New Study: higher tax burden reduces state economic growth & population

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August, 2014 – We consistently hear Rhode Island lawmakers claim that citizens or the wealthy can “afford” some minor, new tax to pay for some new government project. That may be true in some cases.

But what is also true, in almost all cases, is that OUR STATE’S ECONOMY CANNOT AFFORD THE TAX HIKES.

A new study by the nationally renowned Mercatus Center explains this cause and effect.

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Read below or go to the Mercatus page here; http://mercatus.org/publication/state-economic-prosperity-and-taxation

State Economic Prosperity and Taxation

Pavel A. Yakovlev | Jul 10, 2014

Policymakers frequently debate how different methods of taxation affect their states’ economies. While most economists agree that higher taxes result in reduced investment and innovation, previous studies have not found overwhelming evidence that higher tax rates lead to lower eco­nomic growth.

To untangle this paradox, new research by economist Pavel Yakovlev for the Mercatus Center at George Mason University examines the effects of taxation on states’ economic performance, busi­nesses growth, and net migration rates. The study finds that higher state taxes correlate with lower economic performance, even when controlling for various factors. The magnitude and sig­nificance of this effect varies depending on the type of taxes and the type of economic activity in question. The study analyzes the relationship between states’ economic performance and tax variables including effective average tax rates, the personal income tax, and personal income tax progressivity.

To read the study in its entirety, please see “State Economic Prosperity and Taxation.”

KEY FINDINGS

  • A higher average tax burden reduces state economic growth. Dividing total tax revenue by gross state product (GSP) shows that a 1 percent increase in a state’s average tax rate is associated with a decrease of 1.9 percent in the growth rate of its GSP.
  • Taxes impact migration patterns. If higher state taxes lead to lower economic activity and employment, it is conceivable that people will move to states with better economic pro­spects. Of the nine states with no personal income tax, four—Florida, Nevada, Washington, and Tennessee—are among the states with the highest population growth rates in the country in recent decades. Also, data show that a higher personal income tax rate is associ­ated with a higher probability of residents migrating to a state with a lower tax rates.
  • Income tax progressivity affects the number of new firms. The number of new firms open­ing in a state is a key indicator of beneficial creative destruction and innovation that will improve living standards for the state’s residents over time. Other studies have found that new firm entry accounts for 20–50 percent of a state’s overall productivity growth. The lat­est economic data show that the rate of start-up creation is sensitive to personal income tax progressivity. A 1 percent increase in personal income tax progressivity is associated with a reduction of 1.2 percent in the growth rate of the number of firms.
  • While the data show an important relationship between GSP growth and average tax rates, the impact of average tax rates on per capita income is less clear. A 1 percent increase in a state’s average tax rate can be expected to decrease per capita income by 0.07 percent.
  • As previous studies have also noted, these findings can be sensitive to the time period, statisti­cal methods, and variables used. Nevertheless, the results still lead to a general con­clusion: not all tax variables exhibit a significant correlation with the selected measures of economic activity, but when they do, the relationship is usually negative.

CONCLUSION

Higher state taxes generally reduce state economic growth, GSP, and even population. It is clear that people produce or consume less, or even move to a different state, in response to higher taxes. Not all types of tax increases can be expected to significantly harm economic outcomes, but higher taxes are generally correlated with lower standards of living.

Read Publication PDF

State of the State

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Center’s CEO discusses the recently passed FY-2015 budget, BIG QUESTIONS for gubernatorial candidates, and the state of the state on “State of the State” cable TV.

[button url=”http://vimeo.com/channels/365354/99366876″ target=”_blank” size=”medium” style=”royalblue” ] Cable TV Interview [/button]

Commentary: 2-out-of-3 Ain’t Good Enough

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By Mike Stenhouse, CEO

The 2015 state budget is now public. Corporate tax and estate tax cuts are in. Help for the middle class is out. In fact, the average worker is being asked to pay for reforms that benefit more well-off constituencies.  Why? It’s not just a matter of fairness; it’s a question of economic stability.

Rhode Island’s poor economic performance and dismal jobs outlook can largely be attributed to high levels of taxation and regulation across all points of Rhode Island’s economic lifestyle.

