Tax hikes will cause a loss in jobs

Governor’s proposed Tax Hikes will Harm already Fragile Economy

Tax Increases Will Cost Jobs and Return Far Less than expected

Tax Plan Analysis

Download the entire Policy Analysis here … including detailed tables and additional information.

In late January 2012,Rhode Island’s Governor proposed a new budget that included a number of tax and fee increases, with the goal of balancing the state’s chronic budget deficits. In order to properly assess the impact of such hikes on the state’s economy, the RI Center for Freedom & Prosperity conducted a detailed, economic analysis, utilizing the Center’s dynamic tax modeling tool, RI-STAMP.

The Governor’s plan attempts to address the perpetual budget deficit by cutting some spending and raising some taxes. As demonstrated by RI-STAMP, this path will produce negative consequences.

 Analysis

To best simulate the Governor’s tax proposal, the following revenue targets were entered into RI-STAMP.

  •  $69.7 million increase in Sales Tax revenues via expansion of the base, with tax increases in some sectors
  • * $13.6 million increase in motor vehicle registration fees was input as a Fuel Tax increase
  • $7 million increase in revenues from smoking products and other items entered as a Cigarette Tax
  • $3.8 million in other misc. taxes & fees were not included in the projection

After running these inputs through the RI-STAMP algorithm, the negative economic consequences of the proposed tax and fee increases become clear. Full details can be found in the table on the following page, but in summary:

  •  The expected total revenue increases of $95 million are not attained, as tax increases depress overall economic activity … the state will see only a $35 million increase in revenues.
  • Over 1400 private sector jobs will be lost
  • Municipalities will lose $9.75 million in revenues due to lower commercial property taxes, as a consequence of lower overall economic activity
  • The State will lose almost 1% in overall Gross State Product
  • Investment in the State will drop by $27 Million

Because a sales tax increase would makeRhode Islandeven less competitive with its regional neighbors, and nationally overall, consumer and entrepreneurial behavior would be significantly altered, resulting in lower economic activity and actually worsening the state’s economic plight. Municipalities, all too often overlooked, will also suffer a loss in revenues from this unintended consequence.

 Balancing the budget is the wrong goal; and tax increases are precisely the wrong solution!

 Recommendation:

Conversely, if the OceanStatewas to cut its sales tax to 5%, a very different scenario is projected to occur, because our state would suddenly become a more attractive place to purchase goods and services, meaning economic activity would increase. (See the Policy Brief, Dynamic Effects of Tax Policy)

 If instead,Rhode Islandwants to address the larger economic picture, by looking to produce more jobs and a brighter economic future for our citizens …

 … cutting taxes and cutting spending will produce a more vigorous economy!

Download the entire Policy Analysis here … including detailed tables and additional information.

Media Coverage of this Analysis:

Warwick Beacon: Chewing over a 10% meal tax

Providence Business News – URI Professor Lardaro supports RI-STAMP economic modeling tool

630WPRO – Conservative think tank says new taxes will hurt RI

Boston.com – Think tank criticizes RI Gov.’s tax plan

Governor’s Sales Tax Hike will Hike Unemployment

Download the complete Policy Brief here; includes comparative table and reference end notes.

View or Download the Media Release here; includes quotes and additional information about Scott Moody and STAMP.

Lesson in Capitalism – “Dynamic Effects of Tax Policies”

Balancing the Budget via Sales Tax Increases would Cost Jobs for Rhode Island

January 23, 2012; by J. Scott Moody – adjunct scholar

Consider which of two tax-policy scenarios may be more beneficial for Rhode Island:

A) a policy that increases state revenues to sustain current spending, but which reduces the state’s economic output and where jobs are lost; where municipal revenues go down and where investment in our state is reduced.

B) a policy that reduces state revenues forcing cuts to current spending, but which increases our state’s economic output and where jobs are gained; where municipal revenues go up and where investments in our state rises.

This is the vital debate that must take place in the Ocean State during the 2012 legislative session.

2012 will predictably bring a vigorous debate about how to balance our state budget and how to pay for most of the current spending items in the budget – by some combination of increasing taxes and making cosmetic cuts to existing programs. This is the wrong debate and the wrong objective for the Ocean State!

Instead, debate should focus on how to make Rhode Island more competitive with our neighbors and how to grow our economy so as to add more good jobs for our citizens. Increased tax revenues will naturally follow from the expansion of economic activity.

Dynamic vs Static Tax Modeling

There is a common and fundamental miscalculation when it comes to projecting the effects of tax policy on state revenues. Too often, the more short-sighted and simplistic static calculation is utilized, when in reality is the more complex dynamic effect should be evaluated. The downstream effects of tax policy on various aspects of the economy are rarely discussed or quantified, either at the state or municipal level.

