Do State and Local Fiscal Choices Matter?; S. Lile

THEFREEMAN IDEASON LIBERTY Do STATE AND LOCAL FISCAL CHOICES MATTER? by Stephen E. Lile S tates differ dramatically in overall levels of taxation and spending, and in the relative use of income, sales, property, and other tax types. They also differ in popula tion and economic growth rates. Whether or not fiscal choices affect economic outcomes is of interest, particularly during a period of slow economic growth such as the present. Milton Friedman (Newsweek, July 12, 1976,p. 58) commented on a study! of fiscal differences between Vermont and New Hampshire and observed that "Vermont spends more; Vermont relies more on the state relative to the local community, and Vermont has little to show in return." This note extends Friedman's fiscalcomparisons to three pairs of neighboring states Kentucky-Tennessee, New Hampshire Vermont, and Oregon-Washington-in an effort to see if there is any systematic relationship between fiscal choices, in par ticular taxation, and economic vitality as measured by income per capita and net migration.

The chart on the followingpage shows the latest data available on expenditures, taxa tion, net migration, per capita income, and growth in per capita income for three pairs of adjacent states. States with low taxes are shown to outperform their high-tax neigh bors in terms of income and immigration. Stephen Lile is a professor of economics at Western Kentucky University and a past presi dent of the Kentucky Economic Association. Tennessee, for example, collects about 13 percent less than Kentucky in state-local taxes relative to state personal income ($94 vs. $108). Tennessee's 1990 per capita in come is about 6 percent higher. Moreover, because Tennessee and Kentucky had the same per capita income in 1960, Tennessee income growth over the past 30 years is also about 6 percent greater than Kentucky's. An obvious indicator of a state's eco nomic vitality is whether people are on net moving into or leaving that state. In each of these pairs of states, the low-tax state at tracted more people as compared to its high-tax neighbor. Kentucky actually lost 110,000people during the 1980s,while Ten nessee gained 124,000.

Does the correlation between taxation and income/migration demonstrate that low taxes cause growth? No, but taxes influence location decisions of people and businesses and business decisions to expand, if non-tax factors are roughly equal. Non-tax factors are most likely to be similar in the case of neighboring states. An example based on family tax burdens2 illustrates why .tax burdens can affect growth. The 1990tax burden on a Memphis family ($2,591)with $45,000adjusted gross income is about $1,800 less than the tax burden on a family with the same income living and working in Louisville ($4,407). This implies that, other things the same, the Tennessee employer has a clear advantage 149 150 THE FREEMAN • APRIL 1993 State-Local State-Local Tax Direct State-Local Collections Growth In General Education Per $1,000 Broad-Welfare Personal Personal Expenditure Expenditure of State Based State-Local Net Spending Income Income Per Capita Per Capita Income Income Family Tax Migration Per Capita Per Capita Per Capita STATE 1990 1990 1990 Tax Burden* 1980-90 1990 1990 1960-90 Kentucky $2,607 $ 917 $108 Yes $4,407 -110,000 $389 $15,001 $13,458 Tennessee 2,605 884 94 No 2,591 +124,000 284 15,866 14,321 New Hampshire 2,963 1,099 83 No 2,121 +118,000 333 20,827 18,753 Vermont 3,600 1,511 122 Yes 2,885 + 23,000 472 17,511 15,652 Oregon 3,397 1,298 122 Yes 5,465 + 32,000 337 17,196 14,937 Washington 3,410 1,275 123 No 1,996 +293,000 427 18,775 16,458 Source: U.S. Department of Commerce, Government Finance, 1990-91; Current Population Reports, Series P-25, No. 1058; Survey of Current Business, August 1991; Lile and Philhours, Interstate Comparisons of Family Tax Burdens for 1990.

*The sum of state-local income, sales, and homeowner property tax. Assumes residence and employment in largest city of each state, a house value of $90,000 a family of size four with two wage-earners with combined adjusted gross income of $45,000. For methodology see Stephen E. Lile and Joel E. Philhours, Interstate Comparisons of Family Tax Burdens in 1990, Institute for Economic Development and Public Service, Western Kentucky University, 1991. over the Kentucky employer because he can pay labor less and still be competitive on an after-tax basis. The migration data for Ken tucky (-110,000) and Tennessee (+ 124,000) suggest that a portion of the benefit from Tennessee's lower tax burden accrued to labor in the form of greater employment opportunities and/or greater after-tax earn ings. The differences in family tax burden between Portland ($5,465) and Seattle ($1,996) and between Burlington ($2,885) and Manchester ($2,121) suggest that a sim ilar argument could be used to explain in part why immigration and income growth in Washington and New Hampshire exceed that in Oregon and Vermont, respectively.

No doubt many variables (some histori cal) account for why one state enjoys greater prosperity relative to another. The influence of fiscal choices, and taxation choices in particular, is likely to be greatest in the case of neighboring states because other factors such as climate and location are similar. Policymakers in high tax states, who might be inclined to dismiss supply-side argu ments as they apply to the national econ omy, might wish to reconsider the role that fiscal choices play at the state-local level where the opportunity for business and families to "vote with their feet" is greater. Both theory and experience seem to suggest that a state's fiscal choices do matter. D 1. Colin D. Campbell and Rosemary G. Campbell, A Comparative Study of the Fiscal Systems of New Hampshire and Vermont, 1940-1974, The Wheelabrator Foundation, Inc., 1976. 2. Stephen E. Lile and Joel E. Philhours, Interstate Com parisons of Family Tax Burdens for 1990, Institute for Eco nomic Development and Public Service, Western Kentucky University, 1991.

-FREDERIC BASTIAT What Is Seen and What Is Not Seen H ave you ever heard anyone say: "Taxes are the best investment; they are a life-giving dew. See how many families they keep alive, and follow in imagination their indirect effects on industry; they are infinite, as extensive as life itself'? The advantages that government officials enjoy in drawing their salaries are what is seen. The benefits that result for their suppliers are also what is seen. They are right under your nose. But the disadvantage that the taxpayers try to free themselves from is what is not seen, and the distress that results from it for the merchants who supply them is something further that is not seen, although it should stand out plainly enough to be seen intellectually. When a government officials spends on his own behalf one hundred sous more, this implies that a taxpayer spends on his own behalf one hundred sous the less. But the spending of the government officialis seen, because it is done; while that of the taxpayer is not seen, because-alas!-he is prevented from doing it.

IDEAS ON LIBERTY $ THEFREEMAN IDEASON LIBERTY THE COSTS OF TAX AND SPEND by John D. McGinnis I n 1992, Americans worked from Jan uary 1 to May 5 just to pay their taxes. According to the Tax Foundation, this por tion of the calendar year represents the portion of their total income Americans, on average, pay in taxes. But the whole truth about taxes and spending, however, is much worse than this. The Arithmetic Tax Freedom Day is calculated by adding up all the taxes paid (income taxes, sales taxes, property taxes, corporate taxes, so cial security taxes, user-fees, and so on) and dividing by the total income of individ uals. This result, approximately 34 percent, is then applied to the calendar year and becomes that portion of the year in which individuals work for government. The re mainder of the year after Tax Freedom Day is the time individuals work for them selves. As simple and straightforward as this calculation is, and as intuitively appeal ing as it is, it significantly understates the amount of government in our lives and consequently overstates the amount of free dom we have.