Taxes? Cuts? To economy, it's all the same

  • Article by: PAUL ANTON
  • Updated: May 20, 2011 - 8:51 PM

Theory and evidence suggest that the state's fortunes will be little altered by budget decisions. But more data would be good.

Budget Deficit by Margaret Scott/NewsArt

I have served as a member of Minnesota's Council of Economic Advisors for 26 years. As Democrats and Republicans in St. Paul search for a compromise on the state budget, a major point of contention seems to be what is best for the state's economy.

I propose a method for ending the stalemate. Why not look at the best economic evidence about the difference in impact on the state's economy that would be generated by the alternatives being put forward?

Specifically, what difference would it make if the budget deficit were closed through a combination of tax increases and spending cuts, rather than through an all-cuts budget?

Based on the applicable economic theory and available evidence, my answer is: Whichever budget solution is chosen will make little, if any, difference to the Minnesota economy over the next two years.

The basic reason for this conclusion is that a state must balance its budget. Raising taxes reduces aggregate demand and slows economic growth -- and so does reducing state spending on goods and services. And a dollar subtracted from the economy is a dollar subtracted, regardless of how it was subtracted. This result comes from basic economic theory buttressed by statistical studies of state economic growth.

(Strictly speaking, spending cuts reduce near-term economic activity slightly more than tax increases. That is because some portion of the taxed dollar would have been saved, or spent outside the state's borders. But the difference would be small.)

I find myself in good company in reading the evidence this way. Last December, David Wyss, chief economist for Standard & Poor's, made the same point in an article in the Florida Times-Union, and in a speech to the boot camp for Georgia legislators.

His statement caused such political controversy in Georgia that the respected website PolitiFact subjected it to the scrutiny it usually reserves for statements by politicians. After interviewing economists with wide-ranging perspectives, PolitiFact rated the statement as "True" (not just "Mostly True," let alone "Pants on Fire").

In St. Paul, state economist Tom Stinson said essentially the same thing at the Feb. 28 news conference releasing the latest state budget forecast.

More generally, the professional literature in economics contains a number of statistical studies that reach similar conclusions. Many of these studies are cited in an excellent book published recently by the Urban Institute, "Policy and Evidence in a Partisan Age: The Great Disconnect," by Paul Gary Wyckoff. Prof. Wyckoff produces a trenchant and well-documented argument that politicians from both the left and the right are tempted to appeal to voters by overpromising economic results that are not consistent with the actual evidence on what is achievable, and then goes on to summarize the current evidence in a number of policy areas, including state tax policy. (Incidentally, PolitiFact was so impressed by Wyckoff's book that it broke with its usual policy and recommended the book on its website.)

I understand that Republicans firmly believe that if Minnesota raises its tax rates too high, companies and some high-income individuals will leave the state, thereby affecting long-term state growth. But I am not aware of any careful studies that support that contention, or indicate what would constitute "too high." Given the relatively strong economic growth (compared with other states) that Minnesota experienced during the 1990s (when its tax rates were somewhat higher than today) I doubt there would be great risk in passing a modest tax increase today. But I would be interested in seeing more evidence before setting policies for the long term.

OK, based on the evidence, what do I think should be done? Two things:

First, pass the governor's proposed "half tax increase" as a temporary, two-year surtax that sunsets after the next biennium. It will not slow the economy more than would the equivalent spending cuts.

Second, vote additional resources, maybe between $10 million and $15 million, to fund the production of additional evidence that could be used to set sustainable longer-term economic policies.

What evidence would be most crucial?

• Evaluations of major state programs including benefit-cost studies.

• Economic studies of the costs and benefits of major state regulations.

• A study of the impact of alternative tax rates on firm and individual in-migration and out-migration.

• Implementation of the recent Tax Expenditure Review Report to bring billions of dollars of tax expenditures (exemptions, deductions, credits, etc.) into the formal budget process.

All of these studies could be done by state agencies if they were given additional resources on a one-time basis. However, a good case could be made for forming a state agency similar to the federal Office of Information and Regulatory Assessment to handle ongoing analysis of egulations.

Whatever is done this session, the state is likely to face a substantial budget deficit in the next biennium as well. There are sure to be political differences about how to handle it. However, if the right research is undertaken, the next budget process could be based on solid evidence rather than conjecture or ideology.

Paul Anton, Minneapolis, is chief economist at Anton Economics.

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