Should the "Rich" Pay Even More?

Understood the Social Contract

Wants to Breach It

Earlier this week the President defended his plan that would raise taxes on individuals who earn more than $250,000 per year.  Explaining why such individuals should pay more income taxes than they already do, the President opined as follows:

"There are a lot of wealthy, successful Americans who agree with me [that taxes should be higher] because they want to give something back. If you’ve been successful, you didn’t get there on your own. You didn’t get there on your own. I’m always struck by people who think, well, it must be because I was just so smart. There are a lot of smart people out there. It must be because I worked harder than everybody else. Let me tell you something -- there are a whole bunch of hardworking people out there.

If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business, you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet.”

As others have noted, the President's remarks basically repeat similar arguments made by Harvard Professor and Massachusetts Senate candidate Elizabeth Warren.  As Professor Warren colorfully put it:

"You [businesspersons] didn’t have to worry that marauding bands would come and seize everything at your factory — and hire someone to protect against this — because of the work the rest of us did."

The President's characterization of the relationship between business success and government contains some germs of truth.  After all, individuals leave the state of nature and enter civil society precisely because they believe they are better off with some government than with no government at all.  Moreover, by consenting to live in a civil society, individuals necessarily cede to the larger community a portion of their liberty and a portion of any property they might create or acquire.   In particular, no member of society can exercise his or her liberty or right of property in a way that interferes with similar rights held by others.  As James Madison noted over two centuries ago in Federalist 10, the primary function of government is to protect the liberty and property of each member of society from invasion by others.  Moreover, the same State that protects liberty and property can also execute public works projects that confer benefits on the larger community, projects that no individual or collection of individuals can complete on their own.  Finally, it is not enough that the State protect individuals from each other; the State must also protect itself from external threats by other states.

These various activities implied by the Madisonian social contract are not free; they require the expenditure of real resources. To protect property rights against theft or invasion the state must hire police, judges and prison guards. To enforce contracts the state must hire judges and sheriffs, the latter of whom enforce judicial judgments. To provide national defense or build roads, bridges and other infrastructure governments must levy taxes on individuals and business and enforce those levies with coercion if necessary. Without such coercion, the state would have to rely upon voluntary contributions to pay employees of the State and provide the resources necessary for various infrastructure projects.  It thus seems irrefutable that government and governmental expenditures are necessary conditions for the creation of wealth in the private sector and that government plays a role in the success of every business. (As Professor Warren would say, Ford Motor company cannot make and sell automobiles unless the State protects Ford’s property from trespass by others.  Though it should be noted that individual states, and not the national government, are primarily responsible for protecting factories from "marauding bands.")  

Still, the fact that free enterprise depends upon a well-functioning State that enforces property rights and builds infrastructure does not mean that business owners should feel duty-bound to "give something back" to the State or the larger community.  This assertion, made by the President and many of his supporters, is a non-sequitur.   For, as previously explained on this blog, a State that recognizes and enforces property rights is simply fulfilling its pre-existing obligation under the Madisonian social contract described above; if the State declined to protect property rights and bodily integrity from invasion by others, individuals would have no duty to obey the State's commands.    Moreover, the State does not perform the various functions described above for free, gratuitously showering its citizens with such protections and infrastructure.  Instead, the State levies taxes on individuals and businesses, employing a portion of the proceeds to pay for these various activities.  Indeed, in 2009, individuals in  the top 1 percent of the nation's income distribution paid over 36 percent of all Federal income taxes, that is, 36 times their pro-rata share of government expenses.  Such individuals also paid billions of dollars in state and local sales, property and income taxes.  All in all, then, the "rich" individuals that President Obama and Senator Warren wish to tax even more are already paying their share of governmental expenses several times over.  While such individuals might create more wealth within the free enterprise system than others, such economic success does not alter the terms of the social contract or the rationale for taxation derived therefrom. The state's performance of its pre-existing obligations under the social contract does not thereby justify whatever tax rates the majority might wish to impose.

To be sure, some individuals might sincerely believe that they have an obligation to "give something back."   If so, such individuals should feel perfectly free to increase their donations to charity, overpay their taxes, or both.  However, the fact that some individuals believe they are undertax does not thereby entitle the polity to impose higher taxes on other individuals who already pay far more than they receive in return.

