3 Ways to Bring Taxes Into the 21st Century

But only one of these three modernization methods of revenue raising has a chance.
June 2015
By Justin Marlowe  |  Columnist
Endowed Professor of Public Finance and Civic Engagement at the Daniel J. Evans School of Public Policy & Governance at the University of Washington

‘Tax modernization” was a trending topic in this year’s state legislative sessions. It joins “tax efficiency” and “tax fairness” as the latest benign-sounding way to talk about the thorny issue of who will pay for state and local government.

Modernization is tricky because different sides of tax policy debates deploy it to mean different things. To some, it means state and local governments should collect taxes more efficiently. To others, it means we should apply the taxes we have in new ways. A third group equates a modern revenue system with one that enlists lots of different types of taxes. Each of these groups envisions a unique tax system, but you need them all on board to get meaningful policy change. Tax modernization is a nice way to tie all three perspectives together.

But here’s the problem: When you look at the evidence, you see that only one of these three perspectives has a chance.

Liberals and conservatives alike agree that tax systems can be much fairer and far more efficient. We can automate tax bill payment systems. We can streamline how governments collect and manage taxpayer data. We can build in sophisticated data-tracking systems to detect fraud. When these changes happen, taxpayers are more likely to get the correct tax bill, to pay their fair share and to know their neighbors are paying their fair share. Chicago, Hawaii, West Virginia and many other governments have recently taken up this style of modernization. The criticism, of course, is that without the right kind of transparency, this new technology can actually obfuscate who’s paying which taxes.

Others believe tax modernization means applying the tax instruments we have in new ways. Most state and local tax systems were designed for a 19th-century manufacturing economy. They don’t work for today’s service-driven, electronic, global economy. So how do we update those systems? By applying the sales tax to the services and “intangible” sectors of the economy. By phasing out taxes that are expensive to collect but don’t produce much revenue. By adopting the Streamlined Sales Tax and other reforms that make sales tax systems more uniform across states. Tennessee Gov. Bill Haslam’s proposed Revenue Modernization Act is probably the best recent example of a reform package tailored mostly to this notion of modernization.

It’s hard to make this argument resonate with voters. This might be because tax systems were outmoded long before the advent of the information economy. Connecticut was the last state to adopt a tax on earned income, in 1991. Vermont was the last to adopt a statewide sales tax, in 1969. Most local governments added sales taxes prior to 1985. State and local revenue systems have been remarkably staid, despite big changes in the broader economy.

Diversification also seems lost on voters. In fact, state and local revenues are remarkably undiversified. According to recent Census data, about 75 percent of local governments get more than 75 percent of their tax revenue from two revenue sources, usually property and sales taxes. States are just as dependent on sales taxes and income taxes, but not for lack of trying. Oregon has put a statewide sales tax to voters nine times since 1933. Countless other states and localities have also tried and tried again to diversify. Voters in those states seem OK with putting their proverbial revenue eggs in one or two baskets.

So if past is prologue, tax modernization has a chance, but only if it’s defined to mean making the system we have work efficiently. Folks on the right can stop calling revenue modernization efforts “tax increases.” Those on the left who want to grab new revenue can stop calling it “modernization.” Instead, maybe we can all agree that the future is really about making the system we’ve always had as efficient and transparent as possible.