Austin Guest & Nathan Newman

A progressive solution to the state budget crisis

Amidst the current economic downturn, states legislatures across the country are faced with some of the tightest budget crunches in recent memory.  According to the Center on Budget Policy and Priorities,There are currently 20 states facing a combined budget shortfall of $35 billion in 2009, with 8 more projected to enter the red in 2010.  With over half the country’s states facing immanent deficits and the rest struggling to stay in the black, the temptation in most statehouses has been to “tighten up the belt,” slashing spending on crucial social services and trimming back the public workforce wherever possible.

This slapdash strategy is  a recipe for disaster.  At a time when private spending is already plummeting, laying off state workers and cutting off help to those in need is the last thing our ailing economy needs.  A far more humane and farsighted solution would be to seize the current economic challenges as an opportunity to create a fairer tax system; one  that would increase state revenues, extend help to those most in need, and ask corporations and the wealthy to do their fair share to help the country through tough times.

But are such measures actually fair?  You bet.  As rarely goes noted in the mainstream media, most working families currently pay a higher percentage of their income in taxes than do wealthier citizens.  This is because flat sales taxes hit working class families harder than wealthier citizens, since working families spend a disproportionately high percentage of their income on basic goods.  The result that, as the Institution on Taxation and Economic Policy recently emphasized, “only four states require their best-off citizens to pay as much of their incomes in taxes as middle income families have to pay.”

But would such measures actually be good for the economy?  Sure.  A recent study by Columbia economist Joseph Stiglitz maintains that budget cuts hurt the economy more than tax increases because cuts come dollar-for-dollar out of the economy, while a tax increase, if targeted at the wealthy, “reduces savings rather than consumption, lessening its impact on the economy in the short run.”  Simultaneously, expanding state earned income tax credits for working families would provide an immediate stimulus to the economy by triggering an uptick in consumption by low-wage families, who generally spend tax savings on immediate needs such as groceries, retail goods, and services.

So, assuming that a less regressive tax system is both fair and good for the economy, what’s the best way to go about instituting it? 

The first and most obvious step is to strengthen the progressive income tax by creating higher tax brackets for wealthier tax payers.  In 2004, New Jersey fielded a major budget deficit by creating a 8.97% tax bracket for those making $500,000 a year or more.  Only 30 thousand households saw a tax increase, while 1.8 million got a tax cut.  The New Jersey legislature would do well to keep those recent successes in mind as they field Governor John Corzine’s current plans to gut spending to field the state's budget crisis.

Legislators could add to the benefits of a more progressive income tax by extending the sales tax to legal and financial services used more heavily by rich consumers.

The second step is to resist the temptation to institute property tax caps in the face of the housing market meltdown.  Rather than cap property taxes, which would deliver most of the relief to wealthy property owners who need it least, legislatures should institute property tax “circuit breakers,” which limit property taxes to a percentage of most homeowners’ incomes while fully taxing the property of wealthy owners.  The benefits of such an approach were validated by the results of a recent Connecticut study.

The third step is to cut corporate tax loopholes.  Part of why social services such as Medicaid and Medicare are experiencing a funding crisis is that corporate income tax revenues have dropped from 9.7% of state tax revenue to just 5.7% over the last 3 years.  A 2005 study by Citizens for Tax Justice found that 252 of America’s largest corporations failed to include two-thirds of their U.S. profits on state tax returns, thus avoiding as much as $33 million in taxes a year.

Legislatures could combat this upsurge in corporate tax dodging by requiring corporations to list reports for all subsidiary companies, thus preventing companies such as Wal-Mart from hiding profits through phony transactions among subsidiaries.  They could decouple state tax breaks from federally granted special interest tax breaks.  And they could place a windfall tax on the record profits currently being pulled in by Big Oil.  A recently proposed windfall tax program on oil companies in Washington State is estimated by the Economic Oportunity Institute to raise as much as $500 million a year.

Thus upshot is clear: as economic slowdowns take a bite out of state revenues, cutting off support for those families whose budgets are taking the biggest hits is not the answer.  The real solution is to ask those who have done especially well during the good times to contribute more when things get tougher.  By extending the progressive income tax, instituting property tax circuit breakers, and eliminating corporate tax loopholes, states could produce much-needed short term economic boost while producing long-term fixes to our currently regressive tax system. 

It’s a pretty clear cut solution.  The real question is why more states aren't already instituting it.

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Posted at 7:41 AM, Mar 19, 2008 in Economy
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