Remarks to the Tax Analysts Conference on the State Fiscal Crisis

October 30, 2009

(Click here for video of this event. Joe’s remarks begin at 36:40.)

The Current State Budget Situation

I want to start out by echoing three things that have already been said, and I’m going to say them again just to reiterate.

First is that state budgets historically recover after the general economic recovery. The “lag.” So, even if the economy is recovering right now, we’re not going to see that recovery in state budgets for some time. The state budget crisis that we are currently going through will continue for the foreseeable future.

The second thing is that because every state has to either constitutionally or statutorily balance its budget, the options are that they must raise revenue, cut spending, or some combination. States can’t print money, as Scott said, California IOUs notwithstanding. So those are the options they have to face. I know it sounds like common sense, but so many politicians, so many state legislatures try their hardest to find some other option besides raising revenue, cutting spending, or some combination, and we’ve seen any number of sort of absurd examples. Chris mentioned a few of them in his opening of some of the ways, and I’m sure Doug from COST will be going over some other ways that states are trying to find other options to solve their budget shortfalls. But ultimately, that what it comes down to, and ultimately those are the decisions that need to be made.

The third point that I think bears reiterating is that the stimulus money bought time, and that’s really all it bought, and it’s running out. It was a finite pot of money, and it basically tided over the states. Some states took that opportunity to use the money for one-time purposes, put their fiscal house in order and move ahead; some states just put it right in their budget and kicked the can down the road. Regardless of what they did with it, it’s running out and states are going to be back facing the hard decisions again.

So, we’re talking about causes, and we’re talking about what states should do. A point I would want to make is that not all state tax revenue is created equal. Different states are of course in different stages of state fiscal crisis. California, of course, is the poster child for everything that’s gone wrong. I’m originally from California, so I’m not terribly proud of what its come to represent.

The really first time I really remember a state budget issue, reading in the newspaper in California, was back in 2000 when there was extended debate about what to do with the enormous state budget surplus — multi-billions of dollars generated from capital gains revenues from the dot-com boom. I was in college at the time, so it was sort of a firsthand experience out of college in the Bay Area, and since then, of course, California has probably not balanced its budget legitimately once since then.

And so the question is why states like California are different from other states? Why is it so much worse there than for others?

A lot of it has to do with volatile revenue sources. Some revenue sources are exaggerated by the boom-bust cycle more than other revenue sources. The research seems to indicate that some revenue sources like taxes on high-income earners, taxes on corporate profits, taxes on capital gains — these tend to soar very highly in boom times and then plummet to almost nothing in bust times, and we’ve seen that reflected in state budgets by revenue sources in the current situation. Those states that depended very heavily on taxes on high-income earners, taxes on corporate profits, taxes on capital gains — they got a whole lot of revenue in the boom times, and as states are wont to do, they spent it. And, unfortunately, a lot of them spent it on — not on one-time things but, rather, on ratcheting up their base of ongoing year-to-year operations. So now when those revenue sources have disappeared or plummeted, we’re left with this overhang, and that’s where these budget shortfalls have come from.

I certainly won’t disagree that the recession is no mere coincidence in the severity of this, but I think we have to recognize that revenue volatility and dependence on volatile revenue sources is a major contributing factor. Even in California they’ve recognized this with the current reform commission. They’re debating about the appropriate approach for dealing with volatile revenue sources, but everyone seems to agree that it’s a big contributing factor.

Trends in State Budgets and Taxation

So, with the boom-bust cycle, it’s a question of what do we do going forward, and of course there’s a lot of solutions out there, so I’m just going to talk about a few of the tax trends we’ve seen in state budgets this year so far.

One note on the stimulus, which I don’t think was brought up that much, was the stimulus had a lot of strings attached to it. I mean, a lot of people kind of snickered at Governors Perry and Sanford for taking or not taking the stimulus money, but the strings attached to it were quite substantial. They cordoned off whole areas of state budgets from reductions — probably one of the largest moves of state budgeting power from state capitals to Washington we’ve seen in decades, as part of the stimulus package. And that precluded a lot of cuts from happening to some core governmental services, services that might need some re-evaluation.

In times of recession, it is true there is increased demand for some governmental services — unemployment insurance, Medicaid, shelters. But that also means that it’s a time to start reevaluating some other things the government is spending money on that maybe it’s not a priority for right now. I mean, I can come up with a few absurd examples. There’s the Michigan film tax credits. They have a program giving iPods to school children. I mean, there’s a lot of things that maybe sounded — I don’t know if it would have been a good idea even in good times, but it’s certainly not — it’s something we could probably do without in bad times right now.

There are some other trends going on right now. Millionaire’s taxes, half-millionaire taxes, quarter-millionaire’s taxes are things that we’re seeing at the state level. These are a bad idea, because they essentially create a short-term gain for long-term harm. It is true that if you impose one of these high-income tax surcharges on high-income earners, you know, they’re usually for a temporary period to — if you impose them, you’ll likely see a revenue increase, but what you see is your long-term ability to generate income in the state drop off, because people see that as a sign that that’s how you view people that create jobs, the entrepreneurs in your state, so people are less likely to move into your state, people are less likely to create jobs in your state. That’s the message that that sends.

