The Show-Me State Should Show That Zero Income Tax Can Work in Missouri

"Eliminate the state income tax" is one of those proposals that sounds like it fits libertarianism like a glove. Personally, I don't need much convincing that there are problems with taxing income. I wasn't exactly thrilled in 2013 when the federal income tax reached its 100th birthday. This brings us to current events. 

Tomorrow, the citizens of Missouri are voting on a ballot about whether to eliminate the state income tax. In concept, I like it. All things considered equal, I prefer a consumption tax over an income tax because it generally does lest discourage work, saving, investment, and entrepreneurship. The proposed amendment has stages to phase out the income tax while giving lawmakers a way to find ways to replace the lost revenue. However, my enthusiasm wanes when it collides with economic reality. 

The concern is not simply whether I think consumption taxes are better than income taxes. It is about what happens afterwards. State governments still have expenses, and the state income tax makes up about 69 percent of the state's discretionary revenue fund. Unless the state decides it is going to spend a whole lot less, it needs to make up that lost revenue somehow. The question is whether Missouri can generate enough consumption tax revenue without causing more problems. 

I asked a similar question last year when analyzing Mississippi's income tax elimination proposal, and noted that not every state is built the same. Florida can lean on tourism. Alaska has oil. Nevada has Las Vegas. Texas excels in energy production, has rapid population growth, and property taxes to help make up. 

Missouri certainly has a diverse economy, but what is its equivalent to Texas' energy sector or Florida's tourism sector? This doesn't mean that it is doomed to fail. But it also means that Missouri cannot copy other states and except the same results. I don't see an obvious revenue source replacing over $6 billion in revenue. Every dollar not collected through the income tax has to be replaced somehow, or not spent in the first place. That is the part where I think Missouri will have quite the uphill battle, and that is the part where I would like for them to show me how they would succeed. 

If that weren't enough, there is another challenge. Replacing income taxes with consumption taxes is not as simple as increasing the sales tax rate. Even organizations that generally favor shifting away from income taxes have warned about the difficult. 

The Tax Foundation recently examined this topic and found that replacing state income taxes is much more difficult than estimates suggest. The reason is that a realistic consumption tax base is narrower than advocates often assume. Taxing business inputs creates its own problems, which excluding them means that the tax rate may need to be substantially higher. 

The lesson is not that states should keep income taxes forever. The lesson is that tax reform requires careful design. A poorly structured consumption tax can create problems of its own. I hope Missouri succeeds in create a more economically efficient tax system because that is a goal worth pursuing. 

However, lowering or eliminating a tax is only one part of reform, much like I brought up with the Kansas tax cut experiment last decade. The state must ensure that the replacement system is sustainable, transparent, and does not create unintended consequences. So far, it has not done a good job to show me that.