President Obama's Rejection of Economic Science

Thought the Earth was Flat

Thinks Tax Cuts Slow the Economy

Embraced Economic Science for the Common Good

A recent survey (discussed here) finds that Conservatives are losing faith in Science.    Remarks by President Obama in Iowa earlier this week (reported here by USA Today) suggest that he, too, has abandoned some basic tenents of science, in this case, economic science.  In particular, the President accused Republicans of clinging to policies that would, in his words "double down on some of the policies that didn't work and got us into this mess in the first place."  According to the report in USA Today, the President "cit[ed] in particular proposed tax cuts for the wealthy" as examples of such policies that caused the current downturn and would, if maintained prevent recovery.  The "tax cuts for the wealthy," of course, referred to the 2001 across-the-board reduction in tax rates advocated by President Bush and passed by Congress.

Perhaps USA Today has mis-reported the President's remarks.  If not, the President has apparently decided the repudiate basic science.    There is simply no plausible economic theory or evidence supporting the President's claim that tax cuts for the wealthy or  tax cuts for anyone else, result in an economic downturn.  On the contrary, tax cuts put more money in the pockets of consumers, including rich consumers, who in turn spend a portion of this new wealth, thereby increasing aggregate demand and national output.   See N. Gregory Mankiw, Macroeconomics, 296 (7th Edition 2010) (explaining how tax cuts increase aggregate demand and thus increase national output).   This result is a basic scientific fact, taught annually to thousands of college freshmen annually across the country.  Indeed, the nation's unemployment rate remained below 5.0 percent for all 24 months in 2006-2007, compared to a peak of 5.7 percent the year Congress enacted the tax cuts the President Obama has decried.  (Of course, there were other sources of fiscal stimulus during the first term of the Bush Administration, including increased military spending, such that the tax cuts were not the sole source of economic stimulus.) There is only one circumstance in which tax cuts will not increase output and employment, namely, when the economy is already at full employment.  While tax cuts (or spending increases) will increase aggregate demand in these circumstances, national output will remain the same, because society is already employing all of its resources in their highest-valued uses, with the result that national output is at its maximum.  No one argues that the current economy is at or near full employment.

The President's rejection of scientific fact and theory in this context is particularly odd.   After all, the centerpiece of the President's economic recovery program entailed a so-called "Stimulus Package" of nearly $800 Billion (discussed previously on this blog), spread out over five years, a portion of which included tax cuts.  The logic of the stimulus package depends upon the very same economic models establishing that tax cuts, even tax cuts for the rich, stimulate aggregate demand and national output.

It is also noteworthy that President Obama's attitude toward economic science stands in stark contrast to the approach taken by President Kennedy, pictured above with Dr. Walter Heller, who chaired the Council of Economic Advisors during the Kennedy Administration.  As previously explained on this blog, President Kennedy advocated across-the-board tax cuts as a means of "getting America moving again," the theme of his 1960 presidential campaign.  In so doing, he followed the advice of Heller and others who understood that across-the-board tax cuts would stimulate the economy, not get us into a "mess" as President Obama now claims.

Of course, across-the-board tax cuts are not the only means of stimulating the economy.  The national government could also rely upon spending increases and/or an expansive monetary policy.  Moreover, the government could reduce taxes for lower income and middle income workers.  Nonetheless, any claim that extending such cuts to "the rich" will cause an economic downturn is akin to the claim, by Thales of Miletus, pictured abouve, that the earth is flat.

California Exercising Freedom to Fail

No Longer a Land Worth Finding

In a recent Op-Ed in the Wall Street Journal, former Florida Governor Jeb Bush reminded us that true freedom includes the freedom to fail.  As he put it:

"We have to make it easier for people to do the things that allow them to rise. We have to let them compete. We need to let people fight for business. We need to let people take risks. We need to let people fail. We need to let people suffer the consequences of bad decisions. And we need to let people enjoy the fruits of good decisions, even good luck. That is what economic freedom looks like. Freedom to succeed as well as to fail, freedom to do something or nothing."

Bush, of course, was referring to the economic freedom of individuals and the businesses they own and create to compete in a free market.  But similar considerations apply to states in a system premised upon competitive federalism.   In such a system, states are free to make fiscal and regulatory decisions, so long as those decisions do not interfere with the authority of other states.  (For instance, Virginia is free to raise taxes on its own citizens; it may not raise taxes on citizens of New York.)  This freedom also empowers states to compete with one another for citizens and investment capital.  Thus, a state that offers an attractive mix of fiscal policy and regulation will presumably attract individuals and investment capital, while those that offer unattractive fiscal and regulatory policies will see individuals and capital flee.

Just as individual economic freedom must include the freedom to fail, so too must competitive federalism include the freedom of states to fail if they embrace detrimental fiscal and regulatory policies.  Like individuals, states should suffer the consequences of their actions. 

