Why are high-tax states facing budget deficits?

It’s the spending, stupid

In the Hans Christian Andersen tale "The Emperor's New Clothes," two swindlers convince a clothing-obsessed ruler that they can create the most beautiful garment in the world. The swindlers also claim the garment has a "magical" power: Anyone who is stupid or unfit for his post can't see it. The swindlers create nothing, but everyone praises the nothingness out of fear of being exposed as stupid or incompetent.

A similar thing is happening today with the Nevada Legislature. Thanks to years of reckless spending increases, plus the budget gimmickry, "temporary" tax increases and one-time stimulus funding employed during the 2009 session, Nevada won't be able to maintain its spending levels without raising taxes in 2011.

Knowing this, liberal legislators, led by Senate Majority Leader Steven Horsford and probable incoming Assembly Speaker John Oceguera, are claiming that Nevada faces budget problems because its tax base is too narrow and volatile — i.e., it lacks a "broad-based business tax." So these lawmakers are eager to pass one, Horsford's expressed preference being a corporate income tax.

As the Senate Majority Leader has said:

When you look around the country at stable revenue sources that allow for essential services to be provided in both good and bad times, Nevada's structure is flawed. It's over-reliant on highly volatile taxes such as gaming and sales tax. If we're going to have a system that works in good times and bad times, that revenue structure needs to change.

Lawmakers and others who don't buy Horsford's narrative regularly face scorn. In Nevada's full-contact politics, they are implicitly labeled — by other politicians or some in the press — as stupid or unfit.

Fortunately, it's almost as easy to test this theory as it is to open your eyes and see that the emperor, in fact, has no clothes. There are 49 other states, most of which have a broad-based business tax, a personal income tax or both.

If a broad-based business tax is such a cure-all, states that have levied one should be weathering the current recession just fine. And states with a personal income tax and a corporate income tax should be doing especially well.

Except they're not. Let's compare Nevada with California, New York and Connecticut, all of which have a sales tax, personal income tax and corporate income tax.

State	Personal Income Tax	Corporate Income Tax	Sales Tax
Nevada	None	None	6.85%
California	1.25 - 10.55%	8.84%	8.25%
New York	4 - 8.97%	7.10%	4%
Connecticut	3 - 6.5%	7.50%	6%

So how are these states doing fiscally?

New York is facing a budget hole somewhere between $9.2 billion and $10.2 billion. Its fiscal year began on April 1 and it still doesn't have a budget.

Connecticut, the wealthiest state in the country per capita, is set to borrow $1 billion to cover its budget hole, on top of the $1 billion it borrowed last year. Connecticut also recently saw its credit rating cut from AA+ to AA.

And California is drawing comparisons to nearly bankrupt Greece, having issued almost $3 billion in scrip last year, watched its credit rating fall to A-minus, and been forced now to try to close a $20 billion budget hole.

What happened? Why hasn't the combination of a personal income tax and a corporate income tax prevented these states from suffering budget problems as bad as or even worse than Nevada's?

The reason is that each of these states, like Nevada, has drastically increased inflation-adjusted, per-capita spending over the past 15 years.

State	Real per-capita spending in FY94	Real per- capita spending in FY09	Percent increase
Nevada	$1,024	$1,322	29.1%
California	$2,409	$3,124	29.7%
New York	$2,769	$3,898	40.7%
Connecticut	$2,993	FY 08: $4,012	34.0%

It doesn't matter whether a state has a sales tax, a personal income tax, a corporate income tax or all three. When states pass unsustainable spending increases year after year, eventually they'll run out of gimmicks to employ in order to avoid deficits. Unsustainable spending increases simply become unsustainable.

Nevada's problems don't stem from a lack of revenue, either. As NPRI fiscal policy analyst Geoffrey Lawrence has noted, organizations as ideologically diverse as the Tax Foundation and the Brookings Institution rank Nevada's combined state and local tax collections per capita 25^th-highest and 22^nd-highest, respectively, in the nation.

Instead of putting an end to Nevada's unsustainable spending increases (which are driven, by the way, primarily by exorbitant government salaries), Horsford and Oceguera continue to claim that the lack of a broad-based business tax is the real cause of Nevada's budget woes. The reality, however, is that having a broad-based business tax doesn't prevent politicians from over-spending. Rather, as Nevadans saw in the aftermath of the 2003 tax hikes, more taxes tend to exacerbate the state's spending problem.

It's well known that at the end of "The Emperor's New Clothes," a child finally points out that the emperor is actually naked. Often forgotten is that upon hearing the truth, the emperor simply ignores the child and continues along with his head held even higher than before.

The choices before Nevada's lawmakers are clear. A broad-based business tax hasn't prevented budget deficits in other states and won't do so in Nevada, either. Will lawmakers summon the courage to tell Horsford and Oceguera the truth?

And upon learning that truth, will these legislative leaders adjust their thinking? Or will they carry on as usual, exposed for all the state to see, yet still holding their heads high?

Victor Joecks is the deputy communications director at the Nevada Policy Research Institute. For more information visit http://npri.org.

Tags: Fiscal, Budget, Taxes