RALEIGH -- Having devoted quite a bit of ink -- or, I guess, make that quite a bit of pixels -- to arguing against targeted tax breaks, government subsidies, and other flawed incentive policies, I now find myself in the interesting position of endorsing one of the ideas reportedly to be consider Tuesday during a special legislative session on economic development.
The idea is to eliminate the retail sales tax now applied to materials such as concrete and lumber used to build manufacturing plants. Gov. Mike Easley and legislative leaders are apparently hoping that this move will help to sweeten possible deals with Merck to build a pharmaceutical plant in Durham and with Boeing to build its 7E7 manufacturing facility at Kinston's Global TransPark.
All fine and good, if it comes to that. But I don't think the General Assembly should exempt such purchases from the sales tax as some sort of special gift to these two companies. Rather, I think it is demonstrably good tax policy to reduce or eliminate multiple layers of taxation on the same transaction or stream of income, and that North Carolina's retail sales tax should never have applied to business inputs such as construction materials in the first place.
In actuality, North Carolina doesn't have a retail sales tax, not really. A true retail sales tax would apply a (preferably low) uniform rate to the sale of all goods and services to end-consumers -- and only to those sales. If a business purchases an input, say a raw material or a piece of machinery, and then produces a good that is subject to the retail sales tax, it should not also be compelled to pay a sales tax on the input. From an economic point of view, businesses are simply tax collectors. When faced with a tax or fee, businesses collect money from customers, workers, or investors/owners to pay the government. While there is some disagreement about this, most economists believe that businesses primarily end up collecting transaction-related taxes from consumers in the form of higher prices while collecting employment-related taxes from workers.
To return to our sales-tax example, a business that is compelled to pay taxes on its inputs will likely include that amount in the price charged to consumers. If the latter then must also pay a retail sales tax on the product they buy, they are being taxed twice.
So what? you might ask. Since we are all end-consumers of some basket of goods and services, wouldn't we all just end up paying a roughly proportional amount of our consumed income to the government, regardless of the mechanism by which that income is collected?
No. Some production processes are more "roundabout" (to adapt an old Austrian-economics term to my purpose) in that they involve kinds of capital investment, more steps, and more time. If businesses must purchase a variety of goods before they can produce their particular good or service, their consumers will pay more real tax than others purchasing other products. This is called a "cascading tax" effect, and won't likely be simply accepted by producers and consumers of those products lying down. Instead, such biased tax policy will encourage those industries to become integrated -- to produce as many of their inputs as possible in-house -- so as to escape multiple layers of taxation and thus be price-competitive in the market.
While issues such as tax cascades and artificial integration wouldn't seem to matter much at very low levels of taxation, countries that rely on a retail sales tax for a significant percentage of state and national revenues have faced these challenges for years. And even at low rates, the principle is the same and the effects are similar if proportionally smaller.
Of course, I don't really expect the sales-tax exemption proposed in the General Assembly Tuesday to constitute a reasonable application of the principle I just explained. If it carves out special exemptions just for Merck or Boeing, or just for a small class of businesses, or tries to get around legislative rules by making the change an appropriation rather than a tax change, I'll reserve the right to object.
I'll probably be in that kind of mood, anyway.
Hood is president of the John Locke Foundation and publisher of Carolina Journal.