California seems to be exercising this freedom to fail with a vengeance.   According to Bloomberg News, California Governor Jerry Brown has proposed yet another significant increase in state spending, at a time when the State is already running a large deficit and holds an "A-" credit rating from Standard and Poors.  This rating is significantly lower than that held by Virginia (AAA), Indiana (AAA), the United States of America, (AA+),   France (AA+), Japan (AA-), and Chile (A+), to take but a few examples.   Sovereigns sharing California's credit rating include Botswana, Malaysia, and Malta.   (Go here for a comprehensive list of nations and their credit ratings.)  Indeed, according to this source, California is tied for last among American states with Lousiana when it comes to S & P's rating of its debt.  Brown would finance part of this new spending with yet another increase in state income taxes, raising the rate on individuals earning over $250,000 per year a full percentage point, to 10.3 percent. 

California already has the third highest income tax rates in the nation, behind Hawaii and Oregon, both of which stand at 11 percent.  Its sales taxes are also among the highest in the nation.  At the same time, the state imposes burdensome regulations on business that inhibit job creation and economic opportunity.  It's little wonder, then, that California currently suffers from an unemployment rate over 11 percent, compared to a national average of 8.5 percent.  Nor is it surprising that the state has recently seen a net outflow of citizens, as more and more Californians leave the Golden State for states like Texas.  While those who found California cried out "Eureka" ("I have found it"), more and more are crying "let's get out of here."  Hopefully Americans will resist calls by some to force citizens in more responsible states to bail California out.

Lower Tax Brazil Overtakes Higher Tax Britain

Now Number Six

Brazil has apparently passed Great Britain to become the sixth largest economy in the world measured by GDP, according to this article in the UK Guardian.  (The United States is first, followed by China, Japan, Germany and France.)  Of course, Brazil's population of 203 million is more than three times that of Britain, with the result that Britain's per capita GDP is more than triple that of Brazil.  The Guardian article mentions several factors that it says account from Brazil's strong GDP growth relative to that of Britain.  For instance, Brazil has been exporting heavily to China, itself a rapidly growing economy.  Moreover, the banking and credit crisis in Britain, Europe and the United States has slowed the British economy as well as that of some of its trading partners.

The Guardian story leaves out another possible explanation for the divergence between British and Brazilian growth rates, namely, tax policy.  For, as previously reported on this blog, Brazil's top income tax rate is less than 30 percent, compared to a top rate of 50 percent in Great Britain.  (The top British rate, it should be noted, is the fourth highest in Europe, behind only Sweden, Denmark and the Netherlands.  In 2009, by contrast, Britain had the 13th highest rate in Europe.)  While Brazil has relatively high payroll taxes, one source reports that its tax to GDP ratio is nonetheless significantly lower than that of Britain's.  According to a previous article in the Guardian, some economists in Britain have contended that Britain's high tax rates are rendering the country less competitive internationally and slowing its growth.  Brazil's most recent triumph may be "exhibit A" supporting this assertion.  Nations rarely tax their way to prosperity.

Should Misleading Charts Accompany All Discussions of the Debt Ceiling?

Probably Not "Incoherent"

Useless Visual Aid

In a recent blog post, James Fallows, national correspondent for the Atlantic Monthly, asserts that one cannot both be concerned with structural budget deficits and simultaneously support the across the board tax cuts that President Bush convinced Congress to adopt early in his Administration. Fallows' main argument is a picture --- a chart, reproduced above, which originated in a recent opinion piece in the New York Times. The chart purports to quantify how various policy changes supported by Presidents Bush and Obama, respectively, have increased spending by the National Government and/or deprived the National Government of revenue it supposedly would have received. Among other things, Fallows claims that the chart "demonstrates the utter incoherence of being very concerned about the structural federal deficit but ruling out of consideration the policy that was the single largest contributor to that deficit, namely the Bush-era tax cuts." (emphasis in the original).

Fallows' assertion is unconvincing, to say the least. Here's why.

1. The chart inexplicably omits over $500 Billion --- the forgone revenue attributable to the two year extension of the Bush tax cuts to which President Obama agreed after the 2008 mid-term elections. (See this story.) Indeed, President Obama's own former director of the Office and Management and Budget, Peter Orzag, advocated such an extension shortly after he left the Administration. Fallows does not explain why we should ignore this forgone revenue.

