Rich States, Poor StatesALEC-Laffer State Economic Competitiveness IndexArthur B. LafferStephen MooreJonathan Williams
ii	 Rich States, Poor StatesRich States, Poor StatesALEC-Laffer State Economic Competitiveness Index© 2013 American Legisl...
About the AuthorsAcknowledgementsForewordIntroductionExecutive SummaryPreface: 10 Golden Rules of Effective TaxationCHAPTE...
iv	 Rich States, Poor StatesAbout the AuthorsDR. ARTHUR B. LAFFERArthur B. Laffer is the founder and chairman of Laffer As...
www.alec.org vAcknowledgementsWe wish to thank the following for making this publication possible:First, our sincere thank...
vi	 Rich States, Poor StatesABOUT THE AUTHORSForewordven as the nation attempts to recover from the harsh economic conditi...
www.alec.org viifolks in Washington squander away your tax dollars, Texas remains vigilant and committed to preservingthe ...
EXECUTIVE SUMMARYviii	 Rich States, Poor Statesam pleased to see Rich States, Poor States in its 6thedition. This edition,...
EXECUTIVE SUMMARYwww.alec.org ixExecutive Summaryith Congress locked in perpetual grid-lock and the U.S. economy stuck in ...
x	 Rich States, Poor StatesEXECUTIVE SUMMARYRank State1 Utah2 North Dakota3 South Dakota4 Wyoming5 Virginia6 Arizona7 Idah...
www.alec.org xiWhen you tax something more you getless of it, and when you tax somethingless you get more of it.Tax policy...
xii	 Rich States, Poor Statesbase, the tax base itself increases. This expan-sion of the tax base will, therefore, offset ...
www.alec.org xiiiEconomists have observed a clear LafferCurve effect with respect to cigarette taxes.States with high toba...
xiv	 Rich States, Poor StatesPREFACEIncome transfer (welfare) paymentsalso create a de facto tax on work and,thus, have a ...
Salt Lake City, Utah1CHAPTERCHAPTERState of the States
2	 Rich States, Poor StatesCHAPTER ONEState of the Statesupreme Court Justice Louis Brandeis fa-mously described the state...
www.alec.org 3STATE OF THE STATESclose loopholes ran into trouble in the Senate,which had been controlled by opponents of ...
4	 Rich States, Poor StatesCHAPTER ONEservices once, at the retail level. As our friendsat the Council on State Taxation r...
www.alec.org 5The Texas Margin Tax ProposalThe Texas margin tax is a type of modified grossreceipts tax. It is a tax of 1 ...
6	 Rich States, Poor StatesCHAPTER ONEin the nation. In addition to the tax rate increase,Prop. 30 was a retroactive tax i...
www.alec.org 7STATE OF THE STATESplains, “Whether it’s for cigarettes or chainsawsor big screen TV sets, New Hampshire bus...
8	 Rich States, Poor StatesCHAPTER ONESession(tax, fee, toll increase by number)Increase Amount($ millions)1. 2012 Special...
www.alec.org 9STATE OF THE STATESThe Negative Effectsof Minimum Wage LawsThe minimum wage has been a controversial top-ic ...
10	 Rich States, Poor StatesCHAPTER ONEStates Address Huge UnfundedPension LiabilitiesPerhaps the most dangerous financial...
www.alec.org 11STATE OF THE STATESdresses one of the largest financial problemsfacing states today, and these efforts have...
12	 Rich States, Poor StatesCHAPTER ONEability for future workers by moving away from adefined-benefit model to a defined-...
www.alec.org 13STATE OF THE STATESdressing unfunded pension liabilities. The centralCalifornia city of roughly 300,000 peo...
14	 Rich States, Poor StatesCHAPTER ONEemployees, including teachers, police, firefighters,and all state workers, to enter...
www.alec.org 15STATE OF THE STATESdata, as well as a review of academic studies thathave tried to statistically analyze th...
16	 Rich States, Poor StatesCHAPTER ONE(ENDNOTES)1	 Peters, Mark. “Kansas Governor Signs Tax Cut Bill.” The Wall Street Jo...
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Rich States, Poor States
Upcoming SlideShare
Loading in...5
×

Rich States, Poor States

50,533

Published on

6th Edition, www.alec.org/rsps

By Arthur B. Laffer, Stephen Moore and Jonathan Williams

All across the nation, states are looking for ways to boost their economies and become more economically competitive. Each state confronts this task with a set of policy decisions unique to their own situation. However, not all state policies lead to economic prosperity and while some states achieve economic prosperity, others continue to struggle in their efforts to revive their economies.

Fortunately, the United States, with its “50 laboratories of democracy,” provides us with empirical evidence to track exactly which policies lead to economic prosperity and which fail to deliver. Rich States, Poor States is an annual economic competiveness study authored by Dr. Arthur Laffer, Stephen Moore of the Wall Street Journal, and Jonathan Williams, Director of the Tax and Fiscal Policy Task Force at the American Legislative Exchange Council.

Armed with years of economic data and empirical evidence from each state, the authors identify which policies can truly lead a state to economic prosperity. Rich States, Poor States not only identifies these policies but also makes sound research-based conclusions about which states are poised to achieve greater economic prosperity and those that are stuck on the path to a lackluster economy. The economic outlook ranking is a forward-looking measure of how each state can expect to perform economically based on 15 policy areas that have proven, over time, to mean greater economic success.

Published in: Business, Technology
0 Comments
3 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
50,533
On Slideshare
0
From Embeds
0
Number of Embeds
43
Actions
Shares
0
Downloads
61
Comments
0
Likes
3
Embeds 0
No embeds

No notes for slide

Transcript of "Rich States, Poor States"

  1. 1. Rich States, Poor StatesALEC-Laffer State Economic Competitiveness IndexArthur B. LafferStephen MooreJonathan Williams
  2. 2. ii Rich States, Poor StatesRich States, Poor StatesALEC-Laffer State Economic Competitiveness Index© 2013 American Legislative Exchange CouncilAll rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of thispublication may be reproduced or distributed in any form or by any means, or stored in a database orretrieval system without the prior permission of the publisher.Published byAmerican Legislative Exchange Council2900 Crystal Drive, 6th FloorArlington, VA 22202www.alec.orgDr. Arthur B. Laffer, Stephen Moore,and Jonathan Williams, AuthorsDesigned by Joel SorrellISBN: 978-0-9853779-3-9Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index has been published bythe American Legislative Exchange Council, America’s largest nonpartisan, voluntary membershiporganization of state legislators. Made up of nearly one-third of America’s state elected officials, theCouncil provides a unique opportunity for state lawmakers, business leaders, and citizen organizationsfrom around the country to share experiences and develop state-based, pro-growth models based onacademic research, existing state policy, and proven business practices.The American Legislative Exchange Council is classified by the Internal Revenue Service as a 501(c)(3) non-profit and public policy and educational organization. Individuals, philanthropic foundations, businesses,or associations are eligible to support the Council’s work through tax-deductible gifts.
  3. 3. About the AuthorsAcknowledgementsForewordIntroductionExecutive SummaryPreface: 10 Golden Rules of Effective TaxationCHAPTER 1. State of the States Momentum for Pro-Growth Tax Reform Surges The Midwestern Tax Divide Anti-Growth Proposals in the States The Negative Effects of Minimum Wage Laws States Address Huge Unfunded Pension Liabilities Michigan Becomes 24th Right-to-Work State ConclusionCHAPTER 2. Tax Reform to Fix California’s Economy The Current California Tax Structure The Incidence vs. Burden of a Tax Economic Reform: The Principles of Good Tax Policy The Solution: A Flat Tax A Balanced Approach The Results Fixing CaliforniaCHAPTER 3. There They Go Again: A New Dose of Junk Economics The Proof Is in the Numbers: Responding to the Critics Population Metrics West Virginia and Nevada: A Case Study in Why Not to Rely Solely On Per-Capita Measures Reverse Causation and Population Oil, Sunshine, and Prosperity The 11 States that Adopted an Income Tax Other Economic Factors Our Critics Overlook IRS Data, Moving Van Data, and State Migration Addressing Other Criticisms of Pro-Growth Tax Reform ConclusionCHAPTER 4. State Rankings: 2013 ALEC-Laffer State Economic Competitiveness IndexAppendix. Economic Outlook MethodologyAbout the American Legislative Exchange Councilivvviviiiixxi135591014151921273032323333374142434545464848495255108110Table of Contents
  4. 4. iv Rich States, Poor StatesAbout the AuthorsDR. ARTHUR B. LAFFERArthur B. Laffer is the founder and chairman of Laffer Associates, an economic research and consultingfirm, as well as Laffer Investments, an institutional investment firm. As a result of Laffer’s economicinsight and influence in starting a worldwide tax-cutting movement during the 1980s, many publicationshave named him “The Father of Supply-Side Economics.” He is a founding member of the CongressionalPolicy Advisory Board, which assisted in forming legislation for the 105th, 106th, and 107th congresses.Laffer served as a member of President Reagan’s Economic Policy Advisory Board for both terms. InMarch 1999, he was noted by Time Magazine as one of the “Century’s Greatest Minds” for his inventionof the Laffer Curve, which has been called one of “a few of the advances that powered this extraordinarycentury.” He has received many awards for his economic research, including two Graham and DoddAwards from the Financial Analyst Federation. He graduated from Yale with a bachelor’s degree ineconomics in 1963 and received both his MBA and Ph.D. in economics from Stanford University.STEPHEN MOOREStephen Moore joined The Wall Street Journal as a member of the editorial board and senior economicswriter on May 31, 2005. He splits his time between Washington, D.C., and New York City, focusing oneconomic issues including budget, tax, and monetary policy. Moore was previously the founder andpresident of the Club for Growth, which raises money for political candidates who favor free-marketeconomic policies. Over the years, Moore has served as a senior economist at the Congressional JointEconomic Committee, as a budget expert for The Heritage Foundation, and as a senior economics fellowat the Cato Institute, where he published dozens of studies on federal and state fiscal policy. He was alsoa consultant to the National Economic Commission in 1987 and research director for President Reagan’sCommission on Privatization.JONATHAN WILLIAMSJonathan Williams is the director of the Center for State Fiscal Reform and the Tax and Fiscal Policy TaskForce at the American Legislative Exchange Council (ALEC), where he works with state policymakers,congressional leaders, and members of the private sector to develop fiscal policy solutions for thestates. Prior to joining ALEC, Williams served as staff economist at the nonpartisan Tax Foundation,authoring numerous tax policy studies. Williams’s work has appeared in many publications, includingThe Wall Street Journal, Forbes, and Investor’s Business Daily. He has been a contributing author to theReason Foundation’s Annual Privatization Report and has written for the Ash Center for DemocraticGovernance and Innovation at Harvard’s Kennedy School of Government. In addition, Williams was acontributing author of In Defense of Capitalism (Northwood University Press). Williams has testifiedbefore numerous legislative bodies and spoken to audiences across America. He is a frequent guest ontalk radio shows and has appeared on numerous television outlets, including the PBS NewsHour withJim Lehrer and Fox Business News. Williams was also the recipient of the prestigious Ludwig von MisesAward in Economics.
  5. 5. www.alec.org vAcknowledgementsWe wish to thank the following for making this publication possible:First, our sincere thanks go to the Searle Freedom Trust for their generous support of this research.Next, we thank Ron Scheberle, Michael Bowman, Andrew Bender, William Freeland, Fara Klein, KatiSiconolfi, Ben Wilterdink, Kevin Knight, David Ditch, Joel Sorrell, and the professional staff of theAmerican Legislative Exchange Council for publishing this in a timely manner. We also appreciate theresearch assistance of Ford Scudder, Nick Drinkwater, and Feiran Hao. We hope these research findingswill continue to be a good resource for America’s state legislators and members of the public interestedin pro-growth tax reform.
  6. 6. vi Rich States, Poor StatesABOUT THE AUTHORSForewordven as the nation attempts to recover from the harsh economic conditions of the past severalyears, no state has embodied the economic potential of America quite like Texas. Our state is amodel of prioritizing the core functions of government, limiting its size, and keeping taxes low.These principles, advocated in Rich States, Poor States, have helped Texas enjoy a level of economicgrowth that has led even the New York Times to describe Texas as “the future.”With our population growing by more than 1,000 a day, Texas has gained four congressional seatsover the last 10 years. During that same period, the State of New York has lost seats in Congress and,for the first time in history, California failed to gain a single one. From 2001 to 2010, the population ofTexas grew by more than 17 percent, compared to just 1.5 percent in New York. Ten years ago, Texasaccounted for 7.4 percent of the U.S. economy; today that figure is up to 8.7 percent. Why? It’s simple.Over the last decade, Texas has seen a job growth rate of more than 12.5 percent, far above the nationalaverage. Technology giants and small businesses alike are flocking to Texas, many fleeing states withhigh taxes and burdensome regulations.In 2013, while many states are still struggling to get their finances in order, Texas has brought inmore than we need for essential functions, and maintains a fiscally strong Rainy Day Fund. This fiscalstrength is because we hold the line against those who insist we need to raise taxes to boost revenue.Texas is one of nine states that do not levy a personal income tax, and that allows our residents—employers and employees alike—to keep and reinvest more of what they earn. We’re not dependenton any one industry, either. Texas’ economy is fully diversified, thanks in no small part to our efforts tokeep government out of the private sector’s way, allowing ample room for greater economic growth.It is clear that Texas is following a formula for robust economic growth and continued prosperity, aformula based upon the sound principles outlined by Dr. Arthur Laffer, Stephen Moore, and JonathanWilliams in Rich States, Poor States. It’s our state’s commitment to these conservative principles thatpropelled us into, and maintains us in, the national spotlight highlighting our robust and thrivingeconomy.Unfortunately, we cannot say the same for Washington, D.C. Federal spending is out of control, thefederal tax burden is increasing, and federal regulations are being written by activists seeking to restrictand punish industries, rather than help them grow responsibly and create jobs. While the tax and spendE
  7. 7. www.alec.org viifolks in Washington squander away your tax dollars, Texas remains vigilant and committed to preservingthe principles of limited government and free markets. The evidence is clear: Economic prosperity isattainable for those states that exercise discretion and discipline in spending and taxation. Pro-growthtax and fiscal policies—like those championed by ALEC and throughout Rich States, Poor States—set aclear path to a renewed national economic recovery.States hold the key to our economic future. States always have, and always will compete forresidents, revenues, and industries. Competition is the foundation of success and economic strengthin this country. And the stronger our states are individually, the stronger our nation is as a whole. Asstates continue to sort out budgets and finances, Texas is certainly the example to follow. But no matterwhich state you’re in, by letting people keep more of their money, limiting government interference,and maintaining fiscal discipline, your state can create an environment that fosters opportunity andprosperity for its citizens, while expanding the engine for America’s renewed economic growth.Sincerely,Rick PerryGovernor of Texas
  8. 8. EXECUTIVE SUMMARYviii Rich States, Poor Statesam pleased to see Rich States, Poor States in its 6thedition. This edition, like its predecessors,reviews fiscal policies that contribute to economic growth compared to policies that detract fromsuch growth. It has become a go-to source for state policymakers.States around the country have worked hard to recover from the recent national recession. Themeasures of economic competitiveness outlined in this report help states gauge how they are faring.And, as the federal government persists in non-growth strategies—taxing, racking up debt, andregulating at disturbing levels—states correspondingly look for ways to improve their own economicperformance. In terms of sound fiscal policies, there is no federal role model to follow.Dr. Arthur Laffer, Stephen Moore, and Jonathan Williams, however, offer important guidance forstates. These authors explore fiscal policies that can lead states to “up” their economic game. Theyprovide data and analysis that allow a comparison of practices. They edify in a constructive way, showingthe different fiscal policies a state may choose and the effects of those policies on economic growth.In Wyoming, state executive and legislative officials are ever mindful that a beneficial tax structure,fiscal discipline, and streamlined government contribute to our economic well-being. We want better,not bigger, government. We have a regulatory environment that is reasonable—one that protects ourstate’s natural beauty but also supports businesses operating in our state and attracts more businesses.We continually work for improvement. We are justifiably proud of our top three industries—energy,tourism, and agriculture—and tout them to no end. We are also trumpeting our state’s naturaladvantages—abundant electricity, cool climate, ample space, and the like—to develop Wyoming’sreputation as a great for place technology-related businesses.We have no individual income tax and no corporate income tax. Our state budget is always balanced,and we regularly put money aside into savings. This year, on my recommendation, the WyomingLegislature reduced ongoing spending by more than 6 percent beginning in July 2013. We want toreverse the trajectory of state budget growth and prepare for unforeseen contingencies. With thesupport of the Legislature, our executive branch merged two agencies in 2011, consolidated technologyservices in 2012, and is undertaking a rules reduction project in 2013.Policies like these inure to the benefit of all our citizens, improving present opportunities and futureprospects. Such policies work well in our state—they are not partisan policies, they are simply goodpolicies that yield good results.I look forward to the thought-provoking discussions that are bound to take place among the manypolicymakers who will make use of this latest Rich States, Poor States report. I thank the AmericanLegislative Exchange Council for continuing to produce it. I thank all those involved in completing it.Sincerely,Matthew H. MeadGovernor of WyomingABOUT THE AUTHORSIntroductionI
  9. 9. EXECUTIVE SUMMARYwww.alec.org ixExecutive Summaryith Congress locked in perpetual grid-lock and the U.S. economy stuck in alackluster recovery, state governmentsaround the country are seeking their own solutionsto the country’s economic woes. However, thepaths that states are pursuing to achieve economicprosperity are not all the same. Some have seenmagnificent success in achieving real economic re-covery while others continue to struggle.In this 6thedition of Rich States, Poor States,Dr. Arthur B. Laffer, Stephen Moore, and JonathanWilliams highlight the policies throughout the50 states that have led some states to economicprosperity and others to prolonged real economicrecovery. The authors provide the 2013 ALEC-Laffer State Economic Competitiveness Index,based on state economic policies. The empiricalevidence and analysis contained in this edition ofRich States, Poor States determines which poli-cies lead states to economic prosperity and whichpolicies states should avoid.In chapter 1, the authors review the most sig-nificant state policy developments in a “State ofthe States” analysis. Laffer, Moore, and Williamsprovide a new look at the political and economiclandscapes of the states after the 2012 electioncycle. The authors then outline the highlights andlowlights in the states, from major advances inpension reform to the best and worst changes instate tax policy.Chapter 2 analyzes California’s fiscal woes.This in-depth study of the Golden State’s financesis a unique look at the state’s economic troublesand provides a starting point for a path to eco-nomic recovery. Chapter 2 also serves as a casestudy for all states regarding what policies notto emulate and how to begin the process of trueeconomic recovery.In chapter 3, the authors take on some of themost repeated critiques and attacks from big gov-ernment, pro-tax advocates. Laffer, Moore, andWilliams make the concrete case that overall stategrowth and migration are key drivers of economicprosperity. As citizens “vote with their feet” andmove to states that have more opportunities andare more conducive to economic growth, thosestates will reap the rewards of greater economicprosperity. Critics often take issue with claimsthat taxes and right-to-work status influence stateeconomies. The authors lay out a point by pointcase, based on the economic evidence, why taxesand right-to-work status truly matter for eco-nomic growth. Overall, this chapter puts to restsome of the most common myths that advocatesof higher taxes perpetuate.Finally, chapter 4 is the highly anticipatedALEC-Laffer State Economic Competitiveness In-dex comprised of two separate economic rank-ings. The first ranking is a measure of economicperformance based on the three most effectivemetrics. Growth in gross state product (GSP),absolute domestic migration, and growth in non-farm payroll employment are calculated for eachstate over ten years. Each of these metrics pro-vides an economic insight into the effects of astate’s tax and fiscal policy choices.The second ranking is of a state’s economicoutlook moving forward. This forecast is based ona state’s current standing in 15 equally weightedpolicy areas that are influenced directly by statelawmakers. The 15 policy areas have proven overtime to be the most influential factors, which statelawmakers can control, in determining a state’seconomic growth. In general, states that spendless, especially on transfer payments, and statesthat tax less, particularly on productive activitiesW
  10. 10. x Rich States, Poor StatesEXECUTIVE SUMMARYRank State1 Utah2 North Dakota3 South Dakota4 Wyoming5 Virginia6 Arizona7 Idaho8 Georgia9 Florida10 Mississippi11 Kansas12 Texas13 Nevada14 Indiana15 Wisconsin16 Colorado17 Alabama18 Tennessee19 Oklahoma20 Michigan21 Alaska22 North Carolina23 Missouri24 Arkansas25 IowaALEC-Laffer State Economic Outlook Rankings, 2013Based upon equal-weighting of each state’s rank in 15 policy variablesRank State26 Ohio27 New Hampshire28 Louisiana29 Massachusetts30 Delaware31 South Carolina32 West Virginia33 New Mexico34 Pennsylvania35 Maryland36 Washington37 Nebraska38 Kentucky39 New Jersey40 Hawaii41 Maine42 Montana43 Connecticut44 Oregon45 Rhode Island46 Minnesota47 California48 Illinois49 New York50 Vermontsuch as work or investment, tend to experiencehigher rates of economic growth than states thattax and spend more.The following 15 policy variables are mea-sured in the 2013 ALEC-Laffer Economic Competi-tiveness Index:• Highest Marginal Personal Income Tax Rate• Highest Marginal Corporate Income Tax Rate• Personal Income Tax Progressivity• Property Tax Burden• Sales Tax Burden• Tax Burden from All Remaining Taxes• Estate/Inheritance Tax (Yes or No)• Recently Legislated Tax Policy Changes (Overthe past two years)• Debt Service as a Share of Tax Revenue• Public Employees per 1,000 Residents• Quality of State Legal System• Workers’ Compensation Costs• State Minimum Wage• Right-to-Work State (Yes or No)• Tax or Expenditure LimitsThis 6thedition of Rich States, Poor Statescontains invaluable insight into each of the 50“laboratories of democracy.” With solid empiricalresearch and the latest data on state economies,the evidence is clear on which state tax and fiscalpolicies directly lead to more opportunities, morejobs, and more prosperity for all Americans.
