Jibaholic]

Here is a neat federalist solution to tax reform: a state GDP tax. The federal government can require that states turn over 25% (or whatever) of their GDP but can not specify how that money is raised. That freedom is left to the states. Blue states can use progressive income taxes with high marginal rates. Red states can experiment with a flat tax or a sales tax. This has many advantages over our current system or even a national sales tax or flat tax.

• Depoliticize the tax reform debate. Blue and red states would be free to go their own way. We would not have the toxic debate over which tax system 51% of the population will impose on the other 49% of the population.

• A state GDP tax will dramatically reduce corruption at the national level. For much the same reason as George Will elegantly explained in an article in favor of a sales tax, a state tax would allow us to virtually eliminate "K Street":

  ``K Street'' is shorthand for Washington's lawyer-lobbyist complex. It exists to continually complicate and defend the tax code, which is a cornucopia from which the political class pours benefits on constituencies. By replacing the income tax -- Linder had better repeal the 16th Amendment, to make sure the income tax stays gone -- everyone and all businesses would pay their taxes through economic choices, and K Street's intellectual capital, which consists of knowing how to game the tax code, would be radically depreciated.

  The lobbying would then move down to the state level. The next advantage of a state GDP tax addresses that.

• Basic public choice theory dictates that special interests will immediately start lobbying for deductions regardless of what tax system we use. Our tax code is more convoluted today than it was before Reagan eliminated most deductions, shleters and loopholes. A flat tax may has appeal because it involves quitting deductions "cold turkey" but is inevitable that the deductions, shelters and loopholes will return. Someday the public will get outraged about the jobs we are losing to overseas competition in Industry X, so Industry X will get a tax break in order to keep jobs at home. A sales tax is no better: anti-poverty crusaders will make the case that a digital divide (or whatever) is holding the poor back so computer, software and internet expenses will get exemptions. It is a slippery slope from there. The criteria for tax reform is to choose a solution that is robust enough to withstand the lobbying process.

  States are not immune to the lobbying of special interests, but they are subject to powerful forces of tax competition with other states for jobs and investment capital. State politicians will have to weigh the favors from special interests against lost jobs. That will help keep the states honest. The federal government is also subject to forces of tax competition but it is weaker. Jobs and investment capital flow more easily within the United States than across countries. It is easier for a business to relocate in a new state than a new country.

• A third benefit of a state tax is that we will finally know which tax method works best. Some red states will try a flat tax; others will try a sales tax. Some may try flat taxes but with child deductions or mortgage deductions. Blue states can try to have progressive income taxes with huge, well-funded state revenue agencies to crack down on tax evasion by the rich. No more endless debate about which tax system works best, we'll have empirical proof. This is what federalists mean when they talk about the laboratory of the states.

[Jibaholic]

Let the states duke it out. Loser comes crawling back to the winner on their hands and knees.

[babyface00]

On first reading, this really appears to have some merit.

[so_real]

That would be a grand experiment indeed. One trick would be to accurately measure and keep-honest the GDP numbers. I'm all for drawing a curtain between the Fed and States on this.

[Jibaholic]

The idea came from a friend. His original suggestion was that the it be based on the number of adults living in the state - a poll tax. E.g. $10,000 per adult. That would effectively eliminate any possibility of evasion. I objected because it is regressive - poor states would pay a higher percentage of GDP than wealthier states.

[scrabblehack]

But the "poll" tax is the constitutional option.

I.2.iii:
Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons.