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Busting Tax Myths: Personal income tax no more volatile than other major state taxes

North Carolina policymakers have pledged to make revenue modernization a legislative priority in 2013. Earlier today at a press conference, North Carolina Senate President Phil Berger indicated that there will indeed be a revenue reform package. At this point, it is not entirely clear which specific policy decisions and principles will guide the leglative leadership’s revenue plan.

With that said, Senator Rucho [1], the Co-Chair of the Senate Finance Committee, is touring the state and pitching a proposal [2] that would eliminate the state’s personal and corporate income taxes. One of the arguments used in support of this proposal is that sales tax revenue is less volatile than personal income tax revenue. This is one of many persistent tax myths, however. And if this tax myth is used to guide policy decisions, the result could be even more problems with North Carolina’s tax code.

For sure, sales tax revenues are volatile in the face of economic downturns. This is especially [3] true when the sales tax fails to include services. While Senator Rucho and others have claimed that the sales tax can deliver greater stability than other revenue sources, it is important to note that research [4] demonstrates that the personal income tax is no more volatile than the sales tax in the long-term.

As reported by ITEP in this report [5], it is also important to keep two other facts in mind:

  1.  “Over the long term, progressive income taxes are the most reliable revenue source available to states, displaying more robust growth in the long run than sales, property or excise taxes; and
  2. “States faced with revenue volatility have a variety of sensible fiscal management strategies available to mitigate the impact of volatility.”

Minimizing volatility and increasing stability is an important principle to guide revenue reform. Greater stability can minimize the extent to which ups and downs in the economy can compromise adequate support for key public structures like schools, hospitals, colleges and universities. However, eliminating the personal income tax will only result in a diminished capacity to fund key public investments in the long-run. The issue of volatility would be better addressed through such tools as Rainy Day Funds, which are contributed to in good times so that they can smooth revenue in downturns.