Not All Taxes are Created Equal

Mar 25, 2011 No Comments

Oiling Up for a Better California

By Nik Dixit

As anyone with eyes, ears, and a brain knows, California is in trouble. Battered by recession, we are bleeding uncontrollably. We are losing jobs, and our unemployment sits well above the national average. Our cash-strapped government has made a host of cuts, to basic services like education and health care. Just this summer we issued IOUs, damaging both our credit rating and our pride. In short, our state is imploding. Even the London Observer, a foreign newspaper, recently pondered, “Will California become America’s first failed state?”

How did we get here? Everyone has their own favorite answer. Some blame our initiative process, others our tax structure, and yet others our two-thirds voting requirement to pass a budget. Without doubt, all these played a role. However, alongside them were misperceptions about basic economics.

Republicans in Sacramento believe tax increases must never be considered, no matter what the context or circumstance. Unfortunately, their philosophy governed our recent budgets. For example, in July, forced to close a $26 billion gap, we did so almost entirely through service cuts. Republicans proudly congratulated themselves, sure they had averted economic apocalypse. They were wrong.

Tax increases are not the worst way to balance a budget—they are only the second worst. Even more harmful, from both an economic and human perspective, are service cuts. Allow me to explain.

Since California is constitutionally required to balance its budget, it must either cut spending or raise taxes. Though neither is ideal, government spending has a larger per-dollar effect on the economy.

The reasoning behind this fact is quite simple. If the government issued a tax rebate, individuals could spend it, save it, or use it to pay off debt. Only what they spend, a fraction of the original amount, would circulate through the economy. On the other hand, when the government spends a dollar, the entire dollar is injected. Thus, given a choice between cutting spending and raising taxes the same amount, the latter is preferable. Since taxes have smaller effects, raising them would do less harm.

Such logic is corroborated by prominent experts. According to Joseph Stiglitz, a Nobel Prize winner and former chief economist of the World Bank, “Economic theory and evidence gives a clear and unambiguous answer: It is economically preferable to raise taxes on those with high incomes than to cut state expenditures.” According to Stiglitz and Peter Orszag, the Director of the Office of Management and Budget, “Tax increases on high-income families are the least damaging mechanism for closing state fiscal deficits”.

These economic effects can be quantified, as well. According to Moody’s Economy, a prominent forecasting firm, each dollar cut from infrastructure, unemployment, or food stamps costs the U.S. $1.59, $1.63, and $1.73 in GDP respectively. On the other hand, corporate tax increases or across-the-board tax increases cost only $0.30 and $1.03 per dollar. The bottom line is that while tax increases hurt, service cuts hurt more.

Certainly, spending can be wasteful. We should always look for opportunities to save money or trim excess fat. However, at times taxes are the optimal route. We should evaluate them pragmatically, not take them off the table due to ideology.

For example, we could have considered two popular, common sense revenues: tobacco and oil severance fees. Neither would have been egregious, or hurt business in any significant way.

Currently, California ranks thirty-second in the nation in tobacco fees. By increasing fees a mere $1.50 a pack, we could have both reduced smoking and raised revenue ($1.2 billion). Similarly, we could have placed a “severance” fee on oil companies, which drill in our land and profit from our resources. California is the only oil-producing state without such a fee; even Alaska’s stands at 25%. One bill creating a severance fee would have generated $1 billion, all reserved for higher education.

If these ideas make sense to you, you’re not alone. Sixty-six percent of Californians support a severance fee, and a whopping seventy-three percent tobacco fees. Yet, because of their ideology—taxes are always bad, no matter what—Republicans rejected these solutions. Instead they abandoned our schools, roads, and hospitals, choosing affordable cigarettes over affordable education.

The numbers, the experts, and the examples all point to one conclusion—in tough times, we should at least consider taxes. Increases are painful, but so are service cuts. From a purely economic perspective, we can’t afford all-cuts budgets.

Fall 2009

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