TaxEconomicCycle

An analogy can be made between a prosperous state economy and a three-legged stool, where each leg plays an equally important role in keeping balance and maintaining strength, as part of the normal economic cycle through which most individuals progress:

  • First leg – workers – where individuals produce the products and services essential for a growth economy; where valuable professional experience can gained; and where individual wealth can accumulated and spent in the local economy;
  • Second leg – business sector – corporations and entrepreneurs  who, as managers or small business owners, guide the free-market to generate profits that further fuel the overall economy; and where, simultaneously, further personal wealth and experience can be accrued and spent;
  • Third leg – investors – where wealth is put at risk via equity investment back into the business sector, further boosting the economy and creating jobs, and which provides additional opportunity to grow individual wealth; where philanthropy funds local charities; where wealth is spent on a large scale, often in retirement, and, finally; where wealth is passed down to family heirs in the hope of maintaining ongoing investment and philanthropy in the state.

All three economic roles, or legs of the stool, are equally important and are inter-dependent on each other. The free-enterprise system allows individuals move from role one to another as they choose, as they acquire capacity, or as other circumstances dictate.

A balanced, growth economy must have strength in each of its three legs: a partnership of sorts. If any one leg is out of balance or weak, likewise, the other legs – and the overall economy – will also suffer. It is this tri-lateral partnership that creates a vibrant free-market economy and a stable tax “base”, strong enough to support public assistance programs and foundational services such as education and infrastructure.

However, in recent decades in Rhode Island, excessive government interference has systematically weakened all three legs of our economic stool, limiting  the capacity of individuals to move from one role to another; and at all three roles, driving many out of our state.

With high sales and property taxes in a high cost of living state, and with limited opportunity for upward mobility because of a weak jobs market, Rhode Island is a barely affordable home for many workers in low and middle income families, who have little chance of saving money and accumulating initial wealth. Yet no relief is planned in 2015 for the average worker.

With the highest corporate tax in New England and one of the worst business environments among all states, along with a dwindling consumer base, it has become very difficult for businesses and entrepreneurs to prosper in the Ocean state. Limited corporate tax relief is designated in the 2015 budget for the business sector.

For wealth that is accumulated despite these roadblocks, our state has further imposed a dis-incentive for many families to keep that wealth in Rhode Island, by charging one of the nation’s most punitive estate, or death, taxes …  tending to drive high-income individuals out of our state. Some relief is also planned for wealthy investors  in 2015.

Yet, while it is a positive sign that some reform is planned to fortify the two roles that generally involve higher income individuals, why are we ignoring relief for the middle class? To make matters even worse, the new gas taxes and fees on real estate transactions, vehicle inspections, and traffic court appearances, along with the new the ‘use tax’ on income, will be a direct hit on middle and low income families.

This puts the proposed 2015 budget completely out of balance.

There is, however, a policy idea on the table that would restore that balance by aiding those with lower incomes. Our Center’s sales tax reform idea, that cuts the rate to 3%, can also fortify the worker leg, leading to more family savings and creating thousands of vital, new job opportunities. If we also implement a major sales tax cut, strengthening this leg as well, this would spur consumer demand, increasing corporate profits and wealth creation in the other two legs. This is a balanced, win-win solution.  Instead, Rhode Islanders are yet again looking at an unbalanced, win-lose approach.

Rhode Islanders want a government that works for everyone, not just for the well-off. We can do this by cutting corporate, estate, AND sales taxes.

The former rock star, Meatloaf, may have crooned that “two-out-of-three ain’t bad”. But when it comes to fortifying all three economic roles that are equally essential in turning around a struggling state like Rhode Island … two-out-of-three ain’t good enough!

Mike Stenhouse holds an economics degree from Harvard University. 

Without Sales Tax Reform, 2-out-of-3 Ain’t Good Enough

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RI’s 2015 includes corporate and estate tax reforms for big biz and the wealthy, but provides no relief for average family or worker. Read this unique commentary that takes a holistic look at the 3 phases of the economic cycle.

[button url=”http://www.rifreedom.org/?p=11208″ target=”_self” size=”medium” style=”royalblue” ] Commentary: 3 Legs of a Stool[/button]

STATEMENT on FY15 BUDGET: Middle Class to Pay for Corporate & Estate Tax Reforms

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June 6, 2013
Sales Tax Cut Would Have Larger & More Immediate Impact
Pointing to new broad-based taxes and fees that will especially harm the middle-class, that will also help pay for planned cuts for corporations and high-income individuals, the RI Center for Freedom and Prosperity sees little in the budget that cleared the House Finance Committee yesterday that will aid struggling families and small businesses, in a statement released today.
The Center further urges lawmakers to modify the budget so as to make a more immediate and larger impact on job creation. While noting a that a few items in the proposed budget are a small step in the right direction, the Center notes that the budget also takes backwards steps, and argues that much more needs to be done to boost the state’s struggling economy.

“While the modest corporate and estate tax reforms will be helpful over the long term for those constituencies, we then simultaneously turn-around and add to the plight of the average guy, asking them to pay for those reforms by imposing new vehicle fees and gas and use taxes,” said Mike Stenhouse, CEO for the Center. “Nor does this budget have any bold jobs creation plan. If we also cut the sales tax, we can put money back in the pocket of every Rhode Island family and business, and create thousands of new jobs right away.”

The proposed new gas taxes and fees on vehicle inspections and on good-drivers seeking to clear their traffic records, along with the $2+ million in new sales taxes, will be a direct hit on middle and low income families. The deceptively named “Safe Harbor” for the use tax would impose a new default of 0.08% of adjusted gross income tax on residents’ assumed purchases outside of the state.

The Center does note it as a positive step that the proposed budget did make some cuts that were recommended in its April Spotlight on $pending report, namely: suspension of the historic tax credit program and holding the line on state personnel costs.

The $48 million to pay for a reduction in the sales tax to 3%, that would produce about 13,000 jobs, can be made by eliminating the $12 million payment of the 38 Studio bond, by eliminating the $15 million to the HealthSourceRI UHIP project, by eliminating $11 million in General Assembly legislative and community service grants, and by cutting $19 million in excessive overtime payments, all were recommended cuts in the Center’s spending report.

OTHER NEW TAXES & FEES:

* Article 12 of the budget increases the real estate conveyance tax that a seller of a home or other real estate must pay at the time of transfer.    The current tax is $4.00 per $1000 of the sale price;  the FY2015 budget would increase this tax by 15% and would become $4.60 per $1000 in Rhode Island, higher than Massachusetts tax of $4.56 per $1,000.

Statement on 3% Sales Tax Hearings

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May 8, 2014 — OFFICIAL STATEMENT re. the May 7 House Finance Committee hearing on H8039 to lower the state sales tax to 3%. 

The Center’s testimony regarding a proposed sales tax cut to 3%, yesterday, appeared to generate interest from of a number of House Finance Committee members with the presentation of its “complete solution“, including a fiscal note about the anticipated dynamic revenue increases, which would lower the net impact on the state budget to as little as $47 million, in exchange for a potential increase in jobs of over 13,000. The Center then also showed how to find budget savings for this remainder (Spotlight on $pending report) without cutting any essential programs or services.

It appears that, legislatively, sales tax cuts are being considered along with corporate tax and estate tax cuts in 2014. While the Center supports all three reforms, research indicates that sales tax cuts will produce the largest economic boost and create significantly more jobs, at a lower cost per job, than any other tax reform.

The Center is puzzled by the position taken by the RI Hospitality Association, which testified against the 3% bill. It is almost certain that such reform would significantly increase consumer demand throughout the industry (diners, overnight guests, vendor services), perhaps as much as 20%, create more jobs, and lower the cost of conducting business for each of the Association’s member organizations. In 2012 RIHA actively mobilized support to stop a proposed 2% percentage-point increase in industry sales taxes, yet now is working against a sales tax cut of twice that size. The Center questions if RIHA members are aware of or support this position?

Testimony was also heard on bill to decrease the sales tax to 6% on a reduced number of industry sectors. Again, while a small step in the right direction, this reform would produce only one-sixth as many jobs, at just less than half the cost to the state budget, as compared with the 3% plan.

completesolution-explanation

Managing a Phase-In of Major Sales Tax Reform

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The state budget is like a talisman that government officials and special interests raise to ward off the evil spirits of tax reform.  Anything that promises not to raise taxes, or at least not to be “revenue neutral,” is said to be entirely unworkable — destined to eliminate every valued program of government.  And when they’re really stuck, budget protectionists will claim that even a reform that they ought to support for every economic and humanitarian reason is impossible because the budget couldn’t absorb the shock of the first year.  The withdrawals of revenue dependency might kill the junkie.

When it comes to dropping Rhode Island’s state sales tax to 3%, as RI House bill 8039 and Senate bill 2919 would do, the problem is not so dramatic.  To begin with, the companion bills would implement the change at the beginning of 2015, which maintains the higher tax rate through the summer tourist season and the holiday shopping season.  (The latter period on the calendar might also help to reduce the likelihood that people would hold off on purchases in the months leading up to the tax reduction, while also producing a boost during a slower time of the year.)

The following chart, part of the RI Center for Freedom & Prosperity’s “complete solution,” shows the RI Center for Freedom & Prosperity’s suggested approach to managing the implementation of this unprecedented tax reform, taking advantage of the state government’s access to two respected economic modeling tools:  the RI-STAMP model used by the Center and the REMI PI+ model used by the state’s Office of Revenue Analysis.

ricfp-salestax-genrev-3percentplan-web

The total height of the column is the governor’s recommended general fund (state) revenue for the next fiscal year.

  • The dark gray block at the bottom is the $3.054 billion that would be under no risk at all, even if the state dropped its sales tax rate from 7% to 3% for the entire year and the reform had no dynamic effect increasing tax revenue somewhat by improving the economy.
  • The silver block is the $134.25 million that the state secures by starting the reform halfway through the fiscal year plus the dynamic revenue that the REMI PI+ model projects for the reform.  (For a variety of reasons, the Center believes these results to be overly pessimistic.  One very substantial reason is that the Office of Revenue Analysis assumed across-the-board cuts to make up for the reduced revenue, which bit into areas of spending that, they claim, have a strong benefit for the local economy and, therefore, the dynamic effects of the reform.)
  • The red block shows the portion of the revenue for which the state should have some plans to reduce spending if REMI’s pessimism turns out not to have been unreasonable.  The top of this block is the budget that the Center recommends that the General Assembly actually pass.
  • The green block represents the added revenue that RI-STAMP projects the state will realize above the Center’s recommended budget.  If legislators wish to minimize the effects of the reform, they can plan for spending and program increases that would go into effect as this revenue actually comes in.
  • The sliver of blue at the top of the column is the $28.9 million that the Center expects the state to have to trim from the governor’s recommended budget as an investment in the 3% sales tax reform.

The light-green block to the left represents the $224.5 million in savings that the Center’s Spotlight on Spending report identified in the governor’s proposed budget (spanning both his suggested revision for FY14 and spending for FY15).  As the chart shows, these potential savings cover all but the most pessimistic $43 million at the bottom of the red block.

The next chart zooms in on the upper part of the column, with some explanation.  Basically, the strategy calls for the state to pass an initial budget (of $3.3 billion in general revenue spending) and then follow the monthly cash flow reports from the Office of Revenue Analysis.  If the dynamic effects of the more optimistic RI-STAMP model are proving to be the case, nice-to-have spending like grants and pilot programs can be phased in.  If the pessimism of the REMI model is proving to be the case, reductions of a more fundamental (but still non-essential) nature can be phased in.

ricfp-salestax-phasedplan-web

 

Click here for a PDF of these two charts and the full table of Spotlight on Spending recommendations.

“How Money Walks” out of the Ocean State

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Rhode Island needs a major economic boost through a tax cut like reducing the sales tax to 3%!

How Money Walks author, Travis Brown, interviews the Center’s CEO, Mike Stenhouse about how the Center’s sales tax plan might stop the destructive out-migration trend in RI:

According to IRS data compiled by HowMoneyWalks.com:

Between 1992 and 2011:

  • Rhode Island lost over $1.8 billion in ANNUAL adjusted gross income due to out-migration
  • Providence County alone lost over $1.9 billion in AGI
  • Kent and Bristol counties were a minor losers, while Washington and Newport Counties saw gains

Between 1985 and 2011

  • the State lost over 43,314 from state-state out-migration

A 3% State Sales Tax: Updated 2014 Projections

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Based on an updated 2014 version of the Center’s RI-STAMP economic modeling tool, new jobs and revenue projections are projected for a proposed across-the-board cut to the state sales tax to 3%, from its current 7% level.

The 2014 projections, based on updated Rhode Island data, show very similar results to the 2013 projections: over 13,000 jobs and over $450 million in new state revenues. plus over $100 million in new municipal revenues are projected to be created from the massive dynamic economic impact that would result; leaving the state with less than $50 million in budget savings to be identified.

The 2014 projections also include:

  • Multi-year projections for the 3% scenario
  • Near-term jobs and revenue projections for modified 1% sales tax scenario (proposed by 3rd party and also under consideration in 2014)

2014 Projections for a 3% Sales Tax

To see the complete 3% sales tax solution, go to our Sales Tax home page at RIFreedom.org/SalesTax .

 

 

 

Fiscal Analysis: Math of a 3.0% sales tax is budget friendly

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No Budget Cliff:

A legitimate concern for lawmakers when considering sales tax reform, is avoiding severe revenue shortfalls and managing the state’s monthly cash flow. In considering dropping the RI Sales Tax to 3.0%, creating up to 13,000 jobs and over $100 million in new annual revenues for cities and towns, due to growth in the retail shopping sector and related economic activities, it is important to describe how state revenues – in all categories – would be impacted.

Fiscal Projections:

In fiscal year 2015, it is estimated that the state of Rhode Island will take in sales tax revenue of about $938 million.

A static calculation assumes that no increased economic activity will occur as a result of the decreased sales tax rate, and that a reduction in the sales tax from 7% to 3% would result i a loss of  4/7 of the originally projected revenue, or a loss $536 million.

A dynamic calculation attempts to project the effect of increased activity that is expected to occur (in the first full fiscal year after implementation) and projects a net budget loss of only $47 million, as follows:

-$433 million in sales tax receipts: -$536 million straight-line calculation plus $83 million from new transactions.  It is an economic truth that that increased retail activity would result from the lower consumer costs, producing increased transactions and, therefore, sales tax receipts higher than the static calculation, decreasing the net revenue loss in this category.

+$226 million in income tax receipts: With more economic activity, more taxable income will be paid to RI workers, from a) more people hired, b) more hours for existing workers, and c) higher salaries and pass-through-profits for existing employees or business owners.

+$42 million in cigarette tax receipts: With more people shopping in RI, more cigarettes will be purchased in the state.

+$3 million in alcohol tax receipts: With more people shopping in RI, more alcohol will be purchased in the state.

+$27 million in corporate tax receipts: Increased consumer activity will attract new corporations to the state and would likely lead to higher profits from existing corporations.

+104 million in other taxes and sources of revenue: With greater overall economic activity and population growth, and more money to spend by consumers, it can be expected that the state would realize increased receipts from gasoline, vehicle fees, estate, racing and athletic, bank deposits, tangible assets, realty transfer, health care providers fees, and public utilities taxes, as well as increases in court, university tuition, lottery, and other departmental receipts.

NET STATE BUDGET IMPACT: -$47 million

MUNICIPAL IMPACT: +119 million collectively; every city and town is expected to see increased revenue gains, due almost entirely to higher commercial property tax revenues, as a result of new and expanded business formation.

Budget Planning Process:

A number of tools exist for lawmakers to mitigate the budget impact of major sales tax reform. Even if the projected $48 million deficit is overly optimistic, prioritization of spending leaves ample room.

1)      NON-ESSENTIAL SPENDING of over $225 million in non-critical programs were identified in the Center’s Spotlight On $pending report. Lawmakers can choose to prioritize spending so as to create the best opportunity to create jobs and can look at low-hanging fruit in the budget, such as:

  • $23.4 million to return HealthSourceRI to the federal government
  • $12 million 38 Studios annual bond payment
  • $13 million in projected savings from reduced social services demand

2)      ANNUAL BUDGET RECONCILIATION PROCESS, which routinely adjusts the budget in response to changes in revenue that often far exceed the projected sales tax revenue changes.

3)      THIRD-QUARTER IMPLEMENTATION of sales tax reform, beginning the lower rate in the middle of the fiscal year on January 1, 2015 would essentially spread the budget impact over two budget cycles, requiring less savings in 2015 and enabling more flexibility for the 2016 budget.

Monthly Cash Flow:

From the figures above, the dynamic increases in receipts in many categories would occur almost immediately, as more shoppers flow into the state, buying a wide array of products, and more workers are hired. This means that annual, even monthly, gross receipts to the state are not likely to be severely interrupted at any significant level.

To see the complete 3% sales tax solution, go to our Sales Tax home page at RIFreedom.org/SalesTax .