Back
in 2004 when Virginians were debating the merits of
higher taxes, a prominent politician coaxed chuckles from a business-friendly crowd
at an event I attended when
someone asked, wouldn't higher taxes hurt
Virginia's economic growth? Low
taxes were OK, he retorted -- if you wanted to be like
Mississippi. Badda
bing! There
were two assumptions embedded in that quip.
First, that Mississippi had significantly lower than
average taxes. Second, that the state's unenviable
economic performance was no endorsement of low
taxes. It's
often illuminating to refer to the facts.
Back in 2004, according to Tax Foundation
data, the Magnolia state ranked 31st among the 50
states in terms of state and local tax burden per
capita -- five notches higher than Virginia.
Virginia would hardly look to Mississippi as an
example of a low-tax state. Mississippi was
indeed the poorest
state in the country, but it wasn't as poor as it once
was. In 1970, its per capita income was a pitiful 64
percent of the national average. By 2005, it had
clawed its way up to 73 percent of the national
average -- overcoming the legacy of Jim Crow
segregation, an ill-educated workforce and a century
of under-investment in knowledge-creating
institutions. Mississippi's lower-than-average tax
burden, higher than Virginia's though it was in
2000, was one of its few
competitive advantages and arguably accounted for
much of its slow but steady progress toward national
norms. I
don't mean to dwell on Mississippi. The point of the
story is this: A lot of what Virginia's political
elites think they know about taxes and regional economic growth is
driven by ideology and partisanship, and a lot of it
is just plain wrong. The complex reality doesn't
support the position of either those who think taxes
are no big deal, or those who would oppose taxes
blindly without offering alternatives for
accomplishing core missions of state and municipal
government.
Allow me to submit two
propositions:
-
But
all things are rarely equal. The
economic performance of states and regions is
strongly influenced by their local industry mix
-- regional economies rise and fall along with
their leading industries -- as well as the level
of public investment in productivity-enhancing,
wealth-creating assets like schools,
universities, research centers, transportation
systems and other infrastructure.
As
I hope to demonstrate, taxes and public investment both matter. The
central challenge for Virginia government is to keep
taxes as low as possible while also delivering core
public services needed to sustain prosperity and a
high standard of living.
Many
of those who editorialize about state-local government posit a
one-to-one trade-off between taxes and services: In
the absence of borrowing, cuts in taxes can be paid
for only by cuts in services. That
notion, I maintain, is intellectually bankrupt and a sure-fire recipe for stagnation.
Virginia cannot afford such a blinkered approach to
governance.
Instead,
Virginia should follow a third path: working
diligently to make government more
efficient... in effect, to do more with less. We
need to replace a governmental culture of "good
enough" with the zealous pursuit of
productivity and innovation. That's what successful private companies do, even if
it requires painful change, and
it's what the enterprise known as the Commonwealth
of Virginia must do as well.
Economists
have debated the impact of state/local taxes on
economic performance for years. You can hop onto the
Internet and find any number of studies to fit your
preconceived notions. Here's my
quick-and-dirty analysis.
In
the chart below, I've ranked the states by 2000 tax
burden, as calculated by the Tax
Foundation.
As
I argued earlier in the "Economy 4.0"
series, per capita income is the single best metric
for economic prosperity. Accordingly, using Bureau
of Economic Analysis figures, I have expressed each
state's per capita income as a ratio of
the national average in 2000 and 2005.
(A score of 100 equals the national average. A score
of 95 indicates per capita income five percent lower
than the national average; 102 indicates two percent
above average.)
Then
I calculated the percentage-point gain or loss in
relative standing over that five-year period.
Virginia, for instance, rose from 104 to 109,
meaning that its income gained five percentage
points relative to the national average.
