Congress and the president have shown they can move mountains. The fiscal cliff has been pushed off to March.
But the compromise deal that increased tax rates for higher-income households did nothing about the complexity of our tax system. In fact, the bill has new exemptions and extends credits.
Tax simplification would do much to help our moribund national and local economies. How taxes are collected can have a big effect on the economy’s long-term growth rate.
At the state level, the personal property tax is at the forefront of this problem. In his 2013 State of the State speech, Gov. Butch Otter called for the elimination of this statewide tax in exchange for more local flexibility in raising tax revenue. Such a proposal could go a long way in simplifying tax policy in Idaho.
When analyzing any tax policy or government revenue source, economists look at how well the program raises revenue without distorting incentives for households or businesses. The administrative burden of tax (filing tax forms, sending in payments, and record keeping occur all year long) is just one measure of how well a tax is working. Most analysts and businesses agree that the personal property tax isn’t working because it is cumbersome and costly to administer. More problematic, however, is how the law distorts incentives and unjustly burdens some industries.
Economic theory shows us that we should worry more how business owners and individuals respond to tax policies than how hard the taxes are to collect. Any action we change due to how we are taxed affects our likelihood of investing for economic growth.
Such tax-induced actions affect what is known as tax incidence, or how the burden of the tax is shared. You and I bear the burden of many taxes we actually don’t submit to the government.
As in most states, Idaho’s personal property tax is named such to distinguish it from taxation on real property, which is mostly paid by homeowners. However, the personal property tax is a business expense like any other that must be offset against revenues if the business is to make a profit. The tax is therefore directly passed on to consumers in the form of higher prices. The personal property tax is like a hidden sales tax on the consumer.
The personal property tax is also a form of taxation that can lead to strong tax avoidance behavior. In Idaho, the tax is assessed on Jan. 1 each year, or “the first day in which the property was brought into the state or put into service.” By using just one date a year, business owners have an incentive to dispose of property late in the year or buy new equipment early in the year just to get the most use out of it before being taxed. Such moves reduce the efficiency of the tax and the economy overall.
Another economic principle applicable here is horizontal equity. This is the idea that taxpayers with a similar ability to pay taxes should pay the same amount. That is, a tax shouldn’t favor one group over another.
While many will argue that income taxes should be progressive, whereby the rich pay more (vertical equity), it is hard to make the same argument for businesses. The Washington compromise may have created more vertical equity, but the exclusion of so many exemptions violates horizontal equity.
The personal property tax favors service businesses over production or manufacturing businesses. A service business relies mostly on people to get its work done. Manufacturers needed equipment and therefore generally pay higher personal property taxes. Manufacturing industries generally pay higher wages. It’s unreasonable to be promoting these businesses in our state while taxing them more. All else equal, a state with a tax system that is easy to administer, spreads the tax burden and does little to distort incentives will have a faster growing economy.
According to data compiled for 2009 by the Tax Foundation, there is a negative correlation between state income growth and personal property tax collections per capita. On average, those states with lower personal property tax revenue grew faster.
Idaho already has one of the highest corporate income tax rates in the country. Reducing the administrative burden and increasing the horizontal equity of all tax policies are needed to offset this deterrent to new business formation.
Peter Crabb, professor of finance and economics at Northwest Nazarene University in Nampa. firstname.lastname@example.org