Tag Archives: Tax Foundation

Maryland’s “severe financial management issues”

Budgetary balance continues to evade Maryland. In FY 2015 the state anticipates a deficit of $400 million. A fact that is being blaming on entitlements, mandated spending, and fiscal mismanagement in the Developmental Disabilities Administration. The agency has been cited by the HHS Inspector General as over billing the Federal government by $20.6 billion for Medicaid expenses.

For over a decade the state has struggled with structural deficits, or,  spending exceeding revenues. The state’s method of controlling spending – the Spending Affordability Commission – has overseen 30 years of spending increases, and its Debt Affordability Commission has compounded the problem by increasing the state’s debt limits in order to expand spending.

For the details, visit my blog post for the Maryland Public Policy Institute. Of related interest is the Tax Foundation’s recent ranking of government spending the states. Maryland ranks 19, and has increased spending by 30.5% since 2011  2001.

America’s best pension system? The case of Milwaukee

NPR reports that while many municipal and state governments’s pension systems are suffering from deep underfunding, there are some outliers. One such city is Milwaukee, Wisconsin. With a funding ratio of 90 percent, Milwaukee’s public employees’ plan would seem to have beaten the odds with a very simple (and laudable) strategy: fully fund the pension plan every year.

It is common sense. Make the full annual contribution and the plan can ensure that the benefits promised are available when retirement day arrives.

Except, thanks to government accounting guidance, it’s a little more complicated than that.

The problem is that the annual contribution the city is (prudently) making each year is calculated incorrectly. This flawed approach is why Detroit could claim a few short years ago that its plans were 100 percent funded. It is why New Jersey thought its plans were overfunded in the late 1990s.

Public plans calculate their liabilities – and thus the annual amount needed to contribute to the fund – based on how much they expect the assets to return. Milwaukee’s discount rate is 8.25%, recently lowered from 8.5%.

Unfortunately, if these liabilities are considered safe and guaranteed by the government, then they should valued as such. A better rate to use is the yield US Treasury bonds. In economist-speak: the value of liabilities and assets are independent. By way of analogy: Your monthly mortgage payment doesn’t change based on how much you think you may earn in your 401(K).

On a default-free, market valuation basis, Milwaukee’s pension plans is 40% funded and has a funding gap of $6.5 billion.

The good news – Milwaukee’s elected officials have funding discipline. They aren’t skipping, skimming, or torturing their contributions based on  the desire to avoid paying their bills. And this can be said of many other cities and states. Funding a pension shouldn’t be magic or entail lots of uncertainty for the sponsor or employee.

But that leads to the bad news. Even when governments are responsible managers, they’re being sunk by bad accounting. Public sector accounting assumptions (GASB 25) lead governments to miscalculate the bill for public sector pension contributions. Even when governments pay 100 percent of the recommended amount – as it is presently calculated – this amount is too little to fully fund pension promises.

Last week I posted the Tax Foundation’s map of what pension funding levels look like under market valuation. Almost all state plans are under the 50 percent funded level. That is, they are in far worse funding shape than their current accounts recognize.

Until plans de-link the value of the liability from the expected performance of plan assets, even the best -managed plans are going to be in danger of not having put aside enough to pay these promises. Even the best intentions cannot undo the effects of bad accounting assumptions.

 

 

Happy Tax Freedom Day

Today, the Tax Foundation notes that Americans have worked enough to pay off their 2013 taxes, leaving the rest of the year’s earnings available for private consumption and investment:

Tax Freedom Day is the day when the nation as a whole has earned enough money to pay its total tax bill for the year. A vivid, calendar based illustration of the cost of government, Tax Freedom Day divides all federal, state, and local taxes by the nation’s income. In 2013, Americans will pay $2.76 trillion in federal taxes and $1.45 trillion in state taxes, for a total tax bill of $4.22 trillion, or 29.4 percent of income. April 18 is 29.4 percent, or 108 days, into the year.