Next,
I broke down the 50 states by quintiles and
calculated the average tax burden and average income
gains for each quintile, as seen below.(1)
Tax
Burden and Income Growth
(2000
to 2005) |
Rank
|
State
|
Relative
Income
2000
|
Relative
Income
2005
|
Gain
|
2000
Tax Burden
|
1
|
Maine
|
87
|
89
|
2
|
13.2%
|
2
|
New
York
|
117
|
116
|
-1
|
12.9%
|
3
|
Hawaii
|
95
|
100
|
5
|
12.2%
|
4
|
Wisconsin
|
96
|
97
|
1
|
12.1%
|
5
|
Rhode
Island
|
98
|
102
|
4
|
11.7%
|
6
|
Minnesota
|
107
|
108
|
1
|
11.6%
|
7
|
Vermont
|
93
|
95
|
2
|
11.6%
|
8
|
Utah
|
80
|
79
|
-1
|
11.3%
|
9
|
Connecticut
|
139
|
137
|
-2
|
11.2%
|
10
|
California
|
109
|
107
|
-2
|
11.2%
|
|
1st
quintile
|
|
Average:
|
0.9
|
11.9%
|
11
|
Illinois
|
108
|
105
|
-3
|
11.1%
|
12
|
New
Mexico
|
74
|
81
|
7 |
11.1%
|
13
|
Idaho
|
81
|
83
|
2
|
11.0%
|
14
|
Nebraska
|
93
|
96
|
3
|
11.0%
|
15
|
Ohio
|
95
|
92
|
-3 |
11.0%
|
16
|
Iowa
|
89
|
92
|
3
|
10.8%
|
17
|
West
Virginia
|
73
|
77
|
4
|
10.7%
|
18
|
Georgia
|
94
|
90
|
-4
|
10.5%
|
19
|
Louisiana*
|
77
|
72
|
5
|
10.5%
|
20
|
Maryland
|
115
|
122
|
7
|
10.5%
|
|
2nd
quintile
|
|
Average:
|
2.1
|
10.8%
|
21
|
Washington
|
106
|
103
|
-3 |
10.5%
|
22
|
Mississippi
|
70
|
73
|
3
|
10.5%
|
23
|
Kansas
|
93
|
95
|
2
|
10.5%
|
24
|
Arkansas
|
73
|
77
|
4 |
10.5%
|
25
|
New
Jersey
|
129
|
127
|
-2
|
10.5%
|
26
|
Arizona
|
86
|
87
|
1
|
10.4%
|
27
|
Michigan
|
99
|
95
|
-4 |
10.3%
|
28
|
Massachusetts
|
127
|
126
|
-1
|
10.3%
|
29
|
Kentucky
|
82
|
82
|
0
|
10.3%
|
|
3rd
quintile
|
|
Average:
|
0
|
10.4%
|
30
|
North
Dakota
|
84
|
91
|
7
|
10.1%
|
31
|
South
Carolina
|
82
|
82
|
0
|
10.1%
|
32
|
Montana
|
77
|
84
|
7
|
10.1%
|
33
|
Virginia
|
104
|
109
|
5
|
10.1%
|
34
|
Oregon
|
94
|
94
|
0
|
10.0%
|
35
|
Indiana
|
91
|
90
|
-1
|
10.0%
|
36
|
North
Carolina
|
91
|
90
|
-1
|
10.0%
|
37
|
Pennsylvania
|
99
|
101
|
2
|
10.0%
|
38
|
Missouri
|
91
|
91
|
0
|
9.9%
|
39
|
Wyoming
|
95
|
108
|
13
|
9.9%
|
40
|
Oklahoma
|
82
|
87
|
5
|
9.8%
|
|
4th
quintile
|
|
Average:
|
3.0
|
10.0%
|
41
|
Colorado
|
112
|
109
|
-3
|
9.7%
|
42
|
Florida
|
96
|
99
|
3
|
9.5%
|
43
|
South
Dakota
|
86
|
94
|
8
|
9.4%
|
44
|
Nevada
|
102
|
104
|
2
|
9.4%
|
45
|
Alabama
|
80
|
86
|
6
|
9.2%
|
46
|
Texas
|
95
|
94
|
-1
|
9.1%
|
47
|
Tennessee
|
87
|
90
|
3
|
8.3%
|
48
|
Delaware
|
103
|
108
|
5
|
8.2%
|
49
|
New
Hampshire
|
112
|
110
|
-2
|
7.8%
|
50
|
Alaska
|
100
|
103
|
3
|
6.8%
|
|
5th
quintile
|
|
Average:
|
2.4
|
8.7%
|
*
I used 2004 data for Louisiana. The 2005 data,
which reflected the devastating effects of
Hurricane Katrina, showed a such a precipitous
decline in per capita income that it would
have skewed the numbers significantly.
|
Overall, it is clear to see, lower tax burdens
are associated with higher rates of relative income
growth.
It's
not difficult to explain why this might be the case.
Lower business taxes improve the return on capital
that businesses invest. While taxes may be only one
factor among many influencing the investment
decisions of large corporations whose playing field
is the entire globe, they are particularly
significant for small and midsized businesses that
reinvest profits to fuel their enterprise's growth.
Lower
personal taxes also create a hospitable climate for
foot-loose members of the creative class who have
the means to live anywhere they want. As Richard
Florida has famously argued, the "creatives"
are drawn to communities marked by openness,
diversity and tolerance. But an examination of
internal migration patterns in the U.S. also shows a
consistent flow of well-off citizens from high-tax
states to low-tax states. It appears that many
members of the creative class like to keep the money
they earn rather than have it taxed away.
However, there are plenty of
exceptions to the low-tax rule:
The middle quintile(2)
of states was the worst performer of all between
2000 and 2005 (see the chart below), showing no
gains compared to the national average at all. Thus,
it is equally clear that taxes are not the only
factor that contribute to income growth.
What
are some of those other factors? One is industry
mix. If you dredge
through the details of the per capita income data
over the years,
you'll see that many smaller states move up and down
with changes in the price of energy and agricultural
commodities that play a large role in their
economies. Similarly, the decline of certain
industries can drag a state down, as automobiles
have done to Michigan, while the rise of other
industries, such as information technology in
Virginia, has propelled per capita income growth.
