Bacon's Rebellion

James A. Bacon

What’s It all About, Alfie?

There's more to life -- even political life -- than low taxes. People want prosperity, which includes higher incomes and a lower cost of living.

Now we hear that Gov. Mark R. Warner is putting off announcing the particulars of his tax restructuring initiative until after this year’s legislative races. Big mistake. The governor may avoid turning the November election into a partisan referendum on his proposals, but he still may not like the result. Pumped up by electoral victories last year, the anti-tax wing of the Republican Party is moving into the rhetorical vacuum. The insurgents are eager to turn the election into a referendum on their no-tax-increase agenda.

Virginians desperately need to engage in a debate over the structure and level of state and local taxes -- but that's not the debate we're likely to get. As the discussion is shaping up, the rebels will argue for tax cuts, citing the steady growth of state and local government spending through the 1990s. Their opponents will squirm and wiggle – no one will actually endorse tax hikes publicly -- while noting under their breath the need to fund priorities such as education and transportation. In sum, fall 2003 will become a re-hash of the same, tattered raise-taxes-no-cut-them palaver we’ve been hearing for the past decade.

Totally absent is any recognition of the complex interplay between taxes, incomes and the cost of living. What Virginians crave most isn’t lower taxes, I would argue, so much as higher income after taxes. Citizens hate income tax hikes because they reduce disposable income. Cutting taxes is popular because it puts money back into peoples' pockets. But there are other ways to bolster disposable income: (1) raise wages, salaries and profits, and (2) lower the cost of living so peoples' incomes buy them more.

In theory, then, investing $1 billion in education, transportation or other state programs that boost economic productivity would be worthwhile if it bolstered profits, wages and salaries by, say, $2 billion. Likewise, investing $1 billion in revamping the state Medicaid program would be worthwhile if it reduced Virginians’ medical insurance premiums by $2 billion.

Before I inspire a backlash among my tax-cutting brethren, let me be totally clear: I do believe in low taxes. Keeping state and local government on a strict fiscal diet is sound policy. By forcing legislators to make tough decisions, it discourages bloat; by forcing administrators to economize, it inspires the quest for efficiency. What's more, low taxes are essential to Virginia's economic competitiveness. The evidence is clear that, on average, low-tax states enjoy stronger economic growth than high-tax states.

Finally, I attribute much of the so-called "structural deficit," or mismatch between state-local revenues and expenditures, to excessive growth in spending -- not insufficient taxes. According to the Tax Foundation, the inflation-adjusted growth in Virginia's state/local tax receipts averaged 5.76 percent between 1991 and 2001 -- exceeding the national average for all states of 5.15 percent. For all the howls of anguish, Virginia has not been starved of tax revenue.

Even so, I don’t see low taxes as the sole goal of state and local governance. Besides core functions such as enforcing a rule of law and maintaining a social safety net, state and local governments are key players in creating a positive economic climate in which businesses create wealth and citizens earn bigger paychecks.

Government can deliver the education and training citizens need to participate in a globally competitive economy. It can provide a transportation infrastructure that moves people and goods efficiently. It can stimulate the growth of industry clusters through targeted industry recruitment and university R&D. It can help design livable communities that offer a high quality of life for its citizens, especially members of the wealth-creating "creative class."

In sum, although government is often wasteful and frequently misguided, it is not the enemy. It is a necessary partner in the building of institutions that will propel Virginians to prosperity in the 21st century. And that brings us back to the question, what is prosperity? Is it the simple absence of taxes, or is it something more?

Virginia's taxes can be classified either moderate or low, depending on which yardstick you use to measure them.

Comparing state/local taxes per capita, Virginia would be classified as a moderate-tax state -- ranking 30th in the country. (See below.) In other words, 20 other states impose a lighter tax burden on their citizens.

However, comparing state/local taxes as a percentage of per capita income presents a different picture. Because Virginians enjoy incomes higher than the national average, state-local taxes comprise a smaller percentage of income. Ranking 42nd in the country, the Old Dominion can fairly claim to be a low tax state.

The relatively low rate of taxation has a demonstrable impact on Virginia's standard of living. As seen in the chart below, Virginia's per capita income, the standard measure of prosperity, ranked 15th in the country. Comparing disposable income -- after state, local and federal taxes -- moves the Commonwealth up to 12th place.

