Monthly Archives: January 2012

Is Cutting the Deficit an Electoral Loser?

Here is an NBER article I hope all presidential candidates read:

The conventional wisdom regarding the political consequences of large reductions of budget deficits is that they are very costly for the governments which implement them: they are punished by voters at the following elections. In the present paper, instead, we find no evidence that governments which quickly reduce budget deficits are systematically voted out of office in a sample of 19 OECD countries from 1975 to 2008.  We also take into consideration issues of reverse causality, namely the possibility that only “strong and popular” governments can implement fiscal adjustments and thus they are not voted out of office “despite” having reduced the deficits.  In the end we conclude that many governments can reduce deficits avoiding an electoral defeat.

Alesina described similar findings in his 2010 Mercatus Working paper. There he wrote:

One of the most striking results of Alesina and Ardagna (2010) is that fiscal adjustments (reductions) on the spending side are almost as likely to be associated with high growth (i.e. a successful episode) as fiscal expansions on the spending side,

Limiting Eminent Domain Authority for the States

In June 2005, the Supreme Court’s decision in Kelo vs. City of New London extended the power of eminent domain by allowing governments to condemn private property and transfer it to others for private economic development. This decision sparked a great deal of controversy and its repercussions and implications have been widely studied (see for example, the work by Ed Lopez and Bruce Benson).

Last week, the House Judiciary Committee approved a measure that would limit government’s use of eminent domain. Specifically, the Private Property Rights Protection Act Act (H.R. 1433) would prohibit:

States and localities that receive Federal economic development funds from using eminent domain to take private property for economic development purposes. States and localities that use eminent domain for private economic development are ineligible under the bill to receive Federal economic development funds for 2 fiscal years.

When the bill was first introduced in 2011, the Honorable Trent Franks outlined its importance with the following statement:

We must restore the property rights protections that were erased from the Constitution by the Kelo decision. Fortunately, they are not permanently erased. Let us hope. John Adams wrote over 200 years ago that, ‘‘Property must be secured or liberty cannot exist.’’ As long as the specter of condemnation hangs over all property, arbitrary condemnation hanging over all property, our liberty is threatened.

There were many testimonies given throughout the hearing that pointed to the strengths and the weaknesses of H.R. 1433. Much of the economic literature suggests, however, that in general placing strong limits on eminent domain authority has substantial benefits for economic growth development, and prosperity. I think Ed Lopez, Carrie Kerekes and George Johnson (2007) sum up the importance of limiting this authority particularly well, as they write:

High taxes, excessive regulation, and loosely limited eminent domain powers are all tools of central planning and government control of the economy. Under these policies property rights are insecure, which distorts incentives for making good resource use decisions, discourages using assets as collateral for beneficial investments, and forfeits the dynamic benefits that emerge out of capitalism…Taxes, regulation, and takings through eminent domain decrease the security of property rights; therefore, these government infringements should be limited.

New Education Funding in Illinois Goes to Pensions

Neighborhood Effects readers know that Illinois’s pension problems are much worse than reported. According to the state’s numbers, Illinois’s unfunded pension liabilities amount to roughly $85 billion but as Eileen Norcross and I have argued, the amount is actually closer to $173 billion.

There have been many discussions regarding pension reform in Illinois during the past few months and, unsurprisingly, little has been accomplished. In fact, an article in Statehouse News earlier this week provided evidence that Illinois is continuing to deliberately avoid dealing with the problem by providing temporary quick fixes and banking on the idea that the state’s pension problems will simply disappear when the economy recovers.

According to the article in Statehouse, Illinois’s

12 percent increase in higher education spending this year isn’t going to benefit students. Instead, the additional funding for fiscal 2012 is going into the State Universities Retirement System, or SURS, to address its underfunded pension program…. The dramatic increase in the amount of money being given to SURS, and the other state pension systems, seeks to make up for decades of chronic underfunding by governors and legislators, and shrinking returns on investments because of the stagnant economy.

Education costs are increasing across the country. Students in Illinois paid 30 percent more for a year of college education at a university in 2011 than they did in 2007. Instead of using the additional 12 percent in higher education funds to curb these increasing costs, the state put the money towards its SURS system. This fiscal year students in Illinois are dealing with the consequences of the state’s failure to properly manage its pension system. As pension costs continue to grow in Illinois, the state will likely continue putting more money into the system – which means less money will be available for other areas of the budget.

