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BookMark
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From NewsLink, Vol. 6, No. 1, Fall 2001
The great political economist Adam Smith enumerated four principles needed by a market-oriented economy as it established a credible system of public finance. Smith believed that citizens ought to pay taxes according to their ability to pay, which, he thought, best measured the benefits they received from government expenditures. He also maintained that taxes levied should not be arbitrary and easy to administer. Lastly, Smith observed that “every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state.” This is called the “neutrality principle” by modern-day economists.
Smith believed in moderate taxation and, while he later became the patron saint of the limited-government school of political economy, he held few antigovernment sentiments. He recognized the existence of a legitimate role for government in providing defense, security and public works. Successive generations of liberals have invoked his ability-to-pay standard as providing a basis progressive income taxes (even though Smith did not have in mind using the tax system as an instrument of income redistribution).
Despite the generality of his prescriptions, Smith's principles have guided tax scholars for more than two centuries. Among these scholars, there is broad agreement that tax systems should be efficient and broad based – free of the clutter of deductions and exemptions. Another ideal upon with scholars agree is that taxes should distort business and household behavior as little as possible.
Unfortunately, the voices of Smith and of the generations of scholars who have followed in his footsteps are sometimes not heard at the state level of government. Today, in virtually every state capital, legislators trip over themselves to offer tax breaks for particular individuals or businesses. These tax breaks are often made in the name of fairness or economic development. But in the long run, as any adherent to Smith would explain, lead to less equitable, less neutral, and more costly tax systems.
When theoreticians complain about this state of affairs, the practical-minded (if not overtly anti-intellectual) state legislator are likely to sneer at their impracticality. As one such legislator recently asked: “Adam Smith? How many jobs can he create in Virginia?”
Journalist, author, educator and lawyer, David Brunori is a Renaissance man who thinks state tax policy is important and that Smith's principles need to be renewed. His slim volume State Tax Policy: A Political Perspective is a well-argued rejoinder to this kind of anti-intellectualism.
Brunori gives state legislators credit where credit is due: ”For the past quarter century, state lawmakers have been able to provide the services demanded by their constituents in an atmosphere plagued by balanced budget laws, a shrinking tax base, and decidedly anti-tax political sentiments. This resourcefulness is an under-appreciated attribute.”
Unfortunately, the states often ignore the principles of sound tax policy. One example is their traditional reliance on regressive sales taxes that violate the Smithian ability-to-pay principle. Another is their inability to shed taxes, such as corporate taxes, that are no longer justifiable. State tax policy too often reflects a faith in government to rectify every inequity. The frequency of proposed targeted tax cuts is the scourge of good tax policy but one wonders how
Brunori is especially critical of targeted tax cuts enacted by states in order to promote job creation. On this score, one wonders if he would be equally critical of the federal tax policies ingrained in Democratic party platforms and speeches, not to mention such beloved and time-honored tax breaks as the home mortgage deduction and the Earned Income Tax Credit.
Scholars generally eschew a tax regimen in which states compete for business by conducting a “race to the bottom,” offering one tax break after another until they've jeopardized their ability to fund needed services. There is a movement afoot that would invoke the Commerce Clause to prevent interstate competition of this kind.
As Brunori reminds us, however, interstate competition overall is desirable because it promotes innovation, efficiency and responsiveness. And states can increase their competitiveness by keeping their taxes broad based. On the other hand, a tax cut for a specific industry such as defense or financial services in one state is far inferior to a tax cut applicable to all businesses and all taxpayers, suggests Brunori. Unfortunately such narrow, targeted incentives are multiplying across the nation.
The federal government and most states have proscribed taxes on Internet sales, in part because of the administrative problems that arise when one state attempts to tax the sales of another and in part out of a policy of keeping state taxes low. But a policy of exempting Internet sales from taxation violates the principle that taxes should be broad based and hence, “neutral.” According to the Center for Business and Research at the University of Tennessee, state and local governments can expect to lose more than $54 billion in sales tax revenue because of cross-border Internet sales.
Some might argue, then, that given the nature of digital commerce, it might just be easier for the federal government to preempt the states by levying a federal sales tax. Doing so would increase simplicity and neutrality but would eliminate the interstate competition that keeps tax rates low. And so goes the debate.
The shift toward targeted tax cuts and Internet avoidance may induce legislators to shift the burdens onto personal income taxpayers. In 1998, personal income taxes surpassed sales taxes in as the leading source of revenue for the states. While Brunori largely ignores the economic effects of stiff income taxes upon production, he acknowledges the public's new-found intuition that higher personal income taxes place their states at a competitive disadvantage. He writes: “An economy built on mobile capital and intangible property is subject to much greater interstate competition than a manufacturing-based economy. High-technology companies and service firms can relocate to other states at much less cost than can traditional manufacturing companies.”
As his subtitle points out, Brunori's book is about politics. But here his analysis falls short. Brunori places far too much trust in state legislatures following David Broder's noted critique of ballot democracy and the proliferation of voter initiatives across the United States. “The greatest limitation of direct democracy, however, is that it requires an up or down vote on tax policy measures. Voters must decide to approve or to reject a proposal. There is no room for compromise and no mechanism for negotiation.” But given the self-interest of legislature toward growing government, some tax limitation issues decided at the ballot box provides the kind of certainty legislature lack. This is a virtue.
Drafting sensible state tax policies may be a thankless job. Most state tax systems were established during an earlier industrial age. Tax reform needs to be addressed honestly with an eye toward both preserving American federalism and encouraging market economies. Brunori's exhortation may be a triumph of hope over experience given the nature of politics. But he's written a thoughtful, worthwhile primer on an increasingly important subject.
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NewsLink is the quarterly newsletter of the Beacon Hill Institute for Public Policy Research at Suffolk University. © 1996-2000. All rights reserved.
This page was updated on 9/9/02 8:49 PM
