What if states paid the federal tax, instead of taxpayers, based on population size?

Question:

Instead of everybody filing tax returns with the IRS and creating a central point of failure (or hacking), imagine a hypothetical system where the government created a Flat Tax Per Person Living within the State’s boundaries according to the last Census.

For example, $10,000. Every state must provide the Federal government with $10,000 per person, but the Federal government does not care how they put that money together. Important to mention that there is no federal corporate tax rate in this hypothetical. They look at California and send a tax bill for $392 billion (39.24 million people * $10,000)

How California, or any state, comes up with that tax bill is completely irrelevant. They could do an income tax, a sales tax, a levy on product sales, a corporate tax rate, a fee on produce (grapes?), whatever. Every state is then forced into a competition for the most efficient and balanced tax system possible; as well as the most efficient use of spending possible. At least in theory without a lot of exceptions and corner cases (I’d still keep the IRS around for tariffs).

Thoughts? I’m sure it’s a dumb idea but I want to hear the logic why. I’ve asked this question a few places without answers yet, but feel this may give the best answer.

Answer:

This is an interesting thought experiment. Many factors must be considered, and it is difficult to address them all at once, but here are some important ones. First, the regressivity of the lump sum tax would entail equity concerns that have political ramifications. If income distribution is uneven across states, then states with many low-income earners would face a relatively larger tax burden. Second, the incentives to engage in virtually all economic activities (e.g., migration, education, and investment) would change. For example, migrating to locations with large agglomeration benefits (e.g., large cities and states) and risky investments may appear more attractive if the additional expected income is untaxed. Whether these adjustments are welfare-improving, in the long run, needs to be evaluated. Third, the proposed decentralization would save individuals from having to file federal taxes, but how the resulting state competition impacts welfare is unclear. If states with many low-income earners enact more progressive taxes to win votes, high-income earners in those states would have incentives to migrate out, making the rest worse off. Hence, the three points discussed above (and many others not discussed here) must be considered together to predict the result of your proposal.

Answered by
  • Assistant Professor
Last updated on
May 22, 2023

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