Missouri’s Version of the FairTax

April 22, 2009

Missouri lawmakers are considering a drastic change to their tax system. A bill recently passed by the state’s House of Representatives would allow residents to vote on a Constitutional amendment that would eliminate corporate and individual income taxes in the state and replace them with a broad based sales tax. The plan is essentially a state version of the national FairTax proposal popular with some grassroots groups that would replace the federal income tax with a national sales tax. If the Senate passes the bill Missouri residents would be voting on the amendment in November of 2010.

Missouri currently has a sales tax, a corporate income tax, and a personal income tax. The sales tax rate is 4.225%, and the top corporate and personal tax rates are 6.25% and 6%, respectively. The plan put forth would replace all those taxes with a single sales tax levied at a rate of 5.11%. Accompanying the sales tax rate hike would be a substantially broadened sales tax base that would include all purchases. Currently most services are tax exempt and certain goods, most notably groceries, are taxed at a reduced rate of 1.225%. These exemptions would not exist under the new tax structure.

The overhaul of the tax system is meant to be revenue neutral. In other words, the revenue from the sales tax increase and broadening of the tax base is meant to exactly offset the elimination of income taxes. In 2008 Missouri’s sales tax brought in $3.2 billion while the state’s corporate and individual income taxes brought in $5.5 billion. In order to achieve revenue neutrality, at a rate of 5.11% the base would have to increase by 124%, or a little more than double. This may sound like a huge increase, but it is very possible.

As stated above, services, which make up a large part of modern economies, would be fully taxable under the new system. Also fully taxable would be groceries, which make up a significant portion of household expenditures. Only final “retail” purchases would be taxable, meaning that business inputs would be exempt (as they should be under a consumption tax). Many states’ sales tax bases are actually quite narrow, and analysis by Indiana University economist John Mikesell in 2003 put Missouri’s sales tax base at around 40% of state personal income, so it is conceivable that the sales tax base could double when the exemptions are eliminated. Once instituted, if the sales tax did not achieve revenue neutrality the legislature would be allowed a one-time adjustment to the tax rate to bring revenues in line. There is also a provision that would allow the legislature to add exclusions from the sales tax, subject to a two-thirds vote.

A rebate is included in the proposal which represents a minimum level of consumption that is seen as necessary for all households and deserving of a tax-free status. The rebate would be provided to all households and would equal the sales tax rate times the applicable federal poverty guidelines.

FairTax supporters everywhere will be keeping their eyes glued to Missouri as this story develops.

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