Because of the increase in payroll taxes and income taxes on high income earners as part of the fiscal cliff deal, Tax Freedom day falls three days later this year than it did last year. While many limited government advocates will view this tax burden as too large, the Tax Foundation website points out that the $4.22 trillion we will pay in taxes this year will not cover the full cost of government spending. Including this year’s deficit spending, which is a tax on future earnings, would push Tax Freedom Day out to May 9th.

Virginia’s transportation plan under the microscope

Last week Virginia Governor Bob McDonnell shared his plan to address the state’s transportation needs. The big news is that the Governor wants to eliminate Virginia’s gas tax of 17.5 cents/gallon. This revenue would be replaced with an increase in the state’s sales tax from 5 percent to 5.8 percent. This along with a transfer of $812 million from the general fund, a $15 increase in the car registration fee, a $100 fee on alternative fuel vehicles and the promise of federal revenues should Congress pass legislation to tax online sales brings the total amount of revenue projected to fund Virginia’s transportation to $3.1 billion.

As the Tax Foundation points out, more than half of this relies on a transfer from the state’s general fund, and on Congressional legislation that has not yet passed.

Virginia plans to spend $4.9 billion on transportation. As currently structured, the gas tax only brings in $961 million. There are a few reasons why. First, Virginia hasn’t indexed the gas tax to inflation since 1986. It’s currently worth 40 cents on the dollar. In today’s dollars 17.5 cents is worth about 8 cents. Secondly, while there are more drivers in Virginia, cars are also more fuel efficient and more of those cars (91,000) are alternative fuel. In 2013, the gas tax isn’t bringing in the same amount of revenue as it once did.

But that doesn’t mean that switching from a user-based tax to a general tax isn’t problematic. Two concerns are transparency and fairness. Switching from (an imperfect) user-based fee to a broader tax breaks the link between those who use the roads and those who pay, shorting an important feedback mechanism. Another issue is fairness. Moving from a gas tax to a sales tax leads to cross-subsidization. Those who don’t drive pay for others’ road usage.

The proposal has received a fair amount of criticism with other approaches suggested. Randal O’Toole at Cato likes the idea of Vehicle Miles Travelled (VMT) which would track the number of miles driven via an EZ-Pass type technology billing the user directly for road usage. It would probably take at least a decade to fully implement. And, some have strong libertarian objections. Joseph Henchman at the Tax Foundation proposes a mix of indexing the gas tax to inflation, increased tolls, and levying a local transportation sales tax on NOVA drivers.

The plan opens up Virginia’s 2013 legislative session and is sure to receive a fair amount of discussion among legislators.

States Look to Rainy Day Funds to Avoid Future Crises

For the past nine quarters, state revenue collections have been increasing and are now approaching 2008 levels after adjusting for inflation. Many state policymakers are no longer facing the near-ubiquitous budget gaps of fiscal year 2012, but at the moment those memories seem to remain fresh in their minds.

Many states are looking to rainy day funds as a tool to avoid the revenue shortfalls they have experienced since the recession. In Wisconsin, for example, Governor Walker recently made headlines by building up the states’ fund to $125.4 million. In Texas, the state’s significant Rainy Day Fund has reached over $8 billion, behind only Alaska’s fund that holds over $18 billion.

A June report from the Tax Foundation shows Texas and Alaska are the only states with funds that are significant enough to protect states from budget stress in future business cycle downturns. As the Tax Foundation analysis explains, state rainy day funds can be a useful to smooth spending over the business cycle. Research that Matt Mitchell and Nick Tuszynski cite demonstrates that rainy day funds governed by strict rules about when they may be tapped do achieve modest success in smoothing revenue volatility. Because most states have balanced budget requirements, when tax revenues fall during business cycle downturns, states must respond by raising taxes or cutting spending, both pro-cyclical options. If states are required to contribute to rainy day funds when they have revenue surpluses and then are able to draw on these savings during downturns in order to avoid tax increases or spending cuts, this pro-cyclical trend can be avoided.

The Texas Public Policy Foundation points out some of the benefits of large rainy day funds:

Maintaining large “rainy day” funds  benefits Texas and Alaska in three ways:

1) These states do not rely  on large pots of one-time funding to pay for ongoing expenses, but rather balance their books by bringing spending in line with revenues;

2) These states  have reserves on hand to deal with emergencies; and

3) Having a large “rainy day” fund improves the states’ bond rating which means lower interest rates for borrowing.

However, even as more states begin making significant contributions to their rainy day funds, they have not fulfilled their pension obligations. According to states’ own estimates of their pension liabilities, states’ unfunded pension liabilities total about $1 billion. However using private sector accounting methods, states are actually on the hook for over $3 trillion in unfunded pension liabilities. Because states do not use the risk-free discount rate to value these liabilities, the surpluses they think they have to contribute to rainy day funds are illusions.

Even if states were already contributing appropriately to their pension funds and systematically contributed to rainy day funds during revenue upswings, it’s not clear that rainy day funds are a path toward fiscal discipline.  Because of the perpetual tendency for government to grow, it’s unlikely that state policymakers will take any steps to reduce the growth of government during times of economic growth. If states successfully save tax revenues in rainy day funds to avoid having to make spending cuts during recessions, states will not have to decrease spending at any point during the business cycle. States’ balanced budget requirements can provide a mechanism that helps states cut spending in some areas when revenues drop off, but rainy day funds obviate this requirement. Successful use of rainy day funds could contribute to the trend of states’ spending growing fast than GDP.

Supporters of substantial rainy day funds should acknowledge that these cushions — which on the one hand may provide significant benefits to taxpayers — come at the expense of cyclical opportunities to cut the size of state governments to bring them in line with tax revenues. Without the necessity of cutting spending at some point, state budgets might grow more rapidly that they already are, hindering economic growth in the long run. Whether or not rainy day funds increase the growth rate is an empirical question that advocates should research before recommending this strategy, and this possible drawback should be weighed against their potential to reduce revenue volatility.

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.

 

New Tax Foundation Study on Unemployment Insurance across the States

On Monday, the Tax Foundation released a new study by Joe Henchman on Unemployment Insurance policies in the 50 states. The study highlights that while the federal-state program is supposed to be counter-cyclical, in reality states do not use periods of high growth to prepare their unemployment trust funds for recessions. At the beginning of 2008, most states were prepared to pay less than one year’s worth of high unemployment benefits, leading to quick insolvency for many states’ funds in recession.

In order to provide benefits, states have had to borrow from the federal government. Henchman explains:

Beginning on September 30, 2011, states must pay approximately $1.3 billion in interest on those outstanding balances; in many cases, businesses and employees in those states will also face increases in federal unemployment insurance tax rates as a result of those federal loan balances. These new interest obligations and tax increases, if they ultimately occur, come at a time when private sector hiring is already at a low level and states are under significant fiscal pressure. These unemployment insurance fiscal policies may exacerbate negative job growth and tax trends, instead of operating countercyclically as the program was intended.

The study also provides analysis of the different taxes and benefits across the states. The compilation of the variation of tax rates, duration of benefits, funding gaps, and other policy factors makes this paper an excellent jumping off point to look at state level reforms based on states that have performed relatively well in this program compared to the neighbors.

In a more ambitious policy proposal, Henchman recommends Individual Unemployment Benefit Accounts as an option for reform. These accounts, which Chile adopted in 2002, provide a measure of income stability during periods of unemployment. Unlike state-administered UI programs, though, private accounts do not carry the perverse incentives that may dissuade people from finding work while they are receiving these benefits because money which goes unused during unemployment can be accessed upon retirement. In 2010 Eileen Norcross and I did a brief analysis of the incentives that the current UI program provides and came to the same general policy recommendation.

