Regulatory Reform

Fair Business Competition Requires a Neutral, Consumption-Based Tax System

Recently we had the opportunity to attend a meeting hosted by the Business Coalition for Fair Competition. The meeting was largely a listening session as entrepreneurs and small business owners shared their trials and tribulations of being stuck in head-to-head “marketplace” competition with government or firms granted an unfair competitive advantage by government. One major source of substantive unfairness was bad tax policy that tilted the marketplace towards some business models or business organizations to the detriment of others. Luckily, state policymakers concerned with ensuring vibrant market competition have an easy fix to this problem: dump the income tax, dump carve-out and tax credits, and move to a broad-based consumption tax.

Fair marketplace competition requires neutral treatment of businesses irrespective of their product or service, production methods, various financial features (i.e. capital intensity of production, labor intensity of production, use of shipping , use of subsidiary locations, etc.), or business organization. A simple test for sound tax policy in this regard is the following query: are entrepreneurs and business leaders making business decisions for tax purposes? If the answer for a state is “yes,” that state’s tax code is creating market distortions and an unfair competitive balance in affected marketplaces. These principles of sound tax policy are codified in the American Legislative Exchange Council’s Tax and Fiscal Policy Task Force model policy on the sound principles of tax policy.

Sadly, crony capitalism runs rampant in many state houses as the chosen few businesses are showered with targeted tax credits, special carve-outs, and all types of obscure rules designed to benefit some at the expense of others. In addition to these carve-outs, some businesses (or various forms of institutions acting as businesses) are granted tax exempt status from the state, even though they are engaging in substantive commerce alongside competitors organized as traditional, for-profit businesses. Though charitable institutions, state universities, and churches all have important missions that are well worth advancing, giving those firms an unfair tax benefit when engaging in a commercial enterprise creates a troubling dynamic.

Thankfully, the solution here is not more complicated tax rules and the army of tax administrators that accompany them. Instead, states should move away from income taxation and embrace the taxation of consumption, exempt no good or service from said consumption tax, and exempt no business from collecting and remitting this tax. This means that non-profits will still avoid income taxes (as will every firm under this new regime) but they will be forced to collect sales taxes from their customers. Under such a system, market competition driven by consumer preferences and the innovation of entrepreneurs, not policymakers or tax bureaucrats in state capitols, determines winners and losers in the marketplace.

Moreover, such a system is much simpler, requiring fewer tax compliance professionals and a lower compliance cost for a given amount of tax revenue. Businesses can therefore add productive capacity to the business, or reinvest the saving into the business, therefore raising wages and enabling future hiring.

More importantly still, states that embrace a consumption tax see higher income growth, higher job growth, higher population growth, and even higher tax revenue growth. This is because taxing an activity serves as a disincentive to engaging in said activity. Thus, a tax on wage income, business income, or investment income is really a tax against productivity, hard work, business success, innovation, and prudent steering of scarce investment dollars to fruitful ends. Tax Myths Debunked, Chapter 3 of Rich States, Poor States, and a previous blog post each discuss this well founded economic fact at length.

Policymakers need not choose between economic growth, tax simplicity, and having a fair and neutral tax code. The same policy regime offers the optimum solution towards accomplishing each goal. Broad-based consumption taxes are a win-win-win pathway toward sound tax policy.

In Depth: Regulatory Reform

In his first inaugural address, Thomas Jefferson said that “the sum of good government” was one “which shall restrain men from injuring one another” and “shall leave them otherwise free to regulate their own pursuits of industry.” Sadly, governments – both federal and state – have ignored this axiom and…

+ Regulatory Reform In Depth