What Sanford Is Thinking

Below I tried to explain why Governor Mark Sanford, and Republicans in Washington D.C. want to cut income tax rates. Of the three primary taxes (income, property and sales taxes), the income tax is the most destructive economically, and the sales tax is the least destructive.

A couple of examples will help explain the point. Let’s say I just earned $100 of income, and there is no income tax and only a sales tax. Let’s also say it costs $10 to manufacture a car. In this case, with my $100, I could manufacture 10 cars. When I sell the 10 cars, let's say for $13 a piece, the proceeds would be taxed and the tax man would take a piece. In sum, with no income tax and starting with a $100 of income, 10 cars are produced, sold and then driven by consumers.

Let’s say, instead, there is a 30% income tax, but no sales tax. If I earned $100 of income, immediately, I would have to pay the tax man, so I would have only $70 to invest in my auto manufacturing business. At a price of $10 a car, I could produce only 7 cars. In this case, only 7 cars are produced, sold and driven.

As a rule, when income is taxed, it reduces the amount of money available for investment, thus output is lower, that creates less jobs and our standard of living is lower.

This is why Governor Sanford wants to cut the income tax by 15%, and offset that by raising the sales tax on cigarettes by 68 cents and impose a sales tax on lottery tickets. Income taxes reduce economic growth, and are more destructive than sales taxes.

This is also the reason why Republicans in Washington D.C. would like to see the capital gains income tax eliminated. (Both wages and capital gains are income, so cutting the capital gains tax, is cutting an income tax.) Unlike income from wages, income from capital gains is most likely to be invested and reinvested, so cutting the capital gains tax would be most beneficial for the economy. For example, if you own a stock, and it rises in value, and you sell it, likely you’ll pour all the proceeds into another stock or other kind of investment. Letting capital gains grow untaxed, would increase the amount of investment capital, production, jobs and our standard of living.

Eliminating the income tax totally, for a sales tax, would be the best thing from an economic point of view, but that idea is not politically viable. A progressive tax is one, when income rises, the tax as a percentage of income rises. The income tax is a progressive tax. As your income raises, your tax rate rises. The income tax is hard on high income earners. A regressive tax is one, when income falls, the tax as a percentage of income rises. Property and sales taxes are regressive taxes, and they hit low income earners hard. For example, if you earn $40,000 and pay $1,000 property tax on your house, the tax is 2.5% your income. Likely, many of your neighbors, live in a similar house to yours, paying $1,000 in property tax, but earning less, let’s say $30,000. The tax works out to 3.3% of his income.

Right now in SC the regressive property and sales taxes offset the progressive income tax, so overall the tax system is proportional. That is, when you add up all taxes, the system isn’t biased against the rich or the poor. If the income tax was eliminated or cut significantly and the sales tax was raised, overall the tax system would shift significantly to the regressive side (harming low income earners). For this reason, I think Sanford's initial plan to eliminate the income tax did not fly politically.

If we are talking about trading one tax for another, I would like to see the property tax eliminated, and the sales tax raised. One, it is more likely to occur, because property taxes are regressive, so eliminating them for a higher sales tax would not make the overall tax system much more regressive. Two, property is sometimes an input to production, and like I illustrated above, you don’t want to tax inputs to production, because there will then be less inputs, and that will result in less output. Three, manufacturing is property intensive (manufacturers own a lot of land, plant and equipment), so eliminating the property tax will help lower their costs, giving manufacturing the shot in the arm it needs.