2. The chart is also misleading in a more fundamental sense. In short, the chart is a gerrymandered portrayal of factors that drive spending, revenue and thus the deficit and resulting debt. In particular, the chart focuses exclusively on the fiscal impact of new programs adopted during the Bush and Obama administrations, respectively. Thus, the chart entirely ignores the cost of existing programs, adopted during previous administrations which, taken together, cost far more than the various programs and tax cuts portrayed in the chart. Indeed, according to one source, the National Government spent $28 Trillion in 2002-2010 alone. During 2002-2009, Fallows claims, the Bush tax cuts deprived the National Government of $1.8 Trillion in revenue, a figure that rises to about $2 Trillion if one includes the forgone revenue attributable to the cuts which Congress extended, with President Obama's agreement, after the 2010 mid-term elections. Thus, the Bush tax cuts equal a whopping 7.1 percent of the expenditures by the National Government during the period in question and are hardly the driving force in the current budget deficit, projected to reach $1.5 Trillion, or 10 percent of GDP, in 2011.

3. The chart ignores all sorts of tax deductions and loopholes, adopted before 2002, that, like the Bush-era tax cuts, deprive the National Government of revenue. Examples include the home mortgage interest deduction (including the deduction for second homes) and the tax exemption for employer-provided health insurance. (The former reduces annual tax revenue by $100 Billion per year.) Inclusion of these potential sources of revenue in the Fallows/New York Times Chart would reduce even further the apparent contribution of the Bush-era tax cuts to the deficit.

4. Finally, the chart and any arguments based upon it ignore entirely the long run link between structural deficits and economic growth (or lack thereof), a link emphasized by John F. Kennedy in his 1962 speech to the Economic Club of New York. As explained in an earlier post on this blog, JFK argued that across the board tax cuts during an economic downturn were the best way to encourage investment, work effort and economic growth and thereby, in the longer run, reduce the budget deficit. In JFK's own words:


"The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring about a budget surplus."

Of course, JFK did not believe that tax cuts alone would ultimately lead to a budget surplus. He also advocated spending restraint, arguing that reliance on government expenditures to stimulate the economy would "demoralize our government and the economy" and that government should not "spend more than can be justified on grounds of national need or spent with maximum efficiency."

In short, like Ronald Reagan two decades later, JFK believed that low tax rates were a precondition for economic growth and that tax cuts and spending increases had quite different impacts on the deficit over the longer run. Moreover, both Presidents advocated policies that helped innaugurate lengthy economic expansions and economic growth. Most Americans would gladly embrace the sort of "incoherence" that resulted in such strong and sustained economic growth and resulting job creation and economic opportunity.

Will President Obama Have to Soak the Middle Class?

Both men knew "where the money is."

An article last Monday in the Wall Street Journal "[w]here the tax money is" examined President Obama's purported claim that raising taxes on the wealthy will result in meaningful deficit reduction, thereby making the sort of spending reductions proposed by others, including Congressman Paul Ryan of Wisconsin, unnecessary. To this end, the article calculates the impact on federal revenue and thus the deficit of a 100 percent confiscatory tax on indivduals who earn $380,000 or more per year and finds that such a tax would raise $938 billion annually, far less than the current deficit of over $1.6 trillion. Moreover, a 100 percent tax on those individuals in the top five percent of the income distribution would yield $1.89 trillion, just enough to cover the deficit.

Note that these calculations certainly overstate the impact on the deficit of such confiscatory taxation. For one thing, the "wealthy" individuals in question already pay a sizeable portion of their income in taxes, with the result that the net increase in revenue resulting from a 100 percent tax rate would be less than the $938 billion and $1.6 trillion figures, respectively. Moreover, at least some individuals who must pay their entire salary to the government would work less, or not work at all, and thus create less income, if the government simply confiscated their income under the guise of "taxation." Such a reduction in work effort, of course, will also reduce the rate of economic growth and thus reduce the income of other citizens as well, thereby reducing tax payments from lower income groups. In short, even a 100 percent tax rate on high income earners, whether "high income" is defined as the top 1 percent or top 5 percent, defined, will still leave the United States with a very large deficit.

