Bill Jaeger: Which Economic Analyses Can Oregonians Trust?

NOTE: William K. Jaeger, Professor, Graduate Program in Applied Economics, Oregon State University asked for space in this blog to post his essay on competing economic analyses.  Here it is:

Now is a good time to reflect on the just-concluded debate over Measures 66 & 67; issues of taxes and public services, kickers and rainy day funds, are unlikely to remain on the back burner in Oregon for long.

In the run-up to the vote last month, there was a wealth of useful information, opinion and passionate testimonials that helped to inform the debate. Oregonians also heard from a number of economists who conveyed what economic research tells us about the effects of changes in taxes or public services on jobs and economic growth.

For every economist saying one thing, however, there appeared to be another economist saying pretty much the opposite. And while economists often disagree on matters of interpretation and policy, what Oregonians saw recently reflected much more than the usual differences of opinion among well-informed economists. Indeed, what occurred in Oregon recently included efforts by a small number of economists that misled Oregonians by: a) misrepresenting what scholarly economic research tells us about state and local taxes and public services, and b) portraying their own estimates as having the same credibility as published, peer-reviewed research.

These efforts represent an extraordinary break with established professional standards in economics – or in any other scholarly field – whether those economists are affiliated with universities, research institutes, or respected consulting firms. Moreover, these efforts make it difficult for the general public to distinguish between the valid insights from scholarly economic research, versus the often-contradictory claims made by three economists supported by the Portland-based libertarian Cascade Policy Institute (CPI).

It is important to be clear on what these three economists (Randy Pozdena, Eric Fruits and Bill Conerly) wrote and said, and how their words and analysis compare to established economic research and established professional conduct. First, they referred to peer-reviewed scholarly research, but repeatedly misrepresented the findings of that research. Here are a few examples:

Beyond Measures 66 & 67: What Do We Do Now?

[From Fred Thompson]

When the legislature convenes this week in emergency session, lawmakers are expected to address many of the taxing and spending issues raised during the campaign over Measures 66 & 67. Gov. Ted Kulongoski, for example, announced that if they don't do something about the kicker this session, he will order them back to Salem until they do. Lane Shetterly and Tony VanVliet, former Republican state representatives, in an editorial entitled “Where Oregon must go from here” argue that their main order of business ought to be fixing our “volatile revenue system that condemns us to repeat our long history of boom-and-bust budget cycles, spending on services in good times and making deep cuts when the economy turns sour.” The last Republican elected to state-wide office, former labor commissioner Jack Roberts writes that “the kind of fundamental tax and spending reform that the state badly needs” includes revising the kicker, addressing corporate and capital gains taxes, and removing the working poor from the tax rolls. Similarly, Chuck Shekatoff of the left-leaning Oregon Center for Public Policy Research offers a similar list: fixing the kicker, corporate-tax reform, and expanding “the Earned Income Tax Credit to help working families with children make ends meet.” Chuck’s rhetoric may be inflammatory and his facts slippery, but his policy agenda is eminently mainstream.

My point here is that a lot of people agree about what needs to be done, the real question is how? The surprising answer is that there is a fairly simple, cheap solution. By simple, I mean one that does not require extensive legislative or institutional change. By cheap I mean one that won’t cost Oregonians a lot of new money.

The first step is to take the sales tax off the table. There is just no point in talking about consumption taxes at this time. Not only are they a political non-starter, they are also probably a bad idea. My research shows that replacing the income tax with comprehensive goods and services tax like Australia’s or a value-added tax like Ontario’s (since we would be starting new, there is not much sense in talking about an old-fashioned retail sales tax like California’s or Washington’s), which was also as progressive as our existing income tax, would be equally volatile and probably nowhere near efficient enough to compensate us for the half-billion in additional personal income taxes we would have to send to Washington DC (state income tax payments can be deducted from income for federal tax purposes, but not sales taxes). The unavoidable fact is that, if one taxes flows (income or consumption) rather than stocks (wealth), revenue volatility is directly proportional to progressivity.

