Taxing Something Doesn't Make it More Valuable

From an article in the Wall Street Journal:

Last year, Congress sharply increased the federal excise tax on "little" cigars—filtered, often sweetly favored products that are similar in size and shape to cigarettes.
...
Sales of products listed as "little" cigars fell by 79%.

The projected increase in tax revenues generated by this tax increase on little cigars was supposed to be used to help finance the expansion of a children's health-insurance program backed by President Barack Obama. But with the decrease in sales, the money just wont be there.

This is just common sense. Taxes create market distortions because those who would otherwise pay the taxes have an opportunity to change their behavior by buying something else (a replacement without the tax- see the story about how consumers have changed their purchasing behavior) or somewhere else where the punitive tax does not apply.

Thanks for reading.

James

Updated: State Revenues

Regular readers of this blog may remember an article I linked to back in June. It was a report from the Rockefeller Institute that discussed how State revenues were declining and predicted that states would end up having to again raise revenues and cut costs in the 2010-2011 budgets. I also posted my thoughts of the possibility of this happening last week.

Bloomberg has picked up the latest update from Rockefeller Institute and has this article:

State Revenue Falls Most Since 1963 on Incomes, Sales (Update2)

By Jerry Hart and William Selway

Oct. 15 (Bloomberg) -- U.S. state tax collections tumbled the most in almost half a century in the second quarter as the economic recession curbed levies on incomes and sales.

The 16.6 percent plunge was the biggest since at least 1963, the Nelson A. Rockefeller Institute of Government said today. For the 12 months to June 30, the fiscal year for most states, revenue declined 8.2 percent, or $63 billion, about twice what states got from the $787 billion U.S. economic stimulus package, the institute said.

State revenue has dwindled for two straight quarters and continued to decline in July and August, the Albany-based research organization said. Budgets for the year that began July 1 already face $26 billion of deficits, the Washington, D.C.- based Center on Budget and Policy Priorities said Aug. 12, forcing state lawmakers to confront additional spending cuts.

“We’re looking at a multiyear problem hitting essentially every state,” Robert Ward, the institute’s deputy director, told reporters. “It has happened during recessions before, but the depth of this decline is unprecedented in modern times.”

Collections dropped in 49 states in the second quarter as sales and personal-income taxes slid for the third consecutive period, the institute said. Income tax was down 27.5 percent and sales tax fell down 9.5 percent, its study said. Both categories fell by the most in 45 years.

“Many economists believe that the national recession has ended and that a tepid recovery is now underway,” Rockefeller analysts Lucy Dadayan and Donald J. Boyd wrote. “Unfortunately for states, an emerging economic recovery does not spell instant budget relief.”

‘Considerably More’

Figures for July and August for 36 early-reporting states showed tax collections down 8 percent, the Rockefeller Institute said. At least 17 states have announced budget shortfalls since July, with “considerably more” expected, Boyd said.

New York’s tax revenue from April 1 to Sept. 15 was $634.5 million below projections and $3.6 billion less than a year ago, Comptroller Thomas DiNapoli said yesterday. California reported last week that revenue trailed a forecast made less than three months earlier by $1.1 billion, or 5.3 percent.

States are anticipating more cuts to current-year budgets, already pared once to bring them into balance. Mississippi Governor Haley Barbour told managers on Oct. 13 to cut spending 5 percent because tax collections in the first three months of fiscal 2010 were 7.7 percent below estimates. Florida Governor Charlie Crist told department heads on Oct. 12 not to request more money for next year, when the state faces a $2.6 billion deficit.

“It’s clear that when governors propose their budgets in January, the vast preponderance will be looking for more spending cuts and tax increases,” Boyd said.

'Housing Market'

The main driver for the second-quarter decline was lower income-tax collections, Boyd said on a conference call, “most likely due to lower capital gains from market declines in 2008 and the bursting real estate bubble.”

Payroll-tax withholding fell 4 percent from a year earlier and estimated-tax payments made in the quarter fell 32 percent in the median state, he said.

“Real wages take 13 to 17 quarters to recover from the end of a recession,” he said. “It will take several years for states to bring spending into line with incomes.”

The study’s retail-sales index showed an 11 percent decline since the start of the recession in December 2007, he said. The second quarter’s 9.5 percent decline in sales taxes followed an 8.3 percent decline in the first quarter, he said.

Alaska’s tax income declined the most of any state, the study said, with an 86.5 percent drop because of lower oil prices. Vermont fared the best, with a 2.2 percent gain because of a one-time estate-tax settlement.

Local tax collections declined by 2.8 percent in the second quarter, the Rockefeller study said. That’s less severe than the state slowdown because municipalities rely more on property taxes, which rose “a surprising” 3.1 percent in the quarter, the report said.

Still, 88 percent of local finance officers said in a September poll by the National League of Cities that they’re less able to cover expenses than in the year before.

To contact the reporters on this story: Jerry Hart in Miami at jhart@bloomberg.net; William Selway in San Francisco at wselway@bloomberg.net.

A couple of points struck me. First, the fall in state revenues is of record proportions. However, while state revenues collectively declined 16.6%, local government tax revenues declined by only 2.8%. This disparity is due in large part to local governments being dependent upon local real estate taxes as opposed to income and sales tax. See the following chart from the Rockefeller Institute Report that depicts this:


Click on image to enlarge

Also from the report is the following statement:

Unfortunately for states, an emerging economic
recovery does not spell instant budget relief. As we have noted
previously, some elements of the economy that are very important
to state finances — particularly employment and wages — are
likely to recover more slowly than gross domestic product. In addition,
state tax revenue, when it does begin to recover, will be below
its earlier peak for at least several years and will not be
sufficient to support spending commitments that are now in
place. Despite the recovery, most states will face budget gaps this
fiscal year and next, and probably for at least one to two
additional years.

When I say state budgets are based on the past, this is exactly why. It is always a game of playing catch-up. Spending every dime in good economic times leads to the severe cuts we are seeing now.

If you like tables and charts and graphs, the Rockefeller Report is really a revelation. It contains a ton of information on every state comparing revenues, changes, and the effect of recent legislation.

One more point I need to make on this, and I did not see this in the Rockefeller Report, is that many states, if not most of them, used the Federal Stimulus funds to balance their budgets this year. I believe Pennsylvania used $3 billion to do just that. What this means is that every one of these states was already in a structural deficit before the new fiscal year began. Many states used that money as a one-time fill for their budget gap. The problem is, this is not a one-time revenue shortcoming. Tough decisions are going to have to be made.

Thanks for reading.

James

Tax Rates and the Local Economy

Some of the issues I pound on when it comes to the school board have to do with fiscal responsibility. With that comes the desire to reduce or lessen the growth of the tax burden on members of our community. That is not to say that the Board has the ability to reduce property taxes, I would never make that promise- not in an environment where property assessments are frozen at 2002 levels and where the District has contracts that increase every year. When I look out 2-5 years it is pretty easy to see what is coming down the pike. When you look at the more than $100 million high school, PSERs (which I will give an update on soon), and the contracts mentioned above, it is easy to see larger than 30% increases in property taxes here in Mt Lebanon. The only reason I say it probably won't be more than that is that I expect the State legislature will come up with a solution to address much of the PSERS expenses coming due in 2012. Call it wishful thinking if you like, but elected officials are in the business of getting re-elected and if they can't come to a solution on that single issue, there won't be many people getting re-elected in 2012. On many occasions I have opined about the coming tax increases and how we will compare to other Districts across the State. I have only touched on what the implications of such high taxes will be. It is those implications that I wish to address here.

To that end, I came across a speech given by Calvin Coolidge on February 12, 1924 in front of the National Republican Club. I don't know if I have ever read a speech by a President that so clearly illustrated the effects of high taxes on economic activity. While President Coolidge's speech was addressing the national economy, the effect of high taxes is the same whether at the federal level or local level. Below are some excerpts with my comments on sections that I think need highlighting:

In time of war, finances, like all else, must yield to national defense and preservation. In time of peace finances, like all else, should minister to the general welfare. Immediately upon my taking office it was determined after conference with Secretary Mellon that the Treasury Department should study the possibility of tax reduction for the purpose of securing relief to all taxpayers of the country and emancipating business from unreasonable and hampering exactions. The result was the proposed bill, which is now pending before the Congress. It is doubtful if any measure ever received more generous testimony of approval. Opposition has appeared to some of its details, but to the policy of immediate and drastic reduction of taxes, so arranged as to benefit all classes and all kinds of business, there has been the most general approbation. These recommendations have been made by the Treasury as the expert financial adviser of the Government. They follow, in their main principle of a decrease in high surtaxes, which is only another name for war taxes, the views of the two preceding Secretaries of the Treasury, both of them Democrats of pronounced ability. They are nonpartisan, well thought out, and sound. They carry out the policy of reducing the taxes of everybody, especially people of moderate income. They give to the country almost a million dollars every working day.

During World War I, taxes were raised to help fund the war effort. The United States still ended up borrowing billions of dollars to help fight the war, and we were also a major credit provider for our allies in that war. However, after the war ended, tax rates were not reduced to pre-war levels. President Coolidge in this speech is essentially calling for a return to the normalization of pre-WWI tax rates. As he said in his opening, he had no problem with financing a war with higher taxes, but in times of peace, he felt differently.

The proposed bill maintains the fixed policy of rates graduated in proportion to ability to pay. That policy has received almost universal sanction. It is sustained by sound arguments based on economic, social, and moral grounds. But in taxation, like everything else, it is necessary to test a theory by practical results. The first object of taxation is to secure revenue. When the taxation of large incomes is approached with that in view, the problem is to find a rate which will produce the largest returns. Experience does not show that the higher rate produces the larger revenue. Experience is all in the other way. When the surtax rate on incomes of $300,000 and over was but 10 per cent, the revenue was about the same as when it was at 65 per cent. There is no escaping the fact that when the taxation of large incomes is excessive, they tend to disappear. In 1916 there were 206 incomes of $1,000,000 or more. Then the high tax rate went into effect.

The next year there were only 141, and in 1918 but 67. In 1919 the number declined to 65. In 1920 it fell to 33, and in 1921 it was further reduced to 21. I am not making any argument with the man who believes that 55 per cent ought to be taken away from the man with $1,000,000 income, or 68 per cent from a $5,000,000 income; but when it is considered that in the effort to get these amounts we are rapidly approaching the point of getting nothing at all, it is necessary to look for a more practical method. That can be done only by a reduction of the high surtaxes when viewed solely as a revenue proposition, to about 25 percent.

I agree perfectly with those who wish to relieve the small taxpayer by getting the largest possible contribution from the people with large incomes. But if the rates on large incomes are so high that they disappear, the small taxpayer will be left to bear the entire burden. If, on the other hand, the rates are placed where they will produce the most revenue from large incomes, then the small taxpayer will be relieved. The experience of the Treasury Department and the opinion of the best experts place the rate which will collect most from the people of great wealth, thus giving the largest relief to people of moderate wealth, at not over 25 per cent.

This part of his speech perfectly illustrates the soundness of the Laffer Curve which was "discovered" in the 1970's by economist Arthur Laffer. The Laffer Curve suggests that there are two tax rates that will produce the exact same revenue. Think about it this way, at 0% tax, the government realizes no revenue and at 100% tax, there is no incentive to work and therefore the government again realizes no tax revenue. At various points along the graph coming down from 100% and up from 0%, there are points at which government can realize the same revenue. This is illustrated perfectly when Coolidge points out that tax receipts at the 65% tax rate were the same as when tax rates were at 10%.

A very important social and economic question is also involved in high rates. That is the result taxation has upon national development. Our progress in that direction depends upon two factors; personal ability and surplus income. An expanding prosperity requires that the largest possible amount of surplus income should be invested in productive enterprise under the direction of the best personal ability. This will not be done if the rewards of such action are very largely taken away by taxation. If we had a tax whereby on the first working day the Government took 5 percent of your wages, on the second day 10 per cent, on the third day 20 per cent, on the fourth day 30 percent, on the fifth day 50 per cent, and on the sixth day 60 percent, how many of you would continue to work on the last two days of the week? It is the same with capital. Surplus income will go into tax-exempt securities. It will refuse to take the risk incidental to embarking in business. This will raise the rate which established business will have to pay for new capital, and result in a marked increase in the cost of living. If new capital will not flow into competing enterprise the present concerns tend toward monopoly, increasing again the prices which the people must pay.

Taken altogether, I think it is easy enough to see that I wish to include in the program a reduction in the high surtax rates, not that small incomes may be required to pay more and large incomes be required to pay less, but that more revenue may be secured from large incomes and taxes on small incomes may be reduced; not because I wish to relieve the wealthy, but because I wish to relieve the country.

President Coolidge here is suggesting that allowing people to keep their surplus capital (and not the government) will lead to better economic growth. People will employ this capital in the most efficient way possible, in a way that gets them a return on their investment. His stated goal is to secure the largest possible amount of revenue to the federal government but not at the expense of stifling production. His plan to do this, under the guidance of Treasury Secretary Mellon, is to reduce the top marginal tax rates to 25%.

This legislation was past shortly after this speech and so began the "Roaring 20's". There were tremendous increases in overall GNP from just under $70 billion to over $103 billion in just over five years. And this happened without a jump in inflation, indeed, prices actually went down while GNP increased.

The point of this is to say that for decades (perhaps more) we have seen the impact that high taxes have on consumption and production. Many of those in favor of a large high school project here in Mt Lebanon like to say that an extra $60 per month is just a cup of coffee a day, or that its just one less dinner out per month. If that is the case then let me ask the obvious question. What if this actually turned out to be true? What if the residents of Mt Lebanon decided to give up their morning cup of joe or their monthly night out at dinner? What is the impact of that decision? How many people from Mt Lebanon do you think go to Aldo's or the Uptown each morning for coffee? How many people hit one of the restaurants on Washington Road or Beverly Road once a month or even once a week? What happens if all of these people actually DO reduce how much coffee they drink or how often they eat out? An increase of $60 a month in tax has the potential to take money directly from the productive part of our local economy (the coffee shops, the florists, the restaurants) and places it directly in the non-production part of local economy (debt service for a high school construction project).

This money will not go to hire more teachers to reduce class sizes. It won't expand programs. It won't make the District magically find ways to become more efficient. There most likely will not be an increase in student achievement and/or test scores due to a newly renovated building- although with our new Superintendent I hope this will happen anyway. The fact is that research does not show that constructing a new building will add anything to our ability to ready our kids for college and life after school. Isn't that what this should be all about?

The question that needs to be addressed has to do with how best to prepare our students for a constantly changing and ever more demanding future. Spending $100 million on bricks and mortar does not seem to be the best answer.

Thanks for reading.

James

Almanac Editorial

There was an interesting editorial in this week's edition of the Almanac. It touched on a lot of issues that need consideration when thinking of the Mt Lebanon High School project.

Here is the entire editorial:


Click on image for link.

Other articles keep popping up in local papers describing how the nation's credit crunch is affecting working and middle class families like the ones that live in Mt Lebanon (kudos BlogLebo for finding that story). While I personally believe that Mt Lebanon, and Pittsburgh more generally, will be spared the worst of the housing downturn, that does not mean we will escape unharmed. With so much of the nation's economy dependent upon consumer spending and that spending supported in large part by ever increasing home prices in recent years, the downturn we are experiencing now could last until home prices rebound. Many economists are now predicting housing prices to continue to drop into 2009 before stabilizing This means it might be some time before we see a true recovery.

This housing recession will have an impact on all local economies as well. We have already seen a number of states, including most of Pennsylvania's neighbors, cut back severely on spending or raise significant taxes to fix budget shortfalls. Please see the following paragraph in the linked article from the Center on Budget and Policy Priorities:

"The bursting of the housing bubble has reduced state sales tax revenue collections from sales of furniture, appliances, construction materials, and the like. Weakening consumption of other products has also cut into sales tax revenues. Property tax revenues have also been affected, and local governments will be looking to states to help address the squeeze on local and education budgets. And if the employment situation continues to deteriorate, income tax revenues will weaken and there will be further downward pressure on sales tax revenues as consumers become reluctant or unable to spend."

While Pennsylvania does not make the list of 29 states in the above article, our latest State budget included adding new debt. Debt service payments increased by over $35 million annually in this latest budget to a grand total of $905 million per year.

The point of all this is to say that we are embarking on a project of a grand scale, no matter what option is chosen, and that we must consider where we are headed as a community economically when discussing what we could, should, and must do.

As always, I welcome your feedback to james.fraasch@gmail.com

James

Monthly Costs of Project

I have received a lot of emails regarding the monthly costs presented at the forum. The following post is on the High School Renovation Blog to explain how the numbers were arrived at:

"During the Community Forum presentation a slide was included to show what the range of project costs would look like in terms of monthly tax increases for a $225,000 home in Mt. Lebanon (the average price of a home sold here in 2007). The numbers are based on bond schedules prepared by the District’s financial advisors using municipal bond rates as of July 18, 2008 and assuming State reimbursement of 16% of the cost of the bond payments. Based on that information, a $90 million project would cost a homeowner about $45 per month, a $110 million project would cost that same homeowner about $55 per month, and a $130 million project would cost about $65 per month."

There were some residents that were confused a bit by the projected monthly numbers juxtaposed against the total project cost. I believe the above information mostly solves that mystery. The post with the linked spreadsheet I had earlier did not include this 16% reimbursement rate.

Thanks for reading.

James

Forum Update

The School Board held the Community Forum on the High School Project last night. There was a wealth of information that was distributed. The documents given out last night is available now on the MTLSD website.

Today I will give an overview about what was talked about last night and later I will post at length about each of the options presented.

There were really four options presented at the meeting last night. Dollar estimates were given last night for each of the options but really, those numbers are still so early in the game (we still do not yet have a Construction Manager for the project) that they really are just educated guesses at this point. I think we ought to take the estimates and give them a range of +-10%. So with that, these were the options presented.

Option 1 was a renovation of the existing structure. This option would essentially bring the existing structure up to code and fix the problems that exist. It would address the seriously outdated mechanical systems in the building and provide for asbestos abatement throughout the structure. I like to compare this option to what was recently completed at all of our elementary schools. Estimated cost of this option was $77.8 million.

Option 1A was a complete renovation with additional significant improvements to certain parts of the existing structure. While this would not include a 'new' building, it would completely change the current Administration building into a learning center for the future while keeping the rest of the school largely the same. Estimated cost of this option was $97.3 million.

Option 2 was a plan to construct a largely new 'wing' of the school. This option would keep intact the existing front on Cochran Road of the Auditorium, Little Theatre, and the current face (B Building) of the school. Buildings behind the front would be demolished in a phased approach that would lead to the large majority of classrooms being held in the new wing built in place of the demolished buildings. This plan would create a 67% new school and 33% renovated school. Administration would be moved into the B-Building. Estimated cost of this option was $118.3 million.

Option 3 was a plan to build a new school. The new building would be built largely on the upper parking lot and practice fields. This would involve very little phasing. Once the construction was complete we would simply move students to the new building. This option also renovates the B-Building on Cochran Road. Administration would again move into this building. Estimated cost of this option is $131.6 million.

Last night was the first time the Board really had a chance to sit down and see all the information presented at one time. It was also the first time that we had a chance to see estimated costs. I think that, given our current economic environment, we all understood that the estimates would come in higher than what the Dejong study showed in January 2007.

Last night it was mentioned during the meeting that for every $25 million we need to finance for this project, it would equal roughly a 1-mill increase in taxes. So a $100 million project could force a 4-mill increase and a new $131.6 million new school would surpass 5 mills. Actually, that rule of thumb is a bit high, but still, these are not insignificant numbers. The page in the presentation that lists monthly costs includes the 16% State reimbursement rate. That monthly number equated to a total millage increase of 3.5 mills, not more than 5. I was able to create a spreadsheet that approximates these numbers however, bond coupon rates over the term of the bond will not be fixed as a simple PMT calculation in a spreadsheet would be. As I get more information on the possible bond issuance, I will let you know.

While it is extremely important to get information out to residents about how this project will effect their pocketbooks, we need to also have the vision to do what is right for our students and our community.

That's all for now. I am going to review the documents again, listen to feedback and post more later this week.

James