How, then, will the United States close its titanic budget deficit, if that is what she chooses to do? One way, of course, is to reduce spending, along the lines suggested by Congressman Ryan. If, however, the United States rejects meaningful spending reductions, the article predicts that Congress will, to quote bank robber Willie Sutton (pictured above), "go where the money is," that is, raise taxes (either directly, or by eliminating deductions) on indivduals in the middle and upper middle classes. For, as the article points out, individuals in the $50,000-$200,000 range produce more taxable income than individuals who earn over $200,000. Such an approach, it should be noted, would be consistent with the observation of nobel laureate Friedrich Hayek, also pictured above, to the effect that a chief function of high (progressive) tax rates on "the rich" is to induce individuals in the middle classes to accept rates that, while high in an absolute sense, are lower than those paid by the rich. (There is, of course, precedent for such an approach. In 1960, for instance, the top marginal federal income tax rate, levied on incomes of $400,000 and above, was 91 percent. Moreover, the marginal rate on income between $12,000 and $16,000 was 30 percent; the marginal rate on income between $24,000 and $28,000 was 43 percent, the marginal rate on incomes between $36,000 and $40,000 was 53 percent, the marginal rate on incomes between $88,000 and $100,000 was 72 percent, and so on. It short, while rates on the "rich" were quite high, so too were rates on individuals in the middle and upper-middle classes.) As Hayek put it:

"It would probably be true, on the other hand, to say that the illusion that by means of progressive taxation the burden can be shifted substantially onto the shoulders of the wealthy has been the chief reason why taxation has increased as fast as it has done and that, under the influence of this illusion, the masses have come to accept a much heavier load than they would have done otherwise. The only major result of the policy has been the severe limitation of the incomes that could be earned by the most successful and thereby gratification of the envy of the less-well-off."

See F.A. Hayek, "Taxation and Redistribution," in The Constitution of Liberty (1960).

Instead of simply redistributing income from rich to the middle class, such an approach would presumably also redistribute income within the middle class.

Hopefully the nation will opt for reduced spending instead of the Sutton approach.

Americans Are Voting With Their Feet For Low Taxes and other Pro-Growth Policies

CNN and Money Magazine recently announced a list of the 10 fastest growing cities in the United States, based upon figures from the most recent census. That is, the following ten cities had the fastest growth rates in the past decade:

1. Palm Coast, Florida, 92 percent.

2. St. George, Utah, 52.9 percent.

3. Las Vegas, Nevada, 41.8 percent.

4. Raleigh, North Carolina, 41.8 percent.

5. Cape Coral, Florida, 40.3 percent.

6. Provo, Utah, 39.8 percent.

7. Greely, Colorado, 39.7 percent.

8. Austin, Texas, 37.3 percent.

9. Myrtle Beach, South Carolina, 37 percent.

10. Bend, Oregon, 36.7 percent.

Obviously this list reflects the general movement in the American population toward the South and West. The list also seems to reflect a correlation between high population growth, on the one hand, and the low tax and pro-growth economic policies followed by the individual states where the cities are located, on the other. For instance the nine fastest-growing cities are in so-called "red" states, measured by whether a state voted for George W. Bush for President in 2004. Moreover, the six fastest-growing cities, and eight out of the top ten, are in so-called "right to work" states, that is, states that have opted under the Taft-Hartley Act to prevent unions and employers from negotiating "closed shop agreements," that is, collective bargaining agreements requiring employees to join a union as a condition of employment. (See here for a list of such states.) Also, three of the five fastest growing cities are in states (Florida and Nevada) with no income taxes. Finally, according to the Tax Foundation, eight of the ten cities listed, including seven of the top eight, are ranked among the states with the fifteen best tax climates for business.

The data thus show the American system of competitive federalism at work, with citizens moving to states that adopt pro-growth economic policies, e.g., low taxes and right to work laws. This blog has previously discussed other evidence of such competitive federalism at work. It should be noted that such competitive federalism is not a permanent or given phenomenon, but is instead the result of institutional choices contained in the Constitution itself and federal legislation. For instance, the Constitution divides power between the national and local governments, thereby depriving the national government of a monopoly over the content of tax and regulatory policy. Perhaps James Madison had this sort of competition in mind in Federalist 51, when he wrote:

"In the compound republic of America, the power surrendered by the people is first divided between two distinct governments, and then the portion allotted to each subdivided among distinct and separate departments. Hence a double security arises to the rights of the people. The different governments will control each other, at the same time that each will be controlled by itself."

