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GHEI: Growth without taxes

States look to encourage jobs by dumping levy on income

- - Monday, January 21, 2013

Washington has given up on fundamental tax reform. That leaves it up to the states to experiment with better ways of funding government operations. Louisiana Gov. Bobby Jindal, Nebraska Gov. Dave Heineman and state legislators in North Carolina have all recently come up with plans to eliminate state income taxes.

Kansas Gov. Sam Brownback eventually wants to follow his GOP colleagues with a sales tax entirely replacing the levy on income. In his State of the State address on Tuesday, he called for income tax cuts as a start. "While others choose to raise taxes, we will lower them so our people have more money, not the government," said the Republican chief executive. "Where others choose to grow spending, Kansas grows jobs."

The plans sound radical, but they're rooted in sound economic policy. A study by Cornell's Karel Mertens and University College London's Morten Ravn, soon to appear in the American Economic Review, establishes the link between cutting taxes and increasing growth. They found a 1 percentage point cut in the personal income tax can yield up to 1.8 percent growth in economic output after three quarters. Likewise, cutting corporate income taxes by 1 percent can yield 0.6 percent growth after a year. Other studies, as surveyed by the Tax Foundation's William McBride, confirm the destructive effect that corporate and income taxes have on investment and hard work. Even Christina Romer, President Obama's former economic adviser, realizes this. She co-authored a study that found a 1 percent increase in federal tax revenue leads to a 3 percent drop in gross domestic product after two years.

The relation between taxes and growth is the same at the state level. The Civitas Institute recently examined North Carolina's tax reform plan and found residents would be $14 billion richer today had the Tar Heel State switched to a sales tax in 2000. Another 217,000 would be employed in North Carolina, as well.

The shift to sales taxes does raise concerns of fairness since poorer people expend a larger share of their income on essentials like food. According to the Civitas study, the burden of the sales tax is quite similar to that of income taxes, with higher-income households paying more because they spend more on consumption of goods, in dollar values. While a broad-based sales tax makes the most sense from an efficiency perspective, exempting food and items such as out-of-pocket medical expenses from the sales tax would push the required rate from about 6.5 percent to just over 7 percent while maintaining revenue neutrality in North Carolina. The key to success is to minimize such exemptions, preventing the onslaught of interest groups seeking special treatment from undermining the positive impact the tax system change would have on growth.

Currently, seven states, including Florida and Texas, have no income tax. The exploration of various tax alternatives is a testament to the advantage of the federalist system, as states that make the right choices will be rewarded with economic growth. Lawmakers on Capitol Hill should watch closely so they can implement the reforms that work.

Nita Ghei is a contributing Opinion writer for The Washington Times.