Missouri’s Version of the FairTax

April 22, 2009

Mark Robyn

Mark Robyn

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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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.

An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.

A corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.