“I’ve been thinking a lot about Medicaid, and I’m concerned. I believe Medicaid is suffering from an identity crisis. Medicaid doesn’t know what it wants to be, and it doesn’t know its purpose in life. Some people want Medicaid to expand. I just want it to work.”
… Such are the musings of a healthcare policy wonk in Mississippi.
I have been discussing Medicaid, and healthcare generally, for many years now. I am no longer surprised when people do not know the difference between Medicare and Medicaid. I am surprised, however, when proponents of Medicaid expansion do not seem to understand what Medicaid actually is. For instance, that the Mississippi Division of Medicaid is not a healthcare provider, but a healthcare purchaser and that this distinction has significant consequences.
Medicare is a (mostly) single-payer, national insurance program fully funded by the federal government. By contrast, Medicaid is a joint federal-state program, with lots and lots of federal strings attached.
Medicare is a government-subsidized insurance plan for the elderly. Medicaid is a government-subsidized insurance plan initially created to help the blind, disabled, pregnant women, and children.
Now that we have that straight, what, exactly, is Medicaid?
Medicaid is an insurance program. But Medicaid is also a welfare program. This is the root of the problem for Medicaid. This is why costs keep going up, and this is one reason fraud is such a problem.
Medicaid is the largest single insurance plan in the United States, with approximately 75 million recipients. By contrast, Medicare has 44 million enrollees. This means that the federal agency (CMS) that pays for Medicaid/Medicare is the largest single-payer for healthcare in the United States. In short, if Medicaid were an insurance company it would be huge.
As an insurer, Medicaid does not operate like other insurers. To begin with, this is because health insurance in the United States does not work the way other kinds of insurance do. Consider how your auto insurance or homeowner’s insurance works. Auto insurance does not generally cover a flat tire. Homeowner’s insurance does not cover routine repairs and renovations.
Health insurance, however, covers a much wider array of services than do other types of insurance. It covers preventative care (comparable to controlling for termites or adding gutters, if we are comparing the body to a house). It covers emergency care (comparable to a fire or a flood, which is what typical homeowner’s insurance covers). It covers non-emergency, routine care (comparable to fixing the foundation or installing storm windows).
One reason health insurance is so expensive – though many people do not realize it because the cost is often automatically deducted from their paycheck – is because it covers so much.
Because it covers so much, Medicaid is just plain expensive, all the more so because healthcare prices keep rising. And when I say expensive, I do not mean to the recipients, I mean the overall price tag for the federal government and the states – that is, taxpayers and future debt holders. (This is not even to mention the cost-shifting that leads to increased prices for private insurance customers.)
Another reason Medicaid is expensive is because it is not just an insurance program, it is a welfare program. Indeed, unlike TANF (cash welfare) and other welfare programs, Medicaid is an open-ended entitlement. This means anyone eligible for Medicaid has a legal right to enroll. Federally mandated coverage groups include children, very low-income parents, pregnant women, and aged, blind, and disabled individuals receiving SSI (Supplemental Security Income).
States may cover optional services and populations, and many do in order to drawdown even more federal funds. At the same time, states are prohibited from implementing enrollment caps or individual spending caps. The only real limit on Medicaid spending is demonstrated need. Consequently, as healthcare economist Robert Graboyes puts it, Medicaid is “a market perpetually in a state of excess demand.”
To translate, this means that Medicaid spending is very hard for states to control. Advocates of Medicaid expansion claim it is a great deal because the federal government is paying 90 percent of the cost. This sounds a lot like renting a $10 million mansion at a 90 percent discount. The mansion may be 90 percent off, but you still need to come up with a million dollars in rent every year. Except in the case of Medicaid, that $1 million payment this year could turn into $2 million next year and $3 million after that. And there is really nothing you can do about it.
In order for Medicaid to work better, two things have to happen. First, Medicaid needs to begin operating like other welfare programs. This means enrollment is going to have to be limited. (Which also means expanding Medicaid to able-bodied, working-age adults is a very bad idea if your goal is to provide healthcare to those who really need it.)
Apart from limiting enrollment, which states cannot do right now, the most obvious way to control Medicaid costs is to cut payments to providers. This approach has a significant downside because it will encourage more healthcare professionals to stop taking Medicaid altogether.
The second thing that needs to happen is to begin treating Medicaid insurance as we do other kinds of insurance. This would mean transforming Medicaid into a catastrophic coverage type plan that only pays for major health events and then pairing that coverage with a publicly funded large Healthcare Savings Account (HSA). Such an account would give Medicaid recipients an incentive to control costs for themselves and to invest more in their long-term doctor-patient relationships.
I am not holding my breath for these two reforms to occur anytime soon. The Biden Administration is intent on “increasing access” to healthcare by increasing enrollment in Medicaid, regardless of whether this actually increases access or improves healthcare outcomes. That said, it is important to acknowledge that Medicaid is not like other kinds of insurance or, even, other kinds of welfare. And these are two reasons, among many, that make expanding Medicaid bad policy for Mississippi.
***FOR IMMEDIATE RELEASE***
Contact: Hunter Estes, [email protected]
Governor Tate Reeves has just signed HB1263 which makes it easier for people to move to Mississippi to work. The statute removes a bureaucratic barrier that keeps skilled newcomers from being able to earn a living.
Authored by Representative Becky Currie, this new law allows people who already have a license in another state to more easily get one when they settle in the Magnolia state. We interviewed Rep. Currie about the importance of the legislation here.
The legislation was passed almost unanimously out of both the House and the Senate.
This new law is part of a wider move to make Mississippi more business friendly and open to entrepreneurs.
“We are incredibly thankful to Representative Becky Currie, Senator Angela Hill, Senator Kevin Blackwell, Senator John Polk, Governor Tate Reeves, Speaker Philip Gunn, and Lt. Gov. Delbert Hosemann for their work on this legislation,” noted Douglas Carswell, President & CEO of the Mississippi Center for Public Policy, which has been driving the calls for reform.
“We spend millions of dollars trying to recruit companies to come here, but this law is a simple, effective way to create more jobs right here in Mississippi. For too long, people have been moving out of state to work. This helps reverse that by making it easier for folks to come here and continue the pursuit of the American dream.”
MCPP's Dr. Jameson Taylor noted, “this has been a two-year effort. In 2020, we worked with the Department of Defense to enact the nation’s best law to make it easier for military spouses and dependents to move to Mississippi and start working right away. This year we expanded the law to extend these same benefits to skilled workers moving to Mississippi.”
Data recently released by the Legatum Institute’s Prosperity Index shows that Mississippi is the 41st most costly state in the Union in terms of acquiring an occupational license.
“It is especially important that this law was passed and signed, and that high barriers to work opportunities don’t hold back folks that want to come here to work,” Carswell explained.
Already, Arizona, Montana, Pennsylvania, Missouri, Utah, Iowa and Idaho have passed this reform, which is also being introduced in multiple state legislatures this year.
MCPP President’s Douglas Carswell is available for media interviews. Please email [email protected] for requests.
***ENDS***
Who was America’s greatest President ever? Was it George Washington, who beat the British and helped establish the Republic? How about Abe Lincoln, who saved the Republic and extended Constitutional freedoms to every American?
My personal favorite President is Ronald Reagan. He extended American liberties across the globe when he won the Cold War.
The truth is that America has been blessed by good leadership for much of her existence, and there are plenty of other good Presidents to choose from. But things have not always been that way.
Who would you rank as the worst ever American President?
For me, Lyndon B Johnson has to be a strong contender for that title. Reading Robert Caro’s magisterial biographic series about LBJ reveals some unflattering truths about the 36th President. LBJ comes across as both ruthless and venal.
Yet it is not so much LBJ’s character that condemns him as the consequences of his time in office. LBJ attempted to lay the foundations for what he called ‘the Great Society’. What he sowed instead were the seeds of social decay, which Mississippi and other states have been struggling with ever since.
Under Lyndon Johnson, the size and role of the state increased dramatically, with social spending programs introduced across much of America for the first time. As government grew, welfare dependency emerged and created a system of supplicant Americans, beholden on politicians for handouts.
Far from elevating the conditions of Americans, the expansion of welfare under LBJ has reduced many to a position of dependency.
What ought to alarm us today is that the system of dependency has just been expanded dramatically over the past year, especially here in Mississippi.
When Covid first struck, many of the limitations that there had been on the receipt of welfare were suspended. The amount paid out has been increased significantly, too. These changes were presented at the time as temporary measures designed to help those that had lost their job.
What is becoming increasingly clear is that unlimited access to welfare support has all kinds of harmful consequences – both on society and those receiving welfare checks.
Talking to a local business owner in Jackson the other day, I was surprised to learn that they are struggling to cope with customer demand. With the Covid situation improved, business, they said, was getting back to normal.
The trouble, they said, was that they found it hard to get folks to come back to work. Employees who had left when the Covid crisis first hit were unwilling to return since they would be worse off working than retaining public benefits.
LBJ’s legacy pervades our system of education, too. Changes that were supposed to ensure every American had the same opportunities in life have ended up embedding low expectations. There are too many districts in our state that have had F-ratings one year after another. This is because, to be blunt about it, too many schools are run in the interests of those on the payroll, rather than in the interests of young people needing a head start in life.
What can we do about it? We need to undo the legacy of LBJ. That means reforming the welfare system and the education system to ensure that there is accountability for outcomes.
We need to ensure that the rules on who receives welfare, and under what circumstances, are returned to the state level. Mississippi needs a set of rules to ensure that those that get welfare do so because they have fallen on genuinely hard circumstances, not as a lifestyle choice.
In education, we need to stop funding institutions, and ensure that we fund individual students instead. Teachers should be rewarded for their successes and improved performance.
There is nothing inevitable about some of the long term social and economic problems that have festered since the 1960s. Looking around the world, the free market has managed to elevate the condition of people of every culture, color, country, and continent. We need more free market reform here in Mississippi too.
Opening the door to new technologies in Mississippi is going to take a new way of thinking about regulation. The old approach of regulating first and asking questions later is not going to work. That is why states, like Utah and Wyoming, are opening the door wide to innovation by applying a regulatory soft-touch to new business ideas, like blockchain.
One idea, passed by the Utah Legislature this year, is the concept of a regulatory sandbox. This idea has gained traction in different forms already in Mississippi. In 2017, a bill to create a regulatory-lite zone, sponsored by Rep. Greg Snowden, passed the House. Subsequently, Speaker Philip Gunn introduced bills aimed at using red-tape reduction as an economic development tool.
This session, Rep. Dan Eubanks has been blazing his own trail. Rep. Eubanks introduced two bills – HB 1454 and HB 1455 – that would create a new program to allow companies to test innovative concepts without being smothered by regulation. Borrowing from Utah, the bills create a regulatory “sandbox,” which would encourage innovators to develop technologies and business concepts.
This vision of a regulatory sandbox champions one of the Mississippi Technology Institute’s key aspirations for innovation. MTI recently had the opportunity to discuss this legislation with Rep. Eubanks. MTI’s Tech Specialist Matthew Nicaud conducted the interview.
Matthew: What is the purpose of the two sandbox bills you introduced?
Rep. Eubanks: The bills create a special program called a “regulatory sandbox”: one creates a general sandbox, the other creates a sandbox just for Farm Tech. The idea of a sandbox allows innovative businesses to be exempt from all non-essential regulations in a specific sector, such as energy or agriculture. What this does is create an environment where innovators can grow their business ideas without being burdened by unnecessary regulations. It also gives regulators a platform to understand innovation and develop appropriately informed regulations. This prevents the regulatory agencies from making vague and arbitrary rules that hinder new ideas. Really, what the sandbox does is encourage dialogue between businesses and regulators so that they can better understand how to work together.
Matthew: Why is innovation an important tool to encourage prosperity in Mississippi?
Rep. Eubanks: Innovation creates a platform for the development of new tools and business models. Mississippians can use these new ideas to generate capital, grow businesses, and provide for their families. The people of our state have the drive and the vision to unleash prosperity. By using the creative avenues that come about from innovation, Mississippi citizens have the potential to further prosper and grow.
Matthew: With technology advancing at such a rapid pace, how would these bills create a friendly environment for technological innovation?
Rep. Eubanks: Ultimately it is people, not the government, who will continue to create the innovations that drive our economy. History has shown us that the free market is the greatest engine for innovation. I believe that the best thing for the government to do is step aside. We should let the innovators put their great ideas out into the market. Innovation moves at a very fast pace, and it doesn’t wait around for regulators. So, Mississippi has a responsibility to create an environment where innovation can be explored without regulations impeding the progress. Creating a “sandbox” environment does just that. It protects innovators from heavy-handed and misinformed regulations. It is an important step in the right direction.
Matthew: Has there been innovative success in other states that implemented regulatory sandboxes?
Rep. Eubanks: The state of Utah has created regulatory sandboxes and has seen much success. The state has seen innovations in multiple industries ranging from insurance to legal service technologies. In addition, other states have created sandboxes for the testing and development of financial technologies. This has not only facilitated greater access to capital, but it also has allowed for the further application of innovative financial technologies such as mobile banking and blockchain. Mississippi has a special opportunity to be a place of innovation for several of its largest industries, such as agriculture and manufacturing. There is so much potential if we can be an early adapter in this area.