Take the state “sales tax” as an example. Rhode Island is expected to derive about $989.5 million from this tax, currently at 7%. In 2011, to balance the budget, the Governor proposed over $150 million in tax increases through an expansion of the state sales tax: reducing the sales tax on some items and charging new sales taxes on other items. For modeling purposes, assuming a overall target of $175 million in new revenues, this would have effectively raised the existing state sales tax rate to about 8.2%. While not an exact apples-apples comparison with the Governor’s 2011 plan, an analysis of the higher 8.2% sales tax, utilizing RI-STAMP, a state tax and analysis modeling program customized specifically for Rhode Island, shows the kind of negative consequences that can be expected to occur when any state sales tax hike is considered.

Tragically, this sales tax increase would not raise nearly the amount of revenues statically calculated because it would cause serious harm to our already deteriorating state and municipal economies. In summary, a sales tax hike of $175 million is projected to produce severe unintended consequences for theOceanState:

  • Only a $55 million gain in net state revenues (vs the $175 million gain anticipated)
  • A loss in Gross State Product o $932 million
  • A loss of $22 million in municipal revenues
  • A loss of $64 million in investment in our state
  • A loss of 2,224 jobs

 Because a sales tax increase would make Rhode Island even less competitive with its regional neighbors and nationally overall, consumer and entrepreneurial behavior would be significantly altered, resulting in lower economic activity and actually worsening the state’s economic plight. Municipalities, all too often overlooked, will also suffer from this unintended consequence.

Balancing the budget is the wrong goal; and tax increases are precisely the wrong solution!

Conversely, if the Ocean State was to cut its sales tax to 5%, a very different scenario is projected to occur, because our state would suddenly become a more attractive place to purchase goods and services, meaning economic activity would increase.

The static projection of a 2% sales tax cut would put the loss in state revenues, at 2/7 of the current revenue, or about $282.75 million in lower revenues to the state. But again, this static calculation ignores the true dynamic economic impact of tax reductions. RI-STAMP projects the following positive consequences from this tax decrease:

  • Only a $74 million loss in net state revenues (vs the $283 million loss anticipated)
  • A gain in Gross State Product o $1.9 Billion
  • A gain of $44 million in municipal revenues
  • A gain of $121 million in investment in our state
  • A gain of 4,327 jobs

Just from this single tax reform, economic forces, which have been restrained by a burdensome tax structure, will be unleashed in the Ocean State. If the state can find $56 million in cuts, the Rhode Island economy will be vastly enhanced, resulting in more jobs and more local revenues … and we will balance a lower budget!

The Governor’s office recently stated that it plans to address the upcoming budget deficit by cutting spending and raising taxes. As demonstrated above, this path produces negative consequences.

If instead, we look to address the larger economic picture and look to produce more jobs and a brighter economic future for our citizens …

… cutting taxes and cutting spending will produce a more vigorous economy!

Additionally, from a regional and psychological perspective, instead of suffering the ignominy of charging highest sales tax in New England, Rhode Island would benefit by boasting the second lowest sales tax.

Reality Supports Theory

Some may argue that an economic modeling program is just theory and that the actual world may present a very different reality. However, right here in our own New England back-yard, there is specific empirical evidence that fully supports the core premise of the RI-STAMP projections regarding the effects of sales tax policy.

It is well-known that cross-border shopping exists to the great benefit of the zero sales tax state of New Hampshire, with many Rhode Islanders frequently putting in ‘orders’ with family members and friends crossing through the Granite State to pick up liquor and other items for them … duty free!

In Vermont, a recent study showed that its border counties are losing up to $540 Million in retail sales per year to New Hampshire . In Maine, a similar study showed that its border counties are likewise losing $2.2 Billion, in addition to thousands of retail jobs .

With the close proximity of Rhode Island to many Massachusetts and Connecticut residents, it is clear that Rhode Island can win the southern New England sales tax competition; that our economy can benefit from cross-border shopping and see a pronounced increase in economic activity and jobs for our state and our cities & towns.

WHAT IS RI-STAMP?

Developed by the Beacon Hill Institute at Suffolk University, RI-STAMP is a customized, comprehensive model of the RI state economy, designed to capture the principal effects of city tax changes on that economy. In general STAMP is a five-year dynamic computable general equilibrium (CGE) tax model. As such, it provides a mathematical description of the economic relationships among producers, households, government and the rest of the world. It is general in the sense that it takes all the important markets and flows into account. It is an equilibrium model because it assumes that demand equals supply in every market (goods and services, labor and capital); this is achieved by allowing prices to adjust within the model (i.e., prices are endogenous). The model is computable because it can be used to generate numeric solutions to concrete policy and tax changes, with the help of a computer. And it is a tax model because it pays particular attention to identifying the role played by different taxes.

Download the complete Policy Brief here; includes comparative table and reference end notes.

Media Coverage:

1/30/2012: Americans For Tax Reform , ATR: Opposed to Rhode Island Sales Tax Increase

1/23/2012: GoLocalProv.org, NEW: Conservative Think Tank Rips Chafee on Taxes

Little State, Big Spending

In yet more news to file under thank-god-for-pension-reform-but, the Providence Business News reports that while Rhode Island public sector spending is surprisingly lower than the U.S. average, medicare costs are significantly above national averages.

Medicaid-related vendor payments accounted for more than 20 percent of state and local government spending in Rhode Island from 1999 to 2009, significantly more than the rest of the country, according to a new report from the Rhode Island Public Expenditure Council.

“The report from the budget watchdog group found public-sector spending – by both state and municipal government – in the Ocean State rose 68.9 percent over the 10-year period to $8.9 billion per year, a smaller increase than the 77 percent jump nationally.”

While the somewhat slower growth than the national average is welcome, it’s hardly good news. It goes without saying that there aren’t 68.9 percent more Rhode Islanders today compared to ten years ago, and it’s probably fair to say that the Ocean State isn’t 68.9 percent — or half of that? — better or more efficient than it was in 2001. So what justifies the public sector explosion?

And the faster-than-national-average expansion of Medicaid-related payments is definitely a worrying sign. Controlling Medicare and Medicaid cost growth is a major issue nationally anyway, so for Rhode Island to be spending a significantly greater proportion of public funding than the rest of the country – especially in light of the flexibility that was supposed to come with the first in the nation Medicaid global waiver and block grant – indicates that the system here is particularly broken.

Pension reform was a major and necessary step, but it’s becoming clearer day by day that there’s still so much more to be done. Rhode Island may have averted one major crisis in the making, but it doesn’t mean that we’re anywhere out of the woods. Beyond Pensions, Rhode Island still must grapple with its systemic uncompetitiveness.

 

Pension Reform Bait-and-Switch to Block Broader Reform

An observer of Rhode Island’s political scene needn’t be excessively cynical to be a bit disconcerted by the unity of purpose displayed toward the end of the General Assembly’s special session on pension reform.  Leading Democrats, including some who double as labor union leaders, were onboard.  The union-backed Independent governor, Lincoln Chafee, was onboard.  From the opposing camp, various good government groups were onboard, almost in unity.

Even the ostensibly neutral media joined the parade.  After an overwhelming vote passed the legislation, the Providence Journal editorial board dubbed the achievement as “Rhode Island rescued.”  An analysis by WPRI’s Ted Nesi called the bill, “an extraordinary — and unlikely — achievement for the three leaders most responsible for shepherding it through.”

Two questions arise from this sea of consensus:  Is it really plausible that the combination of budgetary crisis and strong leadership changed the legislature’s stripes so dramatically as to make it a national example of forward-thinking government?  And should we worry that the issue’s momentum carried forward catches and promises that will ultimately harm the state?

An initial answer comes in the form of the last-minute amendment creating a 5.5% “assessment” (aka “tax”) on privatized workers.

A Long-Running Union/Assembly Goal

Back in 2007, as June 15 turned into June 16, Rep. Charlene Lima (D, Cranston) slipped a midnight amendment into the budget bill that would pass before the sun came up.  The amendment created RI General Law 42-148, “Privatization of State Services,” which requires an elaborate review and appeals process before the state can use private contractors for services previously performed by unionized public employees.

The legislation made its appearance in the midst of efforts by Governor Donald Carcieri to address the state’s structural deficits through such privatization, and within a week, his efforts ended.  As Carcieri spokesman Jeff Neal put it, “Bringing competition to the delivery of state services is one of the key ways Rhode Island will be able to fix its budget problems.  Unfortunately, it appears that solution is off the table now.”  The final nail came a year later, when the state Supreme Court declined to review the constitutionality of the law.

In essence, the legislation required a cost-comparison analysis that would pit the private contractor’s bid (plus all remaining inside and transition costs) against an optimistic “new cost estimate” from union workers, “reflecting any innovations that they could incorporate into the work performance standards.”  (Not that the law required them ever to implement the innovations.)  In order to win the contest, the outside vendor would have to offer “substantial” savings; in her initial legislation, Lima used the margin of 10%.  State workers and their unions could then use an appeals process to delay the contract award for months.

