Last week the American Legislative Exchange Council released the fourth edition of Rich States, Poor States: The ALEC-Laffer Economic Competitiveness Index. This is an important study by authors Arthur B. Laffer, Stephen Moore, and Jonathan Williams that identifies states that use “best practices to enable states to drive economic growth, create jobs, and improve the standard of living for their citizens.” On Friday Williams was in Wichita and spoke to a group of business and political leaders at an event sponsored by Kansas Policy Institute and Wichita Independent Business Association.
Williams said that there is reason for optimism in Kansas, but the news is not all good for our state. ALEC calculates economic outlook rankings, which is a “forecast based on a state’s current standing in 15 policy variables, each of which is influenced directly by state lawmakers through the legislative process, looking at states’ forecast for growth. In this ranking, Kansas fell from 25th to 27th among the 50 states in one year. A lot of this, Williams said, was due to the statewide sales tax increase of one cent per dollar which took effect on July 1, 2010. That will “leave a mark on competitiveness,” he added.
Williams praised a bill in the Kansas Legislature this year which would have used increases in tax revenue to buy down the income tax rate. That bill, SB 1, known as the March to Economic Growth Act, passed the House of Representatives but did not advance out of committee in the Senate. This bill was important, Williams said, as one of the key findings of the Rich States, Poor States report is how important low income taxes are for economic growth.
Kansas has a choice to make, Williams told the audience. Kansas could become a growth state like Texas, which has gained four Congressional seats over the last ten years. (Kansas has four seats. States gain Congressional seats when they grow in population more rapidly than other states.) Also, according to co-author Stephen Moore, Texas has created 40 percent of all jobs created during the recent economic recovery. Moore attributes part of Texas’ growth to having no personal income tax and living within its means.
The other course is for Kansas to become accustomed to its mediocre, middle-of-the-pack ranking. But we may not want to live with the loss or prosperity that comes with this ranking. Williams cited research by KPI that show that Kansas was the only state to have a net loss of private sector jobs over the last year. All other states had at least some job growth.
In ranking states on economic outlook, three of our our neighboring states — Colorado (number 6), Missouri (9), and Oklahoma (14) are in the top 15 states. This, said Williams, makes Kansas’ mediocre ranking of 27th look even worse.
Williams outlined some principles that lead to effective tax policy. First, taxes ought to be simple. Complicated tax systems require much effort and cost to comply with, and are a deadweight loss to the economy.
Transparency is important. It should be clear who is paying the tax. Williams said that business taxes violate this principle, as businesses pass on taxes to customers, employees, and investors.
Neutrality — not using tax policy to select winners and lowers — is important, as government has a terrible record of success, and it leads to corruption in the manner of choosing winners.
Predictability is important, and institutional controls like the taxpayer bill of rights or a super majority requirement to raise taxes help in this regard.
Finally, tax policies must be pro-growth.
Williams also said that increasing spending is not a good answer to economic problems. The ARRA (federal stimulus program of 2009) allowed states to live beyond their means for two years, and the money had many strings attached. Maintenance of effort requirements forced states to abandon good budgeting practices, and set states up to fail once the stimulus money stopped. In Kansas, the budget shortfall at the start of the legislative session in January was about $550 billion, and most of that was due to the end of the stimulus money.
In analyzing tax policy, Williams told of how many people insist on using static analysis to predict the outcome of changes to tax policy. He showed the famous Laffer Curve, made prominent by co-author Arthur Laffer. The concepts illustrated by the curve include these: At an income tax rate of zero, the government collects no tax revenue. At a tax rate of 100 percent, again the government collects no revenue, as no one will work if all their earnings go to taxes. Between these two rates, revenue will rise as the tax rate is increased, until at some point tax revenue begins to fall with increasing tax rates. Eventually people figure out it just doesn’t pay to work any longer after the tax rate becomes too high.
It’s important, therefore, to include human behavior and reaction to changes in tax policy. This is dynamic analysis — realizing that as tax rates change, people alter their behavior. Static analysis, on the other hand, doesn’t take this into account. Williams recounted an example as told in the book Flat Tax Revolution: Using a Postcard to Abolish the IRS by Steve Forbes:
In 1989, Bob Packwood (R-OR) requested a revenue forecast from Congress’s Joint Committee on Taxation (JCT) on a hypothetical tax increase raising the top rate to 100 percent on incomes over $200,000. The JCT responded by forecasting increased revenues of $204 billion in 1990 and $299 billion in 1993. Essentially, the JCT predicted that people would continue to work even if the government taxed them out of every penny they earned.
Williams said that only about ten states use a method of analysis different from static analysis when considering tax policy changes. Therefore, pro-growth tax policies often don’t get a good revenue score and are rejected for that reason. But the static models don’t take into account that as tax rates decrease, revenue may increase, or not decline as much as static models predict.
On the state pension crisis, Williams said that official estimates understate the magnitude of the actual problem, as government accounting standards do not require states to fully recognize the full magnitude of recent investment losses. The losses may be spread over several years. Further, he said that states generally use an assumed rate of return that is greater than what is likely to be realized. He said that legendary investor Warren Buffet has recommended that state use six percent as their future earnings assumption. Kansas uses eight percent. Over long periods of time, which is the timeframe of pension plans, this difference in returns produces a large change in earnings.
For more information on this report and its findings for Kansas, see Rich States, Poor States released for 2011. The report is available to read in its entirety at no cost at Rich States, Poor States: The ALEC-Laffer Economic Competitiveness Index.