  11. 11. www.alec.org xiWhen you tax something more you getless of it, and when you tax somethingless you get more of it.Tax policy is all about reward and punishment.Most politicians know instinctively that taxesreduce the activity being taxed—even if theydo not care to admit it. Congress and state law-makers routinely tax things that they consider“bad” to discourage the activity. We reduce, orin some cases entirely eliminate, taxes on behav-ior that we want to encourage, such as homebuying, going to college, giving money to char-ity, and so on. By lowering the tax rate in somecases to zero, we lower the after-tax cost, in thehopes that this will lead more people to engagein a desirable activity. It is wise to keep taxes onwork, savings, and investment as low as possiblein order not to deter people from participating inthese activities.Individuals work and produce goodsand services to earn money for presentor future consumption.Workers save, but they do so for the purpose ofconserving resources so they or their childrencan consume in the future. A corollary to this isthat people do not work to pay taxes—thoughsome politicians seem to think they do.Taxes create a wedge between thecost of working and the rewards fromworking.To state this in economic terms, the differencebetween the price paid by people who demandgoods and services for consumption and the412310 Golden Rules of Effective Taxationprice received by people who provide thesegoods and services—the suppliers—is calledthe wedge. Income and other payroll taxes, aswell as regulations, restrictions, and govern-ment requirements, separate the wages employ-ers pay from the wages employees receive. Ifa worker pays 15 percent of his income in pay-roll taxes, 25 percent in federal income taxes,and 5 percent in state income taxes, his $50,000wage is reduced to roughly $27,500 after taxes.The lost $22,500 of income is the tax wedge,or approximately 45 percent. As large as thewedge seems in this example, it is just part ofthe total wedge. The wedge also includes excise,sales, and property taxes, plus an assortment ofcosts, such as the market value of the accoun-tants and lawyers hired to maintain compliancewith government regulations. As the wedgegrows, the total cost to a firm of employing aperson goes up, but the net payment receivedby the person goes down. Thus, both the quan-tity of labor demanded and quantity suppliedfall to a new, lower equilibrium level, and alower level of economic activity ensues. This iswhy all taxes ultimately affect people’s incentiveto work and invest, though some taxes clearlyhave a more detrimental effect than others.An increase in tax rates will not lead toa dollar-for-dollar increase in tax reve-nues, and a reduction in tax rates thatencourages production will lead to less than adollar-for-dollar reduction in tax revenues.Lower marginal tax rates reduce the tax wedgeand lead to an expansion in the production baseand improved resource allocation. Thus, whileless tax revenue may be collected per unit of tax
  12. 12. xii Rich States, Poor Statesbase, the tax base itself increases. This expan-sion of the tax base will, therefore, offset some(and in some cases, all) of the loss in revenuesbecause of the now lower rates.Tax rate changes also affect the amount oftax avoidance. The higher the marginal tax rate,the greater the incentive to reduce taxable in-come. Tax avoidance takes many forms, fromworkers electing to take an improvement in non-taxable fringe benefits in lieu of higher grosswages to investment in tax shelter programs.Business decisions, too, are based increasinglyon tax considerations as opposed to market ef-ficiency. For example, the incentive to avoid a40 percent tax, which takes $40 of every $100earned, is twice as high as the incentive to avoida 20 percent tax, for which a worker forfeits $20of every $100 earned.An obvious way to avoid paying a tax is toeliminate market transactions upon which thetax is applied. This can be accomplished throughvertical integration: Manufacturers can establishwholesale outlets; retailers can purchase goodsdirectly from manufacturers; companies canacquire suppliers or distributors. The numberof steps remains the same, but fewer and few-er steps involve market transactions and there-by avoid the tax. If states refrain from applyingtheir sales taxes on business-to-business trans-actions, they will avoid the numerous econom-ic distortions caused by tax cascading. Michigan,for example, should not tax the sale of rubber toa tire company, then tax the tire when it is soldto the auto company, then tax the sale of the carfrom the auto company to the dealer, then taxthe dealer’s sale of the car to the final purchas-er of the car, or the rubber and wheels are taxedmultiple times. Additionally, the tax cost be-comes embedded in the price of the product andremains hidden from the consumer.If tax rates become too high, they maylead to a reduction in tax receipts. Therelationship between tax rates and taxreceipts has been described by the Laffer Curve.The Laffer Curve (illustrated to the right) summa-rizes this phenomenon. We start this curve withthe undeniable fact that there are two tax ratesthat generate no tax revenue: a zero tax rate anda 100 percent tax rate. (Remember Golden Rule5Source: Laffer AssociatesThe Laffer CurveTax RevenuePREFACE#2: People don’t work for the privilege of payingtaxes, so if all their earnings are taken in taxes,they do not work, or at least they do not earn in-come the government knows about. And, thus,the government receives no revenues.)Now, within what is referred to as the “nor-mal range,” an increase in tax rates will lead to anincrease in tax revenues. At some point, howev-er, higher tax rates become counterproductive.Above this point, called the “prohibitive range,”an increase in tax rates leads to a reduction in taxrevenues and vice versa. Over the entire range,with a tax rate reduction, the revenues collect-ed per dollar of tax base falls. This is the arith-metic effect. But the number of units in the taxbase expands. Lower tax rates lead to higher lev-els of personal income, employment, retail sales,investment, and general economic activity. Thisis the economic, or incentive, effect. Tax avoid-ance also declines. In the normal range, the arith-metic effect of a tax rate reduction dominates.In the prohibitive range, the economic effect isdominant.Of course, where a state’s tax rate lies alongthe Laffer Curve depends on many factors, in-cluding tax rates in neighboring jurisdictions. If astate with a high employment or payroll tax bor-ders a state with large population centers alongthat border, businesses will have an incentive toshift their operations from inside the jurisdictionof the high tax state to the jurisdiction of the lowtax state.
  13. 13. www.alec.org xiiiEconomists have observed a clear LafferCurve effect with respect to cigarette taxes.States with high tobacco taxes that are locatednext to states with low tobacco taxes have verylow retail sales of cigarettes relative to the lowtax states. Illinois smokers buy many cartons ofcigarettes when in Indiana, and the retail sales ofcigarettes in the two states show this.The more mobile the factors beingtaxed, the larger the response to achange in tax rates. The less mobile thefactor, the smaller the change in the tax basefor a given change in tax rates.Taxes on capital are almost impossible to enforcein the 21st century because capital is instantlytransportable. For example, imagine the behav-ior of an entrepreneur or corporation that buildsa factory at a time when profit taxes are low.Once the factory is built, the low rate is raisedsubstantially without warning. The owners ofthe factory may feel cheated by the tax bait andswitch, but they probably do not shut the factorydown because it still earns a positive after-taxprofit. The factory will remain in operation fora time even though the rate of return, after-tax,has fallen sharply. If the factory were to be shutdown, the after-tax return would be zero. Aftersome time has passed, when equipment needsservicing, the lower rate of return will discouragefurther investment, and the plant will eventuallymove where tax rates are lower.A study by the American Enterprise Insti-tute has found that high corporate income tax-es at the national level are associated with lowergrowth in wages. Again, it appears a chain reac-tion occurs when corporate taxes get too high.Capital moves out of the high tax area, but wag-es are a function of the ratio of capital to labor,so the reduction in capital decreases the wagerate.The distinction between initial impact andburden was perhaps best explained by one of ourfavorite 20th century economists, Nobel winnerFriedrich A. Hayek, who makes the point as fol-lows in his classic, The Constitution of Liberty:“The illusion that by some means of pro-gressive taxation the burden can beshifted substantially onto the shouldersof the wealthy has been the chief reasonwhy taxation has increased as fast as it hasdone and that, under the influence of thisillusion, the masses have come to accept amuch heavier load than they would havedone otherwise. The only major result ofthe policy has been the severe limitationof the incomes that could be earned bythe most successful and thereby gratifica-tion of the envy of the less well off.”Raising tax rates on one source of rev-enue may reduce the tax revenue fromother sources, while reducing the taxrate on one activity may raise the taxes raisedfrom other activities.For example, an increase in the tax rate on cor-porate profits would be expected to lead to adiminution in the amount of corporate activity,and hence profits, within the taxing district. Thatalone implies less than a proportionate increasein corporate tax revenues. Such a reduction incorporate activity also implies a reduction in em-ployment and personal income. As a result, per-sonal income tax revenues would fall. This de-cline, too, could offset the increase in corporatetax revenues. Conversely, a reduction in corpo-rate tax rates may lead to a less than expectedloss in revenues and an increase in tax receiptsfrom other sources.An economically efficient tax systemhas a sensible, broad base and a lowrate.Ideally, the tax system of a state, city, or coun-try will distort economic activity only minimal-ly. High tax rates alter economic behavior. Ron-ald Reagan used to tell the story that he wouldstop making movies during his acting careeronce he was in the 90 percent tax bracket be-cause the income he received was so low aftertaxes were taken away. If the tax base is broad,tax rates can be kept as low and nonconfiscato-ry as possible. This is one reason we favor a flattax with minimal deductions and loopholes. It isalso why more than 20 nations have now adopt-ed a flat tax.678PREFACE
  14. 14. xiv Rich States, Poor StatesPREFACEIncome transfer (welfare) paymentsalso create a de facto tax on work and,thus, have a high impact on the vitalityof a state’s economy.Unemployment benefits, welfare payments,and subsidies all represent a redistribution ofincome. For every transfer recipient, there is anequivalent tax payment or future tax liability.Thus, income effects cancel. In many instances,these payments are given to people only in theabsence of work or output. Examples includefood stamps (income tests), Social Security ben-efits (retirement tests), agricultural subsidies,and, of course, unemployment compensationitself. Thus, the wedge on work effort is growingat the same time that subsidies for not workingare increasing. Transfer payments represent atax on production and a subsidy to leisure. Theirautomatic increase in the event of a fall in marketincome leads to an even sharper drop in output.In some high benefit states, such as Hawaii,Massachusetts, and New York, the entire pack-age of welfare payments can pay people the109equivalent of a $10 per hour job (and let us notforget: Welfare benefits are not taxed, but wagesand salaries are). Because these benefits shrinkas income levels from work climb, welfare canimpose very high marginal tax rates (60 percentor more) on low income Americans. And thosedisincentives to work have a deleterious effect.We found a high, statistically significant, negativerelationship between the level of benefits in astate and the percentage reduction in caseloads.In sum, high welfare benefits magnify the taxwedge between effort and reward. As such, out-put is expected to fall as a consequence of mak-ing benefits from not working more generous.Thus, an increase in unemployment benefits isexpected to lead to a rise in unemployment.Finally, and most important of all for statelegislators to remember:If A and B are two locations, and iftaxes are raised in B and loweredin A, producers and manufactur-ers will have a greater incentive to move fromB to A.
