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If
you want to spend more money on state and local
government programs like education and
transportation, you basically have two options:
Raise taxes or expand the tax base through economic
growth. Of the two approaches, economic growth is a
whole lot more fun.
Former
Gov. Jim Gilmore stressed the virtues of a growing
tax base two years ago when addressing the Governor’s
Commission on Government Finance Reform for the 21st
century:
The
old philosophy advocated impetuous tax increases to
pay for the latest and shiniest government program,
while the new paradigm relies upon steady economic
growth to generate tax surpluses to fund our most
pressing priorities. … The key to our success has
been economic growth.
It’s
a shame that the gush of tax revenue from the
Internet bubble was, at that very moment, slowing to
a trickle. Too bad, too, that the Gilmore
administration didn’t see the revenue bust coming
– or, if it did, that it chose to obscure the
looming shortfalls to provide political cover for
Republican nominee Mark Earley in his
behind-in-the-polls race against Mark R. Warner. By
the time Warner moved into the governor's mansion,
the state’s finances were in tatters.
Now, as Warner and senior legislators take a hard
look at reforming the state’s tax structure,
nobody but nobody is quoting Gilmore.
That’s
Virginia’s
misfortune. Even if his execution fell woefully
short, Gilmore had the right idea:
The best way to fund vital state programs without
stifling the economy is to expand the tax base. Virginia
needs to hold a conversation on what kind of tax
structure will accomplish that goal. But no such
discourse is taking place. As outlined last week
(“A 19th
Century Tax Code for a 21st Century
Economy,"
May
5, 2003
),
Gov. Warner is sounding the theme of
“fairness,” while the General Assembly is
mending the frayed edges of the tax code, not
contemplating a structural overhaul.
It
would come as no surprise if Warner shared skepticism
about a philosophy that Democrats deride as “trickle
down economics.” But you’ve got to
wonder about the General Assembly Republicans, who
have as much say-so as the governor in the outcome
of tax reform. Does anyone in the majority party
remember Ronald Reagan and his supply-side
revolution? Does anyone notice that President George
W. Bush is pushing for $700 million in tax cuts? The
federal government has the luxury, of course, of
running deficits, which the Commonwealth
of Virginia
does not.
But there’s little evidence that anyone
in
Virginia
is giving the slightest thought how to update
the state's antiquated tax structure with a
pro-growth agenda.
Let’s
assume, for purposes of argument, that restructuring
the tax code could add ½ of one percent to Virginia’s
annual rate of economic growth – an entirely
reasonable supposition given the enormous variability
in state growth rates. A higher growth rate
would add close to $100 million a year to state and
local coffers the first year, $200 million the
second, $300 million the third, and so on. After a
decade, we’re talking pretty serious money:
roughly $1 billion a year.
It's worth the effort.
So,
what does a pro-growth tax structure look like?
First, it cuts state and local taxes that
inhibit entrepreneurial activity, business
investment and wealth creation, and replaces them
with taxes on consumption. Second, it’s revenue
neutral in that it doesn’t try to boost revenues
through a back-door tax increase.
As
an aside, I would add two cautionary notes. From a
“fairness” perspective, a pro-growth tax
structure should not reduce taxes for the affluent
by increasing the burden on the poor. Furthermore, any
restructuring should not lighten the load on state
taxes by shifting the weight to the localities, or
vice versa.
That
said, here’s
my take on taxes that should be cut:
Spike
the corporate income tax.
The tax brings in a surprisingly small amount of
revenue – only $364 million in 2001, compared to
$7.1 billion in personal income taxes. Abolishing
the tax, as
Washington
(state), Nevada
and Wyoming
have done would send a strong signal that
Virginia is a favorable location for established businesses.
Northern
Virginia
has emerged as a national center of corporate
headquarters; Richmond,
a strong regional corporate center, recently
convinced Philip Morris USA to relocate its
divisional H.Q. to the city. Zeroing out the
corporate income tax would make these regions, and
others in
Virginia,
even more attractive
to corporate headquarters
facilities.
Abolish
BPOL.
Business lobbies consistently rate local business
occupational license taxes as among the most odious.
These taxes raised $454 million for localities in
2001, but they stifle business growth at an early,
and fragile, phase of their development. Ridding
this burden would accelerate the growth of
entrepreneurial growth companies, the economy’s
dynamos.
Eliminate
machine and tool taxes.
These taxes on industrial equipment, which raised
$203 million for localities in 2003, discriminate
against the manufacturing sector. Manufacturing is
critical to
Virginia’s
economy, especially in small cities and towns: As a primary business sector, it
still employs
hundreds of thousands directly, and supports
hundreds of thousands more indirectly. I can think
of no legitimate reason for singling out
manufacturers to pay taxes for which other
businesses have no counterpart
Repeal
the death tax.
