Wednesday, January 26, 2011


Politicians know taxes hurt business. This is why they give out tax credits and make exemptions from their own taxes. But their understanding of common-sense economics tends to wither away when government revenues drop in recession times. Instead of reforming away deficit-driving entitlements, politicians cater to their own spending addiction and seek to replace lost revenues. Alas, tax credits and exemptions come under fire. The latest example is from Connecticut where lawmakers and the governor are considering termination of sales tax exemptions. The Hartford Courant has the story:

In flush economic times, the legislature could leave untouched the huge  number of exemptions from the state's 6 percent sales tax: haircuts, prescription drugs, boat repairs, car washes, and food purchased at supermarkets, to name a few. But with a looming budget deficit, projected at $3.5 billion in the next  fiscal year, "everything is on the table," Gov. Dannel P. Malloy has  said repeatedly. He and his advisers have been conducting a comprehensive analysis of the  state's complicated and extensive system of tax exemptions and credits,  which total more than $5 billion annually. On Wednesday, Malloy said he  had not made any final decisions on proposed taxes. But he also would  not rule out changing any exemptions, with one exception — those for  charitable organizations. More than $3 billion worth of exemptions are related to the sales tax. ... The food exemption is designed to help the poor because, compared with the wealthy, they spend a larger percentage of their income on food. But Pomp said in an interview that the exemption is "a pretty stupid, inefficient way'' to help the poor because the across-the-board exemption also covers multimillionaires in Fairfield County when they buy steak and lobster at the local supermarket.

The only thing stupid about a tax exemption is the tax, not the exemption. What the law professor does not understand is that a tax discourages consumption. The less of a necessity a product is to the consumer, the more price sensitive they will be. Even a six percent price increase can discourage enough buyers to cause job losses in businesses that produce and sell "luxury food". If the law professor is really concerned about state government revenues, he should propose an exemption-free sales tax across all private consumption, at two or three percent.

Obviously, a shift in taxation from an exemption-perforated sales tax to a lower but exemption-free tax is not what the Connecticut economy needs. It needs less government and a net drop in tax rates. While state spending has grown at a comparatively modest 4.8 percent per year the past five years, but in terms of taxes things are not so great. The Tax Foundation ranks The Constitution State 47th in business tax climate, right down there with California, New Jersey and New York. This helps explain the state's meager growth rate: from 1999 to 2008 Connecticut ranked 40th in state GDP growth with an average of 1.7 percent annually, adjusted for inflation. Raising taxes on the wealthy - whether through a "luxury food" sales tax or otherwise - will not improve that economic track record.

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