RALEIGH – As a follow-up to last week’s discussion of the progressivity of the tax code, I call your attention to a story in yesterday’s USA Today. It compares the haul from the main sources of revenue for state and local governments.
What’s the form of taxation that generates the most revenue for states and localities? Since the 1970s, it’s been the sales tax. Before that it was the property tax. Now, it’s the income tax – if you combine revenue from state or local income taxes and surging federal subsidy, most of which derives from the federal income tax.
As of early 2009, federal funds are now the single-largest revenue source for state and local government. One of the many deleterious effects of Bailout Nation is to erode further the relationship between finance and responsibility. Just as federal corporate bailouts spare business owners, lenders, and employees the consequences of their decisions, so federal bailouts of states and localities spares elected officials the responsibility of having to raise the taxes they directly control to finance their spending binges of the past two decades.
Separating the decision to tax from the decision to spend is not a good policy response to past fiscal mismanagement. It will only guarantee future fiscal mismanagement.
It is true, however, that substituting federal income taxes for sales and property taxes will have the effect of making the overall tax code more “progressive,” in North Carolina and elsewhere. While self-styled progressives like to attach the label to all of their pet schemes for transferring power from private individuals and voluntary associations to the coercive State, the plain fact of the matter is that steeply “progressive” tax systems, better labeled as punitive tax systems, are backward, immoral, and counterproductive.
They are backward because they harken back to the crude populist appeals of the late 19th and early 20th centuries, when quasi-socialists sought to mobilize displaced farmers, urban workers, and recent immigrants into national movements to adopt European-style welfare statism in America. Elements of their program succeeded, particularly during World War I and the Great Depression (national crises typically give politicians new instruments of social control that they are loathe to surrender after the guns fall silent and the business cycle asserts itself).
Punitive tax systems are immoral because they encourage the sin of envy and fail to treat all individuals as equal citizens of a constitutional republic. It is entirely reasonable to argue that the overall amount of tax citizens pay should rise according to their standard of living – which acts as an indicator of how much benefit they derive from the existence of order, the rule of law, and certain other public goods. But that principle should lead you to conclude that if someone’s standard of living is, say, twice as high as yours, he ought to pay twice as much in taxes as you do. It argues, in other words, for a tax system that is roughly proportional.
Punitive tax systems don’t follow this principle. They punish highly productive entrepreneurs, investors, and professionals with ever-higher marginal tax rates. As James Madison famously observed: “The moment you abandon the cardinal principle of exacting from all individuals the same proportion of their income or of their profits, you are at sea without a rudder or compass and there is no amount of injustice and folly you may not commit.”
Finally, punitive taxes are counterproductive because they discourage economic growth over time and set the stage for the boom-and-bust cycle that characterizes state finances in North Carolina and elsewhere. When times are good, households get kicked into higher tax brackets, increasing revenue collections faster than income and bestowing “windfalls” on legislators that they invariably use to create new spending obligations. When times are tough, households fall into lower tax brackets, so that revenues drop faster than incomes. Budget deficits result, invariably followed by hikes in marginal tax rates.
We need to be working our way out of this thicket, with real tax reform, not pushing our way further into the thicket with federal bailouts.
Hood is president of the John Locke Foundation