We unfortunately see a lot of states doing more and more job creation credits and incentive programs. These usually don’t work. A lot of business location decisions are made for reasons other than a giveaway package negotiated. It’s usually an added plus that a business will be all too happy to take, but it’s not one that usually drives decisions. It just uses up a lot of politicians’ and bureaucrats’ time, as well as taxpayer money, in order to pursue these programs.

In the mid-2000’s in North Carolina there was a package of tax incentives for Dell that involved a long bitter argument at the state level. It went all the way up to the state Supreme Court. We were working with a group there on fighting this incentive package but it made its way through. The politicians ushered it through: everybody was glad-handing and shaking hands, cheering that they got Dell there for millions and millions of dollars. Earlier this month, Dell announced that they’re closing the plant. I certainly can’t be celebratory in a moment like that, because there are real people that are losing their jobs, and it’s going to be very hard for their economy there. But ultimately that just shows the futility of this approach of economic development.

The better approach is to sort of lay out a welcome mat for all businesses, not picking and choosing winners and losers to bestow on certain favors. And if your state’s tax code and your state’s economy is so bad that you basically have to bribe people to move into the state to create jobs, that’s a sign that that’s what you need to fix. You need to fix your state’s tax code and your economy, not just create exemptions to it for particular individuals.

Another trend we’re seeing is these so-called Amazon taxes. Amazon.com itself really dislikes having a tax named after them, but that’s the name, unfortunately, that’s stuck. We’ve seen these now in North Carolina, Rhode Island, and New York, where it’s currently under constitutional challenge. It went through the trial-level court in New York, which upheld it, and it’s now on appeal to the Court of Appeals in New York, and I think it was being argued yesterday or today, but the trial-level court upheld it. Unfortunately, as those of us who watch Law and Order know, the trial-level court in New York is called the Supreme Court of New York. So, we saw a lot of news headlines that said “Supreme Court of New York Upholds Amazon Law,” and state legislators read that and they took it to view that the highest court in New York has blessed this tax law, which certainly isn’t the case.

This is just another example of states continuing to push to tax beyond their borders, to reach out and grab tax revenue from other states. Ultimately it is the residents of a state that get the benefit of public services, and they’re the ones that should be paying for those public services. To the extent that states try to export their tax burden to other states and to companies, out-of-state companies and so forth, it’s just a way of allowing their state residents to buy more government than they’re willing to pay for, and that sets up problems down the line when that revenue source runs out.

We’re seeing a lot of excise tax proposals not only on the good old tobacco and alcohol — except beer, never beer — but also now new categories — plastic bags, and soda and fatty foods. Historically, excise taxes are taxes on things that the majority finds distasteful for some reason. They don’t usually tend to be big money raisers, but you can have a whole multitude of them and they can raise up certain amounts of money, and usually it’s entirely random what they choose. A lot of economists like to point to excise taxes as being a way of paying for public goods or externalities, but I can assure you that no government official, no legislator ever looks at it in terms of that question. It’s just a question of how much money will it raise.

And then the last point I would want to raise is tax amnesties, which we’re seeing in quite a few states. These raise one-time amounts of money — cash in hand for states — which is what they’re after right now. They’re problematic, because they’re essentially an exemption from the state’s tax code to people that have broken it, and it sends the signal that, hey, you know, next time around you don’t really need to pay anything because we’ll set aside a time in which you can just cough it up and we’ll call it even. There’s also a lot of penalties associated with them. So, if you miss the tax amnesty and then you’re caught later on, you have to pay not only the back taxes plus the interest plus the fine but the new post-amnesty penalty for not having taken advantage of the amnesty.

I think Virginia had one of those previously, but they’re now having another amnesty, so in this amnesty they’re waiving the previous amnesty penalty, but if you miss this one, you will have to pay another amnesty penalty on top of the previous one. It gets kind of absurd, but it shows the problem associated with not just having a simple, neutral, transparent tax system and instead having to constantly be giving exemptions and waivers and one-person-only deals for it.

So in some we see a lot of big problems out there. Unfortunately, there’s not a lot of effort going on to tackle some of these big issues. There are a lot of possibilities out there — for fundamental tax reform, pension reform. I mean, probably one of the biggest drains on state finances right now is bloated, defined benefit government pensions, which are out of control. A lot of them were indexed to grow at almost absurd levels — 8, 9, 10, 11 percent a year. A lot of them crashed pretty hard when the stock market dropped, and state budgets are expected to backfill that. There’s a lot of opportunities in spending restraints. There’s a few on the ballot this year. Corrections and school choice and so forth. But unfortunately, these are not the things that are being debated yet but we hope will be, because that’s where salvation will lie in some of these spending and tax reform ideas.

Thank you.


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