So Many Myths, So Little Time

The first installment in this series scratched the surface of the abundant supply of Minnesota economic and fiscal policy myths. This article scratches a little deeper, knocking off three additional myths. Some of these myths are not unique to Minnesota, but all are heard in Gopher State policy debates. And all are false.

Myth #1: Cutting Taxes Will Generate Additional Public Revenue

At both the state and federal level, the claim that tax cuts will stimulate revenue growth has persisted for nearly four decades. And the claim has been persistently wrong. At the federal level, “past tax cuts in 1981 and the early 2000s have led to widening budget deficits and lower revenue, not the reverse as some claim,” according to the Committee for a Responsible Federal Budget. Big tax cutting states, such as Kansas, Oklahoma, Louisiana, North Carolina, and Wisconsin, continue to confront deficits, according to the Institute on Taxation & Economic Policy.

The “tax cut equals revenue growth” argument is rooted in the “Laffer curve.” However, for a tax cut to generate additional revenue, tax rates must be extraordinarily high—above the tm point in the following hypothetical Laffer curve. In modern times, federal and state tax rates are simply not that high. At all points to the left of tm (tc, for example), a reduction in tax rates will generate less—not more—revenue.

The conservative belief the tax cuts generate additional public revenue is partially rooted in the conviction that dollars in the private sector are inherently more productive than dollars in the public sector. However, this is often not the case. Public sector dollars build roads, educate students, provide public safety, clean-up polluted land, and so on—all things that make the economy more productive. Tax cuts can lead to productive investments as well—or they can contribute to increased income concentration that does relatively little to stimulate economic growth. The notion that tax cuts are necessarily more productive than public investments is simplistic and wrong.

Economist and former chair of the U.S. Council of Economic Advisors Austan Goolsbee sums it up well:

Moon landing was real. Evolution exists. Tax cuts lose revenue. The research has shown this a thousand times. Enough already.

Myth #2: Minnesota has the Most Progressive Income Tax in the Nation

Income taxes are generally progressive and Minnesota’s income tax is more progressive than in most other states. However, it is far from the most progressive state income tax in the nation, as some have proclaimed. The Suits index is a measure of tax progressivity and regressivity; the higher the index, the more progressive the tax. Suits indexes for income taxes in all fifty states, calculated using the same data used in section E of the 2017 Minnesota Tax Incidence Study, show that Minnesota falls just outside the top ten states in terms of income tax progressivity.

The claim that Minnesota’s income tax is the most progressive in the nation is typically used to argue that we shouldn’t make the state’s income tax any more progressive than it already is. It isn’t and could be more so.

Myth #3: State General Fund Spending is Growing Like Crazy

In order to realistically gauge the change in public spending over time, it is necessary to take into account inflation—which reduces the purchasing power of the dollar—and growth in the number of people who rely on public services such as schools, roads and transit, and medical care. Properly adjusted for these two factors, state general fund spending is less today than it was fifteen years ago.†

In fiscal year (FY) 2003, nearly all general education costs were shifted into the state general fund. However, pervasive “no new tax” dogma during the rest of the decade saw the state’s funding commitment shrink and prevented even a partial restoration of past tax reductions. Real per capita state general fund spending in Minnesota steadily declined after FY 2003—even before the onset of the Great Recession.

State general fund spending plummeted by 14.4% from FY 2009 to FY 2010. From FY 2010 to FY 2012, various accounting gimmicks—such as school aid funding shifts and the sale of tobacco bonds—and a large infusion of federal dollars from the American Recovery and Reinvestment Act temporarily reduced general fund spending on education, Medical Assistance, human services, corrections, and debt service.  This spending still occurred, but was temporarily paid for with non-general fund dollars or shifted into future fiscal years.

State general fund spending has increased—relative to the artificially low levels of FY 2010 through 2012. However, even after the modest growth that occurred after FY 2013, real per capita general fund spending is five percent less today than in FY 2003. Real per capita general fund spending is expected to drop another five percent by FY 2021—largely due to the state’s decision to unwisely ignore most of the impact of inflation on future state expenditures.

This brief series has examined only a handful of myths that litter state policy debates. While it may be impossible to catalog and debunk all the fiscal myths in circulation today, we’ll keep trying!

 

*These Suits indexes are based on 2012 income levels and adjusted for tax changes enacted by states through December 31, 2014. Thus, the effects of Minnesota’s fourth tier income tax enacted in 2013 are reflected in this data. The ITEP data incorporates information for all filer categories (e.g., married joint, single, etc.), although it does not include senior households. Ten states have income taxes that are more progressive than Minnesota’s, based on a comparison of income tax Suits indexes. In two of these states (Tennessee and New Hampshire), the income tax applies primarily to dividend and interest earnings, as most forms of earned income (e.g., salaries and wages) are exempt. As a result, the income taxes in these two states are extremely progressive, with the tax falling almost exclusively on the high-income households that have the preponderance of interest and dividend income. At the same time, the income tax generates a relatively small share of total tax revenue in these two states because the tax is applied to an extremely narrow base. In the other eight states that round out the top ten with the most progressive income taxes, the income tax is a significant revenue source, comprising over a quarter—and in most instances, over a third—of total state and local tax revenue.

Inflation adjustments in this article—including the third graph—are based on the Implicit Price Deflator for State & Local Government Purchases, which is appropriate index to use when adjusting state and local government expenditures for the effects of inflation.