Mark
Crain, an economics professor at
George Mason
University, views the current debate over tax reform in light of Virginia's long-term economic performance. Between
1970 and 1999, according to his recent book, Volatile
States, the inflation-
adjusted per capita income
of Virginia residents increased by an average of
1.97 percent per year. That was the seventh-fastest
growth rate among the 50 states.
In
1970, Virginians ranked 30th among the 50
states in terms of personal income per capita. By
1999, the Old Dominion had moved up to 14th
place.
When
the General Assembly convenes in January to address
the state’s critical problems – education,
transportation, Medicaid and the rest –
legislators should be thankful for the prudence of
their predecessors who crafted the tax
and regulatory climate that made possible such a powerful
performance. Superior growth has
deepened the tax base, giving
the Commonwealth far more resources than it would have had
otherwise to grapple with today’s
seemingly intractable budgetary challenges.
Had
Virginia
grown at the median rate, similar to that of Missouri
or South
Dakota,
incomes would have increased only 1.53 percent
annually over the same period. A mere 0.44 percent
difference may not sound much, but over
30 years it means that Virginians would be earning
roughly 13 to 14 percent less than they do now.
Translated into tax revenue, slower income growth would
have yielded $3 billion to $4 billion less in
revenue.
Talk
about structural budget deficit! If it seems
impossible to make ends meet
now, think how hard it would be if
the state had only $22.5 billion to work with
instead of the actual $26 billion.
Virginia’s
stellar economic performance was no accident, says
Crain. Among the factors contributing to the
state’s prosperity is its stable tax structure and
relatively low level of overall taxation. Over the
1969-1998 period, Virginia
had the 11th lowest marginal tax rate of
all the states. Crain gets very nervous when he
hears people talking about “reforming” Virginia’s
“antiquated” tax structure.
“It’s
bizarre that everybody’s saying we’ve got to
reform the tax system,” Crain says. “It worked
great for 30 years, now, all of a sudden, the whole
thing’s antiquated, a 300-year-old relic of the
agrarian economy.” Virginia
is experiencing a cyclical downturn in the economy,
and people are panicking. “If you think the problem’s bad now, wait until they fix it.”
Crain
published Volatile
States earlier this year, before Gov. Mark
R. Warner announced his intention to make tax
restructuring a major issue in the 2004 legislature.
Crain puts no partisan spin on his findings. Indeed,
he mailed copies of his book to the governor as well
as to key Republican legislators like Speaker of the
House William Howell and Senate Finance Chairman
John Chichester in the hopes that it might influence
their thinking.
Likewise,
I interviewed Crain last week, before the governor
unveiled the specifics of his plan, which involves
raising some taxes, cutting others and closing
loopholes in a package designed to net about $500
million more in revenue per year. My interest, like Crain’s, is not to score political
points but to articulate enduring principles for
shaping Virginia’s
state budget and tax code.
Crain’s
research is rich with insights – far too many to
enumerate here. For those who are interested in
reading more, you can order
his book at Amazon.com.
(Be forewarned. The book, published by an
academic press, will set you back $50. Plus, it’s
loaded with statistical analysis, which makes pretty
tough reading. But for students of state government,
the effort will be amply rewarded.)
Two
broad conclusions stemming from Crain's research seem especially pertinent to the
debate that's shaping up over Virginia’s
budget and tax structure.
-
Even
a seemingly modest change in a state's economic
growth rate can have dramatic effects on the
size of its tax base over a long period of time.
If raising taxes to meet next
year’s budgetary challenges slows economic
growth, it can jeopardize the
state’s fiscal health a decade from now.
-
The
stability and predictability of a state’s
revenue stream is insufficiently appreciated.
Predictability abets long-term planning, which
allows government to restrain spending.
As Warner, Howell, Chichester
and others hammer out the next biennial budget, they
should heed these principles.
Rather than fixating
on how to raise more revenue, law makers should focus on achieving
more
stable revenue. If a predictable revenue stream makes
it possible to run government more efficiently, as Crain’s
work indicates it does, the resulting savings will free
up resources for important initiatives without putting
economic growth at risk.
After
30 years of steady growth, the U.S. economy decelerated markedly in the 1970s.
Economists have advanced numerous theories to
explain the slowdown, but none is entirely
convincing. That may be, Crain suggests, because the
critical changes occurred not at the national level
but at the state level. “We often talk about the
‘national’ economy or the ‘U.S.’ economy, but there are huge differences among
the states in economic performance.”
A close look at the numbers shows that the slowdown
in income growth was concentrated in roughly 22
states. Departing from the “national” pattern,
the economies of 28 states -- Virginia among them --
showed no appreciable deceleration in the last quarter of the 21st
century, Crain observes.
The
differences in growth rates led to a dramatic
reshuffling of income and wealth creation in the
U.S.
(In the table below, Crain ranks the per capita
income growth rates of all 50 states from 1969 to
1999 using two different methods -- the least
squares method and the continuous compounding method
-- of calculating the growth rates.)