Matthew: What can be done to move the sandbox concept forward?
Rep. Eubanks: The creation of a regulatory sandbox program will need to be accomplished through legislation. For a bill to advance through the process, it will need the support of our state leaders. This is a practical way for the legislature to encourage economic development through the power of free-market innovation. The goal to encourage innovation is something I believe we can all agree on. Implementing a regulatory sandbox program is an excellent step toward this goal.
Rep. Dan Eubanks represents DeSoto County, Mississippi (District 25).
A coalition of groups from around the nation, that include the Mississippi Center for Public Policy, have joined together in common cause against new overreach by DC politicians. The group is signaling their opposition to new policy that could limit states’ ability to cut taxes.
The recent “American Rescue Plan Act” serves more as a slush fund for fiscally mismanaged states and localities than as a serious attempt to help those struggling with recovering from the economic consequences of COVID-19 and government-imposed shutdowns.
The Act includes $350 billion in State and Local Fiscal Recovery Funds. These funds come in addition to the hundreds of billions in federal assistance to state and local units of government through the CARES Act and other legislative actions taken by Congress in 2020.
Furthermore, Congress has decided to spend this massive amount of money although total state and local revenues actually increased in 2020, and many states have even seen their surpluses expand.
However, the Act goes a step further than just recklessly spending taxpayer dollars. The editorial board of the Wall Street Journal noted that the new law bars states from using the influx of new funding to reduce state taxes directly or indirectly through 2024. This language is vague and no clarifications about it have emerged from the Department of Treasury so far.
The ambiguous language has many rightly concerned that any efforts at the state level to reduce the tax burden of its citizens could be stymied by the federal government.
Recognizing this vast federal overreach, a coalition of concerned leaders has signed onto a new letter to signal their opposition to the unprecedented move. The campaign was organized by the American Legislative Exchange Council (ALEC).
The letter notes, in part:
“Using federal coercion to artificially elevate state tax burdens at a time when small businesses and hardworking American taxpayers need real tax relief is nonsensical. Our groups have spent decades working with state policymakers and watching them achieve more economically competitive business climates through pro-growth tax and economic reforms. Having the federal government use “the power of the purse” in an attempt to curtail the use of competitive federalism is incredibly damaging to our American system of government.”
It continues, “[w]e will work to protect the fundamental principle of federalism and allow states to continue their progress in pursuing economic gains as the 'laboratories of democracy.' Restricting states from providing pro-growth net tax relief tips the scales of federalism inexorably toward central planning and micromanagement by the federal government.”
You can read the letter in its entirety here. It was signed by MCPP President Douglas Carswell.
This entirely new level of dramatic fiscal recklessness and federal overreach demands opposition. The Mississippi Center for Public Policy is standing for federalism and the ability of states to conduct and control their own tax policy without new limitations.
The US House of Representatives passed a $1.9 Trillion bill, dramatically increasing the US budget deficit. Presented as a COVID-19 relief measure, little of the money will be spent on tackling the virus. Instead, it will hose federal funds at every vested interest imaginable.
This massive injection of money will undoubtedly generate more economic activity short term. But it will not mean sustainable growth and will carry long term negative consequences.
According to the Penn-Wharton Budget Model every $1 of spending in this bill will only lift output by around 20 cents.
So economically illiterate is this measure, even economists that normally favor stimulus spending admit that this is not the way to do it. US federal debt as a percentage of output is now close to the level it was at the end of World War II.
Is there any principled idea behind what this bill is up to, or is this simply a product of political opportunism?
The most favorable explanation is that progressives believe that there is hidden slack in the economy, and that added demand will create its own supply.
I believe what we will see instead is inflation, and a weakening of the US economy’s ability to generate wealth in the long term. That means lower living standards, higher taxes, a devalued dollar, and debt.
What can we do about it? Our job here at the MCPP is to help set out the alternative. America is going to need a roadmap to recovery based on the principles of free markets and limited government.
As some test to destruction the idea that government is able to spend its way to prosperity, millions of Americans need to know that we have an alternative. State by state, in Mississippi and beyond, we need a national movement that develops that alternative. The future prosperity and happiness of our children, and their children, depends upon it.
