Mises Daily Articles
Abolish My State’s Income Tax (Please!)
I have written here about Alabama's tax structure in the past, noting that charges of its regressivity are vastly overstated, compared to other states. Specifically, poverty analyses that overlook the state's relatively lower housing costs, which most of them do, should be ignored. Such analyses are presented by organizations more intent on making partisan points with the overall goal of increasing the state's tax take, on the assumption that higher taxes today lead to higher levels of prosperity tomorrow.
But this just ain't so. If it were, then states with larger government sectors would today be in better shape. Instead, it is precisely those states that are today in the worst fiscal shape. California continues to lose segments of its productive sector to other states with lower tax and regulatory regimes, a trend that will continue as long as its governor promotes tax hikes and the union sector.1 Then there's Illinois, which is bleeding firms and may even see Caterpillar Inc. shutter its operations in Peoria and relocate to more business-friendly environments.
New York and New Jersey are facing enormous fiscal hurdles, too. Indeed, those states that today are dealing with the worst fiscal realities made obvious by the Great Recession are the very ones that Alabama's more (so-called) "progressive" thinkers argued ten years ago that we needed to emulate. (Anyone exposed to the commentary of the Retirement Systems of Alabama's newsletters knows to what I am referring.) Instead, the economic performance of the CINN states (California, Illinois, New York, and New Jersey) in particular illustrates the shortcomings associated with assuming that long-term economic growth is somehow tied to an expansive state-government sector and a protected (and politically active) public-sector teacher workforce.
That Alabama, for various reasons, has been able to reject attempts to expand its regulatory and tax structures has been the primary reason for its weathering the ailing economy since 2008. Although the state has been adversely affected by the national housing bubble, housing prices within Alabama avoided the unsustainable Fed-fueled boom. Fewer Alabamians are under water today as a result, while more find it easier to take advantage of economic opportunities without feeling anchored by a house they can't sell. Meanwhile the capital and labor the state has been able to attract over the last 15 years has resulted in a more diversified economy that survived the downturn better than it otherwise would have.
While this is all for the good, there is still much room for improvement. Currently, Alabama is dependent on federal spending, receiving about $1.65 from that spending for every $1 it pays in taxes.2 A more independent, dynamic, and growing state economy would be less tethered to federal spending programs, while retaining productive citizens who are currently moving elsewhere to take advantage of more favorable economic opportunities.
The state legislature has a historic opportunity to make significant structural changes that were not possible during previous sessions. To maximize the long-term economic growth of the state, it should act now to make changes that have the overall effect of lowering barriers to the movement of capital and labor and developing the Heart of Dixie.
The best place to start is reforming its tax structure.
Currently, Alabamians are taxed mostly on their purchases, property, and income. While property taxes are quite low relative to other states, raising such taxes directly affects the poor, who can least afford tax increases, as well as a productive sector that is forced to transfer funds that would otherwise be used for wealth creation into a wasteful public sector. Such taxes should actually be lowered, but, in the absence of that, the legislature should end the practice of annual tax assessments that began in the last decade.
Sales taxes on purchases should be lowered as well, but the likelihood of this having a significant effect on costs of living is minimal given the prevalence of local tax assessments added to the state tax. As the table below shows, Alabamians pay the fourth highest in sales taxes when local taxes are included. Since the legislature rightly has little control over local tax decisions, reducing these taxes is beyond its ability. I would point out that the assumption that Alabama is a low-tax state is based mostly on its property taxes. However, the assumption does not hold up when sales taxes and fees are included in measures of the overall tax burden. When they are, Alabamians are not taxed that differently from citizens in neighboring states, and they in fact pay more in sales taxes than the average New Yorker.
|State||General Tax||Plus Maximum Local Surtax|
This leaves income taxes, the primary opportunity for this particular legislature to enact change. Alabama borders two states without state income taxes, and it makes sense that these states have attracted more capital and labor over the long run relative to Alabama. This is basic, principles-level microeconomics at work, in which the quantity demanded of a good falls when its price increases, while the quantity demanded increases when its price falls. Since income taxes increase the price of labor, we witness less labor flow to states with income taxes than to those without them.
The legislature should abolish the state income tax, which would make Alabama the fourth Southern state to do so.3 Besides the economic benefits that would accompany the removal of this tax, there are strong moral arguments to be made as well. Institutionalized violence is the essence of every political system, and it necessarily increases as the federal government increases its tax take, both directly and through inflation, to cover long-term liabilities that show no signs of abating.
It becomes imperative, therefore, that states adjust the costs they impose on their citizens to compensate. What's more, abolishing the income tax would not only be hugely popular among Alabamians (if only because it would remove a major source of coercion and compulsion from their lives). It would also reflect a significant break from the state's populist past.
As the Chinese might say, these are interesting economic times. But the Chinese also note that crises often bring opportunities. Alabama's legislature should take advantage of the current economic situation to bring about significant changes to the state's fiscal architecture. This could that relieve onerous and unnecessary burdens inconsistent with a free society, and promote Alabama's long-term economic development. These changes should start with the income tax, in the recognition that the people withdraw their consent.
After all, power concedes nothing without a demand.
- 1. Chief Executive recently reported the results of their 2011 survey of 550 CEOs from across the United States on the best and worst states in which to conduct business. California was ranked 50th, with numbers 46 through 49 being, respectively, Michigan, New Jersey, Illinois, and New York. Texas came in first, while Alabama ranked 26th.
- 2. Data on the flow of federal funds to the states are collected by the Northeast-Midwest Institute.
- 3. In the aforementioned Chief Executive survey, three of the top five states in which to conduct business were states without income taxes. Besides Texas, Florida and Tennessee were ranked third and fourth, respectively.