The idea of tax reform is gaining some traction in Annapolis. Anyone who has dealt with the state’s tax code should recognize that it could use an overhaul. A tax reform commission, as is being proposed by some legislators, could be the vehicle to move the state towards a far better tax code. If legislators are truly interested in improving it, they should make it simpler and more neutral.

The sole purpose of taxes should be to raise enough revenue to pay for the level of government services demanded by the public, through their elected representatives. The tax code’s purpose is raising money —although many legislators view it as a prime way to engage in social engineering.

There are numerous ways to raise this money, and each affects decisions made by individuals. When you raise the cost of an activity, you will decrease the prevalence of that activity (everything else being equal). Ideally, legislators will design a tax code that will minimize its burden on how Marylanders make decisions. 

The Tax Foundation spells out this principle:

Taxes should neither encourage nor discourage personal or business decisions. The purpose of taxes is to raise needed revenue, not to favor or punish specific industries, activities, and products. Minimizing tax preferences broadens the tax base, so that the government can raise sufficient revenue with lower rates.

What does this mean in practical terms?

Legislators should not view the tax code as a way to reduce inequality or penalize (or encourage) certain activities. Doing so places policy decisions ahead of revenue decisions. If legislators think that people with higher incomes are making their money unfairly, they should spell that out in legislation regulating whatever practices they consider “unfair.” Similarly, if legislators do not like certain activities, they should not use the tax code to impose punitive taxes on those activities.

Under this idealized version of the tax code, Marylanders would be able to make economic decisions without undue state influence. If they want to earn income in a certain way, they would make the decision based on factors that are important to them, not on whether they will incur a tax penalty. When they buy something, they will not face the prospect of one item being taxed and another being exempt. In other words, Marylanders will make decisions that are best for them, not for legislators.

The benefits of this are two-fold. As the Tax Foundation points out, when taxes are applied fairly and not designed to encourage or discourage certain activities, rates can be lower. If certain products are not exempt from the sales tax, the overall sales tax rate can be lower. If there are not income tax credits for favored activities, then overall income tax rates can be lower.

The other benefit is less drag on the economy from government meddling. Fewer economic decisions will be made because they please the politicians who wrote the tax code; instead, these decisions will be made with an eye to how they work best for the individuals. That leads to greater efficiency throughout the economy.

Of course, this vision of the tax code will not happen. Tax codes are written by politicians with the help of lobbyists. Interest groups exert pressure so the tax code reflects their narrow view. At the very least, Marylanders should keep a close eye on Annapolis and see how closely the decision-making process lines up with the principles of good tax policy. That will provide a good yardstick by which to judge what emerges.