Commentary

Virginia Sales Tax Referenda: The Big Picture

This article appeared in the Northern Virginia Journal on August 1, 2002.

This November’s sales tax referenda in Northern and Southeastern Virginia are not just about traffic congestion. They are also about preserving the long-term prosperity of the Virginia economy. That’s because tax increases reduce economic growth. Thus, the costs of proposed sales tax increases include the out-of-pocket costs for every retail purchase, plus the costs of fewer business start-ups, slower job creation, and lower income levels in the long run.

High taxes drive away businesses, workers, and consumers, who are all increasingly mobile across state and international borders. High-tech companies and their workers are particularly footloose. Smart governments are recognizing this fact of the modern economy and striving to offer the lowest feasible tax rates.

At the international level, Ireland has flourished since it introduced a low 10-percent corporate tax in the 1980s. This small country of less than 4 million people now receives larger inflows of foreign investment than Japan, Italy, and other big countries. Ireland used to be a poor country in Europe, but now has one of the highest average incomes in the world. This is not the luck of the Irish, but the result of a successful low-tax policy. Virginia should aspire to be the Ireland among the U.S. states.

U.S. states that have lower taxes tend to have higher growth rates. This pattern can be seen by ranking the states by overall tax burden and comparing personal income growth rates over time. Between 1980 and 1999, the 10 lowest-tax states had an 88 percent growth in real incomes, on average, compared to just 51 percent real income growth for the 10 highest-tax states. Virginia was in the low-tax group with income growth of 85 percent during this period.

Certainly, other factors affect relative state growth rates, but numerous studies have confirmed the tax-growth link. A 1995 congressional Joint Economic Committee study looked at state taxes and income growth from 1960 to 1993 and concluded that “higher state and local taxes had a distinct and significant negative effect on personal income growth.” A 1996 study published by the Federal Reserve Bank of Atlanta looked at taxes and income growth from 1960 to 1992. The study found that growth was negatively related both to marginal tax rates and to overall state and local tax burdens.

These big picture effects are really the sum of many small tax effects that accumulate over time. Higher Virginia sales taxes will give buyers of big ticket items more reason to shop in Delaware, which boosts no sales tax at all. And it will reduce the inflow to Virginia of consumers and retail businesses from neighboring states that have higher tax rates. The sum of many such small effects will generate a permanent drain on the economy.

Another negative effect of a sales tax increase this November would be to send state legislators the message that they don’t have to make tough budget trade-offs. Rather than restrain spending, they simple need to put more tax increases in a nice wrapping and sell them as one-sided choices to voters.

Besides, Virginia families already pay 31 percent of their income in taxes to all levels of government. While proponents of sales tax increases point to the “needs” of the state transportation budget, Virginia families have their own needs, but only have 69 cents on the dollar after taxes to pay for them. With housing costs rising quickly - including property assessments rising 15 percent this year in Fairfax County - families have an even greater need to keep their own money from the tax man.

Alternatives are available to fund priority transportation projects. The state should consider private financing proposals, which were successful with the Dulles Greenway in Northern Virginia. And the state could cap general fund spending increases in future years at inflation plus population growth, with the excess channeled to transportation. The important thing for voters to realize is that Virginia has prospered because it is a relatively low-tax state. Hopefully, Virginians will vote to keep it that way in November.

Chris Edwards is director of fiscal policy at the Cato Institute.