In related pension news in Illinois, the Daily Herald provided the following quote from Hanover Park Village President Rodney Craig:

We have a fear that at the end of the day the pensions won’t be there

Without serious structural pension reform, Mr. Craig’s fear will most certainly become a reality. Labeling Illinois’s recent pension quick fix as a disappointment would be an understatement. This is nowhere near the type of reform that needs to happen in Illinois. If the state legislature wants to ensure fiscal stability in the future of Illinois’s pension system then they must start by removing the constitutional protection of pension benefits, reducing the rate of accrual for current employees, increasing current employee contributions, closing the current defined benefit plans and moving all employees to a defined contribution plan.

 

Tax Foundation Releases New State Business Tax Climate Index

On Wednesday the Tax Foundation released the updated State Business Tax Climate Index by Mark Robyn. Wyoming, South Dakota, and Nevada ranked highest on the index because they have low overall tax burdens and tax policies that introduce minimal distortions to business behavior.

The three states at the bottom of the ranking — New Jersey, New York, and California — were also the worst-ranked states last year. Unsurprisingly, these three states are also experiencing domestic outmigration as individuals and businesses leave for locations with lower tax burdens. A study by Jed Kolko, David Neumark, and Marisol Cuella Mejia demonstrates that the SBTCI is one of the most accurate indexes for predicting economic outcomes.

 

Illinois had the largest change in ranking over last year’s, dropping 12 spots. Robyn writes on the importance of tax policy in business decisions:

Anecdotes about the impact of state tax systems on business investment are plentiful. In Illinois early last decade, hundreds of millions of dollars of capital investments were delayed when then-Governor Blagojevich proposed a hefty gross receipts tax. Only when the legislature resoundingly defeated the bill did the investment resume. In 2005, California-based Intel decided to build a multi-billion dollar chip-making facility in Arizona due to its favorable corporate income tax system. In 2010 Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate. Anecdotes such as these reinforce what we know from economic theory: taxes matter to businesses, and those places with the most competitive tax systems will reap the benefits of business-friendly tax climates.

The Tax Foundation is not alone in finding these states relatively lacking in economic freedom. Indexes developed by the Mercatus Center and the American Legislative Exchange Council also ranked these states as among the least economically competitive in the country.

While lawmakers may be tempted to try to improve their states’ rankings in these types of indexes with special business tax breaks or increasing state spending, all three studies demonstrate that the best way to improve a state’s competitiveness ranking is to provide a climate of low, stable taxes that do not favor specific industries.

 

AEI-Mercatus pension panel addresses need for reform

Yesterday Eileen Norcross participated in a panel discussion that was co-hosted by the American Enterprise Institute and the Mercatus Center. The event included two panels, one discussing the case for pension reform, and the second discussing the politics of reform for conservatives.

Eileen participated on the first panel, joined by Scott Beaulier of Troy University and Jason Richwine of the Heritage Foundation. They covered several points of the importance of pension reform, including the necessity for fund managers to use the correct discount rate when determining the pension liability, the importance of upholding fiduciary responsibility to workers and retirees, and the reality that public employee pensions are overly generous compared to private sector compensation.

Drawing on their previous research in pension reform, the panelists made a convincing case for the need for a shift away from defined benefit public pensions. Unfortunately, none were particularly optimistic that drastic reform measures will be undertaken. Scott pointed to Utah as a model states relative to others for responsible pension fund management but said that even their reforms do not go nearly far enough.

Why Are Cell Phone Taxes So High?

Nationwide, combined federal, state, and local taxes on cell phone services average more than 16 percent. That makes a cell phone one of the highest taxed goods around. Cell phone taxes are even higher than beer taxes.

Why?

Image by Carlos Porto

My colleague, Thomas Stratmann, and I attempt to answer that question in our latest working paper. Most of the conventional rationales for above-average taxation just don’t apply: cell phones don’t have obvious negative externality characteristics, they are no longer luxury goods, and consumers are not particularly insensitive to price changes.

So why would policy makers choose to tax them so much? Part of the answer is that no single politician does choose to tax them that much. Instead, the high taxes that we pay on our cell phones are the sum of lots of little taxes imposed by several different political entities. Consider, for example, the tax bill of a typical New Yorker. It includes a federal USF fee, four state taxes, five city taxes, and a local 9-1-1 fee. Each of these is relatively small, but when you add it all up, the combined rate is over 22 percent.

