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Four important questions every constituent should ask about their tax code

Jan 19, 2022 by Anna McCauslin

Every state budget is funded through a system of taxes and fees. It’s important for each constituent to understand how those taxes and fees affect your finances and if applicable, your business.

Individuals make the best decisions for their own families, lives and livelihoods, not the government. People with similar gross incomes in different states will have different abilities to purchase needs and wants depending on how much of their income is used toward taxes and fees.

Businesses are competing across state and national lines, and with technological innovations individuals can work for a company based in one state and live in another. States must compete more with each other now than ever before.

The rates and brackets of corporate and individual income taxes as well as the rates of sales taxes, property taxes, and others all have an impact on the decision-making of businesses and individuals.

Research has shown that states with low and flat — or no — rates of personal income tax or corporate net income tax are growing in population, while states with high rates and complicated tax systems are losing population.

The following questions are important ones every constituent should ask:

  1. What is taxed?
  2. How high are tax rates?
  3. What is not taxed, and why are certain items taxed differently than others?
  4. What should an ideal tax state look like?

By asking these questions, you will gain a better understanding of how your state’s tax code affects you, whether your personal finances or your business.

What is taxed?

The core beneficial role of state government is to protect the foundational rights necessary for people to control their own destiny. State budgets should prioritize residents’ ability to be entrepreneurial to earn their success. When government spending and taxes exceed this positive role, it harms economic performance and diminishes opportunities for all citizens.

While no state is perfect, growing states have low and flat — or no — personal income tax or corporate net income tax. This encourages current employers to stay in the state and appropriately entices businesses to relocate within the state, minus distortionary tax credits — those that pick specific industries to reward at the expense of all others.

Many states also have sales taxes on products and possibly services and various excise taxes. It’s important to understand how reliant your state budget is upon each source of revenue.

Is the budget funded by more stable sales taxes or taxes on specific products or industries that are sensitive to fluctuations? When state budgets are funded by broad tax sources with low rates, revenue ebbs and flows will be less volatile, and better able to fund necessary services during economic downturns.

How high are the tax rates?

Tax rates vary as much as the types of tax levied by a state. Many states have a progressive personal income tax, nine have a flat rate, and nine states do not have an individual income tax at all.

Just as diverse as the rates are the various tax credits and deductions. While standard deductions are equally applied to all taxpayers, joint and individual fliers alike, credits are selective. Small business owners file on individual income tax are particularly sensitive to increases or decreases in this tax.

Forty-eight states levy a corporate net income tax. States may also impose a gross receipts tax on business income, which is one of the more distortive forms of taxation. Corporate Net Income Tax rates vary from 2.5 to nearly 12 percent, the majority being flat rates.

Unfortunately, all corporate tax codes are ripe with examples of rewarding certain industries through complex tax credits or deductions at the expense of all others.

Sales and use tax rates are large sources of income for state budgets. One of the most transparent taxes, the sales tax raises substantial revenue because of the variety of items being sold or services being rendered in the state.

Ideally, sales taxes would be levied only on the final sale of an item or service. When certain products or services are exempted, a higher rate is required to raise the same amount of revenue.

Likewise, if the rate is assessed on a greater variety of items or services, the rates should be lower for all purchasers. It’s also important to know whether your local governments can assess sales taxes, as that will contribute to an overall higher rate.

What is not taxed, and why are certain items taxed differently than others?

Just as important as what is taxed is what is not. When certain items are not taxed it shifts that burden onto individuals purchasing other items.

Excise taxes are levied on certain products to discourage their use, such as marijuana, alcohol, and cigarettes. Legislators often will not tax diapers, certain foods, or other products that are deemed “good” or essential in nature but will enact specific taxes on items that are seen as “bad” or unnecessary.

Excise taxes are usually assessed in addition to the sales tax, leading to an increased final purchase price. This forces purchasers to pay the higher price, go elsewhere to purchase the item, or encourage black markets.

The tax code is appropriate to raise revenue for necessary government functions, not to control what individuals do, items they buy. When taxes are low and flat, they are applied on many services and items to raise the same amount of revenue, thus being less of a burden on residents.

The propensity for legislators to pick winners and losers extends far beyond sales taxes.

Cronyism is a much more insidious form of picking winners and losers. Cronyism exists when the government gives tax credits to certain industries and businesses over others. Favored industries and businesses have an unfair advantage over those that face artificial barriers that would not otherwise exist in the free market.

What should an ideal tax state look like?

Ideally, a state should rely on sales taxes that are low and applied to as many items as possible, avoiding business inputs which lead to tax pyramiding and an increased final purchase price.

States should reform corporate net income taxes and individual income taxes by consolidating brackets, reducing rates, and eliminating corporate welfare and other waste where possible. They could also choose to eliminate these taxes. Other economically harmful taxes, such as gross receipts taxes, franchise taxes, should also be eliminated.

Individuals and businesses owners have a responsibility to understand how their income and the products they purchase are taxed. Learning more about your tax code makes you a more educated resident of your state and more able to hold lawmakers accountable for the taxing decisions they make.

While individuals are moving to lower tax states, you can have the information at your disposal to work to make your state better for yourself and all residents.

Understanding your state’s tax code goes hand in hand with understanding your state’s budgeting process. Ask these important questions you need to ask about state budgets.