Increase taxes to protect and save jobs. Yes, really.

March 2, 2010 | Aaron Keating

That noise you hear is the sound of heads exploding over at the offices of the Washington Policy Center when reading last week’s Puget Sound Business Journal, in which EOI’s policy director Marilyn Watkins writes:

Contrary to what some pundits are saying, the best bet to spur private sector jobs is to raise taxes as much as necessary to maintain state spending.

Since a subscription is required for the PSBJ article, before we take a look at what WPC staffer Carl Gipson wrote about it, I’ll briefly hit the high points of the column:

  • Protecting and creating jobs should be the legislature’s #1 goal this session. Last year’s massive budget cuts, totaling $3.4 billion, equate to about 44,000 fewer jobs throughout Washington’s economy. That’s because…
  • State spending on direct purchases, contracted services and payroll stimulates the local economy to the tune of a $1.41 increase in gross state product (GSP) for every $1 of general state spending. Raising taxes $1 results in a drop of 32 cents to $1.02 in GSP, depending on whether the well-to-do (small drop) or the general public (larger drop) pay more of the tax. So…
  • While tax increases can cost jobs, increased spending on public structures has a net benefit for the job market, especially when the tax increases broaden and stabilize the tax base, discourage behaviors that cost the state (like pollution and poor health habits), and are paid primarily by those who can best afford it. The bottom line is…
  • Even if the the Legislature were to close this year’s entire $2.6 billion budget gap through new taxes, we’d end up with a net of 9,300 to 26,000 jobs saved across all sectors of the economy. Rainy day, fund shifts and (hopefully) some federal dollars could protect up to 30,000 jobs.

That’s it in a nutshell. Now let’s take a look at WPC’s criticisms and see whether they hold water:

First, Mr. Gipson writes that WPC has looked at the numbers, and they predict net job losses from EOI’s approach. What he doesn’t say is the WPC prediction is based on an economic model in which revenue from tax increases is spent only on health care — not exactly a realistic assumption. From their report:

Our simulations assume that the tax proceeds are spent on health care (a blend of physicians’ services, hospital care, nursing home care, and drugs).

The report he cites has another glaring weakness: The matter of who pays the taxes — that is, the tax incidence — is quite important in these models, and Mr. Gipson misses that point completely. Generating revenue by closing tax loopholes and ending tax exemptions that favor a narrow group of well-to-do or out-of-state taxpayers has a very different economic impact than a statewide general sales tax or B & O tax increase, which hits more low- and middle-income taxpayers in the pocketbook.

The next criticism Mr. Gipson levels is that government redistributes resources inefficiently, which “results in a marginal effect once it is reintroduced to the private sector.” Since Mr. Gipson offers zero empirical data to support his premise, I’ll simply ask the logical question begged by his assertion, which is: Inefficient compared to what? What other economic actor, specifically, is in the business of collecting and redistributing resources in our economy? (Hint: None.)

Now, there’s no question that the process of collecting taxes and spending the revenue does have administrative and economic costs. But that’s only half of the economic equation. The other half is: do the social benefits of the public spending outweigh those costs?

To answer that question, you have to put a value on those social benefits, which is tricky. How much are quality schools worth? How about affordable health care? A safety net for the most vulnerable? Modern transportation systems? Affordable housing, public safety, a clean environment? Economists can approximate those values — and sure, we could plug all the numbers into some formula to make our choices — but who is going to write the formula? And who chooses the numbers we use?

If that sounds like a daunting task, that’s because it is. And that is precisely why we use economics to guide and inform our choices. To actually make those choices, we use a little thing called democracy. Is it a perfect system? No. But as Winston Churchill wryly noted: “It has been said that democracy is the worst form of government except all the others that have been tried.”

Mr. Gipson also appears to have given some thought about the implications of making public choices democratically, but has come to a different conclusion:

…once the decision is made that the public sector (policymakers, bureaucrats, et. al.) must direct the spending decisions, those decisions become subjected to politics. Which constituency deserve how much? This becomes a matter of political strategy rather than economics. If it’s true that the multiplier effect for food stamps and unemployment insurance benefits is true — then why are there no increases in those programs in the proposed budgets? It certainly is not because no one is asking for the increases.

Props to Mr. Gipson for so articulately re-stating the point of Marilyn Watkins’ column. Indeed, Washington should be spending more on the social safety net, especially given the positive effect it will have on the state’s economy during the recession.

Other than that, his reasoning is exactly backward. Economic decisions are by definition political decisions, because choices about how to structure our state’s tax code and spend public dollars have a profound effect not just on our economy, but on people’s lives and families. That is all the more reason to make those choices democratically, and that’s exactly why 5500 people showed up in Olympia last Monday to make their voices heard for closing tax loopholes and passing targeted tax increases in order to protect our state’s quality of life.

Near the end of his post, Mr. Gipson cites unemployment insurance as an example of non-stimulative spending to buttress his argument. He writes — again without citing data to support his claim — that UI taxes cost more in reduced economic growth than they create in social benefit.

Unemployment insurance is actually a great place to see the positive multiplier effect of public spending at work. The Department of Labor estimates that every $1 of UI benefits spent creates $1.64 of purchasing power. Washington’s UI system put $4 billion in benefits into our state economy in 2009 — that’s $6.56 billion in economic activity in communities across the state last year alone.

And as for the paper that Mr. Gipson cites in closing (which you can read here), let’s just say that among many economists, the jury is definitely still out on its conclusions. In fact, some believe the results point to the exact opposite conclusion Mr. Gipson makes — namely:

What Romer and Romer’s study (and their earlier work on monetary policy) shows is…failing to consider the reasons for policy changes leads to underestimates of the effects of all types of stimulus. …[T]he most reasonable interpretation of their paper is that all types of fiscal stimulus are more potent than conventional estimates would lead us to believe.

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Posted in State Economy, Tax and Budget

Comments

  1. Alan Harvey says:

    The belief that lower taxes will generate economic energy is exactly wrong. It may be a belief held tightly by many, but where is the evidence?

    The Eyman tax cuts and the Bush tax cuts did not lead to any sort of economic surge, but were followed by stagnation in incomes and employment. A housing boom came about from low interest rates and financial “innovation,” To say that the private sector took these tax cuts and allocated them in any way efficiently is to ignore reality.

    As you say, many people have shown the multiplier for public sector spending is higher than that for other types of spending. And there is a whole argument behind that.

    But the state spending on education, transportation, public safety, public health and the rest also underpins the activities of business. The Economic Vitality Study produced by the DOR around the time of the Gates Tax Reform Commission showed that at least in business siting decisions, market, transportation, workforce availability, education came in 1-2-3-4. Only then did the question of taxes arise. Perhaps it is the business of the WPC to mine government for tax preferences for its members, but it is not in the interest of business activity as a whole.

    The economic arguments of the WPC crowd have blown up in their faces with the current crisis, but rather than admit that and get down to practical means of stabilizing the situation, they continue to insist on the kinds of policies that got us here.

    I do think, though, that closing the loopholes and ending exemptions, while valuable, can only go so far to filling the immense shortfall. Economically efficient taxes, such as the BC-style carbon tax or a reform of the B&O tax are essential.

    Can it be done? Only when the propositions you put forward here and which appeared in Marilyn Watkins column get a fair hearing and wider understanding. It is not charity to build strong public sector services, it is the road to recovery.

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