The state tax on estates yielded $123 million in
2001, but there are compelling reasons to get rid of
it. First, for various technical reasons, the phase-out
of the federal tax will reduce Virginia’s
take from the state tax by half over time anyway.
Second, refusal to eliminate the state tax will put
the Old Dominion in a competitive disadvantage
compared to states that don’t tax estates.
Predictably, many wealthy people will establish
domiciles in estate tax-friendly states to avoid
paying a tax to Virginia upon their death; as long
as they're alive, they'll be paying their income
taxes there as well. The loss to Virginia in income
taxes could be significant.
Third,
as luck would have it, Maryland
and
Washington,
D.C.,
are maintaining their estate taxes. Euthanizing Virginia’s
death tax would make the Commonwealth attractive for
residents of those locales. If wealthy
Washingtonians move to tony neighborhoods across the
Potomac, the state could enjoy a revenue boost from
its income tax. (I examined this issue in some depth
in “Do
the Math,” March
20, 2003.)
Finally,
in combination with the abolition of BPOL and
corporate income taxes, burying the death tax would
send a clear message that Virginia
loves entrepreneurs – the people who create
wealth, hire people and expand the tax base.
Add
it all up, and the tax cuts come to about $1.1
billion – less than 6 percent -- of the $19
billion in state-local taxes raised in 2001.
Under
a tax-neutral formula, if you cut taxes in one
place, you have to raise them somewhere else. Where
does the money come from? Here are some places to
start looking:
Tax
exemptions.
Between 1995 and 2001, according to the Warner
administration, the state has created dozens of
sales, corporate and income tax exemptions – none
of them terribly significant individually – that
collectively bleed $600 million from the tax base
every year. The special treatment of favored
categories of individuals and companies serves no
broad public purpose. (See the Loophole
list here.) The state should
eliminate most of them.
Energy
tax.
A tax on energy consumption – electricity, natural
gas and gasoline – is similar in concept to the
carbon tax touted as a remedy for global warming. In
theory, taxing energy consumption would encourage
businesses and individuals to conserve, thereby
reducing emissions of carbon-dioxide and diminishing
the threat of global warming. You don’t have to
buy into the
tendentious tenets of the Kyoto
Treaty, however, to recognize that taxing energy
consumption is a good idea. By encouraging
conservation, an energy tax would offer Virginians
two tangible benefits: (1) It would reduce
low-atmosphere ozone, acid rain and other forms of air
pollution; and (2) it would insulate Virginia’s
economy from fluctuations in energy prices.
Energy
taxes would be bad for the economy if they were
imposed on top of existing taxes. But they
would be beneficial if they substituted for
BPOL and corporate income taxes. Taxing energy means
taxing consumption, not wealth creation. As a bonus,
energy taxes can be levied locally, making up for
local BPOL and machine-and-tool taxes.
Cigarette
tax.
Virginia
has the lowest cigarette tax in the country, 2.5
cents per pack, a rate that translates into roughly
one percent. Now, I’m not one to demonize the cigarette industry and tax it
out of existence. That would be churlish in light of
Philip Morris USA’s recent decision to move its
divisional headquarters to Virginia.
But raising the state cigarette tax to, say, the second
lowest rate in the country, North Carolina’s,
would double the revenue, bringing in another $15
million or more annually.
A cigarette tax, it's also worth noting, fits my key
criterion of taxing consumption -- in this
case, consumption of something that we'd all be
better off without.
Finally,
a word about the car tax. Viewed through the prism
of its impact on growth, the car tax really isn’t
so bad. It taxes consumption, not wealth creation.
The more conspicuous the consumption, typically in
the form of expensive foreign cars, the higher the
tax. Also, as I have argued before (See "Car
Tax Lotto," March 17, 2003), the benefits
are spread arbitrarily: The phase-out rewards
affluent and high-tax localities at the expense of
poorer, rural counties. The state should scrap the
car-tax legislation and let localities tax vehicles, or
not, as they please.
If
lawmakers want to provide tax relief to Virginia
citizens, they ought to reform state income tax
instead. Why not adjust the tax brackets,
topping out at a mere $17,000, which haven't been
updated since 1926? Jacking up the top
tax bracket to, say, $47,000 would
put $225 back into the pocket of a typical taxpayer
-- as much as repealing the car tax. But the benefit
would be spread far more evenly across regions and
income groups.
Taken
collectively, the proposals listed here are radical
indeed. They would launch Virginia
on an entrepreneurial growth path that rewards
creativity, innovation, industry and risk taking.
Growing businesses would put more Virginians to work
and create higher-paying jobs. When Virginians make
more money, they pay more in income, sales and
property taxes. The economy expands. Incomes grow. The pie gets
bigger. Everybody wins.
Next
week, in the third installment of my series on tax
reform, I will show how restructuring the tax code
can address Virginia's "structural
deficit" by promoting more efficient patterns
of development.
--
May
12, 2003
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