Tag Archives: South Dakota

More labor market freedom means more labor force participation

The U.S. labor force participation (LFP) rate has yet to bounce back to its pre-recession level. Some of the decline is due to retiring baby-boomers but even the prime-age LFP rate, which only counts people age 25 – 54 and thus less affected by retirement, has not recovered.

Economists and government officials are concerned about the weak recovery in labor force participation. A high LFP rate is usually a sign of a strong economy—people are either working or optimistic about their chances of finding a job. A low LFP rate is often a sign of little economic opportunity or disappointment with the employment options available.

The U.S. is a large, diverse country so the national LFP rate obscures substantial state variation in LFP rates. The figure below shows the age 16 and up LFP rates for the 50 states and the U.S. as a whole (black bar) in 2014. (data)

2014-state-lfp-rates

The rates range from a high of 72.6% in North Dakota to a low of 53.1% in West Virginia. The U.S. rate was 62.9%. Several of the states with relatively low rates are in the south, including Mississippi, Alabama and Arkansas. Florida and Arizona also had relatively low labor force participation, which is not surprising considering their reputations as retirement destinations.

There are several reasons why some states have more labor force participation than others. Demographics is one: states with a higher percentage of people over age 65 and between 16 and 22 will have lower rates on average since people in these age groups are often retired or in school full time. States also have different economies made up of different industries and at any given time some industries are thriving while others are struggling.

Federal and state regulation also play a role. Federal regulation disparately impacts different states because of the different industrial compositions of state economies. For example, states with large energy industries tend to be more affected by federal regulation than other states.

States also tax and regulate their labor markets differently. States have different occupational licensing standards, different minimum wages and different levels of payroll and income taxes among other things. Each of these things alters the incentive for businesses to hire or for people to join the labor market and thus affects states’ LFP rates.

We can see the relationship between labor market freedom and labor force participation in the figure below. The figure shows the relationship between the Economic Freedom of North America’s 2013 labor market freedom score (x-axis) and the 2014 labor force participation rate for each state (y-axis).

lab-mkt-freed-and-lfp-rate

As shown in the figure there is a positive relationship—more labor market freedom is associated with a higher LFP rate on average. States with lower freedom scores such as Mississippi, Kentucky and Alabama also had low LFP rates while states with higher freedom scores such as North Dakota, South Dakota and Virginia had higher LFP rates.

This is not an all-else-equal analysis and other variables—such as demographics and industry composition which I mentioned earlier—also play a role. That being said, state officials concerned about their state’s labor market should think about what they can do to increase labor market freedom—and economic freedom more broadly—in their state.

Are state lotteries good sources of revenue?

By Olivia Gonzalez and Adam A. Millsap

With all the hype about the Powerball jackpot, we decided to look at the benefits and costs of state lotteries from the taxpayer’s perspective. The excitement around yesterday’s drawing is for good reason, with the jackpot reaching $1.5 billion – the largest thus far. But most taxpayers will never benefit from the actual prize money, with odds of winning as low as one in 292.2 million for the jackpot. So if few people will ever hit it big, there must be other benefits for taxpayers to justify the implementation of lotteries, right?

Of the 43 states that implement lotteries, the majority of lottery revenues – about 58% on average – go to awarding prizes. A relatively small proportion (7%) is used to pay for administration costs, such as salaries of government workers and advertising. The remaining category, and the primary purpose of implementing state lotteries, is revenue for government services. On average, about one third of state lottery revenues is directed to state funds for this purpose. The chart below displays the state-level breakdown of lottery revenue for the most recent year that data are available (2013).

lottery sales breakdown

It is surprising that such a small portion of state lottery sales actually make it to state funds, especially considering how much politicians advertise the benefits of state lotteries. A handful of states direct more than 50% of lottery revenues towards state funds: Rhode Island, Delaware, West Virginia, Oregon, and South Dakota. The other 38 states allocate significantly less with Arkansas and Massachusetts contributing the smallest percentage, only 21%.