***FOR IMMEDIATE RELEASE***
House Passes Major Occupational Licensing Reform Bill Championed by MCPP
Contact: Hunter Estes, [email protected]
The Mississippi House has just passed HB1263 which makes it easier for people to move to Mississippi to work. The bill removes a bureaucratic barrier that keeps skilled newcomers from being able to earn a living. HB1263 now moves onto Governor Reeves for consideration.
Authored by Representative Becky Currie, this bill would allow people who already have a license in another state to more easily get one when they settle in the Magnolia state. We interviewed Rep. Currie about the importance of the bill here.
The House voted to pass the bill by a vote of 115-1.
Today’s bill is part of a wider move to make Mississippi more business friendly and open to entrepreneurs.
“We are incredibly thankful to Representative Becky Currie, Senator Angela Hill, Senator Kevin Blackwell, Senator John Polk, Speaker Philip Gunn, and Lt. Gov. Delbert Hosemann for their work on this bill,” noted Douglas Carswell, President & CEO of the Mississippi Center for Public Policy, which has been driving the calls for reform.
“We spend millions of dollars trying to recruit companies to come here, but this bill is a simple, effective way to create more jobs right here in Mississippi. For too long, people have been moving out of state to work. This helps reverse that by making it easier for folks to come here and continue the pursuit of the American dream.”
Data recently released by the Legatum Institute’s Prosperity Index shows that Mississippi is the 41st most costly state in the Union in terms of acquiring an occupational license.
“It is especially important that this bill passed, and that high barriers to work opportunities don’t hold back folks that want to come here to work,” Carswell explained.
Already, Arizona, Montana, Pennsylvania, Missouri, Utah, Iowa and Idaho have passed this reform, which is also being introduced in multiple state legislatures this year.
MCPP President’s Douglas Carswell is available for media interviews. Please email [email protected] for requests.
***ENDS***
Famed economist Arthur Laffer endorsed HB1439, the Mississippi Tax Freedom Act, legislation introduced by Mississippi House Speaker Philip Gunn that seeks to eliminate the income tax.
Laffer’s work played a foundational role in defining the economic policies that led to tremendous growth under the Reagan administration in the 1980s. His preeminent and lasting work is known as the Laffer Curve. This theory notes that, through taxation, government gains revenue until, at a certain point, the taxation discourages growth to the point that the government actually takes in less revenue.
In 2019, Laffer was awarded the Presidential Medal of Freedom by President Donald Trump for his accomplishments in and contributions to the study of economics.
In a press release sent out by Speaker Philip Gunn, Laffer stated:
“For decades, I’ve worked with state legislators to eliminate the tax that is the single greatest threat to state economic growth and prosperity—the income tax. My hat goes off to Mississippi Speaker of the House Philip Gunn and his colleagues for their bold plan to make Mississippi more prosperous through income tax elimination and fiscal discipline. America is watching. Mississippi has a once in a generation opportunity to re-position itself for economic growth.”
“I am very pleased to have Dr. Laffer’s support for HB1439,” noted Speaker Gunn. “Dr. Laffer’s leadership was a key inspiration for President Reagan’s transformative tax cuts, which set off an unprecedented boom in the American economy. There is no bigger name in tax reform circles nationally than Dr. Laffer. His support demonstrates the strength of HB1439. It is a credit to the hard work of Chairman Trey Lamar, Speaker Pro Tem Jason White, and our House members. As Dr. Laffer said, this is a once in a generation opportunity. I urge Lt. Governor Hosemann and our Senate to work with the House to bring transformative tax reform to Mississippi this session.”
A recent study by Dr. Joshua R. Hendrickson and Dr. Ronald Mau, economists at the University of Mississippi, showcased that the proposal would likely increase gross domestic product in the state by at least $371 million. This growth is in addition to the personal savings that individual taxpayers would experience because of the plan.
Our Senior Vice President for Policy, Dr. Jameson Taylor, interviewed Hendrickson and Mau to discuss their findings. You can read the full interview here.
HB1439 now awaits consideration in the Senate.
What tax plan is best for the people of Mississippi? What kinds of taxes are best for job growth and the economy? Why is tax policy important, in the first place?
Dr. Jameson Taylor recently interviewed two Mississippi economists for the answers. Dr. Joshua R. Hendrickson and Dr. Ronald Mau have studied the real-life effects of the Mississippi Tax Freedom Act (HB 1439) and produced a timely report on how the Tax Freedom Act would grow Mississippi’s economy.
Dr. Hendrickson holds a Ph.D. from Wayne State University and is an associate professor of economics at the University of Mississippi. Dr. Mau holds a Ph.D. from the University of Notre Dame and is an assistant professor of economics at the University of Mississippi.
