Wednesday, May 27, 2009

California collects so much in taxes, how can it be broke? We might ask about New York and New Jersey as well.

California is hosed. Observers agree. It's stuck with a $21 billion budget gap to close, and no good way to close it after voters defeated in a special election a plan by the state's powers-who-are to do so. Governor Schwarzenegger now is thinking ahead now to if he can get a job as the star of Terminated Terminator V. In the meantime he's refurbishing his image by driving around in a SUV powered by vegetable oil.

How did this happen? Commentators running the political gamut from Bill Maher to Paul Krugman say it is because of California's "voter initiatives", in which voters can directly mandate spending programs while, allegedly, blocking taxes to pay for them.

You see, our state is designed to be ungovernable because we govern by ballot initiative, and we only write two kinds of them: "Spend money on things I like" and "Don't raise my taxes."

More money for teachers and firefighters? Check "yes"! High-speed rail? "Cooool!" Drug treatment for former child actors? "Sure, why not?" But don't even think of taxing me for any of it ... [B.M.]

The seeds of California’s current crisis were planted more than 30 years ago, when voters overwhelmingly passed Proposition 13, a ballot measure that placed the state’s budget in a straitjacket. Property tax rates were capped ...

Even more important, however, Proposition 13 made it extremely hard to raise taxes, even in emergencies: no state tax rate may be increased without a two-thirds majority in both houses of the State Legislature ...

... the Republican rump retains enough seats in the Legislature to block any responsible action ... the Republican Party has been driven mad by lack of power ... [P.K.]

Complaints about the voter initiatives sound plausible, and are partly right. The right part is that voter referendums that mandate spending for selected programs while removing them from the control of the legislature do indeed make the state less "governable". But the Maher-Krugman axis of allegation also makes it sound as if California is somehow institutionally inhibited from raising taxes ... and that its crisis results from collecting too little in taxes.

Yet looking at data for state-and-local tax collections for each state as a percentage the income of its residents, one finds...
# 1. New York 8.8%
= 2. California 7.9%
= 2. New Jersey 7.9%
Having the 2nd-highest taxes in the nation seems hard to square with being saddled with a political system that keeps taxes too low -- and having a budget crisis being caused by under taxation.

Another interesting thing about these three highest-tax states jumps out of the data...
Together, New York, New Jersey, and California face some $65 billion in budget deficits in 2009, amounting to more than two-thirds of the budget gaps faced by all 50 states. [City Journal]
Wow. The states with the highest taxes have the biggest budget gaps, by far!

That fact is rather hard to square with the model of state fiscal governance, which we might call the "Krugman/wise politicians/cheap taxpayers" model, that says about fiscal crises:

“The legislature responsibly decides the level of spending and allocates it wisely, but voters refuse to pay enough taxes to cover it, so budget deficits and crises result. If only we can convince the voters to pay more in taxes, budgets will be balanced and all will be well”.

Instead, it looks a whole lot more consistent with the "Milton Friedman/public choice economics/ Bastiat" model of fiscal crunches...

“Special interest groups capture the political spending allocation process and allocate funds to themselves profligately. Taxes shoot up to pay for it, but can’t stay even, as the more tax collected the more the groups spend. In the end, spending is constrained only by the size of the deficit and/or a fiscal crisis.”

In California, the proposition system is indeed a way for special interest groups to capture the funding allocation process. But is there any evidence it has kept total tax collections down?

I can tell you that this "capture, spend, then tax" process is in play for sure here in New York — the #1 tax collection state. Facing an $18 billion deficit this year the legislature decided to ... increase spending by 8% over the prior year (no cuts for us!) and pay for it by imposing 52(!) new taxes -- from taxes on wine, and on consumers' utility bills, and on nuclear plant operators, to new higher top income tax brackets for all.

But surprise! Just one month later they’ve discovered they misjudged — and after all those tax increases the deficit is back again at $3 billion. And now, good gosh, they are saying they may be forced to make some spending cuts. Which model does that sound like?

Here’s one actual example of “capture” in action here in New York State — it’s not as glib as Maher, nor as partisanly vitriolic as Krugman, but factual examples can be more revealing than either glibness or rhetoric.

One of the 52 new taxes is a payroll tax dropped on Dutchess County, 70 miles away from New York City (and on the city's other surrounding counties) to subsidize the NYC subway and bus system, the MTA. Even though Dutchess is an hour’s drive from the nearest subway station.

Why? Because the MTA pays, oh, 150%-to-double market wages (at the time of the last strike its bus drivers made $63,000, compared to average US household income of $45,000; its sales clerks make $24 an hour, etc.) plus full pensions at age 55 after only 25 years of work. And these labor costs are written into state law (say "capture"!) so if Mayor Bloomberg ever wanted to negotiate them down via collective bargaining ... well, legally, he can’t.

The exorbitant cost that results has to be paid from somewhere. Fares can’t carry it, so in recent years the MTA received a share of the city’s property taxes. That was quite a bonanza during the real estate boom — but the MTA consumed it all without saving any, and now the boom has busted, and so is the MTA.

That money now has to come from somewhere else, because that spending sure isn’t going to be cut(!) ... but the political pain of dropping more tax on NYC (merely because it is the city’s transit system being paid for), the highest-taxed place in the nation already, is too high ... someone has to pay ... so it’s Dutchess county, and the other counties around NYC, first, because they’re closest.

Now Bill Maher might say: “If New Yorkers vote to spend so much on their MTA, they have to be willing to pay the taxes that it will cost.”

To which the people in Dutchess County might respond: “Who voted?”

And if up there in Dutchess they start a tax revolt over this (there are mutterings) and a state fiscal crisis ensues ... will Paul Krugman say that it is because New Yorkers don’t pay enough taxes?

* Tax data for 2007, the last year data is not distorted by the recession, from the Tax Foundation, "per capita taxes paid to home state" divided by "per capita income".