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Posts Tagged ‘Fiscal Policy’

As a general rule, we worry too much about deficits and debt. Yes, red ink matters, but we should pay more attention to variables such as the overall burden of government spending and the structure of the tax system.

That being said, Greece shows that a nation can experience a crisis if investors no longer trust that a government is capable of “servicing” its debt (i.e., paying interest and principal to people and institutions that hold government bonds).

This doesn’t change the fact that Greece’s main fiscal problem is too much spending. It simply shows that it’s also important to recognize the side-effects of too much spending (if you have a brain tumor, that’s your main problem, even if crippling headaches are a side-effect of the tumor).

Anyhow, it’s quite likely that Italy will be the next nation to travel down this path.

This in in part because the Italian economy is moribund, as noted by the Wall Street Journal.

Italy’s national elections…featured populist promises of largess but neglected what economists have long said is the real Italian disease: The country has forgotten how to grow. …The Italian economy contracted deeply in Europe’s debt crisis earlier this decade. A belated recovery now under way yielded 1.5% growth in 2017—a full percentage point less than the eurozone as a whole and not enough to dispel Italians’ pervasive sense of national decline. Many European policy makers view Italy’s stasis as the likeliest cause of a future eurozone crisis.

Why would Italy be the cause of a future crisis?

For the simple reason that it is only the 4th-largest economy in Europe, but this chart from the Financial Times shows it has the most nominal debt.

So what’s the solution?

The obvious answer is to dramatically reduce the burden of government.

Interestingly, even the International Monetary Fund put forth a half-decent proposal based on revenue-neutral tax reform and modest spending restraint.

The scenario modeled assumes a permanent fiscal consolidation of about 2 percent of GDP (in the structural primary balance) over four years…, supported by a pro-growth mix of revenue and expenditure reforms… Two types of growth-friendly revenue and spending measures are considered along the envisaged fiscal consolidation path: shifting taxation from direct to indirect taxes, and lowering expenditure and shifting its composition from transfers to investment. On the revenue side, a lower labor tax wedge (1.5 percent of GDP) is offset by higher VAT collections (1 percent of GDP) and introducing a modern property tax (0.5 percent of GDP). On the expenditure side, spending on public consumption is lowered by 1.25 percent of GDP, while productive public investment spending is increased by 0.5 percent of GDP. The remaining portion of the fiscal consolidation, 1.25 percent of GDP, is implemented via reduced social transfers.

Not overly bold, to be sure, but I suppose I should be delighted that the IMF didn’t follow its usual approach and recommend big tax increases.

So are Italians ready to take my good advice, or even the so-so advice of the IMF?

Nope. They just had an election and the result is a government that wants more red ink.

The Wall Street Journal‘s editorial page is not impressed by the economic agenda of Italy’s putative new government.

Five-Star wants expansive welfare payments for poor Italians, revenues to pay for it not included. Italy’s public debt to GDP, at 132%, is already second-highest in the eurozone behind Greece. Poor Italians need more economic growth to generate job opportunities, not public handouts that discourage work. The League’s promise of a pro-growth 15% flat tax is a far better idea, especially in a country where tax avoidance is rife. The two parties would also reverse the 2011 Monti government pension reforms, which raised the retirement age and moved Italy toward a contribution-based benefit system. …Recent labor-market reforms may also be on the block.

Simply stated, Italy elected free-lunch politicians who promised big tax cuts and big spending increases. I like the first part of that lunch, but the overall meal doesn’t add up in a nation that has a very high debt level.

And I don’t think the government has a very sensible plan to make the numbers work.

…problematic for the rest of Europe are the two parties’ demand for an exemption from the European Union’s 3% GDP cap on annual budget deficits. …the two parties want the European Central Bank to cancel some €250 billion in Italian debt.

Demond Lachman of the American Enterprise Institute suggests this will lead to a fiscal crisis because of two factors. First, the economy is weak.

Anyone who thought that the Eurozone debt crisis was resolved has not been paying attention to economic and political developments in Italy…the recent Italian parliamentary election…saw a surge in support for populist political parties not known for their commitment to economic orthodoxy or to real economic reform. …To say that the Italian economy is in a very poor state would be a gross understatement. Over the past decade, Italy has managed to experience a triple-dip economic recession that has left the level of its economy today 5 percent below its pre-2008 peak. Meanwhile, Italy’s current unemployment level is around double that of its northern neighbors, while its youth unemployment continues to exceed 25 percent. …the country’s public debt to GDP ratio continued to rise to 133 percent, making the country the most indebted country in the Eurozone after Greece. …its banking system remains clogged with non-performing loans that still amount to 15 percent of its balance sheet…

Second, existing debt is high.

…having the world’s third-largest government bond market after Japan and the United States, with $2.5 trillion in bonds outstanding, Italy is simply too large a country for even Germany to save. …global policymakers…, it would seem not too early for them to start making contingency plans for a full blown Italian economic crisis.

Since he writes on issues I care about, I always enjoy reading Lachman’s work. Though I don’t always agree with his analysis.

Why, for instance, does he think an Italian fiscal crisis threatens the European currency?

…the Italian economy is far too large an economy to fail if the Euro is to survive in anything like its present form.

Would the dollar be threatened if (when?) Illinois goes bankrupt?

But let’s not get sidetracked.3

To give you an idea of the fairy-tale thinking of Italian politicians, I’ll close with this chart from L’Osservatorio on the fiscal impact of the government’s agenda. It’s in Italian, but all you need to know is that the promised tax cuts and spending increases are on the left side and the compensating savings (what we would call “pay-fors”) are on the right side.

Wow, makes me wonder if Italy has passed the point of no return.

By the way, Italy may be the next domino, but it’s not the only European nation with fiscal problems.

P.S. No wonder some people want Sardinia to secede from Italy and become part of “sensible” Switzerland.

P.P.S. Some leftists genuinely think the United States should emulate Italy.

P.P.P.S. As a fan of spending caps, I can’t resist pointing out that anti-deficit rules in Europe have not stopped politicians from expanding government.

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During the election season, I speculated Trump was a big government Republican, and he confirmed my analysis this past February when he acquiesced to an orgy of new spending and agreed to bust the spending caps.

That awful spending spree gave huge increases to almost every part of the budget, and I pointed out that the deal probably will create the conditions for future tax hikes.

I got so upset at profligate GOPers that I crunched the numbers and revealed that (with the notable exception of Reagan) Republican presidents are even bigger spenders than Democrats.

Well, Senate Republicans recently had a chance to atone for their sins by voting for a proposal from Rand Paul to balance the budget.

So what did they do? Rejected it, of course.

In a column for Reason, Eric Boehm justly condemns Republicans for being big spenders.

The Senate on Thursday resoundingly rejected the Kentucky Republican’s plan to balance the federal budget by 2023, voting 76 to 21 against a bill that would have required a $400 billion cut in federal spending next year, followed by 1 percent spending increases for the rest of the next decade. …Paul’s proposal never really had a chance of passing, coming as it did just months after Congress approved enormous spending hikes that busted Obama-era caps once championed by Republicans as necessary for fiscal restraint. …Paul’s plan would have balanced the budget by 2023, as long as revenue met current CBO projections. By 2028, his proposal envisioned a $700 billion surplus instead of the $1.5 trillion deficit currently projected by the CBO.

A Lifezette column by Brendan Kirby was even more critical of big-government Republicans.

Sen. Rand Paul (R-Ky.) was hoping his Republican colleagues would be embarrassed by their vote to jack up federal spending earlier this year and support his plan to phase in a balanced budget. Few were. Paul got 20 other Republican senators on Thursday — less than half of the Senate GOP caucus — to vote for his “penny plan,” which would balance the federal budget over five years… No Democrats back the proposal. …Even though Paul’s bid failed, it did pick up the support of some senators who voted for the spending bill in February, including Senate Majority Whip John Cornyn (R-Texas). The others were Sens. Marco Rubio (R-Fla.), John Barrasso (R-Wyo.), Joni Ernst (R-Iowa), Deb Fischer (R-Neb.) and Jerry Moran (R-Kan.). …Paul also got more votes than he did for a similar proposal last year.

Kirby’s article ended on an upbeat note based on voting patterns.

I also want to close on an upbeat note, but for an entirely different reason. Here are the annual numbers from the CBO baseline (what will happen to spending and revenue if government continues on its current path) and the numbers for Senator Paul’s proposal.

And why do these depressing numbers leave me with a feeling of optimism?

For the simple reason that they show how simple it is to make progress with some modest spending restraint. The lower set of number show that Senator Paul quickly gets to a balanced budget by imposing an overall reduction of about 2 percent on spending in 2019, followed by annual increases of about 1 percent until 2025.

I think that’s a great plan, but I’d also be happy with a plan that allows spending to grow by 1 percent each year. Or even 2 percent each year.

My bottom line is that we need some sort of spending cap so that the burden of government spending grows slower than the productive sector of the economy. In other words, comply with the Golden Rule.

And what’s especially remarkable is that solving our fiscal problems is still quite feasible notwithstanding the reckless spending bill that was recently approved (Paul’s proposal, incidentally, leaves in place the small – and temporary – tax cut from the recent reform legislation).

P.S. Senator Paul would achieve a balanced budget in just five years by letting spending grow during that period by a bit less than 4/10ths of 1 percent per year. Does that sound impossibly radical? Well, it’s what Republicans managed to achieve during the heyday of the Tea Party revolution, when they actually produced a five-year nominal spending freeze. In other words, zero spending growth! If they could impose that level of discipline with Obama in the White House, why not do the same with Trump (who quasi-endorsed the Penny Plan) at the other end of Pennsylvania Avenue?

