There’s battle lines being drawn
Nobody’s right if everybody’s wrong
For What It’s Worth by Buffalo Springfield
I recall vividly watching the PR nightmare cascade out of control on the nightly news. It was 1968, and Mayor Daley had intended to use his city's hosting of the Democratic National Convention to showcase Chicago’s progress. Instead, middle-class suburban families like mine watched live coverage of hippies, yippies, and disenchanted youth armed with ideologies, bell bottoms, and protest placards being clubbed by horse-mounted police as they demonstrated outside the convention center.
It was a tumultuous year for America that witnessed the assassinations of Martin Luther King in April and Robert F. Kennedy in June, and would be the high-water mark of U.S. involvement in Vietnam. Across the land, battle lines were deeply etched between pro- and anti-establishment factions.
Today, as well, there are multiple combat lines being incised between a number of fiscal, economic, as well as ideological forces. Of all the various combatants, the U.S. states are emerging on the frontlines of the fight. And some of their tactics are encouragingly following free-market principles. Let’s pick up the story with some recently published data.
It is no secret that U.S. states in general are facing large budget deficits, and a dozen or so in particular are in dire straits. State tax revenue has fallen dramatically since the real estate bust and subsequent recession. Although the National Bureau of Economic Research, the official arbiter of recession dating, declared the nation’s downturn had ended in June 2009, the states treasuries didn’t get the memo for months. Take a look at the table:
The table shows the revenue generated from the three largest sources, not all sources, so the total percentage change may be higher than the data would seem to suggest. Also, these are nominal changes unadjusted for inflation. With inflation ranging between 0.2% and 2.8% during the period reviewed, the gains would have been muted and losses amplified.
I selected the third quarter of 2007 to begin the analysis because that is when the red ink first appeared following the end of the previous recession in 2001. The stand-out in the red ink category is the corporate income tax (CIT). Here’s a closer look: \
If adjusted for inflation, the two quarters of positive CIT growth would be only a few tenths above zero. With or without the adjustment, CIT revenue has declined 11 of the past 13 quarters and remains a troubling statistic. And considering that the 3Q2010 rise was measured against the 3Q2009 figure that was 22.1% below 3Q2008 that was 13.2% below 3Q2007 that was 4.3% below 3Q2006, it was a mighty small leap over an exceptionally low bar.
Of the three revenue sources, CIT is the one to watch and will determine the path of PIT and sales tax growth. A sustained fall in corporate taxes remitted to the state signals company profits are falling or remain negative. Declining or nonexistent company profits do not encourage hiring. And absent rising employment, both PIT and sales tax revenue will stagnate.
Yes, PIT and sales tax revenue have shown some signs of life for 2010 through September. However, whether this rise was due to income tax rebates and other one-time stimulus schemes or organic growth in employment and wages is hard to determine. Time will tell.
But recent events suggest that a battle for tax revenue has commenced, pitting high-tax states against low-tax states.
In January Illinois, faced with a gaping $13 billion hole in its budget, $8 billion in unpaid bills, and addicted to its corrupt spending ways, raised its personal income tax rate 66% and the corporate tax rate 46%.
The reaction from neighboring Wisconsin Governor Scott Walker was immediate. “Escape to Wisconsin,” said Walker, borrowing from an old state tourism board campaign motto, and urged Illinois businesses to move to his state.
Wisconsin’s Walker was not alone. Indiana Governor Mitch Daniels, Michigan’s Rick Snyder, and even Chris Christie in faraway New Jersey have been promoting their states as a haven for businesses that want to flee the tax-and-spend culture.
This trend is not limited to the big three tax revenue targets – PIT, CIT and sales –with some states getting very creative. The latest twist on beggar-thy-tax-neighbor targets cigarettes. New Jersey, New Hampshire and Rhode Island are considering reducing their taxes levied on cigarettes in the hope of drawing smokers from other states to buy in their state, thus increasing revenue.
This is the age-old border town strategy. States with geographically small footprints and/or those with large towns on or near their borders will entice neighboring state residents to make the short drive and save on sales, use or excise taxes.
My prediction: At some point, states will begin reducing their tax on gasoline to draw motorists from across the border. But that’s a topic I will cover next week.
Tax competition is here and it is real, not merely conjecture based on anecdotal evidence. As I pointed out in a previous article in this space, for the years 1998-2008, the states with the lowest PIT experienced far higher rises in gross state product, employment, population and tax receipts. If you want to increase your tax take, lower your tax rate. As counter-intuitive as that sounds, it’s true. Free-market competition has entered the tax sector.
The border town strategy is turning today’s state lines into tomorrow’s battle lines. The taxpayer will be the ultimate winner.
