Taxes, Government and Prosperity

To many readers of the Bacon’s Rebellion blog, the connection between low taxes and economic prosperity is so manifestly evident that it doesn’t need defending. But there are many advocates of expansive government who advance arguments to the contrary. Indeed, as evidenced by the steady increase in state/municipal spending in Virginia and the rising tide of taxes, fees and penalties to pay for it, the Axis of Taxes is in the ascendancy.

In my latest contribution to the “Economy 4.0” series, “Taxes, Government and Prosperity,” I make the case that lower taxes create a business climate more hospitable to economic prosperity (defined as per capita income) than higher taxes do. As evidence, I tracked the growth in per capita income of the 50 states between 2000 and 2005. Look at the results: You’ll see that low-tax states clearly out-performed the high tax states. (I found the same pattern over longer time frames as well.)

Of course, the correlation between low taxes and income growth is far from perfect. Equally clearly, there are other factors at work. One of those factors, I suggest, is how states and municipalities use their tax revenues. If they squander it on bureaucracy, pork barrel projects, public sector unions and inefficient human settlement patterns, high taxes are destructive. If states invest their tax revenues in education, the environment, infrastructure and public amenities that add to the quality of life, high taxes can contribute to prosperity.

Bottom line: The central challenge for Virginia government is to keep taxes as low as possible while continuing to deliver the core public services required to sustain prosperity and a high standard of living.

Yes, Virginia must invest in the public sector. But we cannot tolerate Business As Usual thinking. If Virginia wants to prosper in the 21st century, we have to systematically reinvent our schools, universities, government agencies, transportation systems and human settlement patterns. Tinkering on the margins won’t cut it. Businesses have transformed themselves. Not-for-profits have transformed themselves. Now Virginians must transform their old, outmoded, Industrial Wave governmental institutions (to borrow a phrase from Alvin and Heidi Toffler) into Knowledge Wave institutions.

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16 responses to “Taxes, Government and Prosperity”

  1. Anonymous Avatar

    What happens when you have pork barrel infrastructure or bureaucrtic environmental initiatives?

  2. Jim Bacon Avatar

    Oh… Wise guy! Nyuk! Nyuk!

    You take the pork out of the infrastructure and the bureaucracy out of the environmental initiatives!

  3. Anonymous Avatar

    Jim, one of the bigger problems facing Virginia is that a significant portion of its economy is largely dependent on public appropriations (defense and DHS contractors, along with other contractors such as road builders) or indirect state and local taxpayer subsidies (inadequate or non-existent proffers for public facilities, funding of development-related infrastructure from general taxpayer funds, as opposed to user fees; or the new slave-holding class, i.e., those businesses totally dependent on paying below-market wages to illegal aliens, with the social costs foisted on taxpayers).

    I submit that many segments of the Virginia economy are not interested in efficient and effective government, with low taxes. Rather, they need big, inefficient government without good controls, but with high taxes.


  4. Anonymous Avatar

    Private enterprise provides the wealth to make things happen weather they are helpful to sustainability or not. It optimizes what is best for the indvidual effort, but unless you believe that the public good is the sum of the individual ones, then private enterprise cannot focus its attention on the “common good”.

    Government provides the rules and policy to see to it that long term issues and the “common good” are being resolved, because government has a self interest in its own sustainability. But government cannot make the ethical choices that set social priorities. Like private enterprise, its power is no greater, in the end, than the collective values expressed by the community.

    Civil Society, as practiced in the U.S. is a collection of special interests, each purporting to be the guardain of culture and ethics, and therefor exhorting government to pass rules and regulations according to their views. But, civil society is ultimately composed of individuals who are also engaged in and depend on private enterprise.

    What goes around, comes around.


  5. Anonymous Avatar

    I guess this article proves why bloggers can’t replace journalists, not saying that journalists do stats any better. If you had actually done basic statistical analysis and shown correlation between tax burden and income growth I could somewhat buy off on this, though you would most likely find almost 0 correlation. This has been proved in economic journals that there is little to no correlation between tax rates and growth except at the extremes, and 13% is not extreme.

    There are just too many factors that affect income growth besides marginal tax rates, that to focus all economic decisions through taxes is foolish. According to the chart every mid-Atlantic business should move to Delaware which is clearly not happening nor will it happen. If you look at the locations of the Fortune 500 versus that chart you will see they are all over the place including a lot in the top 10.

    The question is not what the tax rate is, but what are you getting for that tax money. e.g. Are you able to find things such as educated workers and easy access to transportation corridors or are you having to overpay workers to recruit them and pay double the travel expenses because there is no access to a major airport.


  6. Larry Gross Avatar
    Larry Gross

    How does one measure performance in government?

    Let me put in a plug for these guys:

    ….provides training and consulting services to commercial, government, and non-profit organizations in applying best practices in balanced scorecard (BSC), strategic performance management and measurement, and transformation and change management.

    and my own County –

    and one more

    Gibson Consulting Group is an Austin, Texas-based firm specializing in public education management and operations consulting. Since our formation in 1992, we’ve assisted clients in identifying over $120 million in savings by improving productivity and eliminating inefficiencies.

    Here’s an example of their work:

    By the way.. I believe this was Mark Warner’s initiative…

    and then we have the grandaddy of them all in Virginia – JLARC – the Joint Legislative and Review Commssion

    Here’s a sample of their most recent:

    351. Performance and Oversight of Virginia’s Small Community Drinking Water Systems (November 2006

    348. Review of State Spending (2006 Update)

    347. Virginia Compared to the Other States (January 2007)

    344. State Spending on SOQ Costs (2006 Update)

    these are just a few…

  7. Jim Bacon Avatar

    ZS, Did you actually read the column, as oppose to scan it? It might inform your commentary.

