Alan Reynolds

Critics of the Bush tax cuts once claimed the economic benefits from lower federal taxes would be offset by higher state and local taxes. But that depends on where you live and whether your state is raising taxes (bad news) or cutting spending (good news).

For the nation as a whole, the idea that increased state tax rates might neutralize lower federal taxes was always nonsense. Very few states are raising income or sales tax rates, and the few sliding down that treacherous slope already have the worst tax systems in the country. In fact, seven states reduced income tax rates last year -- Hawaii, Maryland, Massachusetts, Michigan, North Carolina, Oklahoma and Rhode Island.

From 1991 through 2001, state taxes rose by 4.2 percent a year in real, inflation-adjusted terms, according to the Tax Foundation. Real incomes of taxpayers rose more slowly, by 3.5 percent a year. In California, real incomes grew by only 3.2 percent a year, yet tax receipts grew by 5.4 percent a year. This was an unsustainable trend: State taxes could not possibly keep rising faster than taxpayers' incomes indefinitely, or taxpayers' after-tax incomes would fall continually until there was nothing left.

From 1999 to 2001, many states and cities made lavish spending plans on the basis of a temporary revenue windfall from stock options and capital gains. Spending by state and local governments rose 4 percent in 1996, 4.4 percent in 1997, 5.4 percent in 1998, 7 percent in 1999, 8.2 percent in 2000 and 8.1 percent in 2001. That, too, was an unsustainable trend: State and local spending could not keep rising by 8 percent a year because at that rate it would double every nine years and eventually account for 100 percent of GDP.

These are facts. What we usually hear are opinions. USA Today thus began a recent survey on state finances with the National Governors Association whining about "the worst financial crisis since World War II." What else did the governors expect after allowing state spending to grow so much faster than the incomes of taxpayers?

USA Today focused on the 10 most populous states, finding only one (Texas) that plans to cut spending from general funds by even a dollar. On the other hand, income tax rates have already been increased in Arkansas, Nebraska and New York, with California Gov. Grey Davis eager to join that list (and perhaps subconsciously eager to collect on that state's greatly increased unemployment benefits).


Alan Reynolds

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