 

Room for Debate, Governors Edition

Budgeting is not easy. While some Republicans claim budget cuts are a way to boost short-term growth, the data (see p. 5) suggest that spending cuts are no more stimulative than spending increases (which is to say they aren’t stimulative). But that isn’t why budgets need to be reined-in. They need to be reined-in because it is mathematically impossible for state budgets to continue to grow faster than the private sector on which they depend. And if they aren’t reined-in, future cuts will be far larger and far more painful than those being proposed today.

That is me, writing in today’s New York Times Room for Debate. It also features pieces by Joe Henchman of the Tax Foundation and Elizabeth McNichol of the Center on Budget and Policy Priorities.

Economically Free States see 30 Percent Faster Job Growth

In my last post, I mentioned a couple of business climate indices. There is a new paper by Jed Kolko, David Neumark, and Marisol Cuellar Mejia which examines these types of indices in depth. They find that states with high rankings in economic freedom indices tend to have faster job growth, greater wage growth, and greater growth in gross state product.

There are a lot of indexes out there that attempt to rank states in terms of their business climates and the results of their rankings often conflict. As the authors write:

[A]cross all 50 states, every state but one ranks in the top 20 in at least one index, and every state ranks in the bottom half in at least one index.

However, it turns out that when you dig deeper, the indices can be grouped into two general categories and there is actually a lot of consistency within these categories.

Economic Freedom Indices:

The first category examines what the authors call “taxes and costs” and what I might call economic freedom. It includes factors such as the cost of doing business, the size of government, tax rates and tax burden, regulation, litigation, and welfare and transfer payments. The following five indices tend to capture these types of factors:

The economic freedom component of the Freedom in the 50 States Index by Sorens and Ruger would almost certainly fall into this category too, but since the authors focused on indices that have been around for several years, they do not include it.

Productivity and Quality of Life:

The second group of indices tends to measure what the authors call “productivity or quality of life.” These indices include measures of quality of life; equity; employment, earnings and job quality; business incubation; human capital; infrastructure; and technology, knowledge jobs, and digital economy. It appears to me that a number of the indices in this group focus on outcomes (are there a lot of “knowledge jobs in the state”?) while others in this group focus on policy inputs aimed at improving the quality of life (has the government invested in business incubation and human capital?). The indices that tend to fall into this category include:

  • The State New Economy Index by the Progressive Policy Institute, the Information, Technology and Innovation Foundation, and the Kauffman Foundation,
  • The Development Report Card for the States—Performance by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Development Capacity, also by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Business Vitality, also by the Corporation for Enterprise Development, and
  • The State Competitiveness Index by the Beacon Hill Institute.

The distinction isn’t always clear cut and I’d note that the Beacon Hill State Competitiveness Index, for one, also seems to capture a lot of economic freedom-type factors. The authors categorize an eleventh index, the Fiscal Policy Report Card on the Nation’s Governors by the Cato Institute, as falling somewhere between these two broad groups.

The authors examined the degree to which these indices predicted job growth, wages, and Gross State Product (controlling for other factors that might influence economic growth, including weather and historical industry mix). They found that the quality of life indices generally do a poor job of predicting these positive economic outcomes. In contrast, the economic freedom (aka “low taxes and few regulatory costs”) indices are strong predictors of job growth, wages, and GSP. In particular, the authors found “the corporate income tax structure and base matter for wage and GSP growth, though not necessarily for employment growth.” furthermore, the relationship, “does not appear to be driven by the top marginal tax rate, but rather by other factors such as the simplicity of corporate taxation…” They also found that greater welfare and transfer payment spending was associated with slower economic growth (they have reason to dismiss most concerns about reverse causality; but I’ll leave that to the reader to investigate).

The two indices with the best record for predicting economic progress were the Economic Freedom of North America index by Fraser (“the strongest and most robust evidence”) and the State Business Tax Climate by the Tax Foundation. Looking at the Fraser index, they found that moving a state from the 40th to the 10th place in terms of economic freedom “would increase the rate of growth of employment by 0.317 percentage point.” Given that the mean employment growth rate is 1.15 percent, this amounts to about 30 percent faster employment growth.