Dr. Taylor: It seems like the income tax is not something most people think about. People see this money taken out of their paycheck, but don’t realize it’s actually part of their tax bill from the state and federal government. Why is tax policy important for the average Mississippian?
Drs. Hendrickson and Mau: Tax policy is important to the average Mississippian because it affects how much money they really bring home in their paycheck. It also affects the costs of the things that they buy. In addition to other taxes in the economy, these income and consumption taxes reduce household resources available to save or spend.
On a more macro level, tax policy is important because it affects economic activity in the state, a key measure being the total amount invested in the state. When investment income is taxed, investment returns are lower, and investment resources may flow elsewhere. Tax policy can also affect whether businesses want to locate here or workers want to live here.
Dr. Taylor: Tax policy differs quite a bit from state to state. Nine states essentially have no income tax. Five states have no state sales tax. Mississippi is in the middle of the pack in terms of its overall tax burden. How much does tax policy affect where people choose to move?
Drs. Hendrickson and Mau: Tax policy is important. While tax policy might not always be the most important determinant of where a firm or a particular person decides to move, it does matter at the margin. In other words, when a particular person or company is choosing between moving to one state or another, the taxes that one has to pay in each of those states will play a role in that decision.
Dr. Taylor: The Tax Freedom Act essentially eliminates the income tax in exchange for raising the sales tax, excepting a cut to the grocery sales tax. What does the research show is the best way to levy taxes and what are the tradeoffs between taxing income and taxing consumption/sales?
Drs. Hendrickson and Mau: In general, research shows that a consumption-based tax system is preferred to an income-based tax system on efficiency grounds. People have no doubt heard the phrase, “when you tax something, you get less of it.” This is what economists mean by inefficiency. The tax prevents economic activity that would have taken place without the tax.
All taxes create distortions in economic activity, but not all taxes create the same magnitude of inefficiency. When designing a tax system, one would like to generate as much revenue as possible with the smallest distortions possible.
Consumption-based tax systems are preferred to income-based tax systems because the former create fewer distortions—income taxes not only tax labor income but also tax income that comes from savings. A tax on savings income lowers the after-tax rate of return on savings. Due to the nature of compound interest, the costs of taxation increase with the duration of savings.
Think about why people save. They might save to buy a new car, to have money for a rainy day, or for their retirement. Thus, we can think of savings as a way to pay for future consumption. Since the cost of taxation increases with the duration of savings, taxing income from savings is like having a tax on future consumption where the tax rate is higher every subsequent year in the future.
As we said, the goal of tax policy is to raise as much revenue as possible while also trying to minimize the distortions in economic activity that come from taxes. A higher and higher tax rate on future consumption not only creates a distortion, but the distortion gets larger with time. People not only have the incentive to save less, but they have an incentive to save for shorter durations of time.
A consumption-based tax system also creates distortions. However, in contrast to a tax on income, a consumption-based tax system taxes consumption in each period equally. As a result, you get fewer distortions.
Dr. Taylor: Your study finds that the Mississippi Tax Freedom Act (HB 1439) would increase incomes and economic activity in Mississippi. Why is this the case? How would it affect incomes in Mississippi?
Drs. Hendrickson and Mau: Our analysis really highlights the benefits of a more efficient tax system. When it comes to tax reform, what policymakers would like to do is increase economic activity without reducing the amount of tax revenue that they bring in. Of course, that is not easy to do. When you eliminate a particular tax, you eliminate the distortions and increase economic activity. However, you also lose the revenue that tax generates. To make up for that lost revenue, you have to create a new tax or increase another existing tax. Doing so generates revenue but also creates new or bigger distortions. For tax reform to be successful by the terms we just described, the new tax regime would have to be more efficient than the existing regime.
Our analysis shows that eliminating the income tax and replacing the revenue with a higher sales tax increases economic efficiency. This is because the distortions of the sales tax are smaller than the distortions from the income tax. The reason is what we described in answer to the last question. Income taxes tend to discourage savings and investment. As a result, shifting away from the income tax provides greater incentives to save and invest. This is where the economic benefits come in. This increase in investment leads to more production, higher marginal productivity of workers, and higher labor income. Furthermore, as a sign that a more efficient tax system drives this, we find that consumption would increase, despite a higher sales tax. This demonstrates that the economic effects of eliminating inefficiencies more than offset the cost of the tax increases.