Newspaper article THE JOURNAL RECORD

Optimal State Taxes

Newspaper article THE JOURNAL RECORD

Optimal State Taxes

Article excerpt

In December, Gov. Frank Keating offered a major reform of the Oklahoma tax system. His proposal would replace the individual income tax, the state sales tax on groceries, and the corporate franchise tax with a 5.9 percent state sales tax on a broad range of services. So far, critics of the proposal have drowned out its supporters.

In particular, local politicians don't want to see the state sales tax on groceries repealed. Most cities get a significant portion of their revenue from local sales taxes on groceries, and they don't think they can get away with taxing groceries unless the state does, too. Complaints have also been heard from the bankers, Realtors, and other service providers who would face the new sales tax on services. Of course, the losers in tax reform always cry louder than the winners.

In short, the governor's proposal is nearly dead on arrival at the Legislature. There's no stampede for a special session on tax reform, and I doubt if the regular session will even bother putting the governor's proposal on the ballot for "a vote of the people."

Still, politics aside, it's worth considering the merits of the governor's tax reform proposal. Just what is the proper state tax base? Should we tax income, groceries, or services?

For what it is worth, economists actually have quite a lot to say about what the "optimal" tax base should be. In particular, the theory of optimal commodity taxation provides a framework for deciding at what rates various goods and services should be taxed.

One extreme approach would be to collect a lump sum tax of around $1,700 from every Oklahoman ($6 billion in state tax revenues divided by 3.5 million Oklahomans). Such a so-called "head" tax would be efficient -- that is to say, it would not distort our decisions about working and investing. But most of us think that a head tax would be unfair. In any event, it would be harsh and impractical to collect that $1,700 per person tax from low-income Oklahomans.

That's where optimal tax theory comes in. Its goal is to design an efficient tax system to finance state expenditures without using any lump sum taxes.

At the outset, consider a representative citizen who consumes only a range of goods, services, and leisure. Our citizen decides how much to work, and spends the resulting earned income on goods and services. The optimal tax system is one that raises needed state revenues without distorting our citizen's choices about work and investment.

The goods and services, of course, are all different prices. The genius of optimal tax theory is to recognize that leisure is itself a commodity -- like goods and services -- and that the wage rate -- say $10 per hour -- is the price of leisure. If you want to consume more food and movies, you have to work harder (consume less leisure).

So what's the right tax system? According to optimal tax theory, the optimal tax is a tax at the same rate on all commodities, including leisure. That's virtually equivalent to a head tax, so it does not distort decisions about work and investment.

Of course, even ivory tower economists recognize that putting a tax on leisure is impossible. …

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