Fast forward to November 2011.  As the pension reform legislation moved toward stunningly smooth passage, the following language slipped into the mix, amidst a variety of “technical amendments”:

42-149-3.1. Assessment on state expenditures for non-state employee services. – Whenever a department, commission, board, council, agency or public corporation incurs expenditures through contracts or agreements by which a nongovernmental person or entity agrees to provide services which are substantially similar to and in lieu of services hereto fore provided, in whole or in part, by regular employees of the department, commission, board, council, agency or public corporation covered by chapter 36-8, those expenditures shall be subject to an assessment equal to five and one-half percent (5.5%) of the cost of the service. That assessment shall be paid to the retirement system on a quarterly basis in accordance with subsection 36-10-2(e).

Government leaders are quite open about the intention behind the new statute.  House Speaker Gordon Fox (D, Providence) has acknowledged it as an effort to prevent future governors from returning to Carcieri’s methods.  Richard Licht, director of the Department of Administration for the current governor, told WRNI’s Ian Donnis that “the purpose of it” is to “curb the state’s use of outside employees.”

Whatever “substantial savings” might have meant under Lima’s legislation, they now must overcome an additional 5.5% handicap, and as the state’s structural deficits continue, government officials will be nudged even more strongly toward tax increases and/or service reductions.

A Tax for the Pension System

The secondary effect of the 5.5% provision is, obviously, to introduce another taxpayer stream of revenue for the pension system.  The amount that state entities spend on contract employees is not readily available, but Licht puts the annual revenue to the pension system at a projected $2 million (though he admits that no thorough analysis has been performed).

In the context of the pension reform, however, dollar amounts have typically been described in terms of the amortization period.  That is, in the 25 years that it is supposed to take for the pension system to be sufficiently funded, this last-minute money grab will amount to around $50 million paid from the state’s general revenue.

Or Something More Insidious?

Whatever the dollar amounts, a key difference between this latest scheme and the Lima amendment should not be overlooked.  The definitions section of the 2007 law defines “in-house” services as those involving “in-house state programs and employees.”  Section 3 of the law explicitly begins the review process “prior to the closure, consolidation or privatization of any state facility, function or program.”

The new law is not so carefully limited.  It describes the included services as those provided by employees covered by RI General Law 36-8, which establishes the state pension system.  That system is not limited to state workers.  Indeed, subsection 36-10-2(e), which the new law cites for the process of payment, refers to state contributions to teachers’ pensions, as well as state workers’ pensions.  Depending how enthusiastically the various parties wish to press their advantage, it may turn out that the 5.5% assessment applies to contractors hired to perform any service “similar to or in lieu of” any employee in the pension system, whether employed by the state, a school district, or a municipality.

The most financially and politically significant example that comes to mind is that of charter schools.  In general, teachers in such schools are required by state law to participate in the retirement system, but mayoral academies can opt out.  If they do so, will their budgets be subjected to the 5.5% assessment?  Given the fact that the last-minute amendment was not thoroughly vetted before submittal nor thoroughly debated before being voted into law, that may very well be the case.

Pension Reform as a Barrier to Broader Reform

I’ve been arguing against General Treasurer Gina Raimondo’s pension reform on the grounds that it (1) is insufficient by several orders of magnitude to solve the entire problem, and (2) puts future adjustments and reforms fully in the hands of the state Retirement Board, with seven of 15 members appointed directly by unions.  Even when agreeing, supporters of the legislation have proclaimed it as a huge step in the right direction.

The privatization tax may be an early indication that crisis and leadership only yielded a quarter step forward, soon to be followed by four steps back.  At the very least, the state has one less tool to rein in its structural deficits, and the restriction may apply to any other government entity in Rhode Island that participates in the pension system but wishes to explore privatization.

The scope may broaden even more (and more definitively) if reform of municipal pensions brings additional public employees within reach of General Law 36-8.  And reformers would do well also to ponder the relevance of this latest General Assembly bait-and-switch while advocating for another of their favorite notions:  consolidation.  Bringing local services under the purview of state employees will virtually ensure that they remain forever “in house.”

Beyond all of this speculation is the likelihood that the amendment was just the first surprise that helped buy such broad assent and smooth passage for the bill.  It isn’t cynical at all to observe that, whatever else it might be, Rhode Island’s entrenched establishment is sufficiently savvy to see when basic math threatens the application of reality to unrealistic benefits and to make the best of reforms… and with a vengeance.