Real
Per Capita Income
Growth
Rates
(1969 to 1999) |
|
Least
Squares |
Compounded |
|
Growth
rate
(%) |
Rank |
Growth
rate
(%) |
Rank |
New
Hampshire |
2.14 |
1 |
2.03 |
9 |
Connecticut |
2.11 |
2 |
1.95 |
13 |
Massachusetts |
2.11 |
3 |
2.07 |
7 |
North
Carolina |
2.10 |
4 |
2.15 |
1 |
Georgia |
2.05 |
5 |
2.14 |
2 |
Tennessee |
2.04 |
6 |
2.13 |
3 |
Virginia |
1.97 |
7 |
2.04 |
8 |
Alabama |
1.97 |
8 |
2.03 |
11 |
South
Carolina |
1.90 |
9 |
2.02 |
12 |
New
Jersey |
1.89 |
10 |
1.83 |
17 |
Rhode
Island |
1.79 |
11 |
1.71 |
24 |
Mississippi |
1.79 |
12 |
2.12 |
4 |
Arkansas |
1.78 |
13 |
2.08 |
6 |
Maine |
1.77 |
14 |
1.81 |
18 |
Vermont |
1.75 |
15 |
1.73 |
21 |
Minnesota |
1.74 |
16 |
1.94 |
14 |
Colorado |
1.70 |
17 |
2.11 |
5 |
Maryland |
1.69 |
18 |
1.77 |
20 |
New
York |
1.67 |
19 |
1.61 |
33 |
Florida |
1.63 |
20 |
1.71 |
23 |
Louisiana |
1.62 |
21 |
1.83 |
16 |
Kentucky |
1.62 |
22 |
1.81 |
19 |
Pennsylvania |
1.59 |
23 |
1.67 |
28 |
Texas |
1.53 |
24 |
1.87 |
15 |
South
Dakota |
1.53 |
25 |
2.03 |
10 |
Missouri |
1.50 |
26 |
1.63 |
31 |
Washington |
1.48 |
27 |
1.63 |
32 |
Nebraska |
1.46 |
28 |
1.70 |
25 |
Delaware |
1.43 |
29 |
1.41 |
43 |
New
Mexico |
1.42 |
30 |
1.66 |
30 |
Wisconsin |
1.37 |
31 |
1.58 |
36 |
Kansas |
1.35 |
32 |
1.68 |
26 |
Indiana |
1.35 |
33 |
1.46 |
40 |
Illinois |
1.34 |
34 |
1.51 |
39 |
West Virginia |
1.34 |
35 |
1.66 |
29 |
Ohio |
1.33 |
36 |
1.40 |
44 |
Oregon |
1.32 |
37 |
1.59 |
35 |
Utah |
1.30 |
38 |
1.67 |
27 |
Arizona |
1.28 |
39 |
1.54 |
37 |
Michigan |
1.25 |
40 |
1.33 |
46 |
Oklahoma |
1.23 |
41 |
1.33 |
46 |
Iowa |
1.18 |
42 |
1.44 |
42 |
Nevada |
1.15 |
43 |
1.37 |
45 |
Idaho |
1.13 |
44 |
1.44 |
42 |
California |
1.09 |
45 |
1.23 |
48 |
Hawaii |
1.01 |
46 |
0.96 |
49 |
North
Dakota |
1.00 |
46 |
1.72 |
22 |
Wyoming |
0.95 |
48 |
1.61 |
34 |
Montana |
0.88 |
49 |
1.29 |
47 |
Alaska |
0.33 |
50 |
0.94 |
50 |
Source:
Volatile States, Table 1.4, page 13.
"The
Virginia
economy stacks up really well by almost any gauge
you use," Crain says. "In terms of income
per capita and income per worker, we moved from
towards the bottom to one of the top. We performed
well both absolutely and compared to other
states."
Virginia
fares well by another, less commonly recognized
measure: income volatility. In some states, incomes
tend to fluctuate more widely in good times and bad
than in others. Crain's research shows that states with
more volatile incomes tend to have higher per capita
incomes. He theorizes that employees
compensate for the greater uncertainty of their
paychecks by demanding higher higher pay.
Virginia is an anomaly. The Old Dominion
is blessed not only with a relatively high per
capita income but with among the most stable incomes in
the country. Indeed, by one measure, calculated by
using the Regression index, Virginia gets the top
ranking in the country.
"That
makes us pretty desirable, and something we'd like
to preserve," Crain says. "Compared to the
other 50 state economies, our living standards are
both high and stable."
In
Volatile States, Crain did not endeavor to
prove the point
that low-tax states tend to out-perform high-tax
states. He takes it as a given that
"Virginia's penchant for a low, flat and stable
tax structure provides a constructive environment
for business investments, job creation and rising
living standards."