Increasingly, Virginia's more dynamic regions are shifting economic development strategies from creating new jobs creating wealth and growing incomes. That represents a major step forward from when state and local initiatives sought to create jobs, even if it meant that people had to migrate into the state in order to fill them. But there's a limit on the ability of regions to increase disposable income and increase the real standard of living.

A perverse phenomenon can be observed from the chart above: As a state increases in prosperity, its citizens move into higher federal tax brackets and pay a higher percentage of their income to the federal government. Call it the Connecticut Syndrome after the most heavily taxed state in the U.S. Connecticut's problem is not as much high state-local taxes as a per capita income that throws residents into top federal tax brackets. As a relatively high-income state with one very high-income region, Northern Virginia, the Old Dominion itself suffers a mild case of the Connecticut syndrome. 

In theory, there is a way out of this dilemma. But that requires focusing on something that state-local governments traditionally ignore: the local cost of living. Most people associate the cost of living as with the national rate of inflation, a phenomenon that falls within the purview of the federal government and influenced by such things as the money supply, interest rates, federal fiscal policy and the global flow of capital.

But the cost of living varies widely between different regions of the United States, and even within states. For instance, according to the Realtor.com salary calculator, a household earning $100,000 in Bristol would require $192,000 in Alexandria to enjoy a comparable standard of living.

State-local governments pursue a range of policies that affect the regional cost of living. Higher taxes, of course, drive up the cost of living. So do zoning policies that restrict supply and drive up the cost of housing. So do land use policies that segregate land uses, scatter development and compel people to drive greater distances and spend more money on transportation. All of these factors, in turn, feed back into the labor markets. A high cost of housing and transportation chokes the labor supply, especially for middle-class, blue-collar and service occupations, pushing up wage and salary levels for everything from teachers and construction workers to shop clerks and domestic help.

As a state-level strategy for promoting the well being of the citizenry, controlling the cost of living offers one huge advantage over raising incomes -- it increases purchasing power without pushing citizens into higher federal tax brackets. A lower cost of living translates into a higher standard of living without fighting against the headwind of progressive income taxes.

State political leaders do not think in these terms. The debate over the state Medicaid program, for instance, is cast as a fiscal issue. To curb out-of-control growth in the state share of this health care program, the Commonwealth short-changes hospitals and doctors -- oblivious to the fact that providers, in turn, pass on their higher costs in the form of higher insurance premiums to businesses and their employees.

Given Virginia's long-term budget crunch, it would seem the height of fiscal insanity to expand Virginia's Medicaid program, notwithstanding the fact that Virginia spends less per capita than almost any other state. But expanding Medicaid would do the following: First, it would inject hundreds of millions of matching federal dollars into Virginia's healthcare system. Second, it would take immense cost pressure off providers. Third, assuming that providers and insurers pass on the savings to their patients, it reduce the medical insurance premiums paid by businesses and their employees.

In other words, spending more money on Medicaid would not only improve health care for the direct beneficiaries but lower the cost of doing business, which would strengthen the economy, and cut the cost of living for the millions of Virginians who pay medical insurance premiums.

As I've argued in previous columns, Virginia's tax structure is antiquated and in desperate need of reform. A reformed tax structure should do two things: (1) Stimulate the economy, expanding tax revenue by growing the tax base, not by raising rates; and (2) reduce the cost of government by taming the scattered, low-density and expensive pattern of real estate development.

But as endless as my three columns must have seemed to readers -- when is this guy going to get a life and talk about something else? -- it's not the end of the story. Virginia's political leaders need to consider the impact of taxes and spending programs on the general prosperity, which takes into account incomes, taxes and cost of living. All other things being equal, lower taxes are better than higher taxes. But in our complex mix of federal, state and local governments, in which the public and private sectors are indissolubly tangled, things rarely are equal. 

Will office seekers be talking about any of these issues this fall? Not unless someone makes them. Will Gov. Warner and senior Republicans pick them up after the elections when the pre-General Assembly legislative maneuvering begins? I'm not holding my breath.

-- June 2, 2003

Bacon's Theorem: P = (I - T) C.

Prosperity (P) equals Income (I) minus Taxes (T), multiplied by (C) the Cost of Living coefficient.

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