We believe that this pattern of taxation is characteristic of what Columbia Law School Professor Michael Heller has called a “tragedy of the anticommons.”

In the better-known tragedy of the commons multiple parties have the right to use one resource and tend to over-use it since they fail to account for the way that their use harms others (think of the ocean; it’s owned by everyone and is over-fished). In a tragedy of the anticommons, however, multiple parties have the right to exclude others from using a resource by taxing or somehow regulating its use.

Heller points to the Rhine river as a classic example. Under the Holy Roman Empire only one party–the Empire–had the right to tax trade on the river. The government was careful, then, not to over-tax (over-exclude) trade. But once the Empire fell, multiple barons gained the right to tax trade (p. 3):

The growing gauntlet of “robber baron” tollbooths made shipping impracticable. The river continued to flow, but boatmen would no longer bother making the journey. . . . For hundreds of years, everyone suffered—even the barons. The European economic pie shrank. Wealth disappeared. Too many tolls meant too little trade.

Like the barons on the Rhine, multiple parties have the power to tax cell phones: Federal, state, county, city, and special district coffers all tax the base. In many cases, multiple taxes apply even at one level of government (e.g. five taxes levied by the city of New York).

We test the anticommons theory using variation in tax rates and taxing entities across the states. We write:

The anticommons problem has two dimensions. First, the mobile-service tax base funds numerous distinct projects at each level of government. Second, the base is taxed by numerous overlapping levels of government. We use state-level data from three years to examine the possible economic, demographic, and political factors that might explain the variation in these rates. We find that wireless tax rates increase with the number of overlapping tax bases.

Pension costs rising in local governments

Long Island villages are contending with increasing contributions to the state pension system. They expect to be billed $1.2 billion this fiscal year for school district employees, public workers, police and firefighters. Maryland counties can expect to begin footing part of the pension tab for teachers in a cost-sharing plan put forth by Governor O’Malley. And Rhode Island municipalities are asking the governor for increased state aid to fill their pension shortfalls and budget deficits.

What is worth noting in all of these cases is how this funding crisis highlights both the importance of accurate accounting, and the fiscal relationship between the state and local governments. Where localities participate in the state plan but do no make annual contributions (as in Maryland), there is a tendency for fiscal illusion to take over. The plans seem inexpensive and thus counties may end up expanding other parts of the county budget. Billing local governments for their portion of the pension tab makes for good fiscal discipline and transparency.

In the case of Long Island, the costs are already shared between the state and local governments. Rhode Island municipalities participate in the state run plan and in many cases operate their own local plans. Here the problem is the same as it is across the country – pension promises have been undervalued and thus underfunded. Costs are rising fast. State and local governments are going to be sharing in the growing burden in the form of higher taxes, service cuts and/or increased debt. Pension plans will be reformed and restructured. But the first step must be an accurate accounting as we found in our recent research on New Jersey.

In New Jersey pension costs are shared between the local and state governments. As with all plans the costs are obscured for the purposes of accounting leaving a good portion of the mounting expense off the books. Accounting choices that push costs forward or hide them altogether have turned pension funding into a looming nightmare for city governments, public sector workers and taxpayers across the country.

Maryland’s New Budget Proposal

Maryland’s fiscal challenges did not occur over night and, in fact, the state has been running structural deficits for the past several years. The Governor’s recent proposal to balance the state’s budget consists of two major components: (1) having the state share the costs of the teachers’ pension system with county level governments and (2) modifying the state’s tax code.

Cost Sharing:

As the system currently stands, local governments in Maryland determine teacher salaries but the state, however, picks up the entire cost of teacher pensions. The Governor’s proposal would essentially split these costs – the state would continue to pay for a portion of the teachers’ pension costs but county governments would also pick up a portion of the cost. Although some consider this to be an extreme reform, the principle behind the reform is really not that severe.

When the average family in the U.S. makes their budget for the week or the month they must include everything they spend money on – groceries, gas, health insurance, and etc. Governor O’Malley is essentially asking county governments to do the same. He is asking units of local government to budget for what they spend money on, which includes teacher pensions.

