Tax hikes vs. spending cuts in the VA General Assembly

Virginia leaders should learn from Delaware Governor Ruth Ann Miner, who is proposing tax increases in her state for 2004.

Miner holds, “While I believe that we have cut costs and made government more efficient, I also believe that there are certain obligations government has and certain services the state provides that should not be eliminated. We cannot solve a $300 million deficit completely through cuts without affecting children, the elderly, the poor, public safety and our state’s competitiveness.”

Governor Miner’s direction is opposite to that of the 2003 Virginia General Assembly. Senators and delegates ranging from Frank Ruff to Harry Purkey, from Ben Cline to Bill Bolling, all chimed in at some point with the party line: raising taxes during a recession is the most irresponsible thing we could do to the Virginia economy.

The legislators need to re-read their college Economics textbooks.

“Basic economic theory suggests that direct spending reductions will generate more adverse consequences for the economy in the short run than either a tax increase or a transfer program reduction,” say Peter Orszag and Joseph Stiglitz (who won a 2001 Nobel Prize in Economics) in an article for the Center on Budget and Policy Priorities titled, “Budget Cuts vs. Tax Increases at the State Level: Is One More Counter-Productive than the Other During a Recession?”

The argument is simple. By law, Virginia has to have a balanced budget, which means we cannot plan to spend more than we take in. That leaves us with two choices: raise taxes or cut public spending.

The anti-tax forces refuse to consider one of these options. They would never have us raise taxes for any reason. The problem is that their position hurts the Virginia economy worse than the alternative, keeping us locked in a recession for a longer period of time than necessary.

Raising taxes works better than cutting spending “because some of the tax increase would result in reduced saving rather than reduced consumption, say Orszag and Stiglitz. Consumption, or buying things, is the key to an economic turnaround. When anyone, including the state government, stops buying things it slows the recovery.

But a tax increase leaves less money in the pockets of individuals, which means they can buy less, yes? Indeed. The only difference is that individuals do two things with their money: spend it or save it. Saving money is fine, but it doesn’t speed up the economic recovery.

So with the money they are paying in higher taxes, individuals would have spent part of the money and saved part of the money. In contrast, spending cuts by the government are a dollar-for-dollar loss to our state economy.

What about the “transfer programs” referred to in the quote above? These are state programs like unemployment insurance, Social Security, and TANF benefits where the state passes money on to individuals rather than buying goods and services.

Are cuts in transfer programs also worse than tax hikes? It depends on who is receiving the money. Lower-income individuals tend to spend all or nearly all of their budget. Middle and upper-income individuals can afford to save more. Thus, transfer programs which give money to lower-income people are better for the economy than tax cuts, since more of it will be used for purchases and less will be saved.

Incredibly, this means that the kinds of spending cuts that might make sense in a recession are transfer programs that benefit higher-income people. Inversely, the tax cuts that make sense are those that benefit low-income people. They will likely spend those dollars right away, pumping the full amount right back into the economy for the purchase of necessities.

On this basis, we can evaluate the tax and budget decisions of the 2003 General Assembly.

Absolutely lowest on the list of effective economic stimuli is the cut in the estate tax. The benefit is delayed until 2005, so it does nothing to get us out of the current recession. It goes only to the extremely wealthy with estates worth over $1 million, who save a lot of their money already. It reduces state revenue by over a hundred million dollars, forcing further spending cuts. Such a raw and ignorant money grab has not been seen in this state for years. Not only is it immoral, it is bad economics.

The only tax hikes were a few fee increases, particularly increased drivers license fees, DUI charges, saltwater fishing and other court charges. Tax hikes that make the most sense in a recession are those that fall upon higher-income individuals. These user-fee hikes fail the test.

Most harmful may be the massive budget cuts forced upon the state by the revenue shortfall. Weeding out inefficient spending is one thing; cutting core services is quite another. Cuts to higher education, public safety, transportation, public libraries and health programs will have an enormous economic effect, both in the short and long-term.

That leaves tax hikes, specifically directed at those most able to pay. It turns out that failing to raise taxes during a recession is the most irresponsible thing we could do to the Virginia economy.