  15. 15. Salt Lake City, Utah1CHAPTERCHAPTERState of the States
  16. 16. 2 Rich States, Poor StatesCHAPTER ONEState of the Statesupreme Court Justice Louis Brandeis fa-mously described the states as “labora-tories of democracy.” Over the many edi-tions of this publication, we attest to the wisdomof that declaration, as we have witnessed thestates rise and fall based on changes in policy. Forinstance, a decade ago, who would have guessedthat Michigan would enjoy real growth in privatesector employment and significant gains in eco-nomic competitiveness? However, fiscal conser-vatives in the legislature worked with Gov. RickSnyder and made significant policy changes, likerepealing the hated Michigan Business Tax andenacting a freedom-to-work law, and, by doing so,set the state on the path to renewed competitive-ness and economic recovery.When a state changes policy, for better orworse, it immediately affects the incentive struc-ture for individuals and businesses alike, and thechange in incentives directly influences the state’scompetitiveness. Through statistical and anecdot-al evidence, this publication makes a compellingcase that pro-growth fiscal policy is what reallymakes the difference for economic vitality in thestates.Since the last edition of this publication inearly 2012, we have witnessed historic move-ment toward pro-growth tax reform across thestates. Reform minded governors and legislatorsare working to reform public pensions, prioritizespending, and reshape their tax codes. We areencouraged to see so many policymakers takeup the cause of fiscal reform to make their statesmore competitive. The stakes are incredibly high.According to statistics from the Internal RevenueService, more than $2 trillion of wealth has movedacross state lines in the past 15 years. What anincredible reward for competitive states. On theother hand, states with poor policies should beafraid, since capital, both investment and human,is more mobile than ever.We anticipate the fiscally responsible stateswill reform government pensions, adopt taxreform and spending restraints, and other pro-growth policies—and they will be rewarded fortheir actions. On the contrary, the states that val-ue redistribution, punitive tax rates, and bloatedgovernment spending will continue to sacrificeeconomic growth. Additionally, these big govern-ment states will increasingly attempt to pick win-ners and losers in a misguided effort to buy jobsthrough policies that reek of cronyism. If a statefeels like it must offer a special targeted incentivejust to attract or retain a company, chances arefairly good that the state’s underlying policy is un-attractive for business.In this chapter, we outline some of the mostimportant policy proposals that have been de-bated across the 50 laboratories in the past year.As you will read, we have analyzed proposalsthat will help economic competitiveness as wellas those that will harm it. However, by and large,this has been a year where a majority of electedofficials have avoided massive tax increases (withthe exception of California).  Furthermore, com-petitiveness enhancing tax reform has been onthe forefront in many states. While fundamentalreform takes time to accomplish, taxpayers acrossAmerica should be very encouraged as we wit-ness the movement for fiscal reform continue togain momentum.The Kansas UprisingGov. Sam Brownback campaigned in 2010 promis-ing a tax cut to make the Kansas economy morecompetitive. But his plan to reduce tax rates andS
  17. 17. www.alec.org 3STATE OF THE STATESclose loopholes ran into trouble in the Senate,which had been controlled by opponents of taxreform. The governor managed to pass his tax cut,but the Left-leaning Senate coalition refused tocut loopholes and pork spending projects.1Rep. Richard Carlson, chairman of the Kan-sas Committee on Taxation, commented on thetax reform accomplishment, “What a remark-able change one legislative session can make inthe course of history when we have a governorwith guts and a House with backbone. The legisla-tive session was tense and stressful with all thenaysayers in play, but, in the end, the taxpayers ofKansas won the day.”2Details of the plan:• Moved from a three tier tax system to two• Top rate lowered to 4.9 percent from 6.5• Bottom rate lowered to 3 percent from 3.5• Non-wage income from pass-through entitiesexempt from taxationThe most outside of the box section of theplan is the “Small Business Accelerator,” whichexempts all non-wage income from taxation forall pass-through entities. This means that the vastmajority of small businesses in Kansas are nownot subject to an income tax on their businessearnings. This includes all sole proprietorships,partnerships, S corporations, and limited liabilitycompanies (LLCs).This bold tax reform was designed to jump-start small businesses in Kansas and boost eco-nomic growth. In the two years of the Brownbackadministration, with the tax reform less than ayear old, results are already starting to show.• The Kansas unemployment rate has droppedfrom 7 to 5.5 percent.• The state has shifted from the second highestincome tax rate to the second lowest in theregion.• In 2013, the Kauffman Foundation gave Kansasan A rating for its small business climate; whileneighboring Missouri received a C rating.• In 2012, Kansas had the largest number ofnew small business filings in state history withmore than 15,000.3After the election of 2012, a new legislativemakeup now gives Gov. Brownback a conserva-tive majority and a voter mandate to finish thejob of simplifying the Kansas tax code and pos-sibly phasing out the income tax. “This is all aboutmaking Kansas a more competitive place to dobusiness,” Gov. Brownback said.4Voters agreed.Lawmakers are considering plans to provide fur-ther tax relief in 2013.5While the Kansas tax reform plan has receivedcriticism from both sides of the political spec-trum, the resulting economic growth in Kansasspeaks for itself. The plan is not perfect, but it is abold step toward pro-growth tax reform that willcertainly continue to unlock more of Kansas’ eco-nomic potential.Perhaps the greatest compliment for the Kan-sas tax rate reductions comes from a competitoracross the state line. As Missouri Sen. Ed Emeryput it, “Kansas has been able to leap ahead. Theirnew tax policies promote economic freedom andmake it hard for Missouri to compete for busi-nesses. When a state is playing catch-up on taxpolicy, it loses the benefits of leading. The eco-nomic benefits align more with the innovatorthan with those saying ‘me too.’” 6Momentum for Pro-Growth TaxReform SurgesNebraska, North Carolina, and Louisiana are threestates in a growing number that have policymak-ers considering phasing down or repealing theirincome tax entirely. Central to the argument inall of these cases is the premise that underlies allsix editions of this publication: Taxes matter forcompetitiveness and economic growth. More tothe point, the way taxes are levied matters in ad-dition to the level of taxation. Taxes on income di-rectly harm the incentives for productive activitysuch as savings, investment, innovation, and hardwork. It is encouraging to see so many reformminded governors and legislators tackling funda-mental reform.NebraskaIn Nebraska, Gov. Dave Heineman proposed re-placing the income tax with an expanded salestax that would include services and business-to-business transactions, which are a hidden costfor consumers.7However, the governor had towithdraw his recommendation in the face of op-position from groups currently exempt from thetax, as well as concerns from business and free-market groups that the business-to-business tax-es could actually harm growth. A pro-growth salestax should tax final consumption of goods and
  18. 18. 4 Rich States, Poor StatesCHAPTER ONEservices once, at the retail level. As our friendsat the Council on State Taxation recently stated,“Any proposal to extend the sales tax to servicesprimarily consumed by business, without an ex-emption for business-to-business sales of servicesrequired under a retail sales tax, is equivalent toimposing another level of gross receipts taxes onthese sales by service providers.”8Tax reformersin other states would be wise to avoid business-to-business taxes altogether.LouisianaLouisiana policymakers, in pursuit of higher in-come and job growth, have floated the elimina-tion of the state’s personal income tax and cor-porate tax in order to improve their businessclimate and boost competitiveness. Unlike manyother states, Louisiana relies minimally on incomeand corporate taxes as sources of revenue (14.2percent and 2.4 percent in 2010, respectively).9Because of this, Louisiana has an easier path topro-growth tax reform compared to many otherstates due to the comparatively smaller revenuegap that eliminating the personal income tax andcorporate income tax would create.Before the legislative session, Louisiana Gov.Bobby Jindal had largely led efforts to eliminatethe personal and business income tax, primarilythrough an expansion of the sales tax.10But dueto some key shortcomings with the governor’splan (most notably the taxation of business-to-business income, which rightly drew oppositionfrom business groups), the governor has sincepulled his tax reform plan and called on the leg-islature to take the lead on tax reform. Thoughthe governor’s partial withdrawal from craftingthe legislation has been viewed by many as akey setback, the prospects for tax reform in thecurrent legislative session live on in Louisiana’sHouse and Senate.North CarolinaIn North Carolina, a group of state legislatorsare pushing tax reform that would see the stateincome tax slashed or eliminated entirely, thecorporate and business tax burden significantlyreduced, and the estate tax eliminated. NorthCarolina faces a challenging path to reform givenits heavy reliance on personal income tax and cor-porate income tax (27.9 percent and 4.0 percent,respectively). However, the widespread supportfor reform by the state’s fiscally conservative ma-jorities in both houses of the state’s general as-sembly makes the prospects for at least partialreform in the current legislative session look ex-tremely optimistic.11Led by State Sen. Bob Rucho, the generalassembly has already seen multiple reform billsfiled and debated, which attempt to lower andeventually phase out North Carolina’s taxation ofpersonal and business income as well as elimi-nate the estate tax immediately. Most recently,consensus has been built around a bill that wouldbring the personal income tax to one flat rate andthen gradually lower the rates of the personal in-come tax and the corporate tax over a period offour years, while gradually broadening the baseof the state’s sales tax to include all consumerservice transactions. This reform effort would ex-empt business-to-business sales, a positive signfor both business groups and tax economists whocriticize such taxation. The proposal also involvesreforms to the state’s franchise tax and elimina-tion of the state estate tax. Given that North Car-olina’s business climate has generally lagged be-hind its regional competitors, this reform woulddo much to improve the state’s competitivenessand put it on a path to earn the status of one ofthe nation’s best state tax jurisdictions.New Mexico Cuts Corporate Tax RatesWhile many bold ideas for tax reform have stalledin the 2013 legislative session, New Mexico is awelcome exception. Gov. Susana Martinez cameinto the session determined to reform the corpo-rate income tax and create more jobs.12This wasimperative for the State of New Mexico to increasebusiness investment and become a more competi-tive state in attracting businesses. For many years,New Mexico has had the highest corporate in-come tax rate in the Southwest region (except forCalifornia) at a top rate of 7.9 percent.13The true centerpiece of the reform from thisyear is the significant cut in the corporate incometax, from 7.9 percent to 5.9, which will make NewMexico more attractive to businesses and will cer-tainly help to grow the state. While there remainsome problems with the tax reform package, bi-partisan corporate tax rate reduction is certainly anotable success story.