This proposal is definitely a step in the right direction. Splitting the cost of pensions with the county governments introduces more transparency and accountability into the teachers’ pension system. More importantly, cost-sharing introduces a better sense of fiscal discipline for county level budgeting.

Tax Code:

The second component of the Governor’s proposal consists of modifying the state’s tax code – increasing the tobacco tax, getting rid of tax loopholes in the mining industry, implementing a tax on internet sales, and changing the tax structure for high income earners. There seems to be some confusion on this final point. To be clear, as I understand it, this is not an increase in the tax rate but rather it’s a decrease in the number of tax exemptions for high income earners.

Some of these ideas are certainly better than others, but what’s important about these tax reforms is that Governor O’Malley is seemingly trying to introduce neutrality into the tax code. If this is in fact what he is trying to do, then it’s a step in the right direction. State’s that introduce neutrality and generality in their tax code by getting rid of tax loopholes, reducing the number of exemptions, and broadening their tax base have been able to lower tax rates while increasing revenues.

Taking Reform a Step Further:

The Governor is taking Maryland in the right direction by introducing structural reform into the state’s budgeting process. This budget proposal, however, is only one of many steps that need to be taken. If Maryland really wants to get its fiscal house in order it needs to continue focusing on institutional reform. One reform, for example, that the Governor should consider is implementing an effective spending limit – specifically, one that ties spending growth to the sum of population growth and inflation.

For more on this topic, watch my recent interview with Fox-5 news:

Gov. O’Malley Outlines $311 Million in New Revenue for Maryland: MyFoxDC.com

New Research on Immigration Policy

Immigration reform is something that has already surfaced in the recent GOP debates and will certainly receive more attention in the coming months as we make our way further into another presidential election year. The Cato Institute recently released a special edition of the Cato Journal titled “Is Immigration Good for America” in order to influence this debate and help individuals better understand the possibilities for reform.

Each of the 13 articles in this edition of the journal provides a unique insight into a wide variety of issues concerning current immigration policy. Here are a few summaries of some of the arguments I found particularly interesting.

In his article titled “Why Should We Restrict Immigration?” Bryan Caplan explores many of the prominent objectives to the liberalization of immigration policy through a moral lens. He concludes his argument with the following:

there are cheaper and more humane solutions for each and every complaint [against liberalization]. If immigrants hurt American workers, we can charge immigrants higher taxes or admission fees, and use the revenue to compensate the losers. If immigrants burden American taxpayers, we can make immigrants ineligible for benefits. If immigrants hurt American culture, we can impose tests of English fluency and cultural literacy. If immigrants hurt American liberty, we can refuse to give them the right to vote. Whatever your complaint happens to be, immigration restrictions are a needlessly draconian remedy.

In his article titled “Immigration and the Welfare State” Daniel T. Griswold, the editor of this edition of the journal, provides an interesting argument concerning the assertion that immigrants impose extreme long term fiscal burdens on U.S. taxpayers. He concludes with the following:

For those concerned about the fiscal impact of immigration, the goal should be to wall off the welfare state, not our country. As far as constitutionally possible, Congress and the states should deny welfare payments to non-citizen immigrants. This would be good for the immigrants because they could more easily avoid the disincentives to work and family formation caused by welfare payments. It would be good for U.S. taxpayers because it would reduce demand for welfare spending. And it would be good for the U.S. economy because it would remove one of the more potent political arguments against expanded legal immigration.

In our article titled “U.S. Immigration Policy in the 21st Century: A Market-Based Approach,” Joshua Hall, Richard Vedder, and I argue that visas should not be allocated based on arbitrary political criteria but instead through the price system. Our proposal has several components but consists largely of creating an NASDAQ-style international market for visas. From our paper:

The United States is the light of the world, a beacon of freedom and opportunity. Immigration is both a cause and a consequence of this reality. It is obvious that high volumes of immigration can lead to cultural clashes and can challenge our infrastructure. Thus realistically the body politic will insist that limits be placed on it. Let’s allocate access to our great country on the basis of supply and demand, reflecting the intensity of preferences of immigrants themselves and potential employers, rather than on a political process that is simply not as good as the market in allocating resources.

I think these articles, along with the other articles in this edition of the Cato Journal, are definitely worth a read and hopefully we will see these ideas influence the coming debates.