Never assume — it’ll make an economist out of you and me.

March 12, 2010 | Aaron Keating

ShareMaking assumptions is a necessary part of an economist’s work — but that’s no excuse for failing to reveal them when you make your case for a particular public policy choice, as Kriss Sjoblom does in his recent Seattle Times column when he asserts:

…tax hikes will cost Washingtonians jobs and depress the economy. The damage will be greater than it would have been had lawmakers shown more restraint and cut spending deeper.

To support his point of view, Sjoblom cites a recent report by the Washington Research Council, where he is vice president of research. But a close look at that report reveals it is based on two assumptions that are far from realistic:

  • Assumption 1: All new state revenue will be raised through a (large) increase in either the sales or B&O tax. Reality: Those tax increases are both vastly larger than and very different from anything legislators have considered this session.

Given the taxes modeled in the WRC report, it isn’t surprising they predict large job losses. But those aren’t the only options available to policymakers for raising revenue, and the choice of tax does make an economic difference, as we’ll see later.

  • Assumption 2: All new revenue from the tax increase (approx. $1 billion) will be spent only on health care. Reality: While technically the state could spend new revenue that way, it’s not really plausible they would.

Here again, neither the House nor the Senate budget plans propose anything remotely like the model in the WRC report.

Later, we come to the the crux of Sjoblum’s argument: states can’t lift themselves up by their own economic bootstraps because they can’t finance stimulus with deficit spending, higher taxes just drive out business, and the money “leaks out” of state borders.

Moreover, he says, economist Mark Zandi’s finding that each dollar of additional state spending has a multiplier effect of $1.41 the economy isn’t relevant to the discussion because Zandi’s research assumes state spending is funded by the federal borrowing.

But if you peel back the layers of Sjoblum’s arguments here, it’s apparent they too rest on a shaky foundation:

  • Assumption 3: Job losses due to state tax increases always offset any stimulative effect of state spending. Reality: Even when you account for job losses due to state tax increases, there is still a net job savings compared to the all cuts budget approach Mr. Sjoblum advocates.

As EOI’s policy director Marilyn Watkins wrote in a recent column in the Puget Sound Business Journal [emphasis mine]:

According to Mark Zandi, economic advisor to Sen. John McCain, R-Ariz., and businesses around the world, each $1 of general state spending results in a $1.41 increase in economic activity. Using that multiplier, the $3.4 billion already cut from our state budget will lower our gross state product (GSP) by $4.8 billion through 2011. In 2008, there was one job for every $109,100 of GSP. Using a simple ratio, the loss in GSP equates to about 44,000 fewer jobs throughout Washington’s economy.

Does raising taxes also cost jobs? Yes, but not as many as the equivalent cuts in state spending. Zandi estimates each dollar of tax increase results in a drop of 32 cents to $1.02 in gross product, depending on whether the tax hike falls primarily on the well-to-do who will reduce savings more than spending, or the general public.

Even if the Legislature were to close the entire $2.6 billion 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. More likely some of it will come from the rainy day and other funds and — if we’re lucky — the federal government, meaning up to 30,000 protected jobs.

Sjoblom calls this approach counterintuitive. But is it? If the tax increases broaden and stabilize the tax base by closing loopholes and special exemptions, it creates a more level economic playing field and a more predictable business climate. If it discourages behaviors with high social costs, like pollution and poor health habits, it saves taxpayer dollars. If it is paid primarily by those who can best afford it, like out-of-state businesses or very wealthy individuals, it won’t markedly depress consumer demand.

Finally, it’s far from clear that “leaks” to other states will offset the effect of state spending, as Sjoblum asserts. There’s a reason it’s called state spending, after all: these public dollars are spent right here in Washington on structures and services that are vital to our local economy and quality of life. Again, Marilyn Watkins:

State spending not only supports school teachers, unemployment insurance counselors, state patrol officers, and other public servants, but also bolsters jobs in the private sector. About 40 percent of state spending goes straight to private firms through purchases and contracted services. And of course, all those teachers and other public employees spend their paychecks, putting even more into local private businesses and sustaining additional jobs.

Do Oregonians, Idahoans and residents of other states benefit to a degree from that spending? Sure they do. But we here in Washington benefit from other states’ spending too.

The larger point is this: wisely invested in good schools, efficient transportation networks, and a clean environment, public spending can make Washington a more attractive place to live, work and do business. In other words, it can actually stimulate economic growth.

That is a far more rational economic approach than engaging in a race to the bottom with the rest of the country to see who can slash their budgets most in the middle of a recession.

Thanks Austin – the debate continues, as seen in the recent Seattle Times column by Kriss Sjoblom (http://seattletimes.nwsource.com/html/opinion/2011291882_guest09sjoblom.html).

What Mr. Sjoblom conveniently overlooks about the Washington Research Council analysis he quotes is this: the report models spending the all new revenue from tax increase on health care. Technically, the state could do that, but it’s not a plausible they would, which puts those findings on shaky economic ground, to say the least.

Second, Sjoblom criticizes the use of economist Mark Zandi’s research on the multiplier effect of government spending. Sjoblom claims that because states can’t deficit spend job losses associated with tax increases will more than offset the economic stimulus of the spending. This argument ignores the economic elephant in the room: tax incidence.

As Marilyn Watkins points out in her analysis (http://www.eoionline.org/2010/03/02/increase-taxes-to-protect-and-save-jobs-yes-really/) raising taxes $1 results in a drop of 32 cents to $1.02 in Gross State Product (GSP) — depending on whether the well-to-do (small drop) or the general public (larger drop) pay more of the tax. Note that in either case, the drop in GSP is less than the multiplier effect shown.

Marilyn’s analysis accounts for the offsetting effect of tax increases, and finds that even if 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.

The larger point that is often lost in discussions about public revenue and spending – whether we’re in a boom or bust – is this: the government

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Posted in State Economy, Tax and Budget

Comments

  1. Alan Harvey says:

    Stabilizing state spending through efficient taxes is, of course, the way to go. I believe the multipliers are higher than Zandi suggests, particularly for state spending which is itself very job-intensive. And obviously the multiplier works in the negative direction, too, so that reductions in state spending are multiplied with a minus sign.

    Thus the relevant difference is between, for example .41 plus and .39 minus (the inverse of 1.41). Do increases in taxes cost jobs? Yes, of course, but in the case of marginal increases, they may be jobs in China or elsewhere, since those marginal private dollars often buy consumer discretionaries produced elsewhere. State spending is focused on this state.

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