January 10, 1990 THREE REMEDIES FOR THE TAX DRAG ON COLORADO'S ECONOMY By Dwight Filley Independence Senior Fellow Introduction There is an on-going and bitter political debate over the level of Colorado state spend- ing. Proponents of increased state spending -- and necessarily ~- of increased taxes, argue that ‘we would all be better off if more money were taken from us and spent on things we would -not spend it on if left alone. Opponents of increased state taxing and spending often come out second best in the debate since theirs is sometimes perceived as an essentially selfish argument—that they earned the money, so they should be allowed to keep it, and to hell with the common good. But as our ability to gather and analyze data increases, and as different government entities establish different levels of taxing and spending, we are increasingly able to contrast and compare, and to observe empirically the results of a notion which seems obvious to any—that more state spending will make life Detter for all. IN BRIEF + Colorado's growing state budget, fueled by higher taxes, is less beneficial to the average citizen than politicians claim. + Centralized, government-dominated economies are an obvious failure in the communist bloc. Economists find that low taxes contribute to high prosperity in U. S. states as well as nations around the world, + Absent specific restraints, special interests seeking concentrated benefits from government will usually overwhelm unorganized taxpayers whose costs are more diffuse, + Three remedies available to Colorado in 1990 include a constitutional amendment for voter approval of all new taxes, legislation to freeze state hiring, and legislation to cap annual spending growth at 4%, + An appendix by Richard Vedder of Ohio University cites 33 scholarly studies which document the tax drag on economic growth Note: The Independence Issue Papers are published for educational purposes only, and the authors speak for themselves. Nothing written here is to be construed as necessarily repre. ting the views of the independence Institute or as an attempt to influence any election or legislative action.An Outline of the Work ‘This paper will first examine evidence from various jurisdictions which contrast the results of high and low spending and tax levels, and then attempt to explain these results from a political science point of view. Next, options for changing the Colorado governmental structure in which high taxes result will be reviewed, and finally an attempt will be made to counter various arguments used by the high-spending/high-taxing fac tion. The Evidence Although political economy is far from a hard science, and so is unable to predict with the accuracy of disciplines such as chemistry or physics, there is an accumulating body of evidence supporting the thesis that higher state spending is so damaging to the economy that the people are worse off, despite the often intuitive feeling that if the government only had more money, it could improve our lives. Often an individual program seems so obviously beneficial that supporters lose sight of the overall harm the taxation needed to fund the pro- gram will cause. First, consider the communist nations vs. the west. Communism is a system which puts the entire wealth of a nation at the disposal of the pubie sector—a sort of 100% taxation. The utter failure of such systems, which are disintegrating before our eyes, need not be belabored. Next, let's look at a survey done by Dr. Richard Vedder, Distinguished Professor of Economics, Ohio University, entitled “Do Tax Increases Harm Economic Growth and Development?”! He looked at 35 scholarly studies and found that 33 supported the thesis in the title, that tax increases do indeed harm economic growth and development. ‘Two studies are worth particular mention, One, done by the World Bank, compared ten pairs of non- communist countries with similar per capita incomes but different tax levels. In every pair, the low-tax country had sharply higher rates of economic growth, investment and innovation than did the high-tax country, while the high-tax country had slow growth and higher inflation, Perhaps the most surprising finding was that although the low-tax countries naturally collected fewer taxes, their public sectors, that is, the part of the econo- my supported by taxes, actually grew faster because their economies as a whole grew faster. The other study,3 closer to home, demonstrated that in the 1970’s, high growth states in the U.S. levied T Barry Goldwater Inte, Repo 91061989 ~ reprinas an appendix to this paper. 2 Marsden, Keth (1983), “Links Between Taxes and Economie Growth: Some Empirical Evidence,” World Bank Sua Working Papers, No, 604, Washington DC. ‘World Bank 2Jess than half the income taxes per capita that low growth states did, and that low-tax states grew more than one third faster than high-tax states. Next, consider that very heart of government, Washington, D.C. As might be expected, when the District of Columbia is analyzed as if it were the Sist state, it is found to have a huge public sector, as the fol- lowing numbers indicate.4 + State government expenditures per capita D.C. $4,701 U.S. avg $2,504 + Federal grants to state and local governments per capita D.C. $2,436 U.S. avg. $427 + Per pupil expenditure, public schools, D.C. $5,643 U.S. avg. $4,209 Note that federal grants per capita were more than five times higher in the District. Even allowing for the unique burdens and expenses which Washington must bear as the seat of national government, this means that D.C. residents get the benefits of higher "state" spending, while not having a remotely proportionate drain from higher taxes, since taxpayers in the rest of the country picked up most of the tab. Nevertheless, Washington is notorious for its lousy living conditions, as evidenced by the following: + Violent crime rate per 100,000 people D.C. 1,609 US. avg. 609 Homicide death rate D.C. 28.2 U.S. avg. 9.0 + Infant mortality rate D.C. 21.1 U.S. avg. 10.4 Now if the public sector really is able to improve living conditions with more money to spend, then a “state” spending rate nearly twice the national average should certainly do the tick, and federal grants coming in at more than five times the national average ought to be especially helpful, since D.C. residents avoid most of the taxes which pay for these grants. Yet with far more money to hire police, the Washington D.C. violent crime rate is nearly two and half times as high as the rest of the country, and the homicide death rate is more than three times as high. With vast amounts of money available to set up hospitals, infant mortality rates ought to be among the lowest in the coun- try. But no—it turns out to be almost twice as high as the national average. It is clear that at least in this city, higher public spending, even when the local population is spared ‘many of the taxes, correlates with a far lower standard of living. This is true even for the poor, in whose name -nublic expenditures are often made, We can only speculate how much lower the standard of living would be if ‘3 Vedder, Richard (1982), "Rich Sates, Poor Sate: How High Taxes Inhibit Growth,” Journal of Contemporary Studies Fall, 1982 “4 Source” Statistical Abst ofthe United Sres, 1989, as reported in Reason Magatine, December, 1989 Sibi 3