A revenue structure that depended 50/50 on taxing consumption and income (assuming marginal rates of about 5 percent on both), would be only slightly less efficient than a pure consumption tax and would generate a small portfolio effect – that is, it would reduce revenue volatility by about the same amount Measure 66 will increase it). I seriously doubt that this would represent sufficient advantage to justify sending roughly $250 million more a year to the IRS.

[See Thompson, Fred and Gates, Bruce, Betting on the Future with a Cloudy Crystal Ball: Revenue Forecasting, Financial Theory, and Budgets - An Expanded Treatment. Public Administration Review, Vol. 67, No. 5, pp. 48-66, September/October 2007. Available at SSRN: http://ssrn.com/abstract=1123736]

The second step is to take very seriously the proposal put forward by the Legislature's 2008 Task Force on Comprehensive Revenue Restructuring to achieve “virtual stability” by changing the way we forecast revenue and by amending our one-of-a-kind income tax kicker law. As Shetterly, who chaired the 2008 task force, and VanVliet explain, “[i]n May of every legislative session the state economist predicts how much revenue the state will collect over the coming biennium, and the Legislature pegs the state general fund budget to that number. If revenues come in more than 2 percent above the forecast, all of the excess revenue is ‘kicked’ back to taxpayers…. Predicting biennial state revenue within a 2 percent margin of error is nearly impossible. In fact, [the] task force determined that the actual range of accuracy over the past 20 years of personal income tax revenue forecasts has been more like 6 percent, above and below the forecast.”

Chile, which has the world’s most volatile revenue structure and like Oregon has a self-imposed ordinance requiring the enactment of a balanced budget, has found a way to deal with this conundrum. They have redefined the meaning of balance. Their solution is to balance the budget against a forecast based upon long-term revenue growth. The simple fact of the matter is that it is easier to forecast long-run revenue trends accurately than to forecast revenue growth one or two years into the future. Each year, economists in the Chilean Ministry of Finance calculate a sustainable rate of revenue growth based on the geometric mean of past revenue growth and Chile’s executive and legislative branches use that figure as the basis for expenditure planning (budgeting). If revenues come in above the long-term trend, they are kicked into a sinking fund, which can only be used to make up revenue shortfalls or to pay down the national debt.

In other words, Chile has a kicker that looks very much like ours, but theirs constrains the rate at which spending (including unsustainable tax cuts) can grow during booms and stabilizes spending during busts. It constrains spending during booms because the Chileans use a forecast that is consistent with long-run sustainability; ours isn’t. They can stabilize spending during busts, precisely because they put their excess revenues aside for a rainy day; we don’t. Moreover, because the money is safely locked up in a sinking fund, the government of the day cannot get its hands on it except when revenues fall below the forecast, and then only indirectly.

It would be fairly easy for Oregon to achieve the same kind of virtual stability. The legislature needs merely to amend the revenue forecast so that it grows at a sustainable rate and to stipulate that a rainy-day sinking fund would have first call on kicker funds. We don’t need to repeal the kicker; we just need to change what we do with the money.

This proposal goes farther than revenue task force’s, which also recommended changing where the money went, but only the first 6 percent above the forecast -- “Any excess revenue over the 6 percent cap would kick back to taxpayers just as it does today. And once the rainy-day fund has reached a limit of 10 percent of the general fund budget (which we determined would take about four years on average), kicker checks would once again be sent out just like they are now.” My concern is that 10 percent of the general fund budget is just not enough – it is, for example, less than half of the state’s current cash float.

My proposal also goes farther than the task forces in honoring what Shetterly and VanVliet call “the spirit of the kicker – to limit the Legislature's ability to spend every dollar during good times – while creating a viable fund that could be drawn on to help sustain crucial services during hard times. (This would also make tax increases during future downturns less necessary or likely.)” The task force proposal would allow bigger increases in spending during booms.

