Rankings Say Little About States’ Real Business Climate

January 31, 2012 at 3:48 pm

If someone told you a city’s average temperature but not how much it rains there, how would you know whether you liked its climate?  The Tax Foundation’s annual ranking of states’ “business tax climate” is similarly lacking.

In the Tax Foundation’s scale, how a state compares to other states starts and ends with its taxes — generally, the lower the better.  But tax levels don’t tell you if the schools are good, the transportation system is state of the art, or communities are safe.  All of those, not just taxes, determine a state’s economic fortunes — as this study from the Federal Reserve Bank of Cleveland on the importance of education shows.

And since schools, roads, and other necessities cost money, the ranking actually rewards states that don’t invest in what makes them attractive places to live and work.  The Tax Foundation this year gave its top ranking to Wyoming, a state with not a single Fortune 500 company.  If the rankings were meaningful, the streets of Cheyenne should be crawling with CEOs.

Peter Fisher of the Iowa Policy Project, whose book “Grading Places” shows why rankings like these are suspect, points out that the Tax Foundation study doesn’t even accurately report the actual amount of taxes that businesses pay in a state:

Rather than measuring what businesses actually pay, [it] instead focuses on selected characteristics of the tax code while ignoring significant features.  Results differ wildly from a ranking based on what businesses pay in many cases.

As a result, “In some cases, lower taxes actually produce a worse score” in the Tax Foundation rankings.

Fisher concludes, “What this annual release offers is, at its core, an indefensible mish-mash of ‘Stuff the Tax Foundation Doesn’t Like,’ which should be the title.”  He’s right.

Video: Jared Bernstein and Chye-Ching Huang Discuss Capital Gains Taxes

January 31, 2012 at 11:22 am

“There are lots of good reasons to get rid of” the preferential tax treatment of capital gains,
Chye-Ching Huang tells Jared Bernstein in this video.

She notes, for instance, that “at the same time that capital gains income has been growing really rapidly, and growing at the very top of the income distribution, we have been cutting the rates. That is one of the major reasons why the tax system hasn’t been doing as much to push against income inequality as it used to.”

Chye-Ching and Jared discuss what capital gains are and the tax advantages they receive compared to ordinary income.

Bill for Inadequate Unemployment Insurance Taxes Now Coming Due in Many States

January 30, 2012 at 5:29 pm

Businesses in 20 states must make the first payment tomorrow on about $35 billion that these states have borrowed from the federal government in recent years to help pay unemployment insurance (UI) benefits.

18 of 20 States Starting UI Loan Repayments Had Inadequate Reserves When Recession Hit

Most of this borrowing happened because many states kept the business taxes that fund UI benefits too low before the recession, leaving their UI reserves ill prepared for an economic slump.

The U.S. Labor Department recommends that states have enough reserves to cover a year’s worth of UI benefits in a typical recession.  When the recession hit in December 2007, 18 of the 20 states whose first loan repayments are due tomorrow didn’t meet that standard.  Most weren’t even close:  13 of these states had less than half the needed reserves (see graph).

The only states among these 20 that had adequate reserves but still had to borrow from the federal government were Florida and Nevada, both of which were hit exceptionally hard by the bursting of the housing bubble and subsequent economic fallout.

After two years, states that have borrowed to pay UI benefits must start repaying the principal through higher federal UI taxes on their employers.  (Employers ultimately pass on the cost of UI taxes to workers through lower wages.) The taxes keep going up each year until the loan is repaid.

In addition to the 20 states that start repayments tomorrow, Indiana, Michigan, and South Carolina started repayments in 2010 or 2011, while Arizona, Delaware, Kansas, and Vermont will need to make their first payments next year unless they repay their loans in full by November.  Fifteen states didn’t take out any federal loans. (The state loans have nothing to do with the fully federally funded program providing UI benefits for workers whose state UI benefits expire, a program slated to expire at the end of February.)

States whose UI reserves proved inadequate in the last recession need to revisit their UI tax policies to ensure that they are better prepared for the next one.  UI has played an important role in creating jobs and reducing poverty in the last few years; diminishing its power in future recessions would be a step in the wrong direction.

In Case You Missed It…

January 27, 2012 at 5:21 pm

This week on Off the Charts, we focused on the federal budget, federal taxes, the economy, and state budgets.

  • On the federal budget, Paul Van de Water explained that Mitt Romney’s budget proposals would cut Medicare and Medicaid by one-quarter or more, and cut non-defense discretionary programs to a percent of the economy not seen for at least 80 years.

    We also highlighted and updated our analyses of several harmful proposed changes to the congressional budget process, and we pointed to a statement from Robert Reischauer, former director of the Congressional Budget Office and one of our board members, opposing one of the bills.

  • On federal taxes, Chuck Marr explained why people at the top of the income scale should pay more in taxes, and Chye-Ching Huang discussed why the preferential tax treatment for capital gains makes no sense.

    Chuck Marr also urged Congress to consider the interests of U.S. workers in deciding whether to eliminate taxes on corporate foreign profits.

    And we highlighted some facts on the Earned Income Tax Credit (EITC) in honor of the sixth annual EITC Awareness Day.

  • On the economy, Chad Stone outlined why the Federal Reserve’s decision to keep interest rates low is good news given current economic and political conditions.

    He also noted that, while economic growth picked up in the fourth quarter of 2011, serious concerns about the recovery remain.Nick Johnson pointed out that steep cuts in state and local spending are slowing the economy.

  • On state budgets, Nick Johnson explained why Kansas Governor Sam Brownback’s proposal to abolish the income tax on “pass-through” business income would be costly and poorly targeted.

In other news, we released reports on Mitt Romney’s budget proposals, the proposed Kansas tax break for “pass-through” business profits, and three proposed changes in congressional budget procedures: (1) requiring official budget “baselines” to assume that future appropriations will remain frozen indefinitely, (2) changing the accounting of federal credit programs in ways that would overstate their costs, and (3) barring Congress from considering any legislation that would affect the budget until it and the President have agreed on a joint budget resolution for the fiscal year.

New GDP Numbers Show Historic Drop in State and Local Spending

January 27, 2012 at 5:11 pm

State and local government spending on goods and services fell at a faster rate — and hence had a bigger negative impact on economic growth — in 2011 than in any year in the last six decades,  Commerce Department data released today show (see graph).

When states and localities cut spending, they lay off employees (656,000 jobs lost since state and local employment peaked in August 2008), cancel contracts with vendors, eliminate or cut payments to businesses and nonprofits that provide services, and slash benefit payments to individuals.  In all of these circumstances, the companies and organizations that would have received government payments have less money to spend on salaries and supplies, and individuals who would have received salaries or benefits have less money to buy things.  This directly removes demand from the economy.

In 2011, Steepest Decline in State and Local Spending Since 1944

State and local governments have cut deeply their spending on schools and other public services for three straight years.  In fact, economic output from state and local governments fell by 2.3 percent in 2011 — marking the steepest drop since the wartime economy of 1944.  By reducing economic activity, these cuts have slowed the economic recovery.  (The tally includes state and local spending on education, transportation, public safety, and human services, among other areas.  It doesn’t include government benefits such as cash assistance and Medicaid, whose costs grew as the number of eligible beneficiaries rose after the recession hit.)

Three major factors contributed to the steep 2011 decline:  depressed revenues (which are still about 6 percent below pre-recession levels), the depletion of states’ reserve funds, and the end of emergency federal aid in June 2011.

Many states now writing their budgets for next year are again finding that they lack the revenue to pay for fundamental state services, despite the major cuts of previous years.  Unless states raise new revenue, the spending cuts will likely continue.