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Posts Tagged ‘Competitiveness’

I wrote a couple of weeks ago about how New York is committing slow-motion fiscal suicide.

The politicians in Illinois must have noticed because they now want (another “hold my beer” moment?) to accelerate the already-happening collapse of their state.

The new governor, J.B. Pritzker, wants to undo the state’s 4.95 percent flat tax, which is the only decent feature of the Illinois tax system.

And he has a plan to impose a so-called progressive tax with a top rate of 7.95.

Here are some excerpts from the Chicago Tribune‘s report., starting with the actual plan.

Democratic Gov. J.B. Pritzker embarked on a new and potentially bruising political campaign Thursday by seeking to win public approval of a graduated-rate income tax that he contended would raise $3.4 billion by increasing taxes for the wealthy…for his long-discussed plan to replace the state’s constitutionally mandated flat-rate income tax. Currently, all Illinois residents are taxed at 4.95 percent… Pritzker’s proposal is largely reliant on raising taxes significantly on residents making more than $250,000 a year, with those earning $1 million and up taxed at 7.95 percent of their total income. …The corporate tax rate would increase from the current 7 percent to 7.95 percent, matching the top personal rate. …The governor’s proposal would give Illinois the second-highest top marginal tax rate among its neighboring states.

And here’s what would need to happen for the change to occur.

Before Pritzker’s plan can be implemented, three-fifths majorities in each chamber of the legislature must approve a constitutional amendment doing away with the flat tax requirement. The measure would then require voter approval, which couldn’t happen until at least November 2020. …Democrats hold enough seats in both chambers of the legislature to approve the constitutional amendment without any GOP votes. Whether they’ll be willing to do so remains in question. Democratic leaders welcomed Pritzker’s proposal… voters in 2014 endorsed the idea by a wide margin in an advisory referendum.

The sensible people on the Chicago Tribune‘s editorial board are not very impressed, to put it mildly.

…how much will taxes increase under a rate structure Pritzker proposed? You might want to cover your eyes. About $3.4 billion annually… That extraction of dollars from taxpayers’ pockets would be in addition to roughly $5 billion raised annually in new revenue under the 2017 income tax hike. …How did Springfield’s collection of all that new money work out for state government and taxpayers? Here’s how: Illinois remains deeply in debt, continues to borrow to pay bills, faces an insurmountable unfunded pension liability and is losing taxpayers who are fed up with paying more. The flight of Illinoisans to other states is intensifying with 2018’s loss of 45,116 net residents, the worst of five years of consistent, dropping population. …Illinois needs to be adding more taxpayers and businesses, not subtracting them. When politicians raise taxes, they aren’t adding. A switch to a graduated tax would eliminate one of Illinois’ only fishing lures to attract taxpayers and jobs: its constitutionally protected flat income tax. …Pritzker’s proposal, like each tax hike before it, was introduced with no meaningful reform on the spending side of the ledger. This is all about collecting more money. …In fact, the tax hike would come amid promises of spending new billions.

And here’s a quirk that is sure to backfire.

For filers who report income of more than $1 million annually, the 7.95 percent rate would not be marginalized; meaning, it would be applied to every dollar, not just income of more than $1 million. Line up the Allied moving vans for business owners and other high-income families who’ve had a bellyful of one of America’s highest state and local tax burdens.

The Tax Foundation analyzed this part of Pritzker’s plan.

This creates a significant tax cliff, where a person making $1,000,000 pays $70,935 in taxes, while someone earning one dollar more pays $79,500, a difference of $8,565 on a single dollar of income.

That’s quite a marginal tax rate. I suspect even French politicians (as well as Cam Newton) might agree that’s too high.

Though I’m sure that tax lawyers and accountants will applaud since they’ll doubtlessly get a lot of new business from taxpayers who want to avoid that cliff (assuming, of course, that some entrepreneurs, investors, and business owners actually decide to remain in Illinois).

While the tax cliff is awful policy, it’s actually relatively minor compared to the importance of this table in the Tax Foundation report. It shows how the state’s already-low competitiveness ranking will dramatically decline if Pritzker’s class-warfare plan is adopted.

The Illinois Policy Institute has also analyzed the plan.

Unsurprisingly, there will be fewer jobs in the state, with the losses projected to reach catastrophic levels if the new tax scheme is adjusted to finance all of the Pritzker’s new spending.

And when tax rates go up – and they will if states like Connecticut, New Jersey, and California are any indication – that will mean very bad news for middle class taxpayers.

The governor is claiming they will be protected. But once the politicians get the power to tax one person at a higher rate, it’s just a matter of time before they tax everyone at higher rates.

Here’s IPI’s look at projected tax rates based on three different scenarios.

The bottom line is that the middle class will suffer most, thanks to fewer jobs and higher taxes.

Rich taxpayer will be hurt as well, but they have the most escape options, whether they move out of the state or rely on tax avoidance strategies.

Let’s close with a few observations about the state’s core problem of too much spending.

Steve Cortes, writing for Real Clear Politics, outlines the problems in his home state.

…one class of people has found a way to prosper: public employees. …over 94,000 total public employees and retirees in Illinois command $100,000+ salaries from taxpayers…former Chicago Mayor Richard M. Daley, who earned a $140,000 pension for his eight years of service in the Illinois legislature. …Such public-sector extravagance has fiscally transformed Illinois into America’s Greece – only without all the sunshine, ouzo, and amazing ruins.

So nobody should be surprised to learn that the burden of state spending has been growing at an unsustainable rate.

Indeed, over the past 20 years, state spending has ballooned from $34 billion to $86 billion according to the Census Bureau. At the risk of understatement, the politicians in Springfield have not been obeying my Golden Rule.

And today’s miserable fiscal situation will get even worse in the near future since Illinois is ranked near the bottom when it comes to setting aside money for lavish bureaucrat pensions and other retirement goodies.

Indeed, paying off the state’s energized bureaucrat lobby almost certainly is the main motive for Pritzker’s tax hike. As as happened in the past, this tax hike is designed to finance bigger government.

Yet that tax hike won’t work.

Massive out-migration already is wreaking havoc with the state’s finances. And if Pritzker gets his tax hike, the exodus will become even more dramatic.

P.S. Keep in mind, incidentally, that all this bad news for Illinois will almost certainly become worse news thanks to the recent tax reform. Restricting the state and local tax deduction means a much smaller implicit federal subsidy for high-tax states.

P.P.S. I created a poll last year and asked people which state will be the first to suffer a fiscal collapse. Illinois already has a big lead, and I won’t be surprised if that lead expands if Pritzker is able to kill the flat tax.

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According to Freedom in the 50 States, which we reviewed a couple of days ago, New Jersey is in the bottom 10 and has been moving in the wrong direction.

This dismal ranking is not an anomaly. New Jersey also is in the bottom 10 of states according to Economic Freedom of North America, and the Garden State is dead last according the State Business Tax Climate Index and State Fiscal Condition.

In a perverse way, I admire New Jersey’s politicians. They’re not satisfied with the state’s low scores. They want to become even less competitive. If that’s even possible.

As I noted in the interview, the latest proposal for a “rain tax” isn’t necessarily objectionable if examined in isolation.

But in the context of New Jersey’s fiscal deterioration, it’s almost as if politicians are writing another passage in a very long suicide note for the state.

Consider what happened recently with the gas tax, as explained by the Wall Street Journal.

…a silver lining used to be the Garden State’s relatively low gasoline tax of 14.5 cents a gallon—second lowest in the U.S. No more, and therein lies a tale of why taxing the rich to finance government is an illusion. In October 2016, then-Gov. Chris Christie signed a bill raising the gas tax by 22.6 cents to 37.1 cents a gallon…the bill also included a clause that automatically raises the gas tax if it doesn’t produce the expected revenue each year. This is a self-fulfilling economic prophesy. A higher gas tax causes people to drive less, which in turn has meant that revenues have fallen short of the expected $2 billion target. So on Oct. 1 the gas tax will rise another 4.3 cents to 41.4 cents per gallon, which will be the ninth highest in the U.S. …This will be the state’s third tax increase in four months, following June’s increase in income and corporate tax rates. …The larger lesson is that sooner or later the middle class always gets the bill for bigger government. Higher income and corporate taxes drive the affluent out of the state, which means less revenue. That leaves the middle class to pay in higher sales, property and now gasoline taxes.

Needless to say, New Jersey’s taxaholic lawmakers want even more revenue.

Here are some excerpts from a report by Politico.

Gov. Phil Murphy said Wednesday he may propose new tax increases when he unveils his budget in March, saying he’s worried that the state has not done enough to achieve what he called “tax fairness.” …The governor…had sought some $1.7 billion in new taxes… Murphy was met with fierce resistance from fellow Democrats in the Legislature… Murphy ultimately agreed to…$1.6 billion in annual revenue. …Murphy, speaking at a church in Newark where he delivered a speech on his first-year accomplishments, said he needs to leave his options open as he starts to prepare a budget… “I would say everything is on the table. Period, full stop,” he added when pressed again about the idea of new tax increases.

If all this sound worrisome, that’s because it is.

But it gets even worse. As I warned at the end of the interview, the 2017 tax law restricts the ability of federal taxpayers to deduct taxes paid to state and local governments.

And that means the full burden of those taxes is now much more explicit, which means more and more taxpayers in high tax rates are going to “vote with their feet” and move to states with less onerous fiscal regimes.

In other words, New Jersey politicians are making their tax system worse at precisely the moment that the geese with the golden eggs have more incentive to fly away.

Insane.

P.S. Given this grim news, I’m surprised that fewer than 9 percent of people picked New Jersey to be the first state that will suffer fiscal collapse.

P.P.S. What’s really remarkable – albeit in a very sad and tragic sense – is that New Jersey in my lifetime used to be like New Hampshire, with no state income tax and no state sales tax.

P.P.P.S. There is a Jersey with good tax policy, but it’s far away from the American version.

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There were several good features of the 2017 tax bill, including limitations on the state and local tax deduction.

But the 21 percent corporate tax rate was the unquestioned crown jewel of the Tax Cut and Jobs Act. The U.S. system had become extremely anti-competitive thanks to a 35 percent rate that was far above the world average, so reform was desperately needed.

That’s the good news.

The bad news is that Democrats in the House of Representatives already are pushing for a big increase in the corporate rate.

Rep. John Yarmuth, the new House Budget chairman, said his chamber’s budget blueprint will aim to claw back lost revenue by boosting the corporate tax rate from its current 21 percent to as high as 28 percent… he anticipates the budget resolution will envision changes to the 2017 GOP tax overhaul, including raising the corporate tax rate above its current 21 percent. “…We’ll see how much revenue we can get out of it.” The rate was 35 percent before it was cut in the GOP tax bill.

Since Republicans control the Senate and Trump is in the White House, there’s probably no short-term risk of a higher corporate tax rate.

But such an initiative could be a major threat after the 2020 election, so let’s augment our collection of evidence showing why a higher rate would be a very bad idea.

We’ll start with some analysis from the number crunchers at the Tax Foundation.

A corporate tax rate that is more in line with our competitors reduces the incentives for firms to realize their profits in lower-tax jurisdictions and encourages companies to invest in the United States. Raising the corporate income tax rate would dismantle the most significant pro-growth provision in the Tax Cuts and Jobs Act, and carry significant economic consequences. …Raising the corporate income tax rate would reduce economic growth, and lead to a smaller capital stock, lower wage growth, and reduced employment. …Raising the rate to 25 percent would reduce GDP by more than $220 billion and result in 175,700 fewer jobs.

Here’s the table showing the negative effect of a 22 percent rate and a 25 percent rate, so a bit of extrapolation will give you an idea of how the economy will suffer with a 28 percent rate.

By the way, since the adverse impact on wages is one of the main reasons to be against a higher corporate tax rate, I’ll also share this helpful flowchart from the article.

Now let’s look at some research from China, which underscores the importance of low rates if we want more innovation.

Here’s the unique set of data that created an opportunity for the research.

In November 2001, China implemented a tax collection reform on all manufacturing firms established on or after January 2002, which switched the collection of corporate income taxes from the local tax bureau to the state tax bureau. After the reform, similar firms established before or after 2002 could pay very different effective tax rates because of the differences in the management and incentives of those two types of tax bureaus…, resulting in a reduction of effective corporate income tax rates by almost 10% among newly established firms. …the policy change created exogenous variations in the effective tax rate among similar firms established before versus after 2002. We can thus apply a regression discontinuity design (RD) and use the generated variation in the effective tax rate to identify the impact of taxes on firm innovation.

And here are the findings.

Our analysis yields several interesting results. First, we show a strong and robust causal relationship between tax rate and firm innovation. Decreasing the effective tax rate by one standard deviation (0.01) increases the average number of patent application by a significant 5.7% (see Figure 2 for the graphical evidence). The reform also stimulated R&D expenditures and increased the skilled-labour ratio by 14%. Second, a lower tax rate also improves the quality of patents. The impact of tax reform on patent applications mainly comes from its effect on invention and utility patents – decreasing the effective tax rate by one standard deviation improves the probability of having an invention patent application by 4.4% and increases the number of utility patent applications by 4.7%.

Don’t forget that high personal tax rates also discourage innovation, so it’s a pick-your-poison menu.

Here’s a chart from the study, showing the difference in patents between higher-taxed firms and lower-taxed firms.

Last but not least, let’s review some of the findings from a study published by the National Bureau of Economic Research.

We present new data on effective corporate income tax rates in 85 countries in 2004. …In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy. The results are robust to the inclusion of controls for other tax rates, quality of tax administration, security of property rights, level of economic development, regulation, inflation, and openness to trade

And here’s one of the many charts and tables in the study.

The bottom line is that a higher corporate tax rate will be bad for workers for the simple reason that less investment means lower productivity and lower productivity means lower wages.

P.S. It’s also likely that House Democrats will try to increase the top personal tax rate, though hopefully they’re not so crazy as to push for Ocasio-Cortez’s 70 percent rate.

P.P.S. it’s quite possible that an increase in the corporate tax rate would reduce revenues, especially in the long run.

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Today is my last day in Chile, so today’s column will build upon what I wrote last week.

I have three charts that illustrate how Chile’s pro-market reforms have been great news – especially for poor people (or, to be more accurate, for Chileans who used to be poor).

We’ll start with this chart from the most recent issue of Economía y Sociedad, which shows that there’s more mobility in Chile than any other OECD nation.

Honest folks on the left should view this as unambiguously positive.

Similarly, this Gini data (measuring the degree of inequality) should be slam-dunk evidence of progress for all left-of-center people.

For what it’s worth, I don’t care about the Gini coefficient. What matters to me is economic growth so that everyone can get richer.

If rich people happen to get richer faster than poor people (like in China), that’s fine.

And if poor people happen to get richer faster than rich people (like in Chile), that’s fine as well.

What irks me is that folks who fixate on inequality often support policies that retard growth. In other words, they’re so worried about rich people getting richer that they advocate for bigger government, which makes it harder for poor people to become richer.

Economic growth, by contrast, truly is the rising tide that lifts all boats.

Which is why this final chart (based on the Maddison database) is so powerful. It shows 1975-2016 income trends for Chile (red) and other major Latin American economies. As you can see, Chile started near the bottom and is now the region’s richest nation.

Wow, Chile didn’t just converge. It surpassed.

It’s also worth noting how nations such as Argentina, Venezuela, and Cuba have enjoyed very little income growth over the past 40 years.

The bottom line is that those nations are evidence of the costly impact of statism, while Chile is an amazing example of how capitalism generates widely shared prosperity.

P.S. I’m not claiming Chile is a perfect role model. It is #15 in Economic Freedom of the World, so there is considerable room for improvement. But I am arguing it is a successful example of how better policy is great news for all segments of society.

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I’m glad the United States is now ranked #1 in the World Economic Forum’s Global Competitiveness Report, though I point out in this interview that Trump’s performance is mostly a net wash.

His sensible approach to tax and regulation is offset by his weak approach to spending and his problematic view of monetary policy.

I’m embarrassed to admit that I forget to mention protectionism as another area where Trump is pushing in the wrong direction.

But let’s not focus on Trump. Instead, let’s take a closer look at the new data from the World Economic Forum.

And we’ll start with a look at the top 20. You’ll see some familiar jurisdictions, places that always get good grades, such as Singapore, Switzerland, and Hong Kong.

But you’ll also notice that there are several European welfare states with very good scores.

That’s because the GCR – unlike Economic Freedom of the World or the Index of Economic Freedom – does not rank nations based on economic policy. It’s more a measure of the business environment.

But since good policy tends to create a good business environment, there is a connection. Nations such as Germany and the Netherlands, as well as Scandinavian countries, have big welfare states. But the damage of those policies is offset by a very laissez-faire approach to businesses. So the big companies that help put together the GCR understandably give those places good scores.

By the way, it’s also worth mentioning that the 2018 edition uses a revised methodology. And based on this new approach, the United States retroactively gets the top score for 2017 as well.

All that being said, does it matter if a nation is ranked higher rather than lower?

Based on this strong relationship between competitiveness scores and economic output, the answer is yes.

The bottom line is that there’s a very meaningful link between economic liberty and national prosperity.

Now let’s take a closer look at the scores for the United States. As you can see, our top score is mostly due to our market efficiency and innovation environment.

For what it’s worth, I don’t fully agree with the report’s methodology. But that’s mostly because I prefer to look at the degree of economic liberty rather than whether a nation is business friendly. There’s an overlap, of course, but it’s nonetheless important to distinguish between pro-market and pro-business.

In any event, here are a couple of additional findings that caught my eye.

