Planning Decisions, Inc.

THE BOTTOM LINE FROM CHUCK LAWTON

Tax Burden and the Private Sector

Published Sunday March 9, 2008

I’ve been thinking, over the past several weeks, about the relationship between state and local tax burden and economic growth. Proponents of cutting taxes argue that a high tax burden—measured as taxes and fees collected as a share of personal income—leads to slower economic growth, meaning growth in jobs and income. But examination of the data for the fifty states over the past two decades showed that such a simple relationship doesn’t hold true. This is in part because of the immense complexity of the economic development process—there are so many factors involved that it is virtually impossible to isolate the impact of one alone—and in part because a substantial portion of the tax burden is in fact income, most importantly Medicaid and retirement payments.

Narrowing the question to the relationship between tax burden and earnings from employment rather than all income clarifies the issue somewhat. Here, there is a generally negative relationship—states with higher growth rates of earnings per worker tended to have lower (even negative) growth rates in tax burden (defined here as total state and local taxes and fees collected taken as a percent of the total earnings of all those holding jobs in the state). Conversely, states with lower rates of earnings growth per worker tended to have higher growth in their tax burdens.

Trying to shed more light on the issue by narrowing our focus even further, the question becomes, “What is the relationship between earnings growth per private sector worker—here meaning non-government and non-farm—and tax burden?” Here, the relationship—while by no means perfect—is even more apparent. States with above average rates of growth in earnings per private worker tend to have below average rates of growth in tax burden. And, conversely, states with below average rates of growth in earnings per private worker tend to have above average rates of growth in tax burden.

For the U.S. as a whole, the average earnings per private, non-farm worker rose from $29,300 in 1993 to $46,200 in 2006, an increase of 58 percent. The 10 states with the fastest private earnings growth had an average increase of 69 percent, from $28,400 in 1993 to $47,900 in 2006. The 10 states with slowest private earnings growth had an average increase of 46 percent, representing a jump from $25,800 in 1993 to $37,700 in 2006. Maine stood in the middle of this group with an increase of 46 percent from $23,000 in 1993 to $33,600 in 2006.

Now, let’s look at these two groups from the perspective of tax burden—here taken to mean all state and local tax and fee revenue as a percentage of total private, non-farm, earnings. For the U.S. as a whole, this state and local tax burden fell nearly 3 percent between 1993 and 2006, dropping from just over 23 cents per dollar of private earnings to just below 23 cents.

For the ten states with the most rapid growth of private earnings per worker, the state and local tax burden declined nearly nine percent, from 24 cents per dollar of private earnings to 22 cents. Indeed, the tax burden fell in all ten of these states.

For the ten states with the slowest growth of private earnings per worker, the state and local tax burden increased over six percent, from just under 25 cents per dollar of private earnings to just over 26 cents. This burden rose in eight of the ten states. Maine is in this group. Its burden jumped from 28 to 30 cents per dollar of private earnings.

So is there a lesson in all this for Maine? There are, I think, two. The first is to forget personal income as a standard of measure. Yes, income is the source from which all taxes and fees must be paid, and yes, it’s an easy statistic to get for all fifty states and thus is very handy for making a new list every year. But it’s far too mixed a variable to make any useful comparisons. It presents not an “apples to oranges” problem, but an “apples to fruit bowl” comparison. Comparisons based on this measure generate far more heat than light.

The second, and more important lesson, I think, is that the question of tax burden is one of societal balance. How healthy is the public sector? How healthy is the private sector? Dynamic, prosperous economies need both. It is balance between the two that is critical. It is interesting that there is virtually no difference between the high private earnings growth states and the low growth states with respect to public employment as a share of total employment. In the high growth states in 2006, it was 15.4 percent. In the low growth states, it was 15.6 percent. The question is, “What are those public workers doing to enhance and promote private employment growth?” Where they are successful, the system remains in balance, the “burden” is part of the dynamic economy. Where they are not, the balance is upset, public expenditure does become a “burden” and the system risks falling into a self-reinforcing death spiral. This is the position Maine is in today. We must do all we can to stimulate private investment, job creation and earnings growth. The question is less about burden than balance. We must right the balance.

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