Taxes, taxes and taxes … oh, my!
"Revenue solutions" are the talk of Carson City as the Nevada Legislature heads into its final weeks. Unsatisfied with Gov. Brian Sandoval's newest proposals to hold state spending in the next budget cycle at a similar level to the current budget cycle, majority Democrats are pressing for more taxes on Silver State businesses, workers and consumers. These tax increases would push up state spending by about $1 billion.
Majority leaders have proposed $1.2 billion in new taxes, part of which would be used to eliminate the questionable gimmicks within the governor's budget proposal, which include a loan against future insurance property tax revenues, the use of school district bond reserve funds and the continuation of property tax diversions and mining tax prepayments.
The tax package recently unveiled by legislative Democrats has three legs: (1) the removal of sunset provisions from the temporary tax hikes approved in 2009, (2) a revenue-enhancing expansion of the sales-tax base to include some services, and (3) the creation of a new business-margins tax, which Democrats say would eventually replace the current modified business tax.
Every tax instrument impacts economic behavior in unique ways. All of them, however, destroy potential wealth. The reason is that they alter human action away from the welfare-maximizing behaviors that occur within free and open markets. Yet, as governments are compelled to levy taxes in order to provide for certain 'public goods' — such as the rule of law — serious consideration should be given to the relative merits and drawbacks of alternative taxing mechanisms.
Consumption taxes (e.g. general sales taxes) artificially elevate the final prices facing consumers and, therefore, suppress consumer demand for the taxed goods. That, in turn, means retailers see fewer revenues. The decline in revenue is then translated backwards to the factor inputs, meaning reduced demand for — and smaller returns to — labor and capital.
Hence, the legislative majority's plans for extending the higher sales tax rates imposed in 2009 and expanding the sales tax base will ultimately, if passed into law, exert continued downward pressure on private-sector wages at a time when "effective" unemployment rates linger near 24 percent.
As the Nevada Policy Research Institute has highlighted, there is merit to the concept of expanding the sales tax base on a revenue-neutral basis. It would accord with standard theory on sound tax policy, which emphasizes a broad base with uniformly low rates and minimal exemptions. However, Democrats' plans to increase the overall sales-tax burden would only exacerbate the negative impact of this tax on consumer demand and, consequently, on wages and employment.
Democrats have also asked for the elimination of the modified business tax, which is a tax on payroll. In other words, it is a direct tax on labor. The MBT artificially increases labor costs, thereby suppressing the demand for labor. As a result, the tax is a negative incentive for employers to retain existing workers or to hire new ones.
The MBT can also lead to an over-mechanization of industry because the tax artificially skews the cost of capital relative to labor. Economists refer to this trade-off between hiring workers or investing in machines to do the work as the "marginal rate of substitution." Taxes on labor, as with taxes that specifically target capital, distort this delicate balance and lead to sub-optimal levels of production — meaning fewer goods will be available.
However, the business margin tax that Democrats would like to replace the MBT with could be even worse. A major weakness inherent in the proposed margin tax is that the tax is assessed at every stage of production throughout the supply chain. As a result, the tax builds on itself or "pyramids" — effectively leading to a disproportionately high tax rate on complex goods that require multiple stages of production. The tax would likely place Nevada at a competitive disadvantage for high-tech industries (e.g. photovoltaic solar energy, biotech industries, computer manufacturing, etc.) that require many stages of production. It would therefore work directly against the Democrats' own purported goal of economic diversification.
Whatever the particulars of the taxes sought, it should be clear that the majority's quest for more taxes will continue to enrich a protected class of government workers who already enjoy lifestyles far greater than the taxpayers who support them.
NPRI has identified billions in "spending solutions" that could maintain or improve the quality of services. Until each of these is implemented, calls for more taxes should fall on deaf ears.
Geoffrey Lawrence is deputy director of policy at the Nevada Policy Research Institute. For more visit http://npri.org. This article first appeared in the June 2011 edition of Nevada Business.