Friday, July 24, 2009

Oregon's New Taxes and Economic Growth

The anti-tax forces are coming out full force to try and defeat the legislature's new taxes. I don't like what the legislature did - squandering perhaps the best opportunity to enact wholesale tax reform in favor of some band-aid, narrowly targeted new taxes - but I support them nonetheless as I believe the reality of deep cuts (in K-12 education particularly) would have been much worse for the future of the state.

There is no doubt that taxes are distortionary and create dis-incentives: in this case dis-incentives to start and invest in businesses and to locate and work in the state. Income taxes are particularly sensitive in this case, as Oregon already has some of the highest in that nation. By being an outlier, Oregon stands to loose out on skilled and entrepreneurial people who choose where to live (an argument for the diversification of revenue streams). Randall Podenza makes a good case against the taxes by emphasizing the dis-incentives that they create. Though I have some quibbles, particularly in looking at developing countries and their corporate tax rates and levels of investment - this is apples to oranges, and studies that show that taxes are distortionary are not particularly novel or helpful. The key is the cost of the distortion v. the cost of inaction in the face of a revenue crisis.

This is what is missing from this analysis: we understand the potential costs of the taxes, but what of the benefits (or perhaps more accurately - what of the costs of not adequately funding state services, particularly education)?

The rhetoric of the anti-tax types is now rising to absurd levels. Take, for example, today's op-ed in the Oregonian by Robert Millen, in which Mr. Millen paints a gloom-and-doom scenario: a little extra tax burden on top income earners will cause them to flee the state and destroy Oregon's economy! Please.

Millen states: "Recent studies indicate that this has occurred in the high-tax states of New York, Connecticut and New Jersey, all of which have experienced a net loss of high-income earners and the jobs their businesses generate." Which is a rehash of one of the most spurious arguments being employed, that since states in which raised marginal tax rates on high-income earners saw the number of millionaires decrease proves that the rich flee in droves to avoid taxes.

The problem with this is the fact that we are in the midst of the worst economic downturn since the great depression. There is a very good reason that there has been a net loss of high income earners especially, in this case, in the vicinity of Wall Street.

Millen goes on to state: "When our government raises taxes on the rich, their income tends to decline. For example, the last time the top rate was 50 percent, in 1986, the top 1 percent of income earners paid about 25 percent of all income taxes." This is not a statement about absolute incomes as he asserts, but of relative incomes, and of course the tax system is an integral part of relative income distribution. S0 the causal link is nowhere to be found - income inequality in the US has been increasing (why is a matter of some debate but a big factor has been the returns to higher education) so this statistic is completely irrelevant to the current discussion of marginal income taxes.

So what of a real cost-benefit analysis? Well, research on the effects of marginal income tax rates and growth in the US is minimal and flawed in general, due to the practical challenges of overcoming confounding factors that prevent the uncovering of a true causal link. For example, are high-tax, low-growth states low-growth because of high taxes or high-tax because of low-growth?

Nevertheless, I'll leave you with one (admittedly dated) study of the costs and benefits of taxes:

“The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross Section Approach.” L. Jay Helms The Review of Economics and Statistics, Vol. 67, No. 4. (Nov., 1985), pp. 574-582.


“Results based on pooled time series and cross section data are presented, which indicate that state and local tax increases significantly retard economic growth when the revenue is used to fund transfer payments. However, when the revenue is used instead to finance improved public services(such as education, highways, and public health and safety) the favorable impact on location and production decisions provided by the enhanced services may more than counter balance the disincentive effects of the associated taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes.”

Emphasis mine. The point is that the new higher corporate and high-income taxes are costs to businesses and entrepreneurs, if they are spent well, the also create benefits to the same. In addition, those investments in the health, education and infrastructure of the state are vital to long-term growth and prosperity.

So, though I would have preferred for the legislature to have set about trying for wholesale reform of the state tax system, repealing the tax increases, flawed as they are, would be a mistake in my opinion. Hopefully in the future, the state can address its revenue system in comprehensive manner, until then, we cannot dis-invest in the future of the state and its children.

1 comment:

Oliver said...

I imagine many an interesting econ dissertation will come from the various approaches states have taken to balance their budgets. Personally, I much prefer Oregon's moderate mix of tax hikes, spending cuts, and bond initiatives to California's deep, deep cuts.