Many states direct their lottery revenues towards education programs. The largest lottery system, New York’s, usually directs about 30% of their lottery sales to this area. Similarly, Florida’s lottery system transferred about one third of their funds, totaling $1.50 billion, to their Educational Enhancement Trust Fund (EETF) in 2013.

The data presented here are from 2013, so it will be interesting to see how the recent Powerball jackpot revenues will affect lottery revenues more broadly in the future, especially since the Multi-State Lottery Association reduced the odds of winning in October of 2015 in the hope of boosting revenues. State officials argue that reducing the chances of winning allows the prize to grow larger, which increases the demand for tickets and revenue.

The revenue-generating function of state lotteries makes them implicit taxes. The portion of revenue generated from a state lottery that is not used to operate the lottery is just like tax revenue generated from a regular sales or excise tax. So even if lotteries are effective at raising revenue, are they effective tax policy?

Effective tax policy should take into account the tax’s ability to generate revenue as well as its efficiency, equity, transparency, and collectability. Research shows that state lotteries fall short in most of these categories.

The practice of dedicating portions of tax revenue to specific expenditure categories, also known as earmarking, can be detrimental to state budgets. Research that looks specifically at the earmarking of lottery revenues finds that educational expenditures remain unaffected, and sometimes even decline, following the implementation of a state lottery.

This result is due to how earmarking changes the incentives facing politicians. A 1999 study compares the results of lottery revenues directed specifically to fund education with revenues going to a state’s general fund. Patrick Pierce, one of the co-authors, explains that when funds are earmarked for education they go to the intended program but, “instead of adding to the funds for those programs, legislators factor in the lottery revenue and allocate less government money to the program budgets.”

Earmarking also affects total government expenditures, even though from a theoretical perspective it should have little effect since one source of funding is just as good as another. Nevertheless, many empirical studies find the opposite. Mercatus research corroborates this by demonstrating that earmarking tends to result in an increase in total government spending while having little effect on the program expenditures to which the funds are tied. This raises serious transparency concerns because it obscures increases in total government spending that voters may not want.

Last but not least, about four decades of studies have examined lottery tax equity and the majority of them find that lottery sales disproportionately draw from lower-income groups, making them regressive taxes. This only adds to the aforementioned concerns about the transparency, collectability, and revenue raising capabilities of lottery taxes.

Perhaps the effectiveness of lottery taxes can be best summed up by the authors of a 1993 study who wrote that “lotteries as a source of funding are neither efficient nor equitable substitutes for more traditional tax sources.”

Although at least three people walked away with millions of dollars yesterday, many taxpayers are not getting any benefits from their state’s lottery system.

State government spending hits new heights

There is a large literature in macroeconomics that examines the extent to which federal spending “crowds out” investment in the private sector. Basic theory and common sense lead to the conclusion that government spending must replace some private sector spending. After all, dollars are scarce – if the government taxes Paul and uses his money to build a road Paul necessarily has less money to invest in his landscaping business. In theory government spending on public goods like roads could be a net gain. This would occur if the additional value produced by spending one more dollar on roads was greater than the additional value produced by investing one more dollar in Paul’s landscaping business. But even in this scenario, Paul himself may be worse off – he’s one dollar poorer and he may not use the new road – and there is still a dead-weight loss due to the tax.

In reality, the federal government does a lot more than build roads, especially productive ones. In 2014, only 1.9% of federal income tax revenue was spent on transportation. And most of the other stuff that the government does is way less productive, like shuffling money around via entitlement programs – Medicare, Medicaid, and Social Security – and investing in businesses that later go bankrupt like Solyndra. So while it is possible that a dollar spent by the government is more productive than a dollar spent by a guy like Paul, in a country with America’s spending habits it’s unlikely to be the case.

