CHARLOTTE – I’ve previously said that I expect the 2007 session of the North Carolina General Assembly to feature major discussion of big issues – that is, big budgets, big bonded debts, possibly big taxes to pay for it. With regard to the issue of tax reform, however, I fear that neither state lawmakers nor Gov. Mike Easley are willing to think big enough. With even embattled President George W. Bush willing to propose a sweeping (and mostly welcome) change in federal tax policy on health care, it seems a shame that our state leaders can’t rise to the occasion and take some risks in pursuit of rational and growth-enhancing reforms.

The broad outlines of fundamental tax reform have been sketched in this space and elsewhere in the past, but it’s worth restating them in a slightly different form today. Essentially, North Carolina needs to levy state and local taxes that are as simple, fair, neutral, and light as possible to finance basic public services such as law enforcement, education funding, human services, and transportation. Indeed, the characteristics of the program in question should help to guide the form of taxation used.

There are two broad categories of services traditionally carried out at the state or local level of government. Think of them as the two Es: entitlements and enterprises. Entitlements are those goods that citizens have a right to simply by virtue of being citizens. Most everyone would agree on some entitlements, such as public safety and environmental protection. These are core functions of government, which use coercive means (taxes and rules enforced if need be by guns) to protect our individual rights against encroachment. Disagreement rises when you include items such as education funding and public assistance programs, which some believe should be purely voluntary transactions (using either fee-for-service or charitable contributions) and others believe should be considered rights and have at least some amount of taxpayer subsidy.

For the sake of argument, let’s stipulate that the current mix of entitlement programs will be maintained for the purposes of deciding which taxes are best to fund them. The vast majority of the state budget, then, would be considered entitlements: public education, prisons, Medicaid, etc.

Enterprises, on the other hand, are essentially businesses that governments operate based on the notion, whether real or spurious, that there is some economic reason the private sector cannot efficiently perform the service. For example, while limited-access highways began life in America as toll roads, and in an increasing number of cases are being built or renovated using electronic toll collection, it has traditionally been seen as unworkable and inefficient to attempt to charge users directly for the use of arterial roads and city streets. Instead, government acts as a monopoly provider and then charges a rough “fee” for using the road system in the form of a tax per gallon of motor fuel. Other examples of government enterprises include water and sewer service, professional certification, and arts and recreation programs.

Again, setting aside the wisdom of the government doing all these things at all, I think a strong argument can be made that taxpayers should bear the cost of entitlements in proportion to their standard of living, but should bear the cost of enterprises in proportion to their use of services through the use of tolls and other charges. Therefore, because I would submit that the best way to measure one’s standard of living on an annual basis is one’s purchase of goods and services during that year, we should pay for most state government with a flat-rate, broad-based tax on consumption. If you spend three times as much as I do buying food, clothing, shelter, and other goods and services, you should pay close to three times as much as I do in entitlement taxes. For technical reasons, my colleagues and I have argued that the best way to accomplish this is by reforming the income tax system rather than junking it in favor of a true retail sales tax, but in economic terms the tax base would be essentially the same. Properly structured, this flat tax would eliminate the regressivity of the current tax code, which hits lower-income North Carolinians disproportionately because of reliance on a screwy and outdated sales tax that applies to goods but not services.

Don’t like this approach? By all means, policymakers, come up with something else that makes rational sense and promises to reduce the bias, uncertainty, and economic distortion of the current system. But don’t just raise taxes in the most politically palatable way and then call it tax reform.

Hood is president of the John Locke Foundation.