How To Ruin A State Economy In One Easy Step

Why is it the first thing government thinks of doing in case of a budget shortfall is to raise taxes? It rarely occurs to The-Powers-That-Be to cut spending in order to roll expenditures back enough to match what income there is. It happens at town, county, state and federal level all too often. What's worse is when there's also a soft economy and tax revenues fall off. Somehow government thinks that pulling even more money out of the economy will make things better. Every time government has done that it only makes the situation worse and revenues fall even farther. It sets up a vicious cycle. I've seen this before.

Back in the mid to late 70's, the Commonwealth of Massachusetts was suffering from a growing tax burden and the erosion of its economy as a deep recession caused high unemployment. Every time the Commonwealth raised taxes, unemployment rose. Companies, large and small, left the state, looking for greener (and less expensive) pastures. The old joke back then went “Would the last person leaving Massachusetts please turn off the lights?”

We're seeing the same thing again, thirty years later, but this time in Michigan.

It's no fun to kick a state when it's down – especially when the local politicians are doing a fine job of it – but the latest news of Michigan's deepening budget woe is a national warning of what happens when you raise taxes in a weak economy.

Officials in Lansing reported this month that the state faces a revenue shortfall between $350 million and $550 million next budget year. This is a major embarrassment for Governor Jennifer Granholm, the second-term Democrat who shut down the state government last year until the Legislature approved Michigan's biggest tax hike in a generation. Her tax plan raised the state income tax rate to 4.35% from 3.9%, and increased the state's tax on gross business receipts by 22%. Ms. Granholm argued that these new taxes would raise some $1.3 billion in new revenue that could be "invested" in social spending and new businesses and lead to a Michigan renaissance.

Not quite. Six months later one-third of the expected revenues have vanished as the state's economy continues to struggle. Income tax collections are falling behind estimates, as are property tax receipts and those from the state's transaction tax on home sales.

Gee, they raise taxes during a weak economy, and what happens? Their revenues fall. No surprise there. Jobs and residents have voted with their feet, with twice as many people moving out of Michigan as are moving in. As taxes go higher the trend will only steepen. They're stuck in a vicious cycle, apparently unable to do the one thing necessary to turn things around: cut spending.

The same thing could happen here in my home state of New Hampshire. The legislature passed a biennial budget which included a 17.5% increase in expenditures. There's only one thing they forgot.

How to pay for it.

The budget's already over $50 million in the red, with a projected deficit of $200 million before the end of the biennium. The legislature did raise some taxes, but the revenues projected to be raised fell far short. Other tax revenues have also been well below projections. The governor did order a hiring freeze and directed all department heads to cut their budgets in an effort to stanch the slow of red ink. A few tax-and-spend groups have been calling for a state sales or income tax to make up for the shortfall, but we all know the legislature will find new an interesting ways to spend the money and the budget will still be out of balance. So they'll raise them...and revenues will fall, leaving an even bigger revenue shortfall.

The only answer is to cut spending and roll back the tax increases imposed at the beginning of the biennium. The only thing the state legislature here needs to do is look to Michigan to see how well its program of increasing taxes is working. Maybe they'll get the message. But that's not likely.