‘Regressive’ Sales Tax is a Relative Term

This article originally appeared in the News & Observer.

There is one talking point that has become the go-to objection to eliminating North Carolina’s state income taxes and replacing the revenue by expanding the sales tax: “This will shift the tax burden from the rich and onto the backs of the poor!”

But that complaint fails to comprehend the realities of income and wealth in today’s world, and provides a misleading picture of how sales and income taxes really hit people.

Critics charge that an expanded sales tax would be regressive because it would supposedly take a larger share of income from low-income households than from high-income earners. Such objections, however, are ill-founded.

Under the current progressive income tax system, North Carolina suffers from the fifth-highest unemployment rate in the nation. Our high tax rates on productive activity and investment have caused entrepreneurs to take their jobs to more inviting states. So it seems it is our current anti-growth tax system that is soaking the poor and unemployed.

Critics’ statistics are badly skewed. It is important to point out just how poorly constructed the attempted “regressivity” measures really are. Such studies attempt to estimate the amount of sales taxes that households at different income levels will spend and to calculate those taxes paid as a share of income. From this, they determine if a tax is “regressive.”

But these studies fail to account for the significant income fluctuations people experience throughout their lifetimes. For instance, University of Michigan-Flint economist Mark Perry examined U.S. census data to confirm that “more than 3 out of 4 households in the top fifth of (income-earning) households are in their prime earning years between 35-64 years old.” He continued, “The lowest quintile households are more than 1.5 times as likely to be younger (under 35) as the highest quintile households, and more than three times as likely to be old (65 and over).”

This distorts what “low income” is. Consider a retired couple with pension plans, savings, investments, a paid-off house and other assets. They may have little “income,” but they have enough wealth to spend a comfortable amount on goods and services.

Or, as economists from the Beacon Hill Institute at Suffolk University concluded, “The people in the lowest income deciles are not necessarily poor.”

Economist Milton Friedman and a majority of economists since have used this fluctuating income life-cycle to determine that household spending is much more stable over the course of one’s life and a far better reflection of a person’s lifetime well-being. In other words, the most realistic indication of someone’s long-term financial state is not income but spending.

And it is not just relatively well-off households being classified as “low-income” that distorts the data, but also households temporarily at the height of their lifetime earnings being taxed as if they were always that affluent.

According to Tufts University economist Gilbert Metcalf, “higher-annual-income groups are likely to contain some people at the peak of their age-earnings profile for whom peak earnings are a poor measure of annual ability to consume.” That is, someone may put together a few years of high earnings that don’t reflect his or her long-term well-being.

In short, simple “income” statistics often provide a misleading snapshot of financial well-being and of how taxes really affect people.

Critics fail to consider the value of government benefits. Every study and article claiming to measure the effect of a particular tax on different household income levels leave out a vital component: the value of government benefits. Food stamps, Medicaid, free or subsidized child care, housing subsidies and a litany of federal and state welfare programs provide thousands of dollars worth of benefits to low-income households, yet tax burden studies never take this significant component into consideration.

For instance, critics seem to especially bewail levying a sales tax on food. But those paying with food stamps don’t pay sales taxes. That’s just one example of how the regressivity charge fails to jibe with social and economic realities.

Lawmakers, citizens and the media alike should be leery of studies claiming to measure the burden of a tax on households of various incomes. Universally, these studies suffer from the fatal flaws of ignoring a lifestyle earnings cycle and instead using a static snapshot of income, as well as denying the value of government benefits received by low-income households.

Such tax burden studies have no credibility and serve only to distract from the more important debate of how to modernize our tax code to maximize economic growth and job creation.

Brian Balfour is director of policy at the Civitas Institute in Raleigh.