Moreover, states cannot prevent their citizens from traveling to or moving to another state. See Crandall v. Nevada, 73 U.S. 35 (1868). This "fundamental right to travel" ensures that citizens may "exit" states whose economic policies thwart economic growth and wealth creation, and such exit no doubt explains much migration from one state to another. Finally, there is the Taft-Hartley Act, which allows individual states to opt out of that portion of federal labor law that otherwise allows companies and unions to negotiate closed shop agreements. None of this is to say that ALL federal legislation, for instance, facilitates competitive federalism. Some such legislation imposes a uniform federal approach to a regulatory question. In some cases such a unified approach is justified, as when an alternative approach would leave each state free to impose its own regulatory choices on interstate commerce. However, given the vast (and unjustified) scope of the national commerce power under current Supreme Court precedent, some such purportedly federal legislation applies to purely local matters, thereby eliminating the possibility of rivalry between states on matters of local concern. (At the same time, Congress does not always exercise all of the power the Supreme Court has given it. For instance, Congress still allows states to determine much of the content of corporate law, even though Congress possesses the authority under current law to impose a national corporate code.) Finally, some federal legislation affirmatively distorts rivalry between the states, subsidizing those that unduly tax their own citizenry. Thus, under the current tax code, citizens may deduct state taxes from their actual income when calculating that share of their income that will be subject to federal tax. As a result, a state that increases its taxes thereby deprives the national government of revenue the latter would otherwise receive, effectively shifting a portion of the state tax increase to citizens of other states, who must make up the lost federal revenue or, eventually, pay the interest on additional debt the national government must take on to meet its obligations. In short, competitive federalism can enhance overall economic welfare by preventing states from adopting legislation that infringes on economic liberty, and the census results reported by Money/CNN show the results of such federalism at work. At the same time, background rules that allocate too much power to the national government and impact the incentives that states face can dampen such competition and thus undermine (in part) its welfare-increasing properties.

Federalism at Work Protecting Economic Liberty

A recent study by Americans for Tax Reform finds that states with high taxes and pro-union labor laws are losing citizens and thus losing influence in Congress (and, it should be noted, the Electoral College.)

In particular the study finds that eight states are projected to gain at least one Congressional seat as a result of the 2010 Census, with the gains distributed as follows. Note that the states highlighted in red cast their electoral votes for George W. Bush in 2004, while those highlighted in blue cast their for John Kerry.

1) Texas (4 seats);

2) Florida (2 seats);

3) Georgia (1 seat);

4) Nevada (1 seat);

5) South Carolina (1 seat);

6) Utah (1 seat);

7) Washington (1 seat);

The same study finds the losses distributed thusly:

1) New York (2 seats);

2) Ohio (2 seats);

3) Illinois (1 seat);

4) Louisiana (1 seat);

5) Massachusetts (1 seat);

6) Michigan (1 seat);

7) Missouri (1 seat);

8) New Jersey (1 seat);

9) Pennsylvania (1 seat);

The results have obvious ramifications for the 2012 Presidential Election. In particular, the results show a net gain of six electoral votes for states that cast their votes for George W. Bush in 2004 over John Kerry. Recall that, in 2004, President Bush received 286 electoral votes --- 16 more than the 270 needed to prevail. If the same states vote for the Republican candidate in 2012, that candidate will receive 292 electoral votes. As a result, such a candidate could lose, say, Ohio (18 electoral votes in 2012), and still prevail. That is to say, the electoral map is shifting in favor of the Republicans.

The study also finds that, among the states gaining seats, the average top tax rate on personal income is 2.8 percent, while the average top rate in states losing seats is just over 6 percent. Moreover, 7/8s of the states that gained seats have passed so-called "right to work laws." Such laws, authorized by the Taft-Hartley Act of 1947 (passed over President Truman's veto) prevent Unions and employers from negotiating collective bargaining agreements that require employees to join or financially support a union as a condition of employment with the employer in question. States that decline to adopt so-called "right to work laws" are known as "closed shop states."

For proponents of economic liberty, the message of the study is clear, namely, states with low taxes on high income earners and a favorable climate for business create economic opportunities and thus attract in-migration, while states with high taxes on the well-to-do and unfavorable business climates stultify economic growth and induce out-migration. These proponents would also view such migrations as part and parcel of a well-functioning system of federalism whereby states compete with one another for productive citizens and capital. Such competition, they would argue, deters states from adopting unduly onerous regulations and taxes at the behest of special interests, thereby providing a bulwark against economic oppression.

Proponents of high taxes and closed shops might interpret this data in a different way, however. These analysts might see these data as reflecting a "race to the bottom," that is, destructive competition between the states for high income individuals and businesses hostile to unions. Under this view, states compete with each other by lowering taxes and relaxing protection for workers, thereby undermining the ability of each state to generate sufficient tax revenue to support essential functions as well as the ability to ensure fair wages and working conditions for labor. Adherents to this view would presumably decry the system of federalism that allows this competition to take place and, for instance, advocate repeal of that portion of the Taft-Hartley Act that authorizes states to pass right to work laws.

