Spending Cuts and Tax Reform: Not ‘Heads’ or ‘Tails’
State fiscal reform is not a matter of choosing “heads” or “tails.” The tax-cutting, starve-the-beast approach alone cannot sufficiently control the growth of government, either on the state or federal level. Spending reform, absent the return of money back into the hands of entrepreneurs, investors and taxpayers does not sufficiently accomplish growth. Insofar as state fiscal policy goes, taxes and spending are permanently linked as two sides of the same coin. States that make good choices on spending can afford to make good choices on taxes, and states that have a desire to be more business-friendly and competitive are incentivized to reduce spending.
It should come as no surprise that low-tax, economically-competitive states are more likely to be in good fiscal health. More importantly, it also seems that high-tax, non-competitive states are simply using the wrong playbook and, in an attempt to capture revenue, end up losing businesses and commerce. With the recent release of the ninth edition of the Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, each state was handed a summary of how fiscal and economic policies influence their own economic outlook.
When comparing the top ten competitive states against the bottom ten, a clear pattern emerges. For example, one of the 15 equally-weighted policy variables considered in Rich States, Poor States is “debt service as a share of tax revenue.” This variable reflects a few elements of a state’s budget, including overall tax burden, spending levels and also the sheer size of its economy. Misinterpreted, the variable can be viewed as creating a perverse incentive to raise revenue by increasing taxes. However, the more responsible route to managing debt payments is by balancing budgets and reducing the accrual of debt altogether.
Unsurprisingly, states that earned a top ten ranking in Rich States, Poor States manage their debt better than states languishing in the bottom ten, resulting in a five spot advantage, on average, in the “debt service” variable. In terms of raw percentages, top ten states commit a full percentage point less of their tax revenue to debt service than the bottom ten states. However, the solution is not to manipulate the ratio by chasing new revenues.
Neither a state’s fiscal health nor its ability to generate sufficient revenue for core government services requires increasing taxes. In fact, the states with no personal income tax have recently seen more growth in revenue, due to both increased commerce and increased domestic in-migration. The proper path is to prioritize spending restraint, which allows for sustainable tax rate reductions, leading to economic growth and revenue generation.
It is no wonder, then, that State Budget Solutions’ most recent State Debt Report shows a relationship between state debt burdens and a poor economic outlook. Of the five states carrying the most state debt per capita, three are among Rich States, Poor States’ bottom 10 in economic outlook. Each of the five states carrying the least debt per capita are among the Rich States, Poor States top ten for economic outlook.
The need for priority-based budgeting should be obvious. When the proper role of government is heavily weighed during the budget and appropriations process, it becomes possible for a state to tighten the belt without constituents suffering losses of core services. By prioritizing the protection of individual rights and the provision of basic services, citizens can come to appreciate the benefits of limited government. Other spending reforms are even simpler and less demanding. For example, merely forcing agencies to publish mission statements and explain how much of a return on investment they provide to taxpayers can reduce bureaucratic overlap and increase transparency, allowing citizens to gauge whether the services provided are necessary.
Some reforms are more challenging. Unfunded pension liabilities and the struggle to make Annual Required Contribution (ARC) payments – the minimum funding amount needed to maintain long-term stability – represent not only a dead weight on state budgets, but also broken promises to retirees who count on their pension income. While many options for reform exist, the end-goal must first be made clear to both pensioners and taxpayers: reducing taxpayers’ burden will not necessarily harm revenue, but it will boost a state’s economy, which benefits both workers and retirees. Reforms are not punishments, and public sector workers are no one’s enemy. Rather, reasonable reforms are required to keep the promise made by the state to its workers. When those reforms are implemented, the burden of debt can be lifted off both the state and the taxpayer. When spending and debt are properly managed, a state is free to become more economically competitive and prosperous.
This article first appeared in the Huffington Post, on June 1, 2016.