Reality Check on Proposed Georgia Tax Cuts

March 19, 2008

News stories from across the state of Georgia on Wednesday highlighted the current debate in the state on tax policy: should the state cut the car tax, cut income taxes, or cut neither?

The first question that needs to be asked is whether or not a specific tax on cars is justified in the first place, either for externality reasons or some benefit principle justification? Otherwise, it is just an arbitrary tax on a selected product, making it poor tax policy. Therefore, to the extent that the car tax should be raised or lowered depends on the answer to the question “is the current car tax too high or too low for what its purposes are?” If the current car tax is too high, then it should be cut, financed by either higher taxes on a broad based tax or lower spending (depending upon whether government is at its optimal size or not).

And that brings us to the second question: should income taxes be cut? Cutting the income tax would likely have a greater measureable economic effect than cutting the car tax since they are likely more distortionary. But this comes back to a question of fairness versus economic efficiency (narrowly defined). Government could improve economic efficiency (as measured by state GDP) a lot by imposing extremely high taxes on insulin, cigarettes (we already do) and water while cutting income taxes, but such a policy would violate almost any person’s notion of fairness. If it is determined that an income tax should be the general funding source of government, then its rate should be set in accordance with what is the optimal size of government less any properly determined revenue raised from other taxes that are imposed for legitimate reasons (e.g. externalities or user-fee proxies).

In summary, the answer to this ultimate question of whether a tax cut should be passed and if so what kind comes down to answering two other questions: (1) Is the current car tax too high, too low, or just right? and (2) Is the government operating at its optimal size?

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