My own sense is that any "race to the bottom" characterization of these data is strained. I have no doubt that such races can occur. For instance, absent federal regulation, individual states may adopt lax anti-pollution regulation if pollution produced by industrial activity crosses state lines. (Imagine, for instance, a factory in one state that emits pollutants into a river that then flows through several other states.) In such cases, no individual state captures the full costs and benefits of the legislation it passes because of negative externalities flowing from the activity in question. In these settings, it is appropriate for the national government to step in and impose a uniform solution. When it comes to income tax rates and right to work laws, however, any supposed externalities are far less apparent. With respect to these policies, then, states seem to operate more or less as "single owners" of the costs and benefits of legislation they impose. For instance, if a state raises taxes and spends the proceeds on police protection or sanitation, the state's own citizens will benefit and property values will rise. (While other expenditures, e.g., on education, may produce some spillovers, as educated citizens might move elsewhere, the appropriate response to such spillovers would seem to be some national expenditures on education, funded via national taxation, instead of giving individual states the ability to tax and spend without consequence.) Moreover, if "closed shop" laws make industries and workers more productive, then states will adopt such laws as a means of attracting labor and capital. Finally, the size of population flows seems large enough to suggest that working class individuals, that is, individuals supposedly helped by laws allowing closed shops and high taxes on the wealthy, and not just those in the upper income brackets, are moving to low-tax, right to work states.

It should be noted that the "federalism" mentioned here is not of a constitutional dimension, at least according to the jurisprudence of the Supreme Court. Under current Supreme Court case law, Congress could, if it wished, eliminate right to work laws altogether, allowing unions and employers to negotiate "closed shop" arrangements in any state. Indeed, that was the state of the law between passage of the National Labor Relations Act in 1935 and its amendment via the Taft-Hartley Act. (Though it should be noted that, in 1935, the Supreme Court still enforced limitations on Congress's Commerce power, thereby limiting the scope of the NLRA to business of the sort that, if crippled by a strike, would place a direct burden on interstate commerce.) Moreover, Congress could, if it wished, provide citizens in high tax states with tax federal credits that compensate citizens in high tax states for the tax premium they pay compared to their fellow citizens who live in other states. (Indeed, under the current tax code, taxpayers can generally deduct any state taxes they pay from their gross income, and this rule functions as a federal subsidy of sorts for high tax states.) Still, Congress has chosen NOT to take these steps, thereby facilitating competition among the states for labor and capital, competition that deters oppresive taxation and fosters labor and other laws friendly to wealth and job creation. In so doing, Congress seems sensitive to the admonition of James Wilson, perhaps the most under-appreciated of the Founding Fathers, pictured at the top of this post. According to Wilson, describing the appropriate boundaries between state and federal power at the Pennsylvania Ratifying Convention:
"Whatever object of government is confined in its operations and effects, within the bounds of a particular state, should be considered as belonging to the government of that state; whatever object of government extends, in its operation or effects, beyond the bounds of a particular state, should be considered as belonging to the government of the United States."
Fortunately Senator Robert Taft, pictured after Wilson above, and other supporters of the Taft-Hartley Act, agreed with Wilson.

Why Is California Collapsing ???

I.O.U.

Over the past couple of days I have come across two articles with very different diagnoses of California's fiscal crisis. One article, by Kevin O'Leary in Time Magazine, lays the blame for the crisis on Proposition 13, a Constitutional Amendment approved by California voters in 1979 that limits the property taxes that localities may levy. Because of Prop. 13, the argument goes, the state legislature must appropriate more and more money for projects and activities, such as public education, normally funded at the local level. As a result, the state has no little money left over for projects at the state level ordinarily funded by the state legislature.

A second article, by Kevin Hasset of the American Enterprise Institute, argues that California's troubles are the result "an orgy of spending" leading to its $26 Billion deficit. Having stated this conclusion, he then argues that California's experience is a cautionary tale for President Obama and his various expensive proposals.

O'Leary's hypothesis is shared by many, but it is only that, a hypothesis. Moreover, it is subject to a simple empirical test. The theory implies that states like California would derive less tax revenue overall, because of the Proposition 13 constraint, than states without such a restraint, thereby explaining the "gap" between spending and revenues in California. (After all, if California obtains more tax revenue from its citizens that other states, then the distribution of those receipt between state and local government should not logically impact the state's ability to provide services equal to the value of such revenues.) The theory also implies a subsidiary thesis, namely, that in California, local spending would constitute a smaller portion of overall state and local spending combined than in other states.