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I recently wrote about the Tax Foundation’s State Business Tax Climate Index, which is a snapshot of current competitiveness (New Jersey is in last place, which shouldn’t surprise anyone).

But what if we want to know which states are moving in the right direction or wrong direction?

If so, the best document to review is Chris Edwards’ Fiscal Policy Report Card on America’s Governors.

The new edition just came out, so I immediately looked at the rankings. The nation’s best governor – by a comfortable margin – is Susana Martinez of New Mexico.

She is joined by four other governors who earned top marks.

Eight governors, including two Republicans, were in the cellar.

The report has some other data worth sharing.

Here’s a chart that shows what has happened to state spending this century. What caught my eye is the boom-bust cycle of excessive spending growth when the economy is growing (and generating lots of revenue) and cutbacks during the downturn.

Yet another argument for spending caps, such as TABOR in Colorado.

Last but not least, the report included some analysis on tax-driven migration (the topic we covered last week).

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Yesterday, I wrote about the newest edition of Economic Freedom of the World, which is my favorite annual publication.

Not far behind is the Tax Foundation’s State Business Tax Climate Index, which is sort of the domestic version of their equally fascinating (to a wonk) International Tax Competitiveness Index.

And what can we learn from this year’s review of state tax policy? Plenty.

…the specifics of a state’s tax structure matter greatly. The measure of total taxes paid is relevant, but other elements of a state tax system can also enhance or harm the competitiveness of a state’s business environment. The State Business Tax Climate Index distills many complex considerations to an easy-to-understand ranking.

That’s the theory, but what about the results?

Here are the best and worst states.

If you pay close attention, there’s a common thread for the best states.

The absence of a major tax is a common factor among many of the top 10 states. …there are several states that do without one or more of the major taxes: the corporate income tax, the individual income tax, or the sales tax. Wyoming, Nevada, and South Dakota have no corporate or individual income tax (though Nevada imposes gross receipts taxes); Alaska has no individual income or state-level sales tax; Florida has no individual income tax; and New Hampshire, Montana, and Oregon have no sales tax.

By the way, both Utah and Indiana are among the nine states with flat tax systems, so every top-10 state has at least one attractive feature.

But if you peruse the bottom-10 states, you’ll find that every one of them has an income tax with “progressive” rates that punish people for contributing more to the economy.

Indeed, half of the states on that unfortunate list are part of the “Class-Warfare Graduated Tax” club.

Not a desirable group, assuming the goal is faster growth and more jobs.

The Tax Foundation’s report also is worth reading because it reviews some of the academic evidence about the superiority of pro-growth tax systems.

Helms (1985) and Bartik (1985) put forth forceful arguments based on empirical research that taxes guide business decisions. Helms concluded that a state’s ability to attract, retain, and encourage business activity is significantly affected by its pattern of taxation. Furthermore, tax increases significantly retard economic growth when the revenue is used to fund transfer payments. Bartik concluded that the conventional view that state and local taxes have little effect on business is false. Papke and Papke (1986) found that tax differentials among locations may be an important business location factor, concluding that consistently high business taxes can represent a hindrance to the location of industry. …Agostini and Tulayasathien (2001) examined the effects of corporate income taxes on the location of foreign direct investment in U.S. states. They determined that for “foreign investors, the corporate tax rate is the most relevant tax in their investment decision.” Therefore, they found that foreign direct investment was quite sensitive to states’ corporate tax rates. Mark, McGuire, and Papke (2000) found that taxes are a statistically significant factor in private-sector job growth. Specifically, they found that personal property taxes and sales taxes have economically large negative effects on the annual growth of private employment. …Gupta and Hofmann (2003) regressed capital expenditures against a variety of factors… Their model covered 14 years of data and determined that firms tend to locate property in states where they are subject to lower income tax burdens.

None of this research should come as a surprise.

Businesses aren’t moving from California to Texas because business executives prefer heat and humidity over ocean and mountains.

The bottom line is that tax rates matter, whether we’re looking at state data, national data, or international data.

Let’s close by sharing a map from the report. Simply stated, red is bad and teal (or whatever that color is) is good.

P.S. My one complaint about this report from the Tax Foundation is that it doesn’t include the overall fiscal burden. Alaska and Wyoming score well because they have small populations and easily fund much of their (extravagant) state budgets with energy-related taxes. If data on the burden of state government spending was included, South Dakota would be the best state.

P.P.S. Unsurprisingly, Americans are moving from high-tax states to low-tax states.

P.P.P.S. It’s also no surprise to find New Jersey in last place.

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