Crain's
contention is backed by numerous studies, including a 2002
report issued by the American Legislative
Exchange Council. The paper compared the economic
performance between 1990 and 2000 of the 10
highest-tax states with that of the 10 lowest tax
states. The low tax states not only experienced
double the rate of job creation but 60 percent stronger
per capita income growth.
Differences
in tax rates do not, of course, explain all variations in
long-term economic performance between the states. A
casual inspection of the table above will show that
states whose economies were dependent upon farming and
natural resources -- from Iowa to Alaska -- were
particularly likely to have suffered slow income
growth during three decades of declining commodity
prices.
Likewise, high-tax states such as Connecticut and
Massachusetts seemingly defied the odds by turning
in outstanding performances as well.
Crain's
choice of a 30-year time frame may obscure important
shifts that took place in the 1990s as the country
began shifting to a knowledge-based economy. States
blessed by high education levels, strong
university R&D programs or allure to the so-called
"creative class" may well have prospered
in the face of high taxes.
It's
possible, in theory, that Gov. Warner's proposal to boost spending on
education and university research will give
Virginia's economy a Knowledge-
Economy
booster that might offset the deleterious effects of higher
taxes. In theory. But supporters have cited no
studies backing up such a proposition. Until they
do, tax-increase advocates have the burden of proof to show that their
proposals won't hurt the long-term performance of
Virginia's economy.
The
case for raising more revenue weakens
considerably when we consider the merits of an
alternative tax-reform strategy: making
revenues more stable and predictable.
Crain
makes the case that reliability is one of the most
important attributes of a good tax system. As he
writes in Volatile States: "Greater
instability in tax revenues contributes to spending
instability that impedes the efficiency of long-run
state government operations."
Crain
thinks this may be the most important insight of his
book. Tax-cutters typically talk about "fraud,
waste and abuse" in state government spending.
But the real problem isn't the stuff of the
"Fleecing of America" TV news exposes --
it's
the way budget fluctuations disrupt intelligent,
long-term planning. Uncertainty, Crain says, is the
enemy of efficiency.
When
revenues plunge, politicians whack programs with little
regard to the long-term consequences. Arrangements
that would have been efficient under a budget-growth
scenario would be inefficient under a retrenchment
scenario.
"Imagine
you're a university president," says Crain. "You plan down the road five
years. You anticipate growth, lay the framework, put
plans and processes into place, contract out the
lunch service, the parking spaces, the payroll
administration, and then the rug gets jerked out
from you. All of a sudden, none of what you've done
makes sense any more."
When budgets
are unpredictable, people make miscalculations. Closing
the DMV offices was a classic case, Crain says.
"Shut down the offices -- then three
months later open them back up. That must have cost
a fortune."
Unexpected
budget surpluses are almost as bad, Crain argues.
Virginia ran a $750 million budget surplus one year
during the Gilmore administration. Instead of
funding one-time projects, legislators channeled
much of the money into ongoing programs. "Once
it gets built in, it becomes an entitlement -- very
hard to take away."
The
train of logic is very simple: Revenue stability =
more efficient government = budget savings = more
money for priorities like roads, education and
Medicaid.
As
Crain's research shows, some taxes are more volatile
than others. A diversified tax base tends to be less
volatile than a tax dependent upon a single source, such as sales or income. One
good place to start thinking
about tax reform is to study how proposals might
affect the volatility of state revenues.
Lowering the sales tax on food, for instance, will
make sales-tax revenues more dependent upon sales of
highly cyclical consumer goods. Warner's proposal may
make sense from a "fairness" point of
view, but may have unintended consequences from the
vantage point of revenue stability.
Crain
also contends that Virginia's revenue forecasting
process, which filters U.S. economic projections
through a state econometric model in a top-down
process, is flawed. The model overlooks one major
fact: Over the past 30 years, Virginia's economy has
increased 30 percent faster than the U.S. economy.
Thus, the forecasts tend to be conservative and
result in budget surpluses. Surpluses are more fun
than deficits -- it's easier to spend money than to
take it away -- but they still result in a
misallocation of resources. Especially if they
encourage governors to seek tax increases.
Virginia's
financial situation is brightening perceptibly month
by month. In October, reported
Secretary of Finance John Bennett, General Fund
revenues increased $83 million above the amount
collected the same month the year before, a 10.2
percent increase and well in excess of the 4.6 percent
estimate this year's budget is based on. If revenues continue to exceed estimates
by the same margin, the state could find itself
racking up a surplus at the rate of $40 million per
month -- an amount almost equal to the taxes Warner
wants to raise.
Between
Crain's research and the improving fiscal outlook,
the case for a tax increase will get harder to make
with each passing month. Virginia's tax system
really isn't broken. Economic growth will generate
revenues sufficient to address many, though not all,
of Virginia's pressing problems. If lawmakers would
focus on fine-tuning the stability and
predictability of the tax system, the Commonwealth
would be well served.
--
December 1, 2003
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