One point should be stressed here: the state would need to borrow to make up revenue shortfalls to make my version of “virtual stability” fully sustainable – the nature of sinking funds calls for withdrawals to be made gradually over time. I do not believe that it would be fiscally responsible to return the kicker to taxpayers if the sinking fund amounted to less than 100 percent of the state’s general obligation debt, plus a prudent surplus, perhaps10 percent of the general fund budget. Only when the rainy-day sinking fund is full, would returning the kicker to taxpayers be justified.

[See Dothan, Michael U. and Thompson, Fred, A Better Budget Rule (February 10, 2009). Journal of Policy Analysis and Management, Vol. 28, No. 3, pp. 463-478, Summer 2009. Available at SSRN: http://ssrn.com/abstract=1077555]

Is this legal; is it feasible? To answer these questions one has to think back to 2003 and measure 28.

Remember what the opponents of Measure 28 predicted would happen if it failed: nearly a billion dollars cut from the budget, a 100,000 people dropped from the Oregon Health Plan or more, tens of thousands of seniors and people with disabilities denied assistance; schools shut down all around Oregon, and thousands of dangerous criminals released from prison early, causing dramatic reductions in public safety and exploding crime rates.

Certainly, bad things happened when Measure 28 failed. The legislature cut $110 million from the DHS budget. As a result DHS made the following changes to the Standard Oregon Health Plan (OHP), affecting approximately 89,000 members:
• Added premiums of $6-$20 per month based on income.
• Expanded co-pays for office visits, labs, ED, prescriptions, hospitalization.
• Non-payment of premium resulted in 6 month “lock-out” from OHP.
• Eliminated coverage for dental, vision, outpatient mental health, substance abuse, and durable medical equipment.
• Temporarily (two weeks) eliminated prescription benefits.
Moreover, effective July 2004, OHP halted new enrollments; on August 1 it restored them.

According to DHS research about 45 percent of those affected by these policies dropped out of the program, 26 percent for over 5 months, compared with 13 percent and 3 percent of OHP members whose benefits were unchanged. This implies that 29-41 thousand members dropped out of OHP as a result of Measure 28, 20-24 thousand for 5 months or more.
• Those who lost coverage had higher unmet needs for medical care, urgent care, mental health care and prescription medications than those who remained members of OHP.
• Persons with chronic illness who lost coverage were more likely to report unmet health care needs than those who remained members of OHP.
http://www.omip.state.or.us/OHPPR/OHREC/Docs/Presentations/EARLYCohort03_04_ppt.pdf
http://www.oregon.gov/DHS/healthplan/data_pubs/ohpoverview0706.pdf

The Legislature also cut 10 percent of state school aid, causing 84 of the state's 198 districts to truncate the school year by 3 days or more. Six other districts cut days from the year, but not from the end. But it is also apparently true that In 2003-04, Oregon’s school districts accrued unrestricted general-fund balances of 15 percent of their annual revenues, or $526 million – nearly two times the cut in state aid.

Crime rates also increased. According to Oregon Benchmarks data total crimes were up 2 percent above the trend line in 2003 and 2004 and property crimes were up 4 percent;, although crimes against persons were down nearly one percent and behavioral crimes were unchanged.

These are serious consequences. But they are not the cataclysmic effects threatened by Measure 28’s advocates. Most of the devastating cuts to state programs that were predicted never happened. In the end, three-fourths of the spending cuts threatened did not eventuate.

Why? Because the state borrowed most of the tax shortfall that occurred when Measure 28 failed. The Oregon Constitution requires only that the governor present and the state legislature enact a balanced budget, which is what happened prior to 2003, taking into account the tax increases challenged by Measure 28. Since the legislature had enacted a balanced budget and a shortfall then nevertheless ensued, the state could legally borrow to make up the difference, which is precisely what happened. This kind of borrowing would be equally legal and feasible when Oregon experiences a revenue shortfall under a revised revenue forecasting process.

