Last week, NTUF was down in Columbia, South Carolina. State Senator Sean Bennett has put together a series of hearings focused on figuring out what comprehensive tax reform would look like, and how to do it.
It’s an ambitious and laudable goal, but also often a thankless one. There’s a lot of baked-in incentives in politics not to rock the boat, even when the boat could use a little rocking. Legislators who are willing to start some of these tougher conversations deserve more credit from those of us in the policy space, particularly because they aren’t always thanked for it at the ballot box.
Ten Principles of Tax Reform
We were one of a few groups at the table for this discussion, which was candid, thoughtful, and hopefully productive. But, interesting as South Carolina and its unique circumstances are, I wanted to share some of the broader tax reform first principles that I led off the discussion with, in hopes that they can act as a foundation for anyone looking to do more than nibble around the edges of their tax code who doesn’t know where to begin.
1. Start with a plan that acknowledges and anticipates trade-offs. Some of the most disastrous tax reform efforts of the past few decades have gone off the rails because lawmakers tried to keep the easy stuff and drop the hard things. Be prepared to handle pushback without compromising the central goals of reform.
2. The goal should be broad bases and low rates. A narrow tax base picks winners and losers, distorts economic decision-making, and subjects the state’s budget to greater revenue volatility. A broad base, on the other hand, allows for rate reductions.
3. Not all taxes are created equal. The amount of revenue raised from a tax is not necessarily a good indicator of the economic harm created. A tax on employment might raise the same amount of revenue as a tax on consumption, but the economic harm from the former will likely be far greater.
4. Use well-designed triggers for major, long-term rate reduction efforts. Triggers allow a state to use long-term economic and revenue growth to fund rate reductions, without needing to replace a major revenue source overnight. Using triggers, states can signal a goal of tax competitiveness while also assuring taxpayers that the goals are not fiscally reckless.
5. The liability is not the only cost of a tax. Tax reform is not only beneficial to taxpayers if it results in the state collecting less revenue. Compliance burdens, technical errors, and hostile tax administration can all impose economic and financial costs on taxpayers without changing what they actually owe. Tax reform can be revenue-neutral and still save taxpayers time and money.
6. Keep an eye on the competition. Far more so than at the federal level, states are constantly, whether they know it or not, competing to attract new residents and businesses. Competitive states attract taxpayers and businesses from other states, strengthening their tax bases. Uncompetitive states, on the other hand, find themselves needing to raise taxes on residents who are left, accelerating the vicious cycle of outmigration.
7. Don’t let the tail wag the dog. Budgeting should not start with spending goals and finding the taxes to pay for them. Instead, budgeting should begin with finding what the state can sustainably raise from taxes, with what to spend following from that baseline.
8. Avoid the trap of using taxes to solve non-fiscal problems. Increasingly, policymakers at all levels of government have begun to conceptualize taxes as something to target at politically-disfavored groups for purposes other than raising revenue. Government has plenty of other blunt instruments for correcting social ills—using taxes generally just results in bad tax policy.
9. Craft a tax code that works for tomorrow as well as today. Don’t pursue tax reform imagining that the economy of today will look anything like the economy of the future. Here again, a broader base will protect against overreliance on industries or classes of taxpayers that may look different in the future.
10. Be prepared to educate and advocate. Having the right ideas and goals isn’t enough if taxpayers don’t believe in them. Be prepared to convince taxpayers why tax reform will benefit them, or whatever changes you make will not last.