RALEIGH – Gov. Mike Easley surprised some lawmakers and political observers last week by including some $110 million in sales-tax increases (actually $140 million when fully implemented in FY 2006-07). The proposal shouldn’t have come as a surprise, given that Easley administration officials has telegraphed for months their interest in expanding the scope of the sales tax one way or the other.
For its efforts, the administration is drawing criticism from a variety of commentators who say either that the sales-tax changes are not really what was advertised – a streamlining of North Carolina’s system to comport with an emerging national standard – or would unfairly continue a shifting of the tax burden towards the lower end of the income distribution.
Neither criticism is precisely on target. On the other hand, the governor’s choices here, and the way he chose to defend them, were also flawed. The entire brouhaha serves as a useful example of why it is critically important to ground public-policy discussion in fundamental principles, to deduce specific proposals from general goals rather than try to justify ad hoc decisions after the fact.
There is no doubt that North Carolina has some important tax-policy decisions to make. We do not rely on the retail sales tax to the extent that other states do, so the potential for Internet purchases and growth of the service economy further to erode our tax base is not as great as it is in other states. Nevertheless, the potential exists. Retail sales taxes were first imposed in the 1930s when far more money was spent on personal goods (taxed) rather than personal services (not taxed).
Furthermore, while our system is called a “retail” sales tax, in practice it has traditionally applied to many non-retail transactions, such as business purchases of machinery and materials. This is a basic error, with deleterious consequences. If the goal is equality, you have to exempt business inputs from tax if you are going to tax the sale of the output. You also have to levy the same rate on all taxable goods.
Both goals are advanced by Easley’s proposals. If we are going to retain the sales tax, it makes sense to apply the same tax rate to all goods sold at retail, and only those at retail. As for services, again if we are going to retain the sales tax, it makes little sense to differentiate between retail goods and retail services. Thus the application of tax to purchases of entertainment and phone service makes sense – theoretically.
But practically and fiscally, the governor’s policy remains unwise. I doubt that grandiose plans for a national, “streamlined” sales tax will ever come to fruition, or that if it did the result would be to capture the bulk of online purchases within the sales tax. Nor do I think that expanding the scope of the sales tax to services, which could be done without gouging taxpayers by reducing the tax rate accordingly, will actually be accomplished in a sensible manner.
There is no requirement, in other words, that you have to “reform taxes” or “equalize rates” in a way that raises the overall tax burden. You could reduce higher tax rates, rather than raising lower ones. But this governor and legislature aren’t going to do that. A better approach, in my opinion, would be to phase out the sales-tax system and rely on a reformed income tax that applies to “consumed income” – to all income from which net savings are subtracted. By definition, the remainder consists of all household purchases of good and services. That’s the same tax base the sales-tax reforms are supposed to construct, but won’t.
Thus, my view is that Easley’s sales-tax expansions are bad policy, but not for the reasons other cite. They are bad policy because they attempt to preserve an archaic taxing system – and because they raise North Carolina’s tax burden. Perhaps the legislature will counterpropose with something more desirable.
And perhaps I am the next Dalai Lama.
Hood is president of the John Locke Foundation and publisher of Carolina Journal.com.