Bacon's Rebellion

Democracy Thrives in Sunlight

Job Stimulus through Tax Reform

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by

James A. Bacon
in ,

free_lunchby James A. Bacon

It is an axiom of economics that there is no such thing as a free lunch. Like Isaac Newton’s laws of physics, the adage is universally true… most of the time. Just as Newtonian physics breaks down at the quantum level, however, the free-lunch maxim breaks down in the realm of taxes. Some taxes depress economic activity so much that replacing them with less harmful taxes stimulates economic growth and job creation while remaining revenue-neutral.

Finding the right combination of taxes is the animating force behind the four-year effort of the Thomas Jefferson Institute for Public Policy (TJI) to restructure Virginia’s tax code. Working with Chmura Economics & Analytics, President Michael Thompson introduced the idea in 2012 and has been refining the approach ever since. The Institute has just published an update.

In the past year, Thompson has been talking to groups representing business, municipal government and tax reform to identify a restructured tax system for Virginia that would be not only economically beneficial but politically palatable. The approach that emerged from the years-long process would eliminate three counterproductive business taxes — the Business Professional and Occupational License tax, the Machine & Tools tax, and the Merchants Capital tax — and replace lost revenue by expanding the sales tax to encompass currently exempt services. The health care sector would remain exempt.

Of the 23 scenarios examined, the one that produced the most positive economic benefits was “Scenario 5,” which included the reforms noted above plus eliminating the state’s bottom two personal income tax brackets (up to $5,000) and shaving the other two brackets by 9.25%. According to Chmura, the results would be:

  • 79,000 increase in private employment
  • $287 million increase in investment
  • $2.85 billion increase in real disposable income
  • $8.4 billion increase in state GDP

One important caveat: Thompson describes the economic model as a “dynamic tax/spending” model. If I correctly understand the meaning of that phrase, the model achieves revenue neutrality by including in its forecast revenues generated by the economic growth. While I prefer dynamic analysis to static analysis (basing tax policy on the assumption that changes in tax policy have no effect on real-world economic behavior), the approach does entail an extra layer of assumptions, which in turn introduces an added element of uncertainty to the analysis.

If Governor Terry McAuliffe wants to put Virginians back to work, tax policy may be the biggest lever he has at his disposal. He needs to give the idea serious consideration.

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  1. Steve Haner Avatar
    Steve Haner

    Mr. Thompson started this exercise with a specific goal of eliminating two very unpopular business taxes, the business and professional occupations license tax, a.k.a. BPOL, (on gross receipts) and the machinery and tools tax (usually on the original cost of equipment). He covers the revenue hole by creating another business tax which will be equally unpopular, a sales and use tax on services. His scenarios include taxing all services, including education – but he tweaks the list in various versions. Some scenarios do tax health care, as I recall. Hmmm – a six percent sales tax on your tuition to day care, a plumber visit, or on a visit to your lawyer.

    Basically he pits one part of the business community against another, which explains why this exercise remains basically academic. The economic analysis just confirms that consumption taxes do less harm to economic vitality than income taxes.

    I won’t even try to count the number of tax reform efforts I’ve witnessed or participated in during 30+ years at the capitol, but I agree that Virginia needs to look at its tax code on a regular basis and make sure it remains competitive and logical.

  2. LarrytheG Avatar
    LarrytheG

    well – we’re back to the idea that money spent by the private sector somehow works differently than money spent by the govt.

    why would one dynamically score money spent in the private sector but not do the same for money the govt spends – also in the private sector?

    both paths go into the economy. The only thing that changes is who is spending the money.

    A private individual spends his money on a trip to Kings Dominion. The govt collects taxes and buys a state trooper that directs traffic at the State Fair – also near Kings Dominion.

    The King’s Dominion employee buys groceries at the local Food Lion – as does the State Trooper. Both of their salaries are “dynamically” flowing into the economy.

    Why is the money spent on Kings Dominion employees going to generate increased tax revenues any more than the money the Trooper spends?

    The premise seems to be that the State is not putting the money back into the economy or if it does – somehow it will not create as much economic activity if the money stayed with the taxpayer to spend.

    Kansas did this recently. They cut taxes, cut teaching positions and the economy stayed pretty much the same except now the schools are short a bunch of teachers and presumably the saved taxes did get spent on other things in the economy.

    Let me clear. I’m NOT advocating higher taxes or taxation to be spent on wasteful things but I AM questioning the premise that cut taxes benefit the economy as if the taxes were not being spent on the economy also.

    taxes pay salaries – govt employees like state troopers and the cars the state troopers use – private sector jobs to manufacture them.

    If you’re going to dynamically score tax cuts then you’d have to also dynamically score the loss of the govt spending of those taxes.

    seems to me. where am I wrong?

  3. Steve Haner Avatar
    Steve Haner

    I don’t disagree, and people do “dynamically score” government spending proposals all the time. It is a standard element of just about every argument for this program or that – education, road building, social services etc. Advocates for Medicaid expansion are back with an ad campaign now making that very argument.

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