Let States Do the Tax-Collecting Dirty Work

By Amity Shlaes 

“But the best ideas don’t spread spontaneously.”
That line from the New York Times columnist Bill Keller about state experiments involving President Barack Obama’s Affordable Care Act reflects a prevalent attitude: States that break away with original fiscal plans come up with subpar results that waste everyone’s time.

About Amity Shlaes

Amity Shlaes is a senior fellow in economic history at the Council on Foreign Relations and the author of the best-sellers "The Forgotten Man: A New History of the Great Depression" and "The Greedy Hand: Why Taxes Drive Americans Crazy."
More about Amity Shlaes

Photographer: Ben Baker/Redux

This summer, the focus of such criticism is Florida Governor Rick Scott’s announcement that his state won’t participate in the expansion of Medicaid under Obama’s health- care reform. Scott is pulling away from a federal plan, a move Obama will doubtless raise when he tours Florida this weekend. Yet long before this administration came along, states began running off from their own pack of fellow states, experimenting with their own tax base. And these experiments, too, have often been condemned for squandering time and money.

But what if the state experiments are worthwhile, and one of them uncovers the best idea in economic policy? Perhaps that idea could spread without coordinated help from officials in Washington.
The boldest move for the states and their representatives in Congress is to call the critics’ bluff. That is, to develop some kind of giant fiscal experiment, even more dramatic than the opting out of the Medicaid component by Florida. Then all could see whether states can produce a “best idea,” and whether such ideas can spread.
This is what was mooted by Kevin Hassett, an adviser to Mitt Romney and a scholar at the American Enterprise Institute. Hassett didn’t develop details, but we can hypothesize how it all might work. Start by recording the amount each state’s citizens contribute to federal coffers. In 2011, for example, Florida paid a total of about $117 billion in federal taxes, according to the Internal Revenue Service’s Statistics of Income.
The new idea wouldn’t change the amount that states owe, their “bill” from Washington. (Florida would pay $117 billion next year.) And future obligations of states would continue to be indexed to reflect changes in population, economic growth or inflation. The proposal would change only one thing: how the tax is collected. Officials in Washington would leave it to each state government to figure out how to come up with the money.
States would respond in different ways. Some might simply raise their income-tax rates to include the amount of the federal levies. Others, however, might collect the entire amount owed to the federal government through the property tax, so that homeowners confronted only one bill, albeit a screamingly high one, every year. This follows the tradition of the philosopher Henry George’s “single tax.”
Some states might increase sales taxes to capture the amount equivalent to its previous income-tax payments. Yet others might tax only the wealthy. The penalty for a system that fails would be tough, since most states have laws requiring them to balance their budgets.
Some states might find that lower rates draw people and companies. That, in turn, would broaden those states’ tax base dramatically. A state might keep taxes high and provide sterling services, and find they draw population or business. In any case, the rumble of state tax competition we are experiencing today would become a roar.
There will be objections, of course. The first is that states’ collecting the money isn’t our tradition. It is, actually. Under the Articles of Confederation, the states, not individuals, owed payments to the federal government. The modern income tax, where citizens pay the federal government, came into being only a century ago.
The second objection is that some states with low rates happen to be the greatest beneficiaries of federal programs. While politicians of Republican-dominated states lecture on the need for more freedom, their constituents collect Medicaid, school aid, and so on. But this is already true. If more Americans move to low-tax states, the federal government may not have the funds to subsidize states. This would force citizens, including supporters of the Tea Party, to confront their own inconsistency. That has to be a good idea. So is forcing states to be tax collectors. Replacing the IRS means taxpayers can no longer blame the IRS.
The third objection is that a state won’t be able to collect the taxes, even though an individual’s tax bill might be identical to the amount paid in the past when people added up state and local obligations. In a property-tax-based regime, families would get one big bill, a property tax, often in the six figures, which would be too great a shock.
This concern is absolutely legitimate. But not everyone will simply run away. Some will start to think about themselves, their taxes and governments. They will wake up. For the plan lifts the veil of what the Italian economist Amilcare Puviani called “fiscal illusion.” He taught that governments work hard to conceal from citizens how much tax they pay. Because they believe they are paying less than they actually are, people go along with government outlays.
As the scholar Joseph Henchman at the Tax Foundation notes, fiscal illusion is at work in Europe, where great pains are taken to hide from Germans the extent to which they subsidize Greeks. In the U.S., federalism has empowered fiscal illusion. People tend to think of their state and federal tax bills as separate. But if you rip the veil away, Americans will discover the amount of their total tax burden and consider change.
The details can be laid out later, but a plan along these lines is worth contemplating. No one really knows what the “best idea” is for America’s fiscal future. Until we do, long live experiments.