In at least one way, virtual stability would work better for Oregon than Chile. Funds obtained to meet shortfalls would be borrowed by the state at federally tax-exempt rates; the offsetting assets in the sinking fund would be invested at higher taxable rates.

The third step would be to do something about removing the working poor from the tax rolls. Oregon’s personal income tax is progressive. But Measure 66 gives us an opportunity to make it more so. Consider the following table:




What this table shows is that the average, effective state personal-income-tax rates for the bottom two quintiles of Oregon taxpayers is actually higher than their average effective federal personal-income-tax rates. This is because Oregon taxes the first $6,100 of taxable income for a couple filing jointly ($3,050 for a single filer) at a rate of 5 percent, the next $9,100 ($4,550) at a rate of 7 percent, and incomes over $15,200 and less than $250,000 ($7,600-$125,000) at a rate of 9 percent. When the top rate comes down from 11 percent to 10 percent, why don’t we also take that opportunity to index the top rate and eliminate the first two tax-brackets? We ought to be able to afford it.

The fourth step probably ought to include the creation of a special task force to take a look at local revenues.

Oregon is not a high tax state. It was a high tax state during the 1980s, when its combined state and local own-source revenue burden, measured as a proportion of personal income caused Oregon to rank between 3rd and 11th highest in the US.

But it isn’t a low tax state either, not at least when all forms of government revenue are considered. During the last decade its combined state and local own-source revenue burden ranked between the 20th and 29th highest in the country, on average right in the middle.

http://www.taxfoundation.org/taxdata/show/336.html

Oregon’s fall in the revenue league table is NOT due to the state’s failure to raise taxes in line with other states. During the 1980s Oregon consistently ranked near the top ten in terms of state government tax burdens; it still does (9th in 2008). One thing about volatile tax bases is that they are also income elastic, not merely in the short run (which causes revenue volatility) but also over the long run (trend). This means that the State of Oregon’s revenue tends to grow faster over the long run than in other states even without tax increases.

Oregon’s fall in the combined state and local own-source revenue league table is due entirely to reduced local property tax burdens. If one looks only at state and local “tax revenues,” because of Measure 5 and 47, Oregon now ranks in the bottom 10 (this is the basis for the claim that OR taxes are the 44th highest in the county). But Oregon’s local own-source revenue rank hasn’t dropped nearly as fast as its tax rank because local user charges and miscellaneous revenues have been growing faster here than in any other state since passage of Measure 5. Increases in local user charges and miscellaneous revenues have made up more than half of the local revenue lost as a result of retarded property-tax growth.

http://www.census.gov/govs/www/statetax.html
http://www.taxpolicycenter.org/briefing-book/state-local/revenues/index.cfm

The fifth step has to do with corporate and capital gains taxes. We aren’t ready for a task force to look at this issue, but Chuck Shekatoff proposes a reasonable starting point: “Oregon still needs corporate tax disclosure to figure out how to best reform the corporate tax system.” My own view is that we would be better off with a lower marginal tax rate and different system of apportionment, but we don’t really have the facts to judge. We could use more study, in order to more clearly understand potential outcomes of any proposed policy changes in this area. Meanwhile, we have enough to do dealing with the changes that clearly are needed without more study.

So till then, let’s leave well enough alone, and deal with what we know.

Fred Thompson, Director, Willamette University Center for Governance and Public Policy Research

More on Measures 66 and 67

Jeff in the comments section of my post of my Op-Ed, points to an excellent piece by Bill Jaeger in the Register-Guard (how nice it must be to be given an opportunity to write more than 500 words!). One open question for many people are the competing claims by economists about the true effect of the taxes and Jaeger ends thusly:

Professional standards in our field include a peer review process for quality control, and the backing of a well-established research institute, university or respected consulting firm. Research results always are made transparent, and data and methods are made available freely to other researchers who might want to examine them in detail.