  19. 19. www.alec.org 5The Texas Margin Tax ProposalThe Texas margin tax is a type of modified grossreceipts tax. It is a tax of 1 percent (.5 percent forcertain types of businesses) on a business’s “tax-able margin” as opposed to net profits. It appliesto all businesses that have revenues over $1 mil-lion per year and, unlike a normal corporate in-come tax, it is owed regardless of profits or losses.A business’s “taxable margin” is calculated by theleast of three options: 1) total revenue multipliedby 70 percent, 2) total revenue minus the cost ofwages paid, or 3) total revenue minus the cost ofgoods sold.Because of its compliance costs, high revenuevolatility, tax pyramiding, and different treatmentof businesses based on business models (highmargin vs. low margin), there have been effortsin the 2013 session to repeal the tax completely.14While these efforts have failed, Gov. Rick Perryhas proposed his own tax plan, which would mod-ify the tax. The governor intends to create a $1million deduction of the tax for companies withup to $20 million in revenue; currently, business-es with less than $1 million in income are exemptfrom the tax. The governor’s plan also includes aprovision to allow businesses to deduct movingexpenses for relocating to Texas.15Gov. Perry’s plan would result in a tax cut forTexas businesses of about $1.6 billion.16A full re-peal of the tax or any cuts would be pro-growthreforms resulting in Texas unlocking even moreeconomic potential.The Midwestern Tax DivideMichigan Passes Phase Out of DamagingPersonal Property TaxMichigan Gov. Rick Snyder, along with a strongmajority coalition for reform in both houses ofthe state’s legislature, eliminated the state’s per-sonal property tax in 2012. The tax was rightlydescribed by Gov. Snyder as the “second worsttax in the nation,” after the Michigan BusinessTax (MBT), which was also repealed in 2012.17Thenow eliminated tax forced businesses to pay an-nual property taxes on their business equipment,infrastructure, and other various business assets.The tax serves as a massive disincentive toinvestment and reinvestment of capital into theMichigan economy, and provides a large, uniqueexpense to doing business in the state of Michi-gan. Most states have moved away from the taxa-tion of personal property due to the distortion-ary effect these taxes have on business and theiradverse impact on economic growth.18The taxwill gradually be phased out over the coming de-cade, providing another economic lift to the Stateof Michigan, which has seen its business climateradically improve during the past legislative ses-sion.19Minnesota Governor Targets TaxpayersOne must always take the good with the bad, andnot all tax changes moving through the Midwestare growth oriented. Minnesota Gov. Mark Day-ton began 2013 calling for a variety of burden-some tax increases: Hiking the gas tax, raising thetobacco and alcohol excise taxes, and initiatingthe frequently discussed “millionaire’s tax” onearners with over $150,000 in income.20The pro-posal was intended to raise $2.4 billion. By March,however, stiff opposition put the brakes on nearlyevery proposal, leaving only Gov. Dayton’s “snow-bird” tax on individuals who live in Minnesotamore than two months, but less than six.21Anti-Growth Proposals in the StatesJust as there were significant reforms that willhelp to increase economic growth, many stateschose a different path this past year. Higher taxrates in Maryland, New York, Hawaii, Oregon,and California, along with increased regulations,demonstrate a shift away from competitivenessin some states. Costly regulations, such as renew-able energy mandates, distort the market andresult in increased electricity costs for consum-ers. These high tax states often implement vastspending programs such as California’s $60 billionhighspeed rail boondoggle. We examine some ofthese anti-growth initiatives below.California’s Massive Income Tax IncreaseAfter the November 2012 election, a huge newtax increase hit California taxpayers. Proposition30 raised taxes on higher income earners and in-creased the top individual income tax rate to 13.3percent.22This is the rate that many small busi-nesses pay as pass-through entities, and is alsonow the highest state personal income tax rateSTATE OF THE STATES
  20. 20. 6 Rich States, Poor StatesCHAPTER ONEin the nation. In addition to the tax rate increase,Prop. 30 was a retroactive tax increase that ap-plied to income as of January 2012. This retroac-tivity violates the tax principle of predictabilitysince businesses now owe a new tax bill after theyhave planned for the year. Unpredictability in thetax code is detrimental for investment and makesit difficult for business planning.California projects Prop. 30 will raise between$5.4 and $7.6 billion between fiscal year 2014and 2018.23However, given the failure of “taxthe rich” schemes in other states that we havedocumented in previous editions of this study, wehighly doubt those revenue projections will cometo pass. The measure passed with support fromteachers unions, since the revenue was promisedto go toward educational spending. However,many in California are infuriated that these rev-enues are now being diverted to the state’s pen-sion fund.24Read more about California’s brokentax code, its consequences, and possible solutionsfor the Golden State in chapter 2.Tax Hikes Redefined in Washington StateGov. Jay Inslee’s tough stance against higher taxeswhile on the campaign trail soon disappearedwithin days of taking office.25The governor’s pro-posed budget makes permanent the temporarytax increases that were scheduled to sunset thisyear. These taxes include an increased beer tax inaddition to increased business taxes.26By makingthese tax increases permanent, the governor’splan would impose an additional $661 million intax increases on Washington taxpayers over thenext three years alone.27As Erin Shannon from the Washington PolicyCenter explains, “Under Washington State Law,extending those tax hikes would clearly be consid-ered a tax increase because they are scheduled toexpire, and the $661 million is not part of the pro-jected revenue the state is expected to have whenthe new biennium starts on July 1.”28When askedif these tax hikes would violate his campaignpromise, Gov. Inslee stated, “We would not beincreasing taxes for consumers in that regard.”29Gov. Inslee chooses to ignore a basic economicprinciple. It is something about which liberal andconservative economists can agree: Businessesdon’t pay taxes, people do. While businesses col-lect and remit taxes, the economic burden of a taxis always borne by an individual at some level.If It Moves in Vermont, Tax ItPresident Ronald Reagan once famously quippedthat the Left’s view of the economy could be sum-marized in three short phases: “If it moves, tax it;if it keeps moving, regulate it; and if it stops mov-ing, subsidize it.” In Vermont, if you drink bottledwater, buy snacks from vending machines, orhave a sweet tooth, be prepared to pay more thisyear: The Vermont House of Representatives re-cently approved a smorgasbord of tax increases.These taxes include increasing the $2.62 taxon a pack of cigarettes to $3.12 and also increas-ing the $1.87 per ounce tax on smokeless tobaccoand snuff to $2.60.30The tax hike package raisedthe personal income tax for high income earnersand capped itemized deductions.31Some of theadditional tax hikes include extending a 6 percentsales tax to each item of clothing priced at $110or more, increasing the 9 percent meals tax to9.5 and expanding it to vending machines, whilealso excluding bottled water, candy, and dietarysupplements from the food sales tax exemption.32Gov. Peter Shumlin rightly expressed con-cern over how the tax increases would negativelyimpact Vermont’s ability to compete with otherstates for jobs and investments. In an interviewwith Vermont Public Radio, he remarked, “It’sthe wrong thing, wrong time, wrong medicine.And I would argue, totally unnecessary. It’s thetax package that absolutely would be a killer forjobs, and a killer for job growth in the state of Ver-mont.”33Policymakers in Vermont have their workcut out for them, falling one spot and now rankingdead last in our economic outlook rankings of thestates this year.Tobacco Taxes Threaten the New HampshireAdvantageWe often refer to the Granite State’s zero personalincome tax, zero sales tax, and low excise tax ratesas the “New Hampshire Advantage.” Low, com-petitive excise tax rates have helped the GraniteState to compete for businesses and investmentsin the economically troubled Northeast. Perhapsone of our favorite and most ironic stories con-cerns the New Hampshire Advantage and involvesa Massachusetts legislator who voted to increasethe state sales and alcohol taxes. Soon after hisvote, he drove across the state border and pur-chased liquor at one of New Hampshire’s tax freeliquor stores.34As economist J. Scott Moody ex-
  21. 21. www.alec.org 7STATE OF THE STATESplains, “Whether it’s for cigarettes or chainsawsor big screen TV sets, New Hampshire businessesare winning the competition for shoppers’ dol-lars.”35However, a new proposal in the Live Free orDie State may threaten the New Hampshire Ad-vantage. The New Hampshire House passed abudget that would increase the cigarette tax by 30cents per pack.36Businesses and state officials inMassachusetts, Vermont, and Maine are the onlyones who should welcome this onerous tobaccotax hike. Since New Hampshire has a lower tobac-co tax rate than its neighboring states, taxpayersoften cross the border to purchase cigarettes ata competitive rate. For example, in a study con-ducted by Southern New Hampshire University,an estimated 50 percent of all cigarette purchaseswere derived from out of state smokers.37Smallbusinesses, such as convenience stores and gro-cers, would be especially hard hit with a cigarettetax increase.38Furthermore, the study found thata 5.62 percent increase in New Hampshire’s tobac-co tax rate could result in a 6.43 percent decreasein total state revenues.39As New Hampshire Rep.Laurie Sanborn put it, according to a New Hamp-shire Union Leader article, “When we raise the to-bacco tax, we are saying, ‘don’t bother to cometo New Hampshire, we don’t need your money.’”Maryland Drivers Forced to Cough Up More atthe PumpGov. Martin O’Malley’s radical tax and spendagenda did not let up during Maryland’s 2013legislative session. The general assembly passed abill that will increase the state’s gasoline tax by be-tween 13 and 20 cents per gallon while requiringthat the gas tax be indexed to inflation, therebyensuring tax increases well beyond the tenure ofGov. O’Malley.40Tax hikes like these should comeas no surprise to Maryland residents. Since Gov.O’Malley took office in 2007, there have been 32tax, fee, and toll increases (displayed in Table 1on the following page), estimated to cost taxpay-ers $2.3 billion annually.41Such increases havecontributed to Maryland’s noteworthy drop in itseconomic outlook rank, moving from 20thin the5thedition to 35thin this 6thedition.A2012studybythenonpartisangroupChangeMaryland revealed that the state’s wealthiest res-idents are being driven out by excessive personalincome taxes. The report found that a net 31,000residents have exited the state since the impo-sition of a “millionaire’s tax” in 2008. The tax,signed into law by Gov. O’Malley, imposed a per-sonal income tax rate of 6.25 percent on residentswith an annual income of $1 million or more. Thestudy estimates that the out-migration of Mary-land residents has had a net negative impact onthe state’s fiscal health, costing approximately$1.7 billion in lost tax revenues over the past fiveyears. The highest levels of out-migration werefound in Maryland’s wealthiest counties, suggest-ing that the state’s higher income residents arethe ones “voting with their feet” to avoid exces-sive taxation.42Taxachusetts Lives Up to Its NicknamePolicymakers in Massachusetts are consideringa vast array of tax increases this year. Taxpayerscould see an increase in the gasoline tax, cigarettetax, smokeless tobacco taxes, cigar taxes, and anincreased excise tax on utilities, including electriccompanies.43Gov. Patrick’s plan would increase the stateincome tax by 1 percentage point, making therate for all income earners 6.25 percent. His planalso calls for multi-billion dollar increases in in-frastructure and education spending while hikingthe gas tax from 21 cents to 51 cents.44Gov. Patrick’s proposal also includes a reduc-tion in the state’s sales tax rate from 6.25 percentto 4.5 percent. Described by some as an attemptto improve the “fairness” of the state’s tax sys-tem, the reform still fails to place Massachusettson competitive footing with nearby New Hamp-shire, which does not impose taxes on sales orpersonal income.45Arguing in favor of his sales tax proposal, Gov.Patrick recently stated that the sales tax “is widelyregarded to be the most regressive tax that statesimpose.”46This is an interesting position for thegovernor to take, considering that he raised thesales tax rate from 5 percent to 6.25 just fouryears ago. At the time, Gov. Patrick said that thesales tax hike would “bring our budget into bal-ance, offset the need for even more difficult cuts,and expand opportunity throughout the com-monwealth.”47When asked for his thoughts on all of theseMassachusetts tax increase proposals, New Hamp-shire Senate Majority Leader Jeb Bradley simplysaid, “Welcome to New Hampshire!”48
