Wednesday, May 20, 2009

Taxes, Revenues, Spending and Oregon

Update: I have made a correction to an unfair criticism that I did not really intend. Sloppy writing on my part, sorry.

Mark Thoma on Sunday had an Op-Ed piece in the Oregonian treading over some old territory for this blog: suggesting a sales tax. I only wish Mark had done his due diligence emphasized spending stability rather than revenue stability. A while ago I wrote a series of posts in which I tried to find out what I could about the reality of sales tax and income tax volatility.

The conclusion: sales taxes are not much less volatile than income taxes and the two are highly correlated. They may add a tiny bit to stability but they won't solve the problem. We need only to look at our neighbors to the north to see that sales taxes are not then answer to volatility questions. Sales taxes cratered a bit before income taxes, but they will likely recover faster too.

While in the long term we may want to think about appropriate revenue levels it is important to remember that trying to tax our way out of a recession is only a recipe for prolonging the recession. We need to be very careful during this recession to be sure that any new temporary taxes are used to preserve only the most essential services and avoid the temptation to enact a host of new taxes to fill the budget gap.

The real problem looking to the future is not revenue instability but spending instability. Mark is right about this: a permanent rainy-day fund is an absolute necessity. A rainy day fund that is 5% of state GDP and filled by withholding kicker refunds until the fund is full. 5% of GDP is, admittedly, a lot and I'd settle for less (3%?), but 7-8 billion would come in pretty handy right now, wouldn't it? The fund can be invested conservatively and excess returns can be refunded to taxpayers as well. It is true that strict rules will have to be enacted to assure that the rainy day fund is not used in the sunshine. But such rules are relatively simple to write down and enact.

What is important now is to think about the appropriate level of revenues in the long term. I don't know the answer to this off hand, but I do know that Oregon is a relatively low-revenue state. According to the Tax Policy Center of the Urban Institute and the Brookings Institution we raise about $3,360 per person in Oregon which places us 35th in a ranking of states. Compare that to Washington which collects almost $4,000 per person and California, which collects more than $4,500 per person.

This leaves us with some serious issues, most notably the abysmal funding of K-12 education. From the Tax Policy Center's data on expenditures we can see that in a list of state expenditures on K-12 schools Oregon is 41st in the nation at $1,394 per person. However, overall expenditures on all services in Oregon is $6,866 per person which puts us in 22nd place which begs the question, why are we so low in school funding? By the way, the difference in the revenues and expenditure numbers is, I assume, mostly federal transfers for things like medicaid as well as timber payments and the like.

I am far from ready yet to say that revenues should increase, and we know we have no sales tax, but what about corporate taxes which have received so much attention? Are they really so low? Again, according to the Tax Policy Center a little less than 2% of all state revenues comes from corporate income taxes which places us 3oth among states. Per capita, according to the Tax Foundation, we are in 39th place with $109 raised in corporate income tax per person.

Finally two last points about sales and corporate taxes. We are one of the very highest income tax states, meaning that adding a sales tax would have to involve a lowering of the income tax without overburdening Oregon households. Also as companies have to compensate employees for high taxes to keep them from fleeing to other states, income taxes can be seen as an indirect tax on businesses. Food for thought.

This is intended to start a discussion and exploration into these issues and, as always, I welcome your thoughts, opinions, knowledge, etc.


Mark Thoma said...

The latest study I found on this was:

The growth in revenues and the variability in revenues depend critically upon the details, you can get the result you want by changing this or that, but in general over the last 40 years:

1. Income taxes have grown slightly faster than sales taxes, but not by much. The difference isn't enough to solve projected budget gaps. Quoting from the paper:

"Over the past 40 years, sales tax revenues grew at about the same pace as personal income." The paper goes on to note that for the nation as a whole, income taxes grew a bit faster, but within the KC fed district, the opposite was true. So not much difference on growth.

2. The variability is also implementation dependent, but another quote (from the conclusion, pg. 80):

"Sales tax revenues, both general and selective, have been the least volatile tax instruments."

But you are right, the volatility differences aren't as great as what I found in some of the previous research looking at this issue.

The problem with all of this is that it uses data from the period of the Great Moderation when GDP volatility was unusually low - so one has to take that into account in interpreting the studies.

Also, the WA study presumes a flat income tax. Since the greatest volatility is at the upper end of the income distribution (due to cap gains), this reduces the variability in their hypothetical income tax. With a progressive tax in any form, income taxes would become more variable. The study I saw from their economists (which, strangely, only looked at Puget Sound) was very short in terms of the data period covered as well. and the volatility looked statistically identical.

The California study (the one by Levy) actually - if I remember correctly - only finds that income taxes are less variable if you throw out the cap gains part (someone mentioned this in comments as well). It recommends putting that part - the cap gains part - in a rainy day for stability.

When I put all of that together, and added in the theoretical and empirical knowledge we have about consumption versus income at the aggregate level, I was comfortable asserting that it would add - a bit - to stability. But I was also careful to say this would not come anywhere near solving the stability problem, hence the rainy day fund proposal (this didn't come out clearly, but that was the point - we have a problem with volatility and this may help a bit under some implementations, but won't solve it).

Again, though, all of this is detail dependent and I had a particular tax structure in mind. Progressivity matters a lot, as does whether things like food and pharmaceuticals are taxed (most of the studies people cite are for states where necessities are excluded, and that makes the sales tax more volatile - but I would exclude those too as I said).

Patrick Emerson said...

Hi Mark,

I think you and I come to essentially the same conclusion about sales taxes, I guess I would argue that at the moment energy and attention should be paid to the establishment of a rainy-day fund. I didn't meant to sound too critical of you, my point was I think a sales tax is a lot of energy for little gain relative to a rainy day fund and so I kind of hope sales taxes are not in the initial conversation but in the post-rainy day fund conversation. But perhaps I am pessimistic both are possible.

I agree that progressivity is a concern and so I think that any sales tax discussion will also have to include a discussion on changes to the income tax.