Claims that 70,000 jobs will be lost due to the “job killing taxes” represented by Measures 66 and 67 are not based on estimates that conform to these standards of the economics profession. These estimates were not subjected to peer review — at least not voluntarily. When examined by nationally recognized experts on state and local public finance at the Brookings Institution, the result was a scathing report concluding that the analyses were “without merit.”

The economists behind these job-killing estimates have failed to fully explain their methods. Indeed, months after presenting to voters their estimate of 70,000 lost jobs, they are now backtracking on these “guesstimates.” They recently substituted a new paper that purports to come to the same conclusions but using completely new data and different statistical methods. However, they have refused to make their new data and new methods available to other economists or the public.

In addition, these economists have misrepresented the conclusions of scholarly publications and institutions (including statements in the Oregon Voters’ Pamphlet). Perhaps most tellingly, none of these economists is affiliated for purposes of this analysis with an institution with a reputation for unbiased research.

Voters should understand that there is no exact way to estimate the long-term effects of changes in taxes and public services on jobs and economic growth. The evidence from 30 years of economic research, however, reinforces common sense: When your taxes and public services are among the lowest in the country, the benefits from improving poor public services — especially education — are likely to outweigh the costs of modest increases in taxes.

Yes on Measures 66 and 67

Here is my take, published today on The Oregonian's web site:

I support measures 66 and 67 because, based on economic evidence, I believe that the risk to the economy from declining education funding far outweighs the potential harm of the taxes themselves.

Economists understand that taxes have consequences, but the effect of these taxes on most businesses and individuals in Oregon will be minimal and the state will remain one of the lowest business tax states in the country. How low? According to the conservative Tax Foundation, even with the new taxes, Oregon will rank 14th in lowest tax states. Thus Oregon businesses are neither excessively burdened by taxes, nor likely to find greener pastures elsewhere. The effect of the new taxes on employment is therefore likely to be very small, and may be more than offset in the short-run by jobs preserved in social services, public safety and education.

Rejecting these new taxes will, however, likely lead to very severe and long-run consequences on the Oregon economy through the decline in investment in education. The positive economic effects of education are empirically well founded. Economic research by Eric Hanushek of Stanford University has found ‘significant growth effects’ from the improved cognitive abilities that result from investments in education. Claudia Goldin and Larry Katz of Harvard have found that a large part of what explains the phenomenal economic success of the United States in the 20th century is the investment the country made in education. The same is true for states: more educated states tend to be more economically successful than less educated states. It is no accident, for example, that the state of California built the world’s best system of public higher education and saw its economy grow to the 10th largest in the world and become a key engine of growth for the US economy in the second half of the 20th century.

So how is Oregon currently doing in terms of public investment in education? Miserably. In K-12, Oregon currently ranks 49th in the nation in terms of class size and has a school year that is three weeks shorter than the national average. In higher education, Oregon ranks 41st in terms of per-student funding. The percentage of Oregonians earning a college degree is actually decreasing through time. Clearly we are not currently on track to create an economy characterized by healthy growth and job creation and we cannot afford to fall any farther behind.

It is also important to note that private business benefit directly from public investment in education: research by Enrico Moretti of the University of California at Berkeley has found that businesses enjoy increased productivity from locating in cities with a large share of college graduates. In other words, a highly educated population makes businesses more productive.

The Oregonian and others have argued that we should hold out for something better and reject 66 and 67. But the country and the state are in the midst of the worst economic crisis since the Great Depression, we do not have the luxury to wait for something better. Research has shown that even temporary disruptions in education can have lifetime consequences for students. Inarguably the state needs to fix its broken revenue system and we should all demand that it do so soon. But we need the temporary fix that 66 and 67 provide right now. Without investment in the education of Oregon’s children, the future economic prosperity of the state is at risk.

