01/25/2013 06:03 pm ET Updated Mar 27, 2013

The Right Way to Eliminate State Income Taxes

Even as the newly reelected president calls for ever-bigger government, a tax-slashing season has started in some Republican-leaning states. Efforts to eliminate or significantly cut state income taxes have gained steam in Louisiana, Kansas, Oklahoma and Nebraska among others. As a low-tax conservative, it's hard not to cheer the trend: Taxing personal income reduces both the earnings from work and the rewards those earnings entail. Income taxes are also expensive to collect and easy to evade. They're far from ideal by any standard. But states that want to cut or eliminate personal income taxes (a good thing) need to think carefully about how they do it. Doing in it the right way (spending cuts and smart tax substitution) can bring about greater growth and prosperity. Doing in the wrong way will, at best, be a wash. And, right now, many states seem to be doing it the wrong way.

Spending cuts that reduce the size and scope of government probably the best way to replace the money "lost" by cutting income taxes. But few legislators of either party seem honestly willing to make such cuts. Many core Republican voters are, paradoxically, the dependent government spending ranging from transfer payments (Social Security) to government jobs (police officers, for example). Thus, eliminating income taxes and making up the difference through spending cuts is often quite politically difficult for Republicans no matter how much they talk about smaller government.

Thus, one gets a lot of tax swaps on the table. North Carolina legislators, for instance, have proposed higher taxes on sales, higher business license fees, and new taxes on professional services to fill the gap. These may well raise gross taxes on people with modest incomes (who spend a larger percentage of them on consumer goods), make it harder to start a business in the state, and subject a whole range of previously untaxed things to hefty tax bills. Kansas, likewise, has extended a previously scheduled-to-expire increase in the sales tax and may see its bonds downgraded anyway. And so forth.

If they can't simply cut spending -- and most states probably couldn't reasonably eliminate every service currently paid for by the income tax -- states should consider "tax swaps." And two types of tax swaps, on land and pollution, deserve particular consideration.

First, states should consider higher taxes on land. As the 19th-century political economist Henry George first observed, land -- unlike everything else -- isn't actually created by any person (although improvements on it are.) Any given piece of land has the same highest and best use if it's value is taxed at 100 percent or nothing at all. While George's ideal of a single land value tax isn't workable for a wide variety of reasons, the closest thing most localities have to land value taxes -- property taxes -- are a pretty good way to fund government. They're reasonably inexpensive to collect and nearly impossible to evade. Furthermore, they tend to be self-limited: States with very high property taxes like New Hampshire and Texas tend to have low overall taxes too. Switching systems to those that tax the land's value more and improvements more could make a reasonably good tax better.

Second, states should consider raising taxes on bad things like pollution. These taxes, called Pigovian taxes after economist Arthur Pigou, tend to both deliver revenue and reduce a variety of ills. While one type of Pigovian taxes -- in taxes on alcohol and tobacco -- are already high and widely applied, a wider range of Pigovian taxes are well worth considering. While some -- like "fat taxes" seem like consumption taxes by other means, others, like taxes on energy use or carbon pollution -- could make a great deal of sense because they would bring in a fair amount of revenue without most people noticing.

Reducing spending is a good idea. Cutting taxes is also good. And if state politicians want to figure out how to eliminate income taxes, they should work to think about spending cuts and smart, pro-growth tax swaps.

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