Lastly, the authors found that “footloose” industries such as manufacturing that are less-tied to the geography of the state tend to be more responsive to the policies captured by these indices.

——–

Update: I have fixed a broken link to the article.  Thanks to alert readers! 

State and Local Economic Development Programs

Fairfax County’s Economic Development Authority has opened a new office in Los Angeles. Their aim is to lure Californians who are fed up with the Golden State’s web of taxes and regulations. 

It is true, of course, that California’s business climate is abysmal. According to Sorens and Ruger, California is number 44 in terms of fiscal freedom (with 50 being the least-free), and 46 in terms of regulatory freedom. Other indices come to the same conclusion. Kail Padgitt of the Tax Foundation, for example, evaluated states based on their business tax climate and California came in at #49.

Virginia, by contrast, does decently well in both reports. By Sorens and Ruger’s measure, the state is the 13th most-economically-free in the nation and by Padgitt’s, its business tax climate is the 12th-best.

Given the important link between taxes and economic prosperity—see studies by Agostini and Tulayasathien (2003); Mark, McGuire, and Papke (2000); Harden and Hoyt (2003); and Gupta and Hofmann (2003) or reviews by Helen Ladd (1998) or Padgitt (2010)—it might seem only natural for Virginia to highlight its relatively low-tax environment. 

The irony, however, is that taxpayer-funded projects like an economic development office located 2,285 miles away from the county make it more-difficult for Fairfax to maintain its competitive tax rates. More expensive than the office itself are the handful of subsidies and tax expenditures that the state and the county offer to businesses that relocate or that meet special criteria (these subsidies include the option for the state to dole out “discretionary, deal-closing” benefits).

Proponents of economic development programs will no doubt contend that these expenses pay for themselves. But the economic literature is far from conclusive on that score.

Some studies find that targeted incentives lead to employment growth in the industries they target.

But others find evidence to suggest that these results are exaggerated. Examining 366 Ohio firms, for example, Gabe and Kraybill (2002) found that incentives have large effects on announced employment growth but modest or even negative effects on actual employment growth.

According to a recent Wall Street Journal article, some states and localities have begun to notice this discrepancy. John Garcia, the economic development director in my hometown of Albuquerque recently announced that the city was trying to collect nearly half a million dollars in property tax abatements that were given to a call center that relocated and then closed shortly thereafter.

But the real question is not whether these types of incentives are a good deal for the firms that receive them (one would think they would be!), but rather are they a good deal for the state at-large?

In a case study examining Virginia giveaways, Alwang, Peterson, and Mills (2001) draw attention to the fact that “most economic development events involve winners and losers.” For example, other firms may have to pay higher costs for purchased inputs. They found that the benefits doled out to one firm cost others more than $1 million, annually.  

Sweet deals can also crowd-out legitimate government expenditures on true public goods. Burstein and Rolnick (1996), write:

[W]hen competition takes the form of preferential treatment for specific businesses, it misallocates private resources and causes state and local governments to provide too few public goods.

Furthermore, cost-benefit analyses of economic development deals rarely account for the so-called rent-seeking losses that such deals inevitably invite: firms will sink millions of dollars into societally useless activities—lobbying and ingratiating themselves to the politicians—in an effort to win these privileges. The money they spend on smart and expensive lobbyists, lawyers, and accountants would be better spent developing new products and services that actually provide value to customers. These losses are hard to measure but that does not mean that they don’t exist.

In my view, states and localities should aggressively compete with one another over businesses. And part of that competition should involve figuring out ways to provide public goods at the lowest possible tax and regulatory cost. But this cost should be low for everyone, not just for the politically-connect firms.

HT to my colleague, Dan Rothschild, for directing me to the news about Fairfax County.