  22. 22. 8 Rich States, Poor StatesCHAPTER ONESession(tax, fee, toll increase by number)Increase Amount($ millions)1. 2012 Special session New income tax rates at 5% and 5.75% at specified income levels 143.32. 2012 Special session Personal income exemption phase out at specified income levels 35.63. 2012 Special session Recordation tax—indemnity mortgages. Revenue to counties 35.74. 2012 Special session Increases rate for specified tobacco products from 15% to 70% 55. 2012 Special session Death Certificate Fee—$12 to $24 0.76. 2012 Special session Repeals sales tax exemption on specified product 0.77. 2012 Bay Restoration “Flush Tax”—doubles fee 538. 2012 Storm Water Management Fees 341.89. 2012 Weights and Measures Registration Fee increase 0.310. 2012 Double Lead Poisoning Prevention Fund Fee 2.711. 2012 Wetland Water Way Program Fee restructuring 0.312. 2011 Hospital assessment 39013. 2011 Alcoholic beverages—sales tax increase from 6% to 9% 84.814. 2011 Vehicle dealer processing change 5.315. 2011 Increase in Contractor Licensing and Renewal Fees 0.316. 2011 Out of State Attorney Admission Fee 0.0517. 2011 Vanity Plate Fee—$25 to $50 2.518. 2011 Birth Certificate Fee—$12 to $24 419. 2011 Toll increases 9020. 2010 Fishing License and Registration Fees 321. 2009 Speed monitoring system 12.622. 2008 Millionaire’s tax—top marginal rate 5.5% to 6.25% 1023. 2007 Special session Computer services tax 2024. 2007 Special session Income tax rates—new marginal rates ranging from 4.75% to 5.5% 163.625. 2007 Special session Sales tax—5% to 6% 613.126. 2007 Special session State corporate income tax—7% to 8.25% 107.927. 2007 Special session Tobacco tax—$1 to $2 per pack of cigarettes 12128. 2007 Special session Vehicle titling tax—$23 to $50 23.529. 2007 Special session Vehicle excise tax increase 39.630. 2007 Special session Electronic gaming tip jar tax 1031. 2007 Special session Real property transfer tax 14.132. 2007 Special session Captive Real Estate Investment Trusts 10Total (32) 2,3141. Millionaire’s tax in effect through tax years 2008–2010 Source: Change Maryland2. The computer services tax was repealed and replaced with millionaire’s taxTABLE 1| Maryland Tax and Fee Increases: 2007–2012
  23. 23. www.alec.org 9STATE OF THE STATESThe Negative Effectsof Minimum Wage LawsThe minimum wage has been a controversial top-ic since its inception in 1938.49Many studies havefound that this well-intentioned policy often hurtsthose that it aims to help. By discouraging em-ployers from hiring inexperienced and unskilledworkers, minimum wage laws create a barrier toentry into the labor market, which disproportion-ately impacts the poor.50To ensure that a hiring decision will have a netpositive impact on an organization’s bottom line,businesses offer wages that are commensuratewith the productivity of the potential employee.If an employee only has the skills to produce$6.00 per hour worth of value, no rational em-ployer would offer a wage rate of $9.00 per hour,regardless of the minimum wage rate. Such a de-cision would clearly represent a loss of value tothe employer. Rather than allowing employers tooffer a wage rate that is based on the productiv-ity of the employee and enabling unskilled indi-viduals to obtain valuable experience and on thejob training, minimum wage laws effectively banthese unskilled individuals from the labor mar-ket. Unfortunately, those individuals who haveproductivity levels below the minimum wage aretypically those who need experience and on thejob training the most.Maine Legislature Considers IncreasingMinimum WageEven with the perverse incentives that go alongwith minimum wage laws, many states are stillconsidering raising the minimum wage. Most re-cently, a minimum wage hike was considered thisspring in Maine. The Maine House of Representa-tives has passed a bill that would raise the state’sminimum wage to $9.00 per hour by 2016. Thebill would also require that the minimum wageincrease annually in proportion to increases inthe Consumer Price Index.51Advocates of raisingthe minimum wage say that it has remained at$7.50 since 2009 and has not kept up with risingprices.52Gov. Paul LePage has concerns about increas-ing the minimum wage. “I don’t see the point ofhaving the highest minimum wage in the countrywhen our economy is in the tank,” he said. Maineis one of 19 states with a minimum wage abovethe national level of $7.25. Of the New Englandstates, only New Hampshire, which has a mini-mum wage of $7.25, has a lower minimum wagethan Maine. Vermont’s minimum wage, $8.60 anhour, is the highest in the region and is indexedto inflation.53New York Raises Minimum Wage to New HeightsNew York taxpayers are on the hook for the Em-pire State’s new minimum wage policy. New York’sstate budget will raise the state’s minimum wageof $7.25 to $9.00 by 2016.54The new policy hassparked significant controversy, especially in thebusiness community. Heather Briccetti, presidentand CEO of the Business Council of the State ofNew York said, “Raising the minimum wage wouldonly hurt New York’s small businesses, farms, andnonprofits that are struggling to make their cur-rent payrolls, and [would] reduce job opportuni-ties in this difficult economy.”55In addition to the minimum wage hike, thestate will provide a tax credit to businesses thatretain or hire 16 to 19-year-old students. The taxcredit will reimburse employers for part of the dif-ference in wages as the minimum wage increas-es.56Sen. Michael Gianaris recognized these per-verse incentives and remarked, “We’re providingstate subsidies that will result in people losing jobopportunities and ensuring teenagers are stuck atthe minimum wage.”57According to the EmpireCenter, the minimum wage tax credit could costtaxpayers anywhere from $20 to $40 million.58Somuch for economic growth and jobs in the EmpireState.Illinois Driving Out Businesses, Laying OffWorking TeensGov. Pat Quinn elevated the minimum wage is-sue to a top priority in Illinois by focusing on itduring his 2013 State of the State address. Hecalled for the legislature to increase the wagefrom $8.25, already well above the federal man-date, to $10.00 per hour by 2017.59Legislationbefore the Senate would link the wage to infla-tion, which would not take long to make Illinoisthe highest minimum wage state in America. Aneditorial in the Chicago Sun-Times, by no meansa conservative bulwark, pointed out that Illinoiscould not afford a minimum wage increase, giv-en the ease of moving to neighboring states withlower burdens to entry.60
  24. 24. 10 Rich States, Poor StatesCHAPTER ONEStates Address Huge UnfundedPension LiabilitiesPerhaps the most dangerous financial threat tostates today is in the area of unfunded pensionliabilities for government workers. To be sure,states face tremendously long odds to regain theireconomic footing in the wake of the downturn.Many states lost more than 20 percent of theirentire asset portfolio during the market crash of2008. A new report by State Budget Solutions es-timates the average government employee pen-sion plan is only 41 percent funded. Furthermore,total unfunded liabilities equal nearly $5 trillionacross the 50 states.61Unfortunately for pension reform advocates,states have kicked the can down the road formany years, refusing to make tough decisions.In many cases, powerful government employeeunions have stopped meaningful reforms in theirtracks.One major challenge in pension policy is thelack of timely and accurate data available to poli-cymakers and the public alike. For far too longour elected officials have relied upon unrealisticpension data, based on faulty assumptions. Whilegreatly outdated even at the time of release, gov-ernment pension reports have misrepresentedthe actual financial obligations facing taxpayers.The lack of pension transparency has beencaused, in large measure, by government ac-counting standards, which have been very “flexi-ble” when compared to standards used by the pri-vate sector. For instance, in the case of the majorstock market losses of 2008, state and local gov-ernments were not required to officially recognizethe losses on their books for years. This techniqueis called asset smoothing, and because it is sowidely used, taxpayers and even lawmakers areoftentimes kept in the dark while waiting to learnthe full financial impact of a market crash.Another way the true scope of unfunded li-abilities is hidden from taxpayers revolves aroundassumed rates of return for the investmentsmade by pension funds. Most Americans havesuffered some difficult investment losses in their401(k) plans over the years. When states use anassumed rate of return of eight percent or moreto calculate their liabilities, as is the case in a largenumber of states today, the crisis of pension lia-bilities is further hidden from public view.The reform option most discussed by pensionreform experts is transitioning away from the tra-ditional, defined-benefit plans into 401(k)-style,defined-contribution plans for new governmentworkers. Private sector employers moved in thisdirection years ago and many acknowledge thedefined-benefit pension model is unaffordablefor state taxpayers. A new academic study writ-ten by pension reform experts Robert Novy-Marxand Joshua Rauh, reports that, absent reform,the massive unfunded pension liabilities wouldrequire huge taxpayer contributions to bail outfailing defined-benefit plans. Their report notes,“The average immediate increase is $1,385 perhousehold per year. In 12 states, the necessaryimmediate increase is more than $1,500 perhousehold per year, and in five states it is at least$2,000 per household per year.”62The good news, however, is that many statesare recognizing fiscal reality and are looking atfundamental pension reform. Michigan, underthe leadership of Gov. John Engler in the 1990s,and more recently Utah, serve as models for pen-sion reform. In 1997, Michigan enacted a reformthat closed the state’s defined-benefit plan fornew employees and set up 401(k)-style personalaccounts. A recent actuarial analysis conductedfor the Mackinac Center for Public Policy reportedthat the state has already saved upwards of $4.3billion, with the added benefit of workers havingportable personal retirement assets.63One of the greatest problems with defined-benefit plans, outside of the numerous account-ing difficulties outlined above, is the perverseincentive structure the plans provide for electedofficials. It is astonishingly lucrative for electedofficials to have the power to promise lavish fu-ture benefits upon government workers, whilenot having to pay for them up front. Therefore,the 401(k)-style reform may be the key to improv-ing the political incentives for funding pensions,and in the process, solving this major crisis facingstate taxpayers. Once again, incentives matter.Pension Reform Is Not a Partisan IssueOpponents of pension reform often blame parti-san politics as the driving force behind efforts torepair underfunded retirement systems. Howev-er, these opponents ignore the bipartisan natureof many successful pension reform efforts aroundthe country. The fact is that pension reform ad-
