Published: Wednesday, October 22, 2008
When closing budget gap, don't hurt the economy
Red ink flows across the national map. The liberal Washington, D.C.-based Center on Budget and Policy Priorities reports 33 states currently experience budget shortfalls. More, including Washington, face serious gaps next year.
Challenged by a global meltdown in the financial markets and a deepening national recession, state governments form the tail of a vicious game of crack the whip. While nearly overwhelmed by forces over which they have no control, they struggle to exercise some influence. How state lawmakers respond to the national crisis sets the stage for the next round of economic competition.
CBPP analysts identify two choices, "spending cuts and tax increases," saying each will "take money out of the economy, making the downturn even worse." It's a false equivalence -- the economic effects of the alternatives are quite different -- but we'll likely be hearing a lot of such talk in the months ahead. So it's critically important to understand the consequences of how our state Legislature closes a budget gap that may approach $4 billion by January.
Before we consider the issue, though, we should recall how we got here. Although the recession has clearly deepened the budget hole, the problem began with overspending in the good years. Any discussion of "spending cuts" should begin by recognizing the 33 percent hike in ongoing budget commitments over the last four years, coupled with an acknowledgment that some of the "cuts" simply reduce projected growth.
Now consider the claim that managing the budget within existing resources takes money out of the economy. Government cannot spend anything it hasn't first taken from the private sector. Public spending redistributes wealth, substituting political priorities for those of private taxpayers. Yes, recipients of government funds -- public employees, contractors and others -- spend their money like everyone else, returning it to the private economy. A number of communities in our state rely heavily on just such activity. Also, tax-supported construction projects, research and development, and education will often have a positive, sometimes dramatic, economic effect. On a purely economic basis, though, private investment generally produces greater returns. And it generates tax revenues.
Unlike spending cuts, tax hikes immediately drain money from the private economy. State taxes here fall heavily on business and the middle class.
Research reports that Washington businesses pay 51 percent of all state and local taxes, well above the U.S. average of 44 percent. Washington's Business and Occupation tax, levied on gross receipts rather than profits, provides unusual stability in volatile times, even as it hammers small and struggling entrepreneurs. Washington's broad-based sales tax and high cigarette and alcohol taxes fall most heavily on middle- and lower-income taxpayers.
On this, CBPP is correct: Tax increases will make the downturn worse. How they do their damage, though, depends whether they fall most directly on business or households.
Business tax hikes immediately reshape the interstate economic competition. In a report released last month, economist Arthur Laffer wrote, "In tax-raising states, new business starts will decline and business failures will increase. Mobile capital and labor will emigrate to seek higher after-tax returns in other states, and [others] will be left behind to bear the burden of the state and local taxes."
Although global competition gets all the press, most business migration occurs between states. Interstate competition will intensify as states seek to rebuild sagging economies. Competitive states want to attract the new investment that creates jobs, stabilizes communities and, not incidentally, supports public services. Washington is already a high-cost state for business. Tax increases would accelerate the economic decline Laffer describes.
Boosting the sales tax will depress consumption, hurting Main Street retailers and delaying the recovery. Further, it would add to the burdens on families struggling to maintain their eroding standard of living.
These are the options. Lawmakers can add to our economic troubles by boosting taxes, driving investment and jobs to other states, and increasing the burden on beleaguered taxpayers. Or they can close the gap by controlling spending, setting priorities and laying a stable foundation for sustainable economic growth.
It shouldn't be a difficult choice.
Richard S. Davis writes on public policy, economics and politics. His e-mail address is richardsdavis@gmail.com.
Challenged by a global meltdown in the financial markets and a deepening national recession, state governments form the tail of a vicious game of crack the whip. While nearly overwhelmed by forces over which they have no control, they struggle to exercise some influence. How state lawmakers respond to the national crisis sets the stage for the next round of economic competition.
CBPP analysts identify two choices, "spending cuts and tax increases," saying each will "take money out of the economy, making the downturn even worse." It's a false equivalence -- the economic effects of the alternatives are quite different -- but we'll likely be hearing a lot of such talk in the months ahead. So it's critically important to understand the consequences of how our state Legislature closes a budget gap that may approach $4 billion by January.
Before we consider the issue, though, we should recall how we got here. Although the recession has clearly deepened the budget hole, the problem began with overspending in the good years. Any discussion of "spending cuts" should begin by recognizing the 33 percent hike in ongoing budget commitments over the last four years, coupled with an acknowledgment that some of the "cuts" simply reduce projected growth.
Now consider the claim that managing the budget within existing resources takes money out of the economy. Government cannot spend anything it hasn't first taken from the private sector. Public spending redistributes wealth, substituting political priorities for those of private taxpayers. Yes, recipients of government funds -- public employees, contractors and others -- spend their money like everyone else, returning it to the private economy. A number of communities in our state rely heavily on just such activity. Also, tax-supported construction projects, research and development, and education will often have a positive, sometimes dramatic, economic effect. On a purely economic basis, though, private investment generally produces greater returns. And it generates tax revenues.
Unlike spending cuts, tax hikes immediately drain money from the private economy. State taxes here fall heavily on business and the middle class.
Research reports that Washington businesses pay 51 percent of all state and local taxes, well above the U.S. average of 44 percent. Washington's Business and Occupation tax, levied on gross receipts rather than profits, provides unusual stability in volatile times, even as it hammers small and struggling entrepreneurs. Washington's broad-based sales tax and high cigarette and alcohol taxes fall most heavily on middle- and lower-income taxpayers.
On this, CBPP is correct: Tax increases will make the downturn worse. How they do their damage, though, depends whether they fall most directly on business or households.
Business tax hikes immediately reshape the interstate economic competition. In a report released last month, economist Arthur Laffer wrote, "In tax-raising states, new business starts will decline and business failures will increase. Mobile capital and labor will emigrate to seek higher after-tax returns in other states, and [others] will be left behind to bear the burden of the state and local taxes."
Although global competition gets all the press, most business migration occurs between states. Interstate competition will intensify as states seek to rebuild sagging economies. Competitive states want to attract the new investment that creates jobs, stabilizes communities and, not incidentally, supports public services. Washington is already a high-cost state for business. Tax increases would accelerate the economic decline Laffer describes.
Boosting the sales tax will depress consumption, hurting Main Street retailers and delaying the recovery. Further, it would add to the burdens on families struggling to maintain their eroding standard of living.
These are the options. Lawmakers can add to our economic troubles by boosting taxes, driving investment and jobs to other states, and increasing the burden on beleaguered taxpayers. Or they can close the gap by controlling spending, setting priorities and laying a stable foundation for sustainable economic growth.
It shouldn't be a difficult choice.
Richard S. Davis writes on public policy, economics and politics. His e-mail address is richardsdavis@gmail.com.
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