Perspectives

Current trends in state taxation

Consumption tax versus income tax

In recent years, a significant trend has emerged among the states regarding tax reform. Many states, including Georgia, Kansas, Oklahoma, Ohio, and North Carolina, among others, have introduced and/or passed legislation that reduces the state’s income tax rate applicable to individuals, corporations, or both, while attempting to increase tax revenue from consumption taxes. Generally, increased revenue from consumption taxes comes from an increase in the state’s sales and use tax rate or an expansion of the sales/use tax base. This article, by Joe Eleniewski, Doug Nagode, and James P. Trebby, examines the drivers of this trend by identifying possible reasons for it and analyzing the costs and benefits of switching to a tax system primarily based on taxing consumption rather than income.

​An emerging trend in state tax legislation

In recent years, a significant trend has emerged among the states regarding tax reform. Many states, including Georgia, Kansas, Oklahoma, Ohio, and North Carolina, among others, have introduced and/or passed legislation that reduces the state’s income tax rate applicable to individuals, corporations, or both, while attempting to increase tax revenue from consumption taxes.1 Generally, increased revenue from consumption taxes comes from an increase in the state’s sales and use tax rate or an expansion of the sales/use tax base.

This article examines the drivers of this trend by identifying possible reasons for it and analyzing the costs and benefits of switching to a tax system primarily based on taxing consumption rather than income. It is important to note that when discussing income taxation, generally this article focuses on taxation of individuals and corporations only. Therefore, the complexities that accompany the taxation of gifts, trusts, estates, passthrough entities, tax-exempt taxpayers, etc. are outside the scope of our analysis.

First, we start by addressing the current tax regime, both at the federal level and generally at the state level. Next, we discuss the theory behind and issues created by both income tax and consumption tax systems. We then address the general state taxation climate and discuss specific states trending toward a system that increasingly taxes consumption. Finally, we address the consequences of such a trend and speculate regarding whether one type of taxing system may be better than another.

1 Richard W. Stevenson, Governors Push Bigger Reliance on Sales Taxes, New York Times, January 24, 2013.

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