Don’t Let Budget Crunch Stop Tax Cuts

Both major party candidates for governor have pledged to reduce taxes. John Sanchez uses an effective TV ad that shows him standing on a giant map of the United States explaining that all of New Mexico’s neighbors have lower taxes and hence attract more job-creating investment. He and Bill Richardson promise to cut income tax rates and to phase out certain parts of the gross receipts tax, all in an effort to help the state’s economic growth.

Clearly they are on the right track. Study after study has shown that high taxes breed slow economies, particularly at the state level, where people can avoid taxes simply by moving to state with lower taxes.

But will our new governor be distracted by looming budget problems? Like many other states, New Mexico is headed for a budget crunch in 2003, as recession-weakened revenue sources and loosely controlled spending combine to produce a substantial deficit. Thus, it will be tempting for the new governor to conclude that tax cuts are no longer “affordable.”

But this would be a costly mistake. Recent analysis by economist Stephen Moore for the Cato Institute shows that state tax cuts are the right approach regardless of whether the economy is running hot or cold.

Moore shows that states with high tax burdens are likely to see economic decline, while those with lower taxes tend to grow rapidly. During 1990-2000, real personal income grew by 40.5 percent in the ten lowest tax states but only 25.6 percent in the ten highest tax states. Similarly, job growth was twice as fast in the low tax states. States that cut taxes also fared better than those that didn’t.

During the 1990s, Moore explains, some states tried to fix budget problems by raising taxes. For example:

• In 1990, California raised the top income tax rate from 9.5 percent to 11 percent, which failed to raise revenues but drove top earners away. In 1995, the tax hikes were repealed and unemployment fell.
• Massachusetts put itself on a similar roller coaster, with tax hikes meant to close a deficit, causing job losses that were reversed only by subsequent tax cuts.

Other states cut taxes and reaped economic rewards:

• In the mid-1990s, Georgia cut several taxes (including its tax on groceries) and saw an economic boom that made it one of the fastest growing eastern states.
• Michigan attacked its 1991 budget deficit of $1.5 billion not with tax hikes but with budget reductions and tax cuts. The Michigan economy responded with rapid job growth.

All evidence from other states implies that New Mexico’s next governor should hold firm on his campaign promise to cut taxes, regardless of how the budget appears. Raising taxes will only hurt the economy without solving the problem.

Given the power of tax cuts, I would go a few steps farther than Sanchez and Richardson. Too often they promise to “phase out” taxes that should be eliminated outright. For example, the tax on medical services is New Mexico’s worst tax and should be ended immediately before more good doctors leave the state.

Also, we should establish a long term fiscal policy that people can count on. Colorado, for example, has limited future tax and spending increases to the growth rate of population and inflation. This policy recognizes that budget control is necessary for any prolonged low tax strategy. Given New Mexico’s somewhat nonchalant budgeting, this restraint would give needed reassurance to taxpayers.

But above all, don’t try to cure any problem by raising taxes. It won’t work.

Dr. Kenneth M. Brown, an economist, is research director of the Rio Grande Foundation.