In a recent post of Steve’s, members of this blog got into an extended discussion of the methodology used by the Weldon Cooper Center at UVa. to evaluate the effect of tax incentives, specifically its projecting the “impact of raising income taxes by the amount exempted.” As promised, I contacted a senior executive at Weldon Cooper whom I know and asked for some clarification.
His answer was fairly lengthy, so I will quote key portions and try to summarize his position:
“The answer to your question is that every dollar spent has an opportunity cost. As you point out, one way the opportunity cost can be measured is the value of the best alternative way you could have spent the money. Another way is the cost to the economy of extracting a marginal dollar from the economy with a tax instrument….Every tax has some cost in terms of consumption foregone.”
“One cost of a tax is that it might cause some firm or some person to choose to be elsewhere. This is not a ‘conservative’ idea. It is just a standard result of microeconomics. But we must not lose sight of the fact that how the money is spent is important as well. People and firms value public safety, education services, infrastructure, clean environment, good administration and all the rest. These things are not free.”
He objected to the characterization in BR of the Weldon Cooper method as “dynamic scoring”, saying, “this is incorrect and is a politically charged assertion. It doesn’t make us ‘conservative’ to account for opportunity cost and [the effect on the economy of extracting a marginal dollar with a tax instrument].”
In summary, he asserts that any fair analysis must take account of all the effects of government spending. On the one hand, “every tax has some cost in terms of consumption forgone.” On the other hand, taxes are used to provide services to citizens that can be best provided by government, rather than the market.
Hall-Sizemore take: I was off-base in my earlier characterization of the Weldon Cooper approach as being an “assumption that, were it not for the incentives, those revenues would not have been needed. Thus, there was a ‘tax increase’ needed to produce the revenues.” It is, in reality, a way of measuring the opportunity cost in terms of the effect of the marginal cost of raising the funds. It also is a way of consistently comparing different types of economic development incentives.
Actually, balancing of opportunity costs occurs annually in the budget process. Both the Governor and the legislature do it. Either the legislature or the executive could determine that the projected revenue was in excess of what was needed to provide a good mix of services in an efficient way and therefore propose reducing the tax rate, rather than expand services. (Those issues dominated the discussion in last year’s session.) More often, the opposite is the case—the “needs” and the “wants” of the agencies exceed the amount of projected revenue and the executive and legislature decide that the opportunity cost should be borne by the government. Thus, the marginal cost to the economy of raising taxes takes precedence over the cost of foregoing expansion of existing services or initiating new ones.