The same crowding out that occurs at the federal level can occur at the state level. In fact, in many states state spending as a percentage of gross state product (GSP) exceeds federal spending as a percentage of GDP. The graph below shows state spending as a percentage of GSP for all 50 states and Washington D.C. in 1970, 1990, and 2012 (data). The red, dashed line is federal spending as a percentage of GDP in 2012 (21.9%).

state spending gsp graph

As shown in the graph, nearly every state increased their spending relative to GSP from 1970 – 2012 (triangles are above the X’s). Only one state, South Dakota, had lower spending relative to GSP in 2012 than in 1970. In 2012, 15 of the 50 states spent more as a percentage of GSP than the federal government spent as a percentage of GDP (states where the triangle is above the red, dashed line). In 1990 only two states, Arizona and Montana, spent at that level.

It used to be the case that state and local spending was primarily focused on classic government services like roads, water/sewer systems, police officers, firemen, and K-12 education. But state spending is increasingly looking similar to federal spending. Redistributive public welfare expenditures and pension expenditures have increased substantially since 1992. As an example, the tables below provide a breakdown of some key spending areas for two states, Ohio and Pennsylvania, in 1992 and 2012 (1992 data here, 2012 data here). The dollar per capita amounts are adjusted for inflation and are in 2009 dollars.

ohio spending table

penn spending table

As the tables show, spending on public welfare, hospitals, and health increased by 120% in Ohio and 86% in Pennsylvania from 1992 to 2012. Pension expenditures increased by 83% and 125% respectively. And contrary to what many politicians and media types say, funding for higher education – the large majority of state education spending is on higher education – increased dramatically during this time period; up 250% in Ohio and 199% in Pennsylvania. Meanwhile, funding for highways – the classic public good that politicians everywhere insist wouldn’t exist without them – has increased by a much smaller amount in both states.

The state spending increases of the recent past are being driven in large part by public welfare programs that redistribute money, pensions for government employees, and higher education. While one could argue that higher education spending is a productive public investment (Milton Friedman didn’t think so and I agree) it is hard to make a case that public welfare and pension payments are good investments. This alone doesn’t mean that society shouldn’t provide those things. Other factors like equity and economic security might be more important to some people than economic productivity. But this does make it unlikely that the marginal dollar spent by a state government today is as economically productive as that dollar spent in the private sector. Like federal spending, state spending is likely crowding out productive private investment, which will ultimately lower output and economic growth in the long run.

Third Edition of Freedom in the 50 States

Today the Mercatus Center released the third edition of Freedom in the 50 States by Will Ruger and Jason Sorens. In this new edition, the authors score states on over 200 policy variables. Additionally, they have collected data from 2001 to measure how states’ freedom rankings have changed over the past decade. While several organizations publish state freedom rankingsFreedom in the 50 States is the only one that measures both economic and personal freedoms.

Ruger and Sorens have implemented a new methodology for measuring freedom. While previously the authors developed a subjective weighting system in which they sought to determine how significantly policies limited the freedom of how many people, in this edition they have use a victim-cost method, assigning a dollar value to each variable that restricts freedom measuring the cost of restricting freedom for potential victims. The authors’ cost calculations are designed to measure the value of the states’ freedom for the average resident. Since individuals measure the cost of policies differently, readers can put their own price on each freedom variable on the website to find the states that best match their subjective policy preference.

In addition to an overall freedom ranking, Freedom in the 50 States includes a breakdown of states’ Fiscal Policy Ranking, Regulatory Ranking, and Personal Freedom Ranking. On the overall freedom ranking, North Dakota comes in first followed by South Dakota, Tennessee, New Hampshire, and Oklahoma.  At the bottom of the ranking, New York ranks worst by a significant margin, with rent control and burdensome insurance regulations dragging down its regulatory freedom score. New York is behind California at 49th, then New Jersey, Hawaii, and Rhode Island.

The authors note that residents respond to the costs of freedom-reducing policies by voting with their feet. Between 2000 and 2011, New York lost 9% of its population to out-migration. In addition to all types of freedom being associated with domestic migration, the authors find that regulatory freedom in particular is associated with states’ growth in personal income. They conclude:

Freedom is not the only determinant of personal satisfaction and fulfillment, but as our analysis of migration patterns shows, it makes a tangible difference for people’s decisions about where to live. Moreover, we fully expect people in the freer states to develop and benefit from the kinds of institutions (such as symphonies and museums) and amenities (such as better restaurants and cultural attractions) seen in some of the older cities on the coasts.