  25. 25. www.alec.org 11STATE OF THE STATESdresses one of the largest financial problemsfacing states today, and these efforts have beensupported by policymakers from both sides of theaisle.For example, few would accuse ChicagoMayor Rahm Emanuel, a lifelong liberal and for-mer White House Chief of Staff under PresidentBarack Obama, of being ideologically opposedto pensions or public sector unions. However,Mayor Emanuel addressed the city’s $20 billionpension shortfall in 2012 with a set of concreterecommendations, which included increases inthe retirement age and a freeze in cost of livingadjustments.“If we follow along the current path,” MayorEmanuel explained in a letter to city employees,“we know we will confront two stark choices:Either the city’s pension payments will squeezeits ability to offer the essential services that youprovide, or each of our pension funds will gobankrupt, leaving you and your families withoutretirement security.”64This is hardly an ideologicalproposition; rather, it is an honest acknowledge-ment of reality and the consequences of inaction.Prominent liberals such as former CaliforniaSpeaker Willie Brown and Warren Buffett havealso expressed similar concerns about pensionunderfunding.65In today’s political landscape, it’sdifficult to find an issue that both sides agree on;however, pension reform resonates with individu-als from both sides of the aisle. Liberals and con-servatives alike have called for pension reform inorder to protect taxpayers and ensure retirementsecurity.There are also several examples of states thathave worked across the aisle to reform under-funded pensions. For example, overwhelmingly“blue” Rhode Island enacted major reforms thatcreated a 401(k)-style hybrid plan in 2011. De-spite opposition, Rhode Island Speaker GordonFox and Treasurer Gina Raimondo (both Demo-crats) worked together to stabilize the pensionsystem and reduce the state’s unfunded liabilityby $3 billion.66Utah also directly tackled pension reform in2011 with the leadership of conservative SenatorDan Liljenquist. Utah eliminated its old defined-benefit pension plan, creating a new system forenrollees hired after July 1, 2011. New employeesnow have the option of a 401(k)-style plan or ahybrid pension program. Without these reforms,the Utah retirement fund, which was the nation’sbest funded before the 2008 crash, would havefaced a 50 percent chance of becoming insolventby 2028.67Successful Pension Reform in KentuckyOne new story of reform comes out of Kentucky,which passed public pension reform legislation inMarch. The plan, which covers most public em-ployees in the state, excluding teachers, droppedtheir defined-benefit program with fixed pay-ments in retirement.68The plan was underfundedby nearly $19.2 billion, jeopardizing the retire-ment of more than 132,000 state and county em-ployees.The legislation, which was the result of a15-month-long task force on the issue, proposeda “hybrid” retirement plan where new employeescontribute more of their salaries up front, butare guaranteed a return of at least 4 percent ontheir investment, more if the state fund performsbetter than expected. The legislation overwhelm-ingly passed Kentucky’s divided legislature, af-firming the argument that pension reform is nota partisan issue.Illinois Pension Reform LawsuitThe dire straits of state and local pension fundshave become better known recently, but fewstates find themselves facing financial regulatorsin federal civil court. This year, Illinois became thesecond state to settle charges of securities fraudlevied by the Securities Exchange Commissionfor misleading bond investors about the partialpayments the state was making to pension fundssince 1994.69The state has since hired auditors toimprove accounting and oversight of the funds,which allowed the fraud case to be settled outof court, but the $85 billion funding gap remainsunresolved.Kansas Pension Reform MisfireAdvocates for fundamental pension reform wereextremely optimistic this year in Kansas with fis-cal conservative legislators capturing a majority inthe legislature. A recent study estimated the un-funded liability for Kansas to be $21 billion.70Theneed for reform was evident, and the momentseemed perfect to pass an overhaul of the state’spension system that would protect the benefitsof current workers and limit the taxpayer’s li-
  26. 26. 12 Rich States, Poor StatesCHAPTER ONEability for future workers by moving away from adefined-benefit model to a defined-contribution401(k)-style plan for new hires.The push for fundamental reform reached itspeak in March 2013 when two star experts testi-fied in favor of a 401(k)-style retirement system ina hearing before the House Pensions and BenefitsCommittee. Bill Bradley, the retired U.S. Senatorfrom New Jersey and a former presidential can-didate, and Robert Merton, professor of financeat the Massachusetts Institute of Technology andNobel laureate in economics, were accompaniedto the hearing and other meetings by Kansas Lt.Gov. Jeff Colyer. Bradley and Merton both testi-fied that the current defined-benefit model wasunsustainable for state pensions and a 401(k)-style plan was a necessary reform.71As the proposal for a 401(k) retirement planseemed to be gaining ground, a simultaneousmeasure was introduced to give the Kansas Pub-lic Employees Retirement System (KPERS) a quickinfusion of cash to meet its obligations by issuing$1.5 billion in bonds. Both measures were heardin committee for debate, but under intense pres-sure and skepticism from government unions,the measure for a 401(k)-style pension reformpackage was tabled. However, the simultaneousproposal authorizing KPERS to sell $1.5 billion inbond debt did pass the committee and was votedon and passed in the full House of Representa-tives.72The result was a double loss for pension re-form advocates in Kansas. There would be nostructural reform, and the Kansas retirementsystem and taxpayers would take on $1.5 billionin additional debt. While the proposal for fun-damental pension reform failed this session, fis-cally conservative legislators and Gov. Brownbackare optimistic that real reform will have a goodchance of passing in the future.Arizona Takes a Stab at Pension ReformIn a bid to start the ball rolling for fundamentalpension reform, lawmakers in Arizona are mak-ing it personal with a measure to change theirown public retirement plan, which covers allelected officials in the state and operates on thecommon defined-benefit pension model. A 2011study found that the relatively small fund had anunfunded liability gap of about $211 million.73Toillustrate the severity of the problem, one esti-mate claims that the plan supports nearly 1,000retirees, while only 800 current workers are pay-ing into the system.74The proposed solution is to entirely shutdown the current defined-benefit program andreplace it with a 401(k)-style defined-contribu-tion plan moving forward. While the plan is stillbeing considered, it is already facing oppositionfrom some members of the legislature. Despitethe opposition however, Arizona is poised tobecome the next state to achieve meaningfuland fundamental public pension reform. Speak-er Andy Tobin of the Arizona House, and otheradvocates of the reform effort, hope that bystarting with reforming the pension system forelected officials, reforming the other three publicretirement systems in the state (which are muchlarger) could be a smoother process.Hawaii’s Ocean of Red InkUnfunded liabilities are putting taxpayers of theAloha State in a tough fiscal position. In order tomake the state’s current employee health and re-tirement systems viable, Gov. Neil Abercrombieadmitted that the state would need to spend $500million per year for the next 30 years.75Since Ha-waii can’t afford large yearly payments, the gov-ernor proposes spending $100 million per yearinstead, meaning that the pension funds wouldn’tbe financially stable for the next 150 years!76Pennsylvania Gov. Corbett Calls for PensionReformAccording to the Commonwealth Foundation, theKeystone State’s pension costs are expected torise by more than $2.5 billion over the next fouryears.77To help address the state’s unfunded li-abilities, Gov. Tom Corbett called for reforms,including a defined-contribution retirement planfor future state employees. As the governor de-scribes it, “The entire system of state pensions hasbecome a mountain of debt, and the avalanchecould bury our economic growth… Resolving ourpension crisis will be the single most importantthing we do for decades to come.”78We couldn’thave said it better ourselves.Unfunded Liabilities Left to Fester: Stockton, CAFiles for BankruptcyLast year, the city of Stockton became the largestmunicipality to be the victim of officials not ad-
  27. 27. www.alec.org 13STATE OF THE STATESdressing unfunded pension liabilities. The centralCalifornia city of roughly 300,000 people becamethe largest city, so far, to formally file for bank-ruptcy. While there were many factors that con-tributed to Stockton declaring bankruptcy, thecity’s largest creditor was the California PublicEmployees’ Retirement System (CalPERS).79This is likely just the tip of the iceberg, becauseSan Bernardino, CA, (population 213,000) madethe same difficult choice by filing for bankruptcyprotection last year as well.80 The main driver ofSan Bernardino’s budget shortfall is in its person-nel costs, which amount to about 75 percent ofthe city’s budget. Furthermore, retirement costsfor public pensions are currently taking up 13 per-cent of the city’s budget and are expected to riseto 15 percent or higher in the next three years.81We can expect trends like this to continue ifstate and local governments refuse to address thepublic pension problems they are facing. In Cali-fornia alone, spending on public pensions rose by214 percent between 2002 and 2012.82Withoutfundamental pension reform and a move awayfrom the defined-benefit model, this trend of mu-nicipal bankruptcies will most likely continue.As Stockton continued its bankruptcy pro-ceedings under a federal bankruptcy judge, thecity refused to reduce any obligation to their larg-est creditor, CalPERS, and instead slashed theirobligations to municipal bondholders.83Municipal bondholders lend to cities and mu-nicipalities for a multitude of reasons, but mostrecently (as in this case) to help the municipalityfinance payments into the public employee retire-ment system. This has broad negative implicationsfor municipal bonds across the country becausethere is such a large amount of them, since mostmunicipalities issue some form of bonds for vari-ous reasons. In fact, Stockton went even furtherin cutting its obligations to bondholders by reduc-ing the amount the city owed on the principal ofits debt to bondholders. This is the first time thata municipality has been able to do this.This unfair treatment of debt in Stockton’sbankruptcy proceedings has left its municipalbonds nearly worthless. But furthermore, it dras-tically changes the way that potential municipalbondholders will view investments in the future,and not just for Stockton. Municipal bonds arehighly advantageous for investors for two rea-sons: 1) they are largely regarded as extremelylow risk investments, and 2) they are tax exempt.This has allowed municipalities to attract bond-holders to sell debt relatively easily in the past.The problem is that they are clearly no longeras low risk as once thought. This realization ledMoody’s to downgrade the credit rating of pen-sion obligation bonds for Solano County, CA, andmore downgrades are sure to come.84This case is the largest of its kind and willlikely set the precedent for municipal bankruptcyproceedings in the future. This is especially truein California, where there are many other largemunicipalities that are unable to adequately fundtheir pension obligations, as well such as bank-rupt San Bernardino and deeply indebted LosAngeles.85But it’s not all bad news for municipalities inCalifornia. In fact, at least two major cities in theGolden State have taken the hint and worked tofundamentally reform their pension systems. SanJose passed a pension reform measure by a widemargin last year.86It moved the city in a fiscallyresponsible direction by increasing employee re-tirement contributions and mandating that anyfuture benefit increases be brought to the pub-lic for a vote. Since these and other changes topublic pensions adopted in the initiative addressboth current workers as well as future hires, thecitizens of San Jose face legal challenges fromsome government unions wishing to overturn theresults. So far, the court’s decisions have beenmixed on the issue. A similar measure also passedlast year in San Diego, in which all (non-police)new hires will receive a defined-contribution401(k) retirement plan like vast majorities of pri-vate sector workers.87While it appears likely that many more munici-palities will need to file for bankruptcy due to un-funded pension liabilities, citizens are beginning toaddress the problem responsibly. Unfortunately,as discussed in chapter 2, California’s tax and fiscalproblems run far deeper than only unfunded pen-sion liabilities and municipal bankruptcies.Florida Moves to Reduce Unfunded LiabilitiesLegislators in the Sunshine State understand theimportance of fiscal responsibility. Speaker WillWeatherford has made pension reform a signatureissue during his time as House leader. In March2013, the Florida House of Representatives voted73-43 in favor of its proposal to require new public
