Tax Hikes Aren’t Fixing States’ Budget Deficits

Published June 11, 2010

The growing trend of states adopting narrowly applied, targeted tax increases in an effort to close budget deficits is already hurting taxpayers and future budgets. While myriad interest groups and big-spending politicians say targeted tax hikes are the best way for states to deal with their budget crises, this misguided strategy has in fact made many states’ budget problems worse.

The fundamental flaw in arguments for targeted tax increases is the assumption that states face budget problems because they have too little revenue. The real problem, though, is too much government spending – and that problