Federalism in Action

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The greatly imperiled traditional view of federalism has it that among the other mechanisms for the balancing (and hence constraining) of powers in our government, the states require substantial power to balance that of the federal government.

One of the benefits of federalism is that it allows the various states to experiment. If Texas wants to try fiscal discipline while California engages in fiscal incontinence, the rest of the states can watch and judge which fiscal policy is most productive of wealth and happiness for citizens generally.

We see this happening now before our very eyes, as most of the states grapple with budget deficits. Different states are pursuing different policies.

We see, for example, Illinois jamming through a two-thirds hike in personal income taxes and a nearly 50% rise in state corporate taxes to deal with its budget deficit. But in Georgia, a bipartisan tax commission has recommended to the state legislature that it cut its personal and corporate tax rates from the present 6% down to only 4%. As one of the commission members — economist Christine Ries of Georgia Tech — put it, “Our over-riding goal was to get the income tax rate down as low as possible, because the evidence is so clear that this is the biggest driver of growth and jobs.” The commission proposes to cover the tax loss by expanding the application of Georgia’s 4% sales tax to many purchases (such as groceries) now exempt from it.

Shifting corporate and personal income tax to consumption tax seems like an economic no-brainer if you want to encourage the creation of jobs, although as the Wall Street Journal notes,the logical thing would be for Georgia to eliminate the income tax altogether (as nearby Florida and Texas have done).

Again, it is nice to be able to contrast the behavior of, say, California with Utah. Newly-installed California Jerry Brown, the aging Moonbeam whose original decision (1978) to let public employees unionize and collectively bargain was a major reason for the state’s massive overspending today, and who owes his election to massive spending by those same unions, has proposed a plan to deal with the state’s budget deficit. It calls for dramatic increases in taxes and some cuts in spending, but does nothing to address the ridiculously bloated salaries and pensions that state employees receive. He intends to use the prospect of cuts in services to cow the citizens into raising taxes.

This is the typical statist ploy: threaten cuts in public service to get what you really want, which is always more taxes, while leaving the underlying problem (ballooning compensation and pensions for government workers) untouched. At least the miserable Governor Schwarzenegger tried, at the beginning of his regime, to address the public employee pension problem, by floating an initiative that would have put all new hires on defined contribution plans (such as 401k), before being whipped into a girly-liberal by the public employee unions.

Illinois is another case of the statist response to the pension crisis. Governor Pat Quinn, just a month before the November election and in the face of a huge state budget deficit, gave the public employee unions a guaranteed two years of no layoffs and even cost of living increases. With their support he squeaked through to reelection. After winning, he jammed through massive tax increases.

Now, Utah has taken a different tack. The state pension plan was fully funded back in 2007, but suddenly, by 2009, it fell to only 70% funded, meaning that the state faced a pension funding gap of $6.5 billion. This gap was one and a half times the debt allowed by the state constitution. But the constitution makes changing the pension plans of current workers virtually impossible.

So the Utah legislature made a reasonable choice, under the circumstances. It set up a defined contribution plan for all hires, starting this year, the state donating a generous 10% of the employee’s salary. The plan allows employees a defined benefit option — but again, the state’s contribution is capped at 10%.

For workers, the nice thing about the plan is that they have a fully portable plan, and one whose assets they own personally, so they can’t be “borrowed” by government and used to buy votes in the way that Social Security funds are, or appropriated by a union and used to buy politicians.

The nice thing for taxpayers is that this plan will eventually cost them only about half what the old system would. It shields them from having to cover the costs of any future stock market declines.

Legislatures in Montana and a dozen other states are looking at this model.

That, dear reader, is truly federalism in action.




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Comments

Brian

Just a point of clarification. You stated that Texas got rid of its income tax. Actually, it never had one. To institute an income tax in Texas requires a Constitutional amendment to be voted on by the citizens; in short, Texas will likely never have an income tax. This didn't stop the politicians. About a year and a half ago, there was talk of implementing a "payroll tax", which, of course, was simply an income tax, but would have sidestepped the Constitution. This never went anywhere, thankfully.

Brian

Gary Jason

Brian, you are quite right. I am sorry my wording conveyed otherwise, as I never meant to imply they ever had one.

And not only Texas has had attempts made to bring in an income taxe--virtually evey other no-income-tax state has seen recurring efforts to enact one. The pro-government crowd never stops trying to enact them.

Gary Jason

Mr. Harrison worries that efforts to lower state income tax levels in Georgia will lead to incresed property taxes, due to the general inability of political leaders to cut budgets while still supplying the needed public services. He cites a touching story in which budget cuts in public safety led to a child dying in a fire. And he recommends cutting state income taxes only after cutting federal tax and spending levels, lest vital services suffer.

I think that this is muddled logic. First, while I certainly support cutting both federal taxes and spending, that is a separate issue from the one I raised. And given that state and federal spending tends to be focus on different areas, BOTH of them can and should be pursued at the same time.

I am apparently more enthusiastic than Harrison is for state income tax cuts.

One reason I support such cuts is that I see little evidence (other than the anecdote he shares) that most states are underfunding or slashing public safety services, or are likely to if state income taxes are cut. Cops and firefighters are everywhere virtally immune from cuts, given the high level of public support in which they are held, and the power of their unions. Not that their compensation levels shouldn't be addressed, especially their often outrageously high pension and health care benefits. For example, in California, cops and sheriffs often retire on more than $100,000 a year with all medical expenses paid after 25 years of service, and firefighters are often given (at the chief level) pensions of $250,000 a year--at age 50!--with full health coverage.

Moreover, the fat in state budgets tends to be concentrated in the monopolistic, state run public education system, where there is routine overspending (especially on the adminstration end), as well as in the welfare system, where again there is much wastage. There is plenty there to be cut, and such cuts would be unlikely to hurt many people. I have written at length on the topic of voucherizing public schools, for instance, which would allow freezing and then lowering the education budget with a GAIN in student learning outcomes.

Finally, I encourage any citizens--such as Harrison--worried about being taxed out of their homes by rising state property tax levels to do what Californians did many years ago, and just enact laws to limit such increases.

Sui-juris

I think we need a return to such lively discussions of Federalism---that beautiful, although admittedly imperfect, system of dispersed, fractured, inexpedient power to the government. If only it was replicated in microcosm at all lower levels of government too---state, county, city, etc. What wondrous results could be had, if State power was counter-balanced by county sovereignty, and county government, by municipal sovereignty.
My twin brother and I have been libertarian nearly 20 years, and have at various times since then, delved into (obsessed is more like it) many different pillars of libertarianism at different times: Austrian Economics, the history American Revolution, Anachro-capitalism, Constitutionalism, and so on. Lately, I've become smitten with Federalism, and am convinced that, with a few minor adjustments to the Founders/Ratifiers' final product as memorialized in the Constitution, it is our best blueprint for keeping totalitarianism at bay. And by Federalism, I mean de jure Federalism as laid-out in the Constitution (e.g. separation of powers, Constitutional Republicanism, State Sovereignty, checks and balances, etc), as well as de facto Federalism as seen by other institutions such as Natural Rights Theory, competition among states for citizens through best policy, and Jury Nullification.
The name of the game is all about thwarting central planning, making government inexpedient for all but the most dire circumstances, and undermining democratic mob-rule. I'm glad to see Federalism being discussed. We need to focus on "tweaking" it and improving it.

Jon Harrison

What worries me about the Georgia plan is the effect it will have on property taxes. With some exceptions, state income tax rates are pretty low. When these rates are lowered further the result is not that communities limit spending to make up for any shortfall in state aid -- rather, they invariably hike property or other local taxes. And they often do so not because they are spendthrifts, but because they have no choice. If your town needs a new water main or major repairs to a school, there's little option but to find the funds. In many cases the work must be done to meet state or federal mandates.

In many communities the funds for such projects are not only unavailable, they can't be found. In my village, for example, many people simply would be unable to pay a significant property tax increase. They would lose their homes. The community, which already has several abandoned properties for which no buyer can be found, would deteriorate further both socially and economically.

It is possible to limit property tax increases through legislation or ballot initiative, as Massachusetts has done, but such measures do not address the problem of where revenues are to found to undertake mandated or simply necessary projects. The fact is that in the world of today, many localities require state and federal assistance if they are to remain going concerns.

New Hampshire has no state income tax, but its property tax burden is terrific. It derives considerable revenue from a state monopoly on liquor, beer, and wine sales. I'm not sure how prohibiting private enterprise in the alcohol business sits with libertarians. I'm not familiar with the situation in Texas, but then I wouldn't want to live in Texas, even tax-free.

When I last lived in Massachusetts -- in a desirable suburb of Boston -- budget cuts at the local level led to a situation in which a young mother and her infact died in a house fire because our public safety budget had been cut to the bone. And students in the town's schools actually had to share textbooks.

I don't by any means advocate more taxes as the remedy, but I would say cutting relatively low state income tax rates is generally counterproductive. In California, state-imposed tax burdens clearly are hurting the state's economy. But I don't believe that's the case everywhere.

It's all well and good to call for a tax on consumption to replace the current system, but the fact is there is no broad-based support for such a tax. If enacted, it would not replace the current system, but would simply "supplement" the traditional revenue streams. Anyone who thinks politicians will replace the current system in toto with a consumption tax is being naive. Additionally, of course, a consumption tax would be regressive in the extreme, hitting the lower and middle classes particularly hard. Schemes to correct this regressivity through transfers or the like would be hard to implement, and could lead to the creation of a new IRS-type bureaucracy.

My own view is that cuts in state income tax rates should only follow sharp cuts in federal taxes and spending. The latter would free up significant money for growing the American economy, which would obviously benefit states and localities. Simply cutting state tax rates while leaving the federal leviathan untouched will just starve localities, leaving them even more dependant on federal and state largesse.

Of course, sharp cuts in federal taxes and spending would require a revolution in American life, encompassing real entitlement reform and major readjustments to the defense budget and America's commitments overseas. To this point I have seen little support for such radical actions beyond the rhetoric of the Tea Party. And when it comes down to action, even the Tea Partiers have so far shied away from fundamental change.

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