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Even though I wrote about proposed tax increases in Illinois just 10 days ago, it’s time to revisit the issue because the Tax Foundation just published a very informative article about the state’s self-destructive fiscal policy.

It starts by noting that the aggregate tax burden is higher in Illinois than it is in adjoining states.

Just what are Illinois’ neighbors doing on taxes? They’re taxing less, for starters. In Illinois, state and local taxes account for 9.3 percent of state income. The state and local taxes in Illinois’ six neighboring states account, in aggregate, for 8.0 percent of the income of those states.

Here’s the table showing the gap between Illinois and its neighbors. And it’s probably worth noting that the tax gap is the largest with the two states – Indiana and Missouri – that have the longest borders with Illinois.

While the aggregate tax burden is an important measure, I’ve explained before that it’s also important to focus on marginal tax rates. After all, that’s the variable that determines incentives for productive behavior since it measures how much the government confiscates when investors and entrepreneurs generate additional wealth.

And this brings us to the most important point in the article. Illinois politicians want to move in the wrong direction on marginal tax rates while neighboring jurisdictions are moving in the right direction.

Except for Iowa, all of Illinois’ neighbors have cut their income taxes since Illinois adopted its “temporary” income tax increases in 2011—and Iowa is on the verge of adopting a tax reform package that cuts individual income tax rates… Over the same period, Illinois’ single-rate income tax was temporarily raised from 3 to 5 percent, then allowed to partially sunset to 3.75 percent before being raised to the current 4.95 percent rate. A 1.5 percent surtax on pass-through business income brings the rate on many small businesses to 6.45 percent. Now there are calls to amend the state constitution to allow graduated-rate income taxes, with proposals circulating to create a top marginal rate as high as 9.85 percent (11.35 percent on pass-through businesses).

Here’s the chart showing the top rate in various states in 2011, the top rates today, and where top tax rates could be in the near future.

What’s especially remarkable is that Illinois politicians are poised to jack up tax rates just as federal tax reform has significantly reduced the deduction for state and local taxes.

For all intents and purposes, they’re trying to drive job creators out of the state (a shift that already has been happening, but now will accelerate).

Normally, when I write that a jurisdiction is committing fiscal suicide, I try to explain that it’s a slow-motion process. Illinois, however, could be taking the express lane. No wonder readers overwhelmingly picked the Land of Lincoln when asked which state will be the first to suffer a fiscal collapse.

P.S. Illinois politicians claim they want to bust the flat tax so they can impose higher taxes on the (supposedly) evil rich. High-income taxpayers doubtlessly will be the first on the chopping block, but I can say with 99.99 percent certainty that class-warfare tax increases will be a precursor to higher taxes on everybody.

P.P.S. Illinois residents should move to states with no income taxes. But if they only want to cross one border, Indiana would be a very good choice. And Kentucky just shifted to a flat tax, so that’s another potential option.

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A couple of months ago, I thought I did something meaningful by sharing six separate examples of the International Monetary Fund pressuring sub-Saharan African nations to impose higher tax burdens. This was evidence, I suggested, that the IMF had a disturbing agenda of bigger government for the entire region.

I didn’t imply the bureaucrats were motivated by racism. After all, the IMF has pushed for higher taxes in the United States, in China, in Latin America, in the Middle East, and in Europe. (folks who work at the IMF don’t pay taxes on their own salaries, but they clearly believe in equal opportunity when urging higher taxes for everyone else).

Nonetheless, I thought it was scandalous that the IMF was systematically agitating for taxes in a region that desperately needs more investment and entrepreneurship. And my six examples were proof of a continent-wide agenda!

But it turns out that I wasn’t exposing some sort of sinister secret. The IMF just published a new report where the bureaucrats openly argue that there should be big tax hikes in all sub-Saharan nations.

Domestic revenue mobilization is one of the most pressing policy challenges facing sub-Saharan African countries. …the region as a whole could mobilize about 3 to 5 percent of GDP, on average, in additional revenues. …domestic revenue mobilization should be a key component of any fiscal consolidation strategy. Absent adequate efforts to raise domestic revenues, fiscal consolidation tends to rely excessively on reductions in public spending.

Notice, by the way, the term “domestic revenue mobilization.” Such a charming euphemism for higher taxes.

And it’s also worth pointing out that the IMF openly urges more revenue so that governments don’t have to impose spending restraint.

Moreover, the IMF is happy that there have been “substantial gains in revenue mobilization” over the past two decades.

Over the past three decades, many sub-Saharan African countries have achieved substantial gains in revenue mobilization. For the median sub-Saharan African economy, total revenue excluding grants increased from around 14 percent of GDP in the mid-1990s, to more than 18 percent in 2016, while tax revenue increased from 11 to 15 percent. …Two-thirds of sub-Saharan African countries now have revenue ratios above 15 percent, compared with fewer than half in 1995. …the region still has the lowest revenue-to-GDP ratio compared to other regions in the world. The good news is that there are signs of convergence. Over the past three decades, the increase in sub-Saharan Africa’s revenue ratio has been double that for all emerging market and developing economies.

To the bureaucrats at the IMF, the “convergence” toward higher taxes is “good news.”

However, there is some data in the report that is genuine good news.

In most regions of the world, there has been a trend in recent years toward reducing rates for the CIT and the personal income tax (PIT). In sub-Saharan African countries, the average top PIT rate has been reduced from about 44 to 32 percent since 2000, while average top CIT rates have been reduced by more than 5 percentage points during the same period.

Here are two charts showing the decline in tax rates, not only in Africa, but in most other regions.

By the way, the IMF bureaucrats appear to be surprised that revenues went up as tax rates went down. I guess they’ve never heard of the Laffer Curve.

Despite this decline in rates, total direct taxes (PIT and CIT) as a percentage of GDP have been trending upward.

But the IMF obviously didn’t learn from this evidence (or from the evidence it shared last year).

Rather than proposing lower tax rates, the report urges a plethora of tax hikes.

Successful experiences in revenue mobilization have relied on efforts to implement broad-based VATs, gradually expand the base for direct taxes (CIT and PIT), and implement a system to tax small businesses and levy excises on a few key items.

Wow. I don’t know what’s worse, claiming that tax increases are good for growth, or pushing higher taxes in the world’s poorest region.

Let’s close by debunking the IMF’s absurd contention that bigger government would be good for Africa.

I suppose the simplest response would be to share my video series about the economics of government spending, especially since I cite a wealth of academic research.

But let’s take an even simpler approach. The IMF report complained that governments in sub-Saharan Africa don’t have enough money to spend.

The good news, as illustrated by this chart (based on data from the bureaucracy’s World Economic Outlook database), is that the IMF is accurate about relative fiscal burdens.

The bad news is that the IMF wants us to believe that a low fiscal burden is a bad thing. The bureaucrats at the IMF (and at other international bureaucracies) actually want people to believe that bigger government means more prosperity. Which is why the report urges big tax hikes.

But you won’t be surprised to learn that the IMF doesn’t provide any evidence for this bizarre assertion.

Though I’ve had folks on the left sometimes tell me that bigger government must be good for growth because rich nations in the western world have bigger governments while poor nations in Africa have comparatively small governments.

If you want to get in the weeds of public finance theory, the IMF bureaucrats are misinterpreting Wagner’s Law.

But there’s no need to delve into theory. When people make this assertion to me, I challenge them to identify a poor nation that ever became a rich nation with big government.

It’s true, of course, that there are rich nations that have big governments, but all of those countries became rich in the 1800s when government was very small and welfare state programs were basically nonexistent.

So let’s take the previous chart, which supposedly showed too little spending in sub-Saharan Africa, and add another column (in red) showing the level of government spending in North America and Western Europe in the 1800s.

The obvious takeaway is that African nations should cut taxes and reducing spending. The exact opposite of what the IMF recommends.

In other words, the IMF’s agenda of bigger government and higher taxes is a recipe for continued poverty.

But keep in mind that fiscal policy is just one piece of the puzzle. As explained in Economic Freedom of the World, a nation’s prosperity also is affected by regulatory policy, trade policy, monetary policy, and quality of governance.

And nations in sub-Saharan Africa generally score even lower in those areas than they do for fiscal policy. So while those countries should reduce their fiscal burdens, it’s probably even more important for them to address other policy mistakes.

To end on an upbeat note, here’s a video from Reason about how free markets can help bring prosperity to Africa.

I also recommend this video from the Center for Freedom and Prosperity since it does a great job of debunking the argument that higher taxes and bigger government are a recipe for prosperity.

And this video about Botswana is a good case study of how African nations can enjoy more prosperity with market-oriented policy.

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When I did a poll earlier this year, asking which state would be the first to suffer a fiscal crisis, I wasn’t terribly surprised that Illinois wound up in first place.

But I was surprised by the margin. Even though there’s a good case to be made for basket-case jurisdictions such as New Jersey, California, and Connecticut, Illinois not only got a plurality of votes, it received an absolute majority.

Based on what’s happening in the Land of Lincoln, it appears that state politicians want to receive a supermajority of votes. There’s pressure for ever-higher taxes to finance an ever-more-bloated bureaucracy.

And taxpayers are voting with their feet.

The Wall Street Journal editorialized about the consequences of the state’s self-destructive fiscal policy.

Democrats in Illinois ought to be especially chastened by new IRS data showing an acceleration of out-migration. The Prairie State lost a record $4.75 billion in adjusted gross income to other states in the 2015 tax year, according to recently IRS data released. That’s up from $3.4 billion in the prior year. …Florida with zero income tax was the top destination for Illinois expatriates… What’s the matter with Illinois? Too much for us to distill in one editorial, but suffice to say that exorbitant property and business taxes have retarded economic growth. …Taxes may increase as Democrats scrounge for cash to pay for pensions. …Illinois’s unfunded pension liabilities equalled 22.8% of residents’ personal income last year, compared to a median of 3.1% across all states and 1% in Florida. …Illinois’s economy has been stagnant, growing a meager 0.9% on an inflation-adjusted annual basis since 2012—the slowest in the Great Lakes and half as fast as the U.S. overall. This year nearly 100,000 individuals have left the Illinois labor force.

Here’s a chart showing a very depressing decline in the state’s labor force.

By the way, I wonder whether the chart would look even worse if government bureaucrats weren’t included.

The Chicago Tribune has a grim editorial about what’s happening.

From millennials to retirees, …Illinois is losing its promise as a land of opportunity. Government debt and dysfunction contribute to a weak housing market and a stagnant jobs climate. State and local governments face enormous pension and other obligations. Taxes have risen sharply; many Illinois politicians say they must rise more. People are fleeing. Last year’s net loss: 33,703.

In an editorial for the Chicago Tribune, Kristen McQueary correctly worries about the trend.

It’s one thing to harbor natural skepticism toward government. It’s quite another to take the dramatic step of moving your family, your home, your livelihood to another state to escape it. But it’s happening. The naysayers and deniers blame the weather. They eye-roll the U-Haul rebellion. They downplay the dysfunction. Good riddance to those stingy taxpayers, they trumpet. But that is a shallow, ignorant and elitist viewpoint that dismisses the thoughtful and wrenching decisions thousands of once-devoted Illinoisans have made. For four years in a row, Illinois has lost population in alarming numbers. In 2017, Illinois lost a net 33,703 residents, the largest numerical population decline of any state. That’s the size of St. Charles or Woodridge or Galesburg. Wiped off the map. In one year. …Policy choices have consequences. …People are fleeing Illinois. And still, Democratic leaders in Chicago and Cook County, and their supporters, generally deny that high taxes, underfunded pensions, government debt and political dysfunction are the reasons for the exodus — or that it’s acute.

Newspapers in other states have noticed, as evinced by this editorial from the Las Vegas Review-Journal.

When the progressive political class preaches equality and prosperity, but bleeds productive citizens dry by treating them as little more than human ATMs, there should be little surprise when those same citizens take themselves (and their green) to greener pastures. Perhaps no state in the nation is seeing a bigger such exodus than Illinois. …On the flip side, all of the states surrounding Illinois saw their populations increase… Illinois is experiencing a self-inflicted storm of fiscal distress. …While state income taxes in Illinois don’t reach they level impose in states such as New York and California, that’s not for a lack of trying. The state raised its rate by 32 percent over the summer, and Democrats want to even more progressive tax rates to pay for all the goodies they’ve promised to Big Labor in order to grease their re-elections. …Illinois is a financial basket case — which is what you get when you combine political patronage with powerful public-sector unions that control leftist politicians. The state should be a case study for other jurisdictions on how not to conduct public policy. After all, who will pay the bills when the taxpayers flee?

Steve Chapman, in a column for Reason, expects more bad news for Illinois because of pressure for higher taxes.

With the biggest public pension obligations, the slowest personal income growth, and the biggest population loss of any state, it has consistently recorded achievements that are envied by none but educational to all. The state is in the midst of a debilitating fiscal and economic crisis. …Illinois has endured two income tax increases in the past seven years. In 2011, the flat rate on individual income jumped from 3 percent to 5 percent. In 2015, under the original terms, it fell to 3.75 percent—a “cut” that left the rate 25 percent above what it was in 2010. Then last year, over Gov. Bruce Rauner’s veto, the legislature raised the rate to 4.95 percent. None of these changes has ended the state’s economic drought, and it’s reasonable to assume they actually made it drier. …well-paid people can’t generally leave the country to find lower tax rates. They can leave one state for another, and they do. …A 2016 poll by the Paul Simon Public Policy Institute at Southern Illinois University found that nearly half of residents would like to leave the state—and that “taxes are the single biggest reason people want to leave.”

The Wall Street Journal opined on the state’s slow-motion suicide.

The only…restraint…on public union governance in Illinois…the state’s flat income tax. …Democrats in Springfield have filed three constitutional amendments to establish a graduated income tax… Democrats are looking for more revenue to finance ballooning pension costs, which consume about a quarter of state spending. …Connecticut and New Jersey provide cautionary examples. Democrats in both states have soaked their rich time and again, and the predictable result is that both states have fewer rich to soak. Economic growth slowed and revenues faltered. This vicious cycle is already playing out in Illinois amid increasing property, income and business taxes. Over the last four years, Illinois GDP has risen a mere 0.9% per year, half the national average and the slowest in the Great Lakes region. Between 2012 and 2016, Illinois lost $18.35 billion in adjusted gross income to other states. …Democrats claim a progressive income tax will spare the middle-class, but sooner or later they’ll be the targets too because there won’t be enough rich to finance the inexorable demands of public unions. …Once voters approve a progressive tax, Democrats can ratchet up rates as their union lords dictate.

While a bloated and over-compensated bureaucracy (especially unfunded promises for lavish retiree benefits) is the top fiscal drain, the state also loves squandering money in other ways.

Here are some excerpts from a piece in the Belleville News-Democrat.

Illinois is the dependency capital of the Midwest. No other state in the region has more of its population dependent on food stamps… So what’s driving the state’s dependency crisis? State bureaucrats using loopholes and gimmicks to keep more people dependent on welfare. According to the Illinois Department of Human Services, nearly 175,000 able-bodied childless adults are on the program. These are adults in their prime working years — between the ages of 18 and 49 — with no dependent children and no disabilities keeping them from meaningful employment. …the state has relied upon loopholes and gimmicks to trap more and more able-bodied adults in dependency. Federal law allows states to seek temporary waivers of the work requirement in areas with unemployment rates above 10 percent or with a demonstrated lack of job opportunities in the region. …the Illinois Department of Human Services…used old data and it gerrymandered the request in whatever way was necessary to keep more able-bodied adults on welfare. …State bureaucrats have gamed the system and as a result, thousands of able-bodied adults will remain trapped in dependency, with little hope of better lives.

Let’s close with some excerpts from a very depressing column in the Chicago Tribune by Diana Sroka Rickert.

…this is a state government that has been broken for decades. It is designed to reject improvement in every form, at every level. …The Thompson Center…is a near-perfect representation of state government. It is gross, rundown, and nobody cares. …there is a disturbing sense of entitlement among some state employees. …Underperformers aren’t fired; they’re simply transferred to different positions, shuffled elsewhere on the payroll or tucked away at state agencies. …this is a state government that is ranked last by almost every objective and measurable standard. A state government that fails every single one of its residents, day after day — and has failed its residents for decades. A state government that demands more and more money each year, to deliver increasingly less value.

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

P.S. If you want good news on state tax policy, South Dakota may have the nation’s best system. And North Carolina arguably has taken the biggest step in the right direction. Kentucky, meanwhile, has just switched to a flat tax.

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California is a lot like France. They’re both wonderful places to visit.

And they’re both great places to live if you already have a lot of money.

But neither jurisdiction is very friendly to people who want to get rich. And, thanks to tax competition, that’s having a meaningful impact on migration patterns.

I’ve previously written about the exodus of successful and/or aspirational people from France.

Today we’re going to examine the same process inside the United States.

It’s a process that is about to get more intense thanks to federal tax reform, as Art Laffer and Steve Moore explain in a column for the Wall Street Journal.

In the years to come, millions of people, thousands of businesses, and tens of billions of dollars of net income will flee high-tax blue states for low-tax red states. This migration has been happening for years. But the Trump tax bill’s cap on the deduction for state and local taxes, or SALT, will accelerate the pace. …Consider what this means if you’re a high-income earner in Silicon Valley or Hollywood. The top tax rate that you actually pay just jumped from about 8.5% to 13%. Similar figures hold if you live in Manhattan, once New York City’s income tax is factored in. If you earn $10 million or more, your taxes might increase a whopping 50%. …high earners in places with hefty income taxes—not just California and New York, but also Minnesota and New Jersey—will bear more of the true cost of their state government. Also in big trouble are Connecticut and Illinois, where the overall state and local tax burden (especially property taxes) is so onerous that high-income residents will feel the burn now that they can’t deduct these costs on their federal returns. On the other side are nine states—including Florida, Nevada, Texas and Washington—that impose no tax at all on earned income.

Art and Steve put together projections on what this will mean.

Over the past decade, about 3.5 million Americans on net have relocated from the highest-tax states to the lowest-tax ones. …Our analysis of IRS data on tax returns shows that in the past three years alone, Texas and Florida have gained a net $50 billion in income and purchasing power from other states, while California and New York have surrendered a net $23 billion. Now that the SALT subsidy is gone, how bad will it get for high-tax blue states? Very bad. We estimate, based on the historical relationship between tax rates and migration patterns, that both California and New York will lose on net about 800,000 residents over the next three years—roughly twice the number that left from 2014-16. Our calculations suggest that Connecticut, New Jersey and Minnesota combined will hemorrhage another roughly 500,000 people in the same period. …the exodus could puncture large and unexpected holes in blue-state budgets. Lawmakers in Hartford and Trenton have gotten a small taste of this in recent years as billionaire financiers have flown the coop and relocated to Florida. …Progressives should do the math: A 13% tax rate generates zero revenue from someone who leaves the state for friendlier climes.

I don’t know if their estimate is too high or too low, but there’s no question that they are correct about the direction of migration.

And every time a net taxpayer moves out, that further erodes the fiscal position of the high-tax states. Which is why I think one of the interesting questions is which state will be the first to suffer fiscal collapse.

In large part, taxpayers are making a rational cost-benefit analysis. Some states have dramatically increased the burden of government spending. Yet does anyone think that those states are providing better services than states with smaller public sectors? Or that those services are worth all the taxes they have to pay?

Consider, for instance, the difference between New York and Tennessee.

New York spends nearly twice as much on state and local government per person ($16,000) as does economically booming Tennessee ($9,000).

Anyhow, I’m guessing the new restriction on the state and local tax deduction is going to change the behavior of state politicians. At least I hope so.

But nobody ever said politicians were sensible. Ross Marchand of the Taxpayers Protection Alliance explains that Massachusetts and New Jersey are still thinking about more class-warfare taxation.

Massachusetts and New Jersey are currently considering “millionaires’ taxes,” which would significantly increase top rates and spark a “race to the top” for revenue… Instead of helping out the middle class, a millionaires’ tax will result in an exodus from the state, squeezing out opportunities for working Americans. …Prominent millionaires respond to these proposals by threatening to leave, and research shows that the well-to-do regularly follow through on these promises.  …nearly all of the migration that does happen in top brackets has to do with tax changes. Researchers at Stanford University and the Treasury Department estimate that a 10 percent increase in taxes causes a 1 percent bump in migration, assuming no change in any other policy. …If New Jersey and Massachusetts approve new millionaires’ taxes, it is difficult to predict how much will be raised and where these funds will ultimately wind up. But if New York and California are any guide, income surtaxes will be destructive. When it comes to higher taxation, interstate migration is just the tip of the iceberg. Higher-tax states, for instance, see less innovative activity and scientific research according to an analysis by economists at the Federal Reserve and UC Berkeley.

My suggestion is that politicians in Massachusetts and New Jersey should look at what’s happening to California.

CNBC reports on the growing exodus from the Golden State.

Californians may still love the beautiful weather and beaches, but more and more they are fed up with the high housing costs and taxes and deciding to flee to lower-cost states such as Nevada, Arizona and Texas. …said Dave Senser, who lives on a fixed income near San Luis Obispo, California, and now plans to move to Las Vegas. “Rents here are crazy, if you can find a place, and they’re going to tax us to death. That’s what it feels like. At least in Nevada they don’t have a state income tax. And every little bit helps.” …Data from United Van Lines show some of the most popular moving destinations for Californians from 2015 to 2017 were Texas, Arizona, Oregon, Washington and Colorado. Other experts also said Nevada remains a top destination. …Internal Revenue Service data would appear to show that the middle-class and middle-age residents are the ones leaving, according to Joel Kotkin, a presidential fellow in Urban Futures at Chapman University in Orange, California. …Furthermore, Kotkin believes the outmigration from California may start to rise among higher-income people, given that the GOP’s federal tax overhaul will result in certain California taxpayers losing from the state and local tax deduction cap.

The Legislative Analyst’s Office for the California legislature has warned the state’s lawmakers about this trend.

For many years, more people have been leaving California for other states than have been moving here. According to data from the American Community Survey, from 2007 to 2016, about 5 million people moved to California from other states, while about 6 million left California. On net, the state lost 1 million residents to domestic migration—about 2.5 percent of its total population. …Although California generally has been losing residents to the rest of the country, movement between California and some states deviates from this pattern. The figure below shows net migration between California and individual states between 2007 and 2016. California gained, on net, residents from about one-third of states, led by New York, Illinois, and New Jersey.

Here’s the chart showing where Californians are moving. Unsurprisingly, Texas is the main destination.

By the way, state-to-state migration isn’t solely a function of income taxes.

A Market Watch column looks at the impact of property taxes on migration patterns.

Harty’s clients range from first-time buyers with sticker shock to people who’ve lived in and around Chicago all their lives. Each has a different story, but they share a common theme: many believe that Chicago-area property taxes are too high, and relief is just an hour away over the state line. …if all real estate is local, all real estate taxes may be even more so. …Attom’s data show that the average tax burden ranges from $10,612 in the most expensive metro area, Bridgeport-Stamford-Norwalk, Connecticut, to $525 in Montgomery, Alabama. And those are just averages. …taxes are “the icing on the cake” in areas that are seeing strong population inflows… Among the counties that saw the biggest percentage of in-migration in 2017, according to Census data, all are in Texas, Florida, Georgia, or the Carolinas. (Texas doesn’t have particularly low property taxes, but it has no personal income tax, making the overall tax burden much more manageable.) Cook County, where Chicago is located, had the biggest number of people leaving… Blomquist’s analysis of Census data showed that among all counties that had at least a 1% population increase, the average tax bill was $2,706, while in all counties with a least a 1% decline in population, the average was $3,900.

The key sentence in that excerpt is the part about Texas having relatively high property taxes, but making up for that by having no state income tax.

The same thing is true about New Hampshire.

But just imagine what it must be like to live in a state with high income taxes and high property taxes. If this map is any indication, places such as New York and Illinois are particularly awful for taxpayers.

Let’s close with a big-picture look at factors that drive state competitiveness.

Mark Perry takes an up-close look at the characteristics of the five states with the most in-migration and out-migration.

…four of the top five outbound states (Illinois ranked No. 46, Connecticut at No. 49, New Jersey at No. 48, and California at No. 47) were among the five US states with the highest tax burden — New York was No. 50 (highest tax burden). The average tax burden of the top five outbound states was 11.2%, with an average rank of 43.2 out of 50. In contrast, the top five inbound states have an average tax burden of 8.7% and an average rank of 16.6 out of 50. As would be expected, Americans are leaving states with some of the country’s highest overall tax burdens (IL, CT, CA and NJ) and moving to states with lower tax burdens (TN, SC and AZ). …that there are significant differences between the top five inbound and top five outbound US states when they are compared on a variety of measures of economic performance, business climate, tax burdens for businesses and individuals, fiscal health, and labor market dynamism. There is empirical evidence that Americans do “vote with their feet” when they relocate from one state to another, and the evidence suggests that Americans are moving from states that are relatively more economically stagnant, Democratic-controlled fiscally unhealthy states with higher tax burdens, more regulations and with fewer economic and job opportunities to Republican-controlled, fiscally sound states that are relatively more economically vibrant, dynamic and business-friendly, with lower tax and regulatory burdens and more economic and job opportunities.

Here’s Mark’s table, based on 2017 migration data.

As Mark said, people do “vote with their feet” for smaller government.

Which is one of the reasons I’m a big fan of federalism. When there’s decentralization, people can escape bad policy. And that helps to discipline profligate governments.

P.S. I’m writing today’s column from Switzerland, which is a very successful example of genuine federalism.

P.P.S. Americans are free to move from one state to another, and the uncompetitive states can’t stop the process. Unfortunately, the IRS has laws that penalize people who want to move to other nations. In this regard, the U.S. is worse than France.

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The best policy for a state (assuming it wants growth and competitiveness) is to have no income tax. Along with a modest burden of government spending, of course.

The next-best approach is for a state to have a flat tax. If nothing else, a flat tax inevitably will have a reasonable rate since it’s politically difficult to pillage everyone (though Illinois is trying very hard to be an exception to that rule).

Moreover, a flat tax also sends a signal that politicians in the state don’t (or can’t) play the divide-and-conquer game of periodically raising taxes on different income groups.

Today, we have some good news. Kentucky has ditched its so-called progressive income tax and joined the flat tax club. The Tax Foundation has the details (including the changes in the state’s ranking).

…legislators in Kentucky overrode Governor Matt Bevin’s veto to pass HB 366, a tax reform package, in the last few days of the session. Ultimately, HB 366…increases Kentucky’s ranking on the State Business Tax Climate Index from 33rd to 18th. …Here’s how HB 366 changes Kentucky’s tax code: Replacing the current six-bracket individual income tax, which has a top rate of 6.0 percent, with a 5 percent single rate individual income tax; …Replacing the current three-bracket corporate income tax, with its top rate of 6.0 percent, with a 5 percent flat rate; …Expanding the sales tax base to include select services…; and Raising the cigarette tax from 60 cents to $1.10 per pack. …the changes in this tax reform package dramatically improve the state’s tax climate. By broadening bases while lowering rates, starting to correct the inequities in the sales tax base, and taking steps to make the state more friendly to investment, policymakers in the state took a responsible approach to comprehensive tax reform.

Kentucky will have a better tax system, but there is a dark lining to the silver cloud of reform.

The legislation is a net tax increase, meaning state politicians will have more money to spend (which is a variable that is not included in the Tax Foundation’s Business Tax Climate Index).

As a big fan of the no-tax-hike pledge, that makes me sympathetic to some of those who opposed the legislation.

But I confess that I’m nonetheless happy that there’s now another state with a flat tax.

Which motivated me to create a five-column ranking for states with regards to the issue of personal income tax.

The best states are in the first column, since they don’t impose any income tax. The second-best option is a flat tax, and then I have three options for so-called progressive tax regimes. A “low-rate” state means the top bracket is less than 5 percent and a “class-warfare” state means the top bracket is higher than 8 percent (with other states in a middle group).

Kentucky has moved from the fourth column to the second column, which is a nice step. Very similar to what North Carolina did a few years ago.

Kansas, by contrast, recently went from the fourth column to the third column and then back to the fourth column.

And I may have to create a special sixth column for states such as California.

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