[…]

These things take time, but the same kind of dynamic freedom enjoyed in Chicago or New York in the 19th century — that led to their rise — might propel places in the middle of the country to be a bit more hip to those with urbane tastes.

New Edition of Rich States, Poor States out this Week

The fifth edition of Rich States, Poor States  from the American Legislative Exchange Council is now available. Utah took the top spot in the ranking of states’ economic competitiveness, as it has every year the study has been produced. Utah excels in the ranking system because it is a right-to-work state, it has a flat personal income tax, and no estate tax, among other factors considered in the study.

The other states that round out the top ten for Economic Outlook include South Dakota, Virginia, Wyoming, North Dakota, Idaho, Missouri, Colorado, Arizona, and Georgia. On the bottom end of the ranking, the states with the worst Economic Outlook are Hawaii, Maine, Illinois, Vermont, and New York at number 50 for the fourth year in a row.

Several measures of economic competitiveness offer supporting evidence that these states have some of the worst policies for business including Mercatus’ Freedom in the 50 States and the Tax Foundation’s State Business Tax Climate Index.

The authors of Rich States, Poor States, Arthur Laffer, Stephen Moore, and Jonathan Williams demonstrate Tiebout Competition in action. They find a strong correlation between the states that have high Economic Outlook rankings with the states that are experiencing the highest population growth through domestic migration. Likewise, the states that experienced the largest losses due to out-migration include Ohio and New York, ranking 37th and 50th respectively.

The study draws attention to the role that unfunded pension liabilities play for states’ future competitiveness, as this debt will require difficult and unpopular policy decisions as current tax dollars have to be used to fund past promises. Laffer, Moore, and Williams draw a comparison between Wisconsin’s recent reforms that put it on a more sustainable path compared to its neighbor Illinois:

In stark contrast to Wisconsin’s successes, the story in Illinois is not so uplifting. Over the last 10 years, Illinois legislators have continuously ignored the pension burden in their state—so much so that Illinois has one of the worst pension systems in the nation, with an estimated unfunded liability ranging from $54 billion to $192 billion, depending on your actuarial assumptions. Furthermore, the official state estimates do not include the $17.8 billion in pension obligation bond payments that are owed. In addition, Illinois policymakers have spent beyond their means, borrowed money they don’t have, and made promises to public employee unions that they cannot fulfill. Not only did Illinois face significant unfunded pension liabilities, but also lawmakers had to confront large deficits and potential cuts to state programs.

While the policies that improve state economic competitiveness are clear, the path to achieving them is difficult after voters grow accustomed to programs that their states cannot afford. However the bitter medicine of reform is worthwhile, as we know that economic freedom is not only better for business, but evidence shows it also improves individuals’ well-being.

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.

 

Local Governments in the United States

From an article in Stateline:

There are 89,476 local governments in the United States. They include counties, cities, villages, towns and townships, as well as special districts that handle utilities, fire, police and library services.

The authors of this article look at the number of local governments in each state relative to its population, finding that the average for the United States is 3,451 people per unit of local government. North Dakota (249), South Dakota (411), and Nebraska (687) were on low end of the spectrum whereas Hawaii (71,595), Maryland (22,553) and Virginia (15,658) where on the high end.

Illinois, in particular, finds itself in an interesting situation in this data. Although the state has only 1,835 people per unit of local government, its total number of local governments (6,944) is far greater than any other state. To put this into perspective, Pennsylvania (4,871) and Texas (4,835) rank second and third, respectively, for states with the highest number of local governments.