    You said, “to focus all economic decisions through taxes is foolish.”

    I never suggested that Virginia should do such a thing. In fact, I explicitly said that there is a trade-off between low taxes and public investment in services and infrastructure.

    I explicitly acknowledged that other factors play a role in income growth, noting the importance of human capital and transportation systems.

    But if you think that taxes play a negligible factor in economic growth, you have to explain the steady internal migration of people and businesses from high-tax states to low-tax states over the past four or five decades — despite the fact that the high-tax states started with tremendous advantages such as a more educated workforce, the existence of stronger universities and other knowledge-creating institutions, and an international trade policy that favored U.S. knowledge producers over commodity producers.

  8. Anonymous Avatar

    And what happens after they get to a low tax jurisdiction? They start agitating for more amenities.

    I don’t think this is the sort of thing you can understand by just looking at a point in time. If you try, you wind up with another version of three blind men describing an elephant.


  9. Anonymous Avatar

    Ray, I agree, in part, that low-tax communities aggitate for more services. Some parts of the community do, but I submit that there is often a big disconnection between those who want more and those who will be required to pay for “more.” Free continues to sell well.


  10. Anonymous Avatar

    Free continues to sell well.

    I love it. Right on.


  11. Anonymous Avatar

    Jim, Yes I did read your column and I stand by what I say. Your major argument was that tax rates were a large determinant of relative income growth (“Overall, it is clear to see, lower tax burdens are associated with higher rates of relative income growth. It is not difficult to explain why this might be the case.”). Afterwords you acknowledged that it might not be true and that other factors may be in play, but the tone of the article was that taxes are in first place.

    My argument is that taxes have almost zero effect on growth rates and like I said this before, the non-relation between taxes and growth has been shown in peer-reviewed economic journals. The relation only exists with very high (think 80%+) tax rates or with taxes that cost more to administer than what revenue comes in (think VA car tax).

    I also am very skeptical at best about job and population migrations from high tax to low tax states. Like I said before most of the high tax states have a number of Fortune 500 companies and they aren’t moving anywhere. VC money still only goes to about 6 locations and there has been little change in that even after the tech bubble burst. Outside of blue-collar jobs, it’s very difficult to move businesses even with higher tax burdens. I can think of at least a dozen things that most residents and businesses consider before taxes when it comes to locating. Also population trends aren’t well measured with immigration, legal and illegal, and change in household demographics.

    Finally I’m not sure about how well the tax burden is calculated as it doesn’t take into account odd taxes (VA car tax), some local taxes, nor does it account for things like an equivalence of Alaska’s oil royalties that keep their taxes down.


  12. Jim Bacon Avatar

    ZS, Fortune 500 companies aren’t going anywhere? Tell that to MeadWestvaco, which relocated from Connecticut to Richmond two years ago. Tell that to Philip Morris USA, which relocated to Richmond a year or two ago as well. Of course, PM USA is only a major divisional headquarters, but there is a lot of talk that it will be followed by Altria.

    When you examine the impact of taxes, you can’t look at just the taxes that corporations pay. You have to look at the trickle-down effect of lower taxes on the entire economy, the cost of doing business, the cost of living.

    Obviously, neither of those two companies would have moved to Richmond if this region didn’t have significant other assets. But by and large, the municipalities have done a good job of keep taxes reasonably low while providing reasonably high level of government services.

  13. Anonymous Avatar

    “VC money still only goes to about 6 locations and there has been little change in that even after the tech bubble burst. “

    Is that really true? I don’t doubt it, now that you said it, but have never seen or thought of it.

    You have a source?


  14. Anonymous Avatar

    Yes that is true about VC money. It came from a local Angel Fund presenter I got to listen to recently. The numbers are staggering how stacked they are in just a few locations. It’s basically about 90% in Silicon Valley, NoVa, Austin, and the Boston-NY Corridor. Also 40 or 42 (can’t remember which) states had 0 or 1 VC deal for all of last year. I can’t remember the exact name of the VC association he got the stats from, but I believe it was the NVCA.

    Why did PM or MeadWestvaco move to Richmond. Was it taxes or was it the fact that real estate prices in NYC and CT have increased enormously since 2000 while Richmond has stayed relatively stable. If a business can cut its labor and property lease costs in half or more without affecting revenue much, that makes sense regardless of state taxes. As I noted earlier, if taxes were so important why didn’t they move to DE.

    “You have to look at the trickle-down effect of lower taxes on the entire economy, the cost of doing business, the cost of living.”

    This can go both ways. Lower taxes can raise the cost of doing business and living when things like insufficient infrastructure and poor university systems drive up other costs.


  15. Anonymous Avatar

    No wonder I couldn’t get my venture money, I was looking in the wrong city….:-)


  16. E M Risse Avatar

    Jim Bacon’s Economy 4.0 and this chapter are very useful.

    When all is said and done, however, I am uneasy that most come away with the unfounded idea that somehow it is possible to create a sustainable trajectory for civilization with a low contribution to public goods be that via taxes, fees of mysterious public-private partnership “benefits.”

    A technology-based, urban society is very expensive, especially if a democracy is to be maintained.

    Having a democracy means that a substantial majority, not just the top of the food chain, has to be happy and safe.

    A focus on “lowering taxes” and effeciency in government tends to mask the reality of the high cost of anything like continuation of contemporary civilization.

    There is a three way race for Fauquier Sheriff and there was a candidate forum last night. The existing sheriff agreed with every suggestion that the other two candidates had for imporving “public safety” and had only one question: Where is the money coming from when schools, etc, want more too?

    The answer? Stop tinkering with the existing 1790 governance structure and start a democratic process to Fundamenatally Change governace and management of civilization.

    The current trajectory is unsustainable.



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