  28. 28. 14 Rich States, Poor StatesCHAPTER ONEemployees, including teachers, police, firefighters,and all state workers, to enter into a 401(k)-styleplan. A Senate version would allow new employ-ees to choose between a defined-benefit plan ora 401(k)-style plan. But unless the beneficiary af-firmatively opts for a defined-benefit plan, theyare automatically enrolled in a 40l(k)-style plan.88This is not the first time the legislature hasmoved to reform Florida’s retirement system. In2011, legislators made several changes, includ-ing one that required employees to contribute 3percent of their salaries to their retirement. Previ-ously, employees were not required to contributeanything.89Florida’s total state and local unfunded liabil-ity is estimated to be about $90 billion. A studyrequested by Speaker Weatherford reported thatthe state could save $9.8 billion over 30 years ifthe bill is passed into law.90Debunking the Transition Cost Argument AgainstPension ReformDespite significant cost savings, those who op-pose pension reform often claim that any transi-tion from the current system would result in sub-stantial costs in and of itself. Some claim that eventhough reforms might produce significant savings,those savings would be outweighed by the costsassociated with moving to a new system. A re-cent study from the Arnold Foundation finds thatthese claims are incorrect.91Common “transition cost” arguments includethe claim that creating a new system will depriveexisting systems of much needed contributions.However, unlike the Social Security System, stateand local pensions are pre-funded, meaning thatpresent day contributions subsidize the future,rather than present day retirees. As the ArnoldFoundation study explains, “Moving new workersto a new system does not affect the funded levelof past benefit accruals, nor does it affect the debtservice payments employers must make to pay offany accrued debt. The pension debt is a bill that isowed to public workers for past service, and thisdebt must be paid regardless of the go-forwardretirement savings system.” Therefore, shifting toa new system should not have a substantial effecton the funding levels of existing plans once theyare closed. While there may be some rare excep-tions in the case of plans that are extremely un-derfunded, the solution in these cases is compre-hensive reform, rather than continuation along apath that has shown itself to be unsustainable.92Other transition cost arguments include theclaim that a closed fund must shift toward moreconservative investments. These claims are basedupon the now debunked theory of “time diversi-fication,” which held that risk declines over lon-ger investment horizons. However, because anygiven year’s investment return is independent ofthe prior year’s actual return (as argued by No-bel laureate Paul Samuelson), there is no reasonthat investment risk should decline over longerhorizons. While a closed pension plan will need tomove toward more liquid investments in order tomake benefit payments in very late stages, thereis no need for a closed plan to shift toward moreconservative investments. As the Arnold Foun-dation argues, “The level of risk a governmentis willing to take with its pension investmentsshould be independent of whether the plan isopen or closed.”93Michigan Becomes 24thRight-to-Work StateMichigan, a birthplace of organized labor and stillheavily dominated by unions, became the 24thstate in the nation to adopt a right-to-work law.Despite widespread union protests in the statecapital, Republican Gov. Rick Snyder signed thebill within hours of it passing, calling it “pro-work-er and pro-Michigan.” The law took effect March28, 2013, and essentially would prohibit requiringworkers to pay union dues as a condition of em-ployment.Conservatives favor the law because it at-tracts businesses and provides workers with morechoice. It is seen as a much needed counter-weight to the excesses of labor unions, particu-larly in Michigan where the labor agenda has hada deep and lasting impact on the state’s publicpolicies. Liberals and union leaders view right-to-work laws as a way to curb the power of labor andreduce its influence.94Later in this edition of Rich States, Poor States,the performance of right-to-work states will bediscussed extensively, as economic performanceof right-to-work states has become the key intel-lectual grounds for debate on this policy reform.But it’s worth noting in advance that both a sim-ple review of the relevant economic performance
  29. 29. www.alec.org 15STATE OF THE STATESdata, as well as a review of academic studies thathave tried to statistically analyze the effects ofright-to-work laws, have found that right-to-workstates outperform their compulsory union coun-terparts, providing their citizens crucial economicopportunity and a pathway to greater prosperity.Michigan was able to drastically improve theirbusiness climate and prospects for economicgrowth with this sound policy reform.ConclusionToday, we are witnessing an economic “Balkaniza-tion” between states in America. The states withgrowth as a primary objective will continue togrow if they continue to follow free market poli-cies, while the states with redistribution andregulation as their main objectives will continueto shed jobs and economic vitality if they do notlearn from their mistakes. Our view is that thesteady movement of human and investment capi-tal from high tax states to low tax states, whichhas been present for decades, will continue andlikely accelerate over time. The beauty of the American experiment isthis: States are given a great degree of autonomyto choose the best mix of policies for their owncitizens. With these 50 states as “laboratories ofdemocracy,” we have the advantage of analyzingwhat works and what does not. This is not aboutRepublican vs. Democrat—it is about the strugglefor capital and job creation that is being fought onan economic battleground. As you will continue toread in this edition of our publication, we believethat not only the theory  of our work is sound,but the economic data confirms the case for thelimited government model that values economicfreedom for all.
  30. 30. 16 Rich States, Poor StatesCHAPTER ONE(ENDNOTES)1 Peters, Mark. “Kansas Governor Signs Tax Cut Bill.” The Wall Street Journal. May 22, 2012.2 Carlson, Richard. “Tax Reform in Kansas.” Inside ALEC. January/February 2013 p. 13.3 Arnold, Kelly. “Brownback, GOP Put Kansas Back in Game.” The Wichita Eagle. April 19, 2013.4 “Kansas Voter Uprising: GOP Incumbents Who Resisted Reform Get Early Retirement.” The Wall Street Journal. August 8, 2012.5 Cooper, Brad. “Brownback: Keep Full Sales Tax, Cut Income Taxes Further.” The Kansas City Star. January 15, 2013.6 Interview with the authors. March 14, 2013.7 Hammel, Paul and Stoddard, Martha. “Bowing to Critics, Dave Heineman Scraps Tax-Reform Bills.” Omaha World Herald. Febru-ary 16, 2013.8 Cline, Robert, Phillips, Andrew, and Neubig, Tom. “What’s Wrong With Taxing Business Services.” Council on State Taxation. April4, 2013.9 Malm, Liz, and Kant, Ellen.“The Sources of State and Local Tax Revenues.” Tax Foundation. January 28, 2013.10 Deslatte, Melinda. “Jindal Proposes Getting Rid of Income Taxes.” The Associated Press. January 17, 2013.11 Malm, Liz, and Kant, Ellen. “The Sources of State and Local Tax Revenues.” Tax Foundation. January 28, 2013.12 Mayfield, Dan. “Martinez to Ask Legislature for $40M in Economic Development Incentives.” Albuquerque Business First. January3, 2013.13 Laffer, Arthur, Moore, Stephen, and Williams, Jonathan. Rich States, Poor States, 5th ed. American Legislative Exchange Council.April 2012.14 Buki, Chris. “Time to Eliminate the Texas Margin Tax.” Americans for Tax Reform. January 16, 2013.15 MacLaggan, Corrie. “Texas Governor Perry Calls for Tax Cuts for Businesses.” Reuters. April 15, 2013.16 Ibid.17 Hamilton, Amy. “Michigan Governor Approves Phase-Out of Business Personal Property Taxes.” Tax Analysts. October 21, 2012.18 Errecart, Joyce, Gerrish, Ed and Drenkard, Scott. “States Moving Away From Taxes on Tangible Personal Property.” Tax Founda-tion. October 4, 2012.19 Spencer, Jack. “Personal Property Tax Phase-Out Matters For Michigan.” Michigan Capitol Confidential. May 22, 2012.20 Scheck, Tom. “House DFL Calls for Income Tax Surcharge on Wealthiest.” Minnesota Public Radio News. March 19, 2013.21 Zdechlik, Mark. “Critics Say Dayton’s ‘Snowbird’ Tax Would Backfire.” Minnesota Public Radio News. March 21, 2013.22 Nagourney, Adam. “Two-Tax Rise Tests Wealthy in California.” The New York Times. February 7, 2013.23 “Proposition 30.” San Diego County Taxpayers Association. August 2012.24 Crane, David. “California’s New Taxes Are Paying for Pensions.” Bloomberg View. March 27, 2013.25 Stang, John. “Inslee Unshaken on No-New-Taxes Promise.” Crosscut.com. November 14, 2012. Shannon, Erin. “Within Hours of Becoming Governor, Inslee Says He May Break His No-Tax-Increase Pledge.” Washington PolicyCenter. January 17, 2013.26 The temporary tax increases were part of SB 6143, which was an $890 million tax package that the legislature passed in 2010.The tax increases on bottled water and soda in SB 6143 were repealed by voters through Initiative I-1107. For more information,please see: Mercier, Jason. “1-1107: Repealing Tax Increases on Food and Beverages.” Washington Policy Center. September 9, 2010. Shannon, Erin. “So Much for Inslee’s No-Tax-Increase Pledge.” Washington Policy Center. March 28, 2013. “Governor Inslee’s 2013-2015 Budget Priorities for a Working Washington.” Office of Financial Management. Accessed April 11,2013.27 “Balance Sheet Detail: General Fund-State, Education Legacy Trust, Opportunity Pathways, and Budget Stabilization Accounts.”Office of Financial Management. Accessed April 11, 2013. Also see: Shannon, Erin. “So Much for Inslee’s No-Tax-Increase Pledge.” Washington Policy Center. March 28, 2013.28 Shannon, Erin. “So Much for Inslee’s No-Tax-Increase Pledge.” Washington Policy Center. March 28, 2013.29 Garber, Andrew. “Gov. Inslee Says He’s Open to Extending Expiring Taxes.” The Seattle Times. January 17, 2013.30 Downing, Neil. “Vermont House Approves Package of Tax Increases.” Tax Analysts. March 29, 2013.31 Ibid.32 Ibid.33 Downing, Neil. “Vermont Governor Decries House Tax Package But Stops Short of Veto Threat.” Tax Analysts. April 1, 2013.34 McPhee, Michele. “Pol Nabbed on New Hampshire Booze Run.” Boston Herald. September 2, 2009.35 Moody, J. Scott. “The Great Tax Divide: New Hampshire’s Retail Oasis vs. Maine’s Retail Desert.” The New Hampshire Center forEconomic Policy. April 13, 2011.

×