The data are inconsistent with both predictions and thus seem to falsify the O'Leary hypothesis.

According to the U.S. Census Bureau, California raised $236,646,725,000 in state and local revenue in during the 2005-2006 fiscal year, when its population was 36.1 million. That's $6,555 per person. (2005-2006 is the most recent year for which data are available at the census website.)  By contrast, during the same fiscal year, Utah raised $13,275,165,000, on a population of 2.5 million, for a total of $5,310 per person.

That is, California raised 23 percent more revenue per person than Utah in 2005-2006.

Utah, it should be noted, is not idiosyncratic. During the same period, Virginia, with a population of 7.5 million in 2005, raised $44,144,819,000, or $5867 per person, a figure closer to Utah than California. Indiana's tax revenue was also less than $6,000 per person. Here is the Census website, with the data on revenues and spending. 2005 population figures come from other reliable sources, e.g., Census press releases and a report from a think tank at UVA.

Note that a different source puts California per capita taxes in 2005 at $7,253.00, compared to $5,889.10 for Virginia, $5,811.8 for Utah and $5,710.10 for Indiana. Again, California's per capita spending is between 23 and 27 percent higher than that in Virginia, Utah and Indiana respectively.

What about the subsidiary thesis, i.e., that California localities will collect a smaller share of overall state taxes than localities in other states ? Here again, the data apparently contradict the O'Leary thesis. According to data on the same website listed above, California localities derive a LARGER share of overall state tax revenue than the localities in the other three states mentioned. Here are the figures, i.e., the percentage of overall state tax revenue taken at the local level, in the 2005-2006 fiscal year.

California 43 percent.

Virginia 41 percent

Indiana 41.8

Utah 36 percent.

Absent some equivalent to Proposition 13 in these three states, one must respectfully disagree with Mr. O'Leary' hypothesis. Spending, not some inability to tax, is the problem in California.

Note also that, from 1992-2004, a period with relatively low inflation, total state spending in California nearly doubled, according to from $123.9 billion, to $240.2 billion. It's hard to characterize California as a low tax state.

F-22 Stimulus ?

Economic Stimulus ?

This morning Martin Feldstein, who chaired President Reagan's Council of Economic Advisors, weighs in on the version of the stimulus package the House passed yesterday. Among other things, Feldstein argues that some of the debt-financed federal spending will simply displace debt-financed spending at the state level, an argument I made in my previous post. He also argues that spending on infrastructure projects, e.g., roads and bridges, won't take place until it is too late to counteract the current downturn. Moreover, he contends that temporary tax cuts will provide little stimulus, since consumers will simply save the cuts, knowing that they will have to pay higher taxes two years from now. While savings is generally a good thing, Keynesians at least believe in the "paradox of thrift," i.e., if everyone saves too much, aggregate demand will suffer, and the economy will spiral into recession, unless the government borrows the savings and spends it. By contrast, it is said, so-called Classical economists believed that "too much" savings would reduce interest rates and therefore increase investment and long term economic growth, pursuant to "Say's Law."

How, then, would Feldstein stimulate the economy ? He proposes rapid increases in military procurement and construction of military bases. The F-22 Raptor, pictured above, costs over $100 million apiece. Instead of spending billions on mass transit programs, perhaps we can buy another 50 Raptors? Feldstein does not mention Raptors; he may have in mind more mundane items such as ammunition and spare parts depleted during the wars in Iraq and Afghanistan.

Note that Feldstein's conclusion regarding the non-efficacy of temporary tax cuts follows naturally from Milton Friedman's "Permanent Income Theory of Consumption." See Milton Friedman, A Theory of the Consumption Function (Princeton 1957). According to Friedman, individuals make their consumption decision based upon their expectation of their long term "permanent income" and not simply the income they expect in a particular year. Hence, a temporary cut in tax rates, for instance, will have only a modest impact upon consumption, because the cut will have only a modest impact on the consumer's expected income over time. By contrast, a permanent reduction in tax rates will, other things being equal have a larger impact on consumption.

Here is Feldstein's op-ed, from the Washington Post, entitled: "The $800 Billion mistake."

Query whether Feldstein's implicit adoption of Friedman's hypothesis undermines part of his argument. For instance, while infrastructure projects might not literally create jobs within, say, the next six months, they may create the expectation of jobs (and profits for the firms that perform them) and thus increase the permanent income for thousands of individuals, thus increasing consumption expenditures sooner than one might otherwise think.