Another
factor may be the large-scale immigration (legal or
otherwise) of poor, unskilled Latin Americans into
the border states. Undoubtedly that was a factor
behind the under-performance of California and Texas
between 2000 and 2005. However, one shouldn't make
too much of this phenomenon: Arizona and New Mexico,
which also share the border with Mexico, showed
relative income gains over the same period.
Finally,
as some economists have noted, higher levels of
state spending (and the taxes to pay for it) can be
associated with higher incomes if that spending is
used to boost productivity and innovation. One can
argue, for instance, that investing in education and
transportation infrastructure yields benefits that
outweigh the cost in higher taxes.
In
"Rethinking
Growth Strategies," Robert G. Lynch with
the Economic Policy Institute, a left-leaning think
tank,
writes:
The
evidence fails to support the claim that growing
the economy requires shrinking the public sector
and reducing taxes. In particular, there is little
evidence that state and local tax cuts — when
paid for by reducing public services — stimulate
economic activity or create jobs. There is
evidence, however, that increases in taxes, when
used to expand the quantity and quality of public
services, can promote economic development and
employment growth.
Please
note Lynch's key qualifier: Higher taxes "when
used to expand the quantity and quality of public
services" can increase growth. What he
doesn't say is that higher taxes often flow to bloated bureaucracy, pork barrel
projects, public sector unions and wealth transfers to
constituencies with the biggest, strongest lobbyists
-- not to bolster productivity, innovation or
growth.
Most
Virginians would agree, I trust, that not all
state/local spending is created equal. Some
government spending contributes to economic growth,
other spending does not. Some government spending
contributes to the wealth-creating capacity of its
citizens, some does not.
To
maximize Virginia's long-term prosperity, then,
our vision should be to balance the drive for low
taxes with a commitment to bolster the
wealth-creating capacity of the state. As a
generality, that means:
One
way to keep spending and taxes under control is to cut "waste,
fraud and abuse" in state and municipal government.
That's easier said than done, of course, but the potential
exists in Virginia to save hundreds of millions of dollars a
year.
In
one positive development, Republican legislators in
the General Assembly and the Kaine administration
have joined to create operational review teams to
root out costs in such areas as travel, printing and
receivables from state government. Also, reforms are afoot to rationalize
the state's vast real estate holdings and lease
obligations. There is potential, too, to reduce the
cost of medical insurance for the state workforce. On the downside, a ballyhooed
initiative to control information-technology costs
appears to be sputtering, and no one is willing to
go to bat for civil service reform.
Finding
such efficiencies is crucial, but
administrative overhead accounts for
only a fraction of total state spending. The really
big savings will come from transportation, Medicaid and
education.
For instance, Virginia could save tens of
millions of dollars annually by instituting a
state-of-the-art methodology for managing road and
highway assets. The state could save potentially
hundreds of millions of dollars in Medicaid program
expenses by rationalizing the system for medical
records and setting up incentives for recipients to
seek care at the most appropriate venues -- the
doctors office as opposed to the emergency room. As
for K-12 schools, Virginia's bureaucratic and
unaccountable system stifles innovation. The
solution is not more money, I would contend, but less centralized
control.
Finally, at the level of municipal government,
dysfunctional human settlement patterns -- the
scattered, disconnected, low-density pattern of
growth commonly known as "suburban sprawl" --
aggravates traffic congestion, increasing pressure
to build more roads, and runs up the cost of municipal
services.
We will address these issues in more depth in future
sections of the "Economy 4.0" series.
I'm
not under any illusion that achieving these gains
will be easy. Many
of these issues are highly complex, and an array of
special interests will defend the status quo
ferociously. Working for Fundamental Change in
governance and land use is a challenge that could
well consume Virginia for a generation or more. But
the fact that change comes hard is no excuse for
failing to take up the challenge. If Virginia wants
to set the global standard for prosperous and
livable communities, we need lower taxes and
we need institutions that provide core services
efficiently. We should settle for no less.
--
October 15, 2007
(1).
Sharp-eyed
observers will notice that more states gained
ground relatively speaking than lost ground. How is
that possible? Because the losers tended to be the
most populous states. Thus, a handful of large
states with disproportionate weight -- California,
New York, Texas, New Jersey, Illinois and Michigan -- dragged
down the national average.
If
that's the case, one might ask, shouldn't we also
give comparable weight to these states when weighting
the average gains and losses of relative per capita
income? Doing so would bolster my case that taxes
harm growth -- all but one of the states cited above
have moderate or high tax burdens. But I chose not
to: Each of the 50 states as an
independent laboratory for taxes and growth, so each
should be given equal weight.
(2)
Sharp-eyed observers also might note that the second
quintile contains only nine states, while the third
quintile contains eleven. I shifted North Dakota
from the second to the third because it had the same
tax burden -- 10.1 percent -- as three other states
in the third bracket. The whole purpose of the
exercise is to compare the performance of states
with differing tax rates.
|