Friday, February 10, 2006

Pandering to the Rich

Today, the WSJ had a predictably favorable editorial (behind a paywall) (Hat Tip: TaxProf) on a proposal in Rhode Island to enact a flat income tax. The story has a sort of man-bites-dog slant, since the proposal is being promoted by the Democratic leadership in the Rhode Island House. According to The Providence Journal, the tax change will "primarily benefit the relatively small proportion of Rhode Islanders who make more than $250,000 a year."

According to figures compiled in 2003, the tax structure in Rhode Island is extraordinarily regressive, with the lower fifth of all taxpayers paying 13% of their income in state taxes, but with the upper 1% of all taxpayers having a tax burden of only 6% (after taking into account the federal tax deductibility of state taxes). Of the three types of taxes that were analysed (sales and excise, property, and income), the income tax was the only progressive tax source.

Make no doubt about it: States and localities operate under an extreme handicap when attempting to structure a progressive tax system. Wealthier individuals are generally better able to structure their affairs to take advantage of effective tax rate differentials between states. They are, for instance, more mobile, often not having to live in close proximity to the source of their income. Contrast this with most of those the lower 80% of income earners. If nothing else, they have to live close to their place of employment.

Wealthier individuals also have the ability to have multiple places of abode and to carefully plan their affairs so that they can establish their legal domicile is in lower tax jurisdictions. The growth of the Internet and relatively cheap air travel have only exacerbated this problem, since well-paid managers can work a great distance from "central" work sites.

This is a problem that is not susceptible of a simple or easy solution. To the extent that states and localities have to fund basic government services, there will, to some extent, be a race to the bottom. It's not a race that goes to the swift: States such as Alabama, which have taxes that are both low and regressive, are the "winners" here. Their citizens are the losers.

1 comment:

Anonymous said...

The high tax states are bumping into the economic limits imposed by a mobile, electronic society. The internet puts a limit on sales taxes, while cheap transportation along with cheap and rapid communications put a limit on personal income taxes. High inheritance taxes drive the well-to - do elderly out of states, and they take with them their demand for local services, along with their local bank deposits. High real property taxes may hurt growth and development. This leaves coporate buiness taxes as a key revenue source: along with the growth of double weighted sales factors, or even single factor (sales) apportionment schemes, in an effort not to deter local growth. Furthermore, heavy corporate taxation encourages passthroughs such as LLC's. As you posted, there are no easy answers. The states are simply not in a position to enact a redistributional taxation policy.