Economists debate need to raise taxes

The following is a letter sent May 26 by 91 economists to Gov. Charlie Baker, House Speaker Robert DeLeo, and Senate President Karen Spilka, followed by a response from David Tuerck, president of the Beacon Hill Institute and professor of economics at Suffolk University.

MASSACHUSETTS IS FACING enormous health and economic challenges fighting the COVID-19 pandemic. The state has risen to the occasion. This has caused an unexpected increase in state and local spending at exactly the same time that revenues, especially income and sales taxes, are falling, making balancing next years’ operating budget exceptionally difficult.

Now is an appropriate time for the federal government to provide relief to states, an important measure Congress took during the Great Recession. There is also $3.5 billion in the Commonwealth’s rainy-day fund. But we are concerned that the state will also pursue counterproductive budget cuts. Large cuts would erode the health and social infrastructure needed to continue combatting COVID-19, increase an already high level of inequality, and exacerbate the economic downturn. Instead of budget cuts, the state should look to raise revenues to balance its budget.

Economic theory and historical experience show that spending cuts are more harmful than tax increases during recessions. States and localities spend most of their budgets on health, education, public safety, public transformation, and safety net programs. Cutting from housing, public transportation, and healthcare removes spending from the economy when it is most needed and from the people who need it the most and now have been disproportionately affected by COVID-19. Cutting local aid to cities and towns for police and fire protection, parks, and public works erodes public safety and infrastructure. While reducing funding for early education, K-12 and higher education reverses our long-standing investment in human capital—including recent new commitments—with long-run consequences for worker productivity and economic growth.

States must run balanced budgets. In a recession, balancing the budget by cutting spending has a more negative impact on economic growth than balancing the budget by raising taxes. Both the personal income tax and the corporate tax are fair ways to do this, since they fall only on persons with incomes and businesses with profits. A one percentage point increase in the income tax could raise $2.5 billion per year while a one percentage point increase in the corporate tax rate could raise $180 million per year, even if the income tax base falls by 25 percent  and the corporate tax base falls by 50 percent during this recession. These tax rates could be phased back as the economy returns to its pre-recession level.

As the leaders of our state government, you have the responsibility for setting priorities and making the difficult choices that lie ahead. We the undersigned encourage you to raise revenue rather than cut the social and physical infrastructure that will be necessary to protect the health and economic well-being of our people, our communities, and our Commonwealth.

For a list of the 91 economists click here.

Beacon Hill Institute says tax increases would be costly

A letter submitted to state leaders by a group of 91 economists can be seen as the opening volley in a campaign to raise Massachusetts taxes.  There will be similar demands from various business groups and from the same tax-and-spend lobby that agitates for higher taxes in both good times and bad.  At the moment, the only comfort we can take lies in the unwillingness of Gov. Charlie Baker to submit to this pressure.

The signers of the letter argue that the pandemic necessitates an expansion of government services even as state tax revenues fall. But, before clamoring for higher taxes, the signers might have waited to get a clearer idea of how much in revenues the state will have available in fiscal year 2021.  It won’t be until later in June that we have barely enough data to assess the decline in tax revenue that began in March.  And there are other sources of revenue.  The state has already received $2.6 billion in federal aid and may well receive more.  It has a rainy-day fund of $3.46 billion.  Recognizing as it does the importance of having good data before rushing out with policy recommendations, the discipline of economics calls for a more thoughtful approach.

Then there is the logic they use in making their case. “Balancing the budget by cutting spending,” they say, “has a more negative impact on economic growth than balancing the budget by raising taxes.” That argument is dubious enough when it comes to economic contractions that begin on the demand side of the economy but makes no sense at all when it comes to a contraction like this one that began on the supply side.

As regrettable as any decline in state services would be, shoring up those services does nothing to keep a small business going for another month when it has been shut down in the face of a state edict.  And to say that raising the tax on business profits is “fair” since the beleaguered businesses in our state won’t be making much in profits anyway tells us more about the mindset of these writers than they should want to reveal. And their logic is faulty.  All businesses need profits in order to attract capital, and Massachusetts businesses are going to need plenty of capital to satisfy state rules for reopening.  Furthermore, the new taxes would depress take-home wages as well as profits.

We can also wonder why none of the signers, with all their resources, bothered to provide an estimate of the “negative impact” that a tax increase would have on the state economy.  At the Beacon Hill Institute, we decided to correct for that omission by running their proposed tax increases through our state tax model.  Our results:  a loss of 28,651 private sector jobs, $2.6 billion in investment, and $3.37 billion in disposable personal income.

Finally, the authors make one observation that shows why academic economists should never attempt to make predictions about politics.  They say that their proposed tax increases “could be phased back as the economy returns to its pre-recession level.” For the likelihood of that, we should study the fate of ballot Question 4, approved by almost 60 percent of Massachusetts voters in 2000.  Question 4 called for the reduction of the state income tax rate from 5.95 percent to 5 percent by 2003.  As it turns out, it took until 2020 to get the rate down to 5 percent, its reduction having been delayed time after time by one contrived fiscal emergency after another.

Economists are often chided for their inability to agree.  With this episode we have plenty of economics to disagree with.

David Tuerck is the president of the Beacon Hill Institute and a professor of economics at Suffolk University.