NCPA - National Center for Policy Analysis

An Effective Way for States to End the Federal Income Tax

July 9, 2015

In Texas, taxes on income are against the state constitution. However, Texans still pay the federal income tax. For achieving a genuine transition away from federal income taxation, state governments could change the way federal taxes are collected, says Ryan Murphy of the Cato Institute.

In principle, the state could effectively end the federal income tax by using two surprisingly simple and straightforward legislative maneuvers. Texas could choose to send each taxpayer a check in the form of a state tax credit equal to their federal income tax liability. It could then pay for the credit by increasing the state sales tax in a revenue-neutral way. Effectively, that would mean the end of all income taxes in the state while significantly raising sales taxes. This isn't about cutting taxes; rather, this is the tax swap to end all tax swaps.

The real difference between a consumption tax and an income tax is that a consumption tax encourages saving and thrift. We have good reason to believe that discouraging saving -- and therefore investment -- has significant negative effects on growth. There's no good reason to structure the tax code in such a way that it encourages using income on immediate consumption. If anything, we should raise revenues in such a way that discourages activities we think are harmful, not ones that are socially beneficial like saving.

Sales taxes are regressive, especially in comparison to progressive income taxes. But combating income inequality -- or, far more importantly, poverty -- should not impede this tax shift. Orthodox neoclassical welfare economics tells us to raise revenue in the most efficient way and to address distributional concerns in the most efficient way. That means consumption taxes followed by either wage subsidies or guaranteed minimum incomes for the poor.

Source: Ryan H. Murphy, "How States Can Effectively End the Federal Income Tax — and Why They Should," Cato Institute, Summer 2015.

 

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