So what explains the proliferation of local governments in Illinois? One likely cause is a debt loophole in the state’s constitution. Specifically, the 1870 Illinois Constitution limited the amount of debt that a unit of local government could issue but allowed localities a dodge: the special district. In other words, each unit of local government was allowed to get around its legal debt limit via the creation of a special district. Since that time, the state has created 3,249 special districts. This phenomenon of special district creation as tool for expanded fiscal reach is investigated by Bennett and DiLorenzo in their book, Underground Government.

Does Illinois’s situation suggest the need for consolidation? If so, what is the optimal number of governments for a state to have and how is this determined? It’s not necessarily obvious at first glance: what are these governments, how did they arise, what do they do, and how do they finance their operations?

The concept of consolidating governments to increase efficiency has been the root of much debate in public policy. However, as Ostrom, Tiebout, and Warren argue,

It would be a mistake to conclude that public organizations are of an inappropriate size until the informal mechanisms, which might permit larger or smaller political communities, are investigated.

Thus, when debating over whether or not consolidation will increase efficiency, it’s necessary to understand the institutional environment in which the units of local government were created as well as the underlying informal mechanisms connecting them.

Rating State Business Tax Climates

Today the Tax Foundation released its annual State Business Tax Climate Index.

Good tax policy is not just about low rates. The Index’s author, Kail Padgitt, writes:

State lawmakers are always mindful of their states’ business tax climates but they are often tempted to lure business with lucrative tax incentives and subsidies instead of broad-based tax reform. This can be a dangerous proposition.

The public choice pressures that Dr. Padgitt is talking about encourage state policy makers to cut special tax deals for politically-important businesses and to keep rates high for those who are aren’t so well-connected. The Business Tax Climate report is a nice antidote to such thinking:

The goal of the index is to focus lawmakers’ attention on the importance of good tax fundamentals: enacting low tax rates and granting as few deductions, exemptions and credits as possible. This “broad base, low rate” approach is the antithesis of most efforts by state economic development departments who specialize in designing “packages” of short-term tax abatements, exemptions, and other give-aways for prospective employers who have announced that they would consider relocating. Those packages routinely include such large state and local exemptions that resident businesses must pay higher taxes to make up for the lost revenue.

The best climates: South Dakota, Alaska, Wyoming, Nevada, Florida, Montana, New Hampshire, Delaware, Utah and Indiana.

And the worst: New York, California, New Jersey, Connecticut, Ohio, Iowa, Maryland, Minnesota, Rhode Island and North Carolina.

Small Business Survival 2009 – from Bad to Worse

The Small Business & Entrepreneurship Council’s 2009 Index on state’s entrepreneurship policy is out. It’s not good news. The authors acknowledge federal, state, and local policymakers face tough times.  But their responses continue to make the situation much worse – increasing the costs of entrepreneurship, business ownership, and investment.

The biggest obstacle to entrepreneurship, “Public policy gone awry,” that is, higher taxes, regulations, and government spending.

Ranking states according to many factors including taxation, regulation, minimum wage laws leads to a not-too-surprising list.

The most entrepreneurship-friendly states: South Dakota, Nevada, Texas, Wyoming and Washington. The bottom five: Vermont, New York, California, New Jersey and the District of Columbia.

Is the U.S. Senate Obsolete?

Syndicated columnist Neal Pierce has been writing about state and local affairs since at lease the 1970s. In a recent column, he asks, “Are State Governments Obsolete?” It might have been more appropriate to ask whether state governments actually exist — at least in the traditional constitutional sense. Blessed by the Supreme Court and other judicial rulings, state governments have become administrative appendages of the federal government.

In one area after another in the twentieth century — matters of transportation, public health, land use control, education, wildlife management, etc. — the federal government assumed powers that had traditionally been reserved to the states. States might still have an administrative role, but they are now working under a very tight federal leash.

The sweeping environmental laws of the 1970s shifted control over clean air and water to the federal government. The states were, to be sure, left to administer air and water pollution laws day to day but under federally approved programs, leaving real control in federal hands. The Endangered Species Act not only federalized significant parts of wildlife management but also asserted federal authority over large areas of state and local land use. No Child Left Behind moved a large step towards the full federalization of education in the United States.

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