Solution of the week: Tax reform
How to reform and improve Nevada's tax structure in a revenue-neutral manner
- Monday, December 3, 2012
Editor's note: Earlier this year, NPRI released Solutions 2013, a comprehensive sourcebook of research and recommendations in 39 policy areas. Now, each week during the run-up to the 2013 Legislative Session, NPRI will highlight one of these as its Solution of the Week. If you would like NPRI to speak to your organization about this or another policy recommendation, please contact Victor Joecks at email@example.com. Solutions 2013 is also available online here.
For decades, Nevada lawmakers have discussed the possibility of tax "reform." Indeed, they have commissioned a growing library of studies to examine tax‐reform possibilities only to later ignore the recommendations of those studies.
It should be noted that Nevada's most prominent fiscal challenges have occurred on the spending side of the ledger — not the revenue side. After all, per‐capita state and local government revenues in Nevada outpace those in four of Nevada's five immediate neighbors. Given this reality, there is little reason to believe that Silver State government suffers from insufficient revenue.
Nevertheless, NPRI recognizes that no tax structure is perfect and that Nevada's taxing system could be improved, on a revenue‐neutral basis, by designing reform around the considerations outlined here.
Tax reform should minimize revenue volatility. Volatility in tax revenues exacerbates the tax‐and‐spend cycle. During periods of economic growth, upward volatility showers legislatures with unusually high revenues. Lawmakers have historically committed these revenues to expand government programs and liabilities, even though such expansion regularly proves unsustainable when economic recession arrives.
When recessions do occur, downward volatility enlarges the deficit between revenues and the inflated spending levels previously committed to by lawmakers during the period of economic growth. Lawmakers have historically responded to this deficit by calling for new or higher taxes — only to once again over‐commit tax dollars as soon as economic growth returns.
The tax structure should be designed to minimize distortions in economic behavior. Taxes that penalize specific behaviors or consumption patterns discourage individuals from engaging in those behaviors. This causes a destruction of jobs and wealth as individuals are pushed away from welfare‐maximizing behaviors and toward second‐best alternatives. For instance, taxes on savings and investments, such as capital gains taxes, discourage individuals from saving and encourage immediate consumption.
Compliance costs should be kept to a minimum. Complicated taxing mechanisms, such as the federal income tax, carry additional costs as filers must devote thousands of man‐hours to understand the tax code and ensure compliance. The Tax Foundation estimates, for example, that compliance costs associated with the federal income tax will amount to $377 billion in 2013 — more than one‐fifth of the total revenue collected from the tax!
Nevada lawmakers should avoid tax instruments that use complex arrays of deductions and stratified income brackets.
Reform should protect tax equity. Taxpayers in similar circumstances should face similar tax burdens (horizontal equity). Taxpayers at different points along the income scale should also face a proportionally similar tax burden to ensure economic efficiency (vertical equity). Tax structures that are either overly regressive or overly progressive can obstruct economic growth.
If lawmakers are to pursue tax reform, it should be on a revenue‐neutral basis. As Solutions 2013 makes clear, current tax revenues in the Silver State are already more than adequate to provide high‐quality government services.
To the extent Silver State governments have failed to deliver high‐quality services, the failure has resulted from poor policy design or implementation. Solutions 2013's recommendations will correct for this.
All four major objectives of tax reform can be accomplished through a revenue‐neutral expansion of the sales tax base. NPRI has laid out a plan for expanding the sales‐tax base with a consequent lowering of the statewide sales tax rate to 3.5 percent and eliminating other taxes, including the Modified Business Tax.
*Less statistical probability; indicating that variability is likely not associated with the business cycle.
**Declining sales in the real estate market preceded the decline in the overall economy, creating the statistical illusion that revenues from this tax instrument are counter-cyclical.
***Volatility values for state corporate income taxes were generated by analysts at the Federal Reserve Bank of Kansas City.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Geoffrey Lawrence is deputy policy director at the Nevada Policy Research Institute. For more visit http://npri.org.