Last week Fred Thompson shared his take on the measures on this blog. I largely agree with him but I am less sanguine about the disruptive effect of the failure to pass the measures and about the legislature's ability to come up with a quick compromise solution (including borrowing). Though I am much less of a student of the state government than Fred is, so keep that in mind.

Fred Thompson on Measures 66 and 67

Fred Thompson checks in with his take on 66 & 67:

Most of the public debate about Measures 66 and 67 is not very edifying.

Will passing Measures 66 and 67 cost a lot of jobs? Probably not.

They may retard the expansion to full employment and, once there, reduce average job quality, but people who want to work at the compensation levels offered will; others will drop out of the job market or go elsewhere, but 70k? I don’t see it. Moreover, proponents of these measures are almost certainly correct when they argue that cutting state spending would cause more fiscal drag than the tax increases would.

I am especially skeptical of Bill and Randy’s estimates. Even if their analytical assumptions were valid (and I am not persuaded that they are), their estimates would still be off by a factor of two, maybe more. Here, I am talking about their willingness to take the state’s revenue estimates at face value. That is naïve. Measure 67 has two main components: a substantial increase in the minimum corporate income tax and an increase in statutory rates on corporate income. The primary effect of the increase in the minimum tax would be to reduce the ability of corporations to defer tax liabilities.

Accelerating tax payments will increase state tax receipts considerably in the near run, but the discounted present value of all future increases is likely to be small. The increase in the statutory rate will motivate businesses to find new ways to recognize revenue in jurisdictions with lower rates and, if yes on 67 wins, Oregon will be surrounded by them. My hunch is that the estimate of the revenue gain from increasing statutory rates is at least 20 percent too high.

The problem with 66 opponents’ analysis of the effects of the increase in personal income tax rates is double counting. They assume both that the tax will be collected and that a lot of folks with high incomes will find ways to report their incomes in jurisdictions with lower rates, some by moving away (or just not moving here). Both assumptions cannot be true.

Will the fiscal policy effects of Measure 66 be worse than those of Measure 66. Probably. What I don’t like about 66’s personal income tax increases, both in the statutory rate and through the reduction in the federal tax exclusion, is that they are permanent. Most economists accept some version of the permanent income hypothesis.

Consequently, we believe that most of a temporary tax cut will be saved, while most of a permanent tax cut will be spent, which is why a dollar of government spending provides more fiscal stimulus than a dollar tax cut. The opposite is true of tax increases. Temporary tax increases mostly reduce savings; permanent ones mostly reduce consumption, therefore more fiscal drag. Not good. At least not at this time.

Is Federal tax deductibility regressive? Not very.

In Oregon It applies only to the first $10K of federal taxes paid for a married couple filing jointly and the first $5k on an individual filer. The effect of raising this cap from $3K and $1.5K a few years back had little effect on the progressivity of the state's income tax, although it may have slightly reduced the progressivity of the state and local tax structure as a whole. The adjustment to the Federal tax exclusion in Measure 66 is distinctly progressive, tacked on to a marginal rate increase, even more progressive. And all of this piled on top of a state tax structure that is already arguably the nation’s most progressive.

If these measures fail, will Oregon have to cut vital services? Probably not.

Oregon’s Constitution requires the enactment of a balanced budget, not a balanced budget. Were the choice between raising taxes or cutting spending, raising taxes is probably the better option, but that is not the only alternative. Oregon's Constitution requires the Governor to submit and the Legislature to enact a balanced budget. They did. If Measures 66 and 67 are rejected by the voters, the state may legally borrow to make up the shortfall, just as it did in 2003 and 2004, when broader tax increases were rejected by the voters.

Wouldn’t that cause the interest rates the state pays on the bonds to jump? It could. But we could fix that by dedicating future kicker funds to repayment of state debt.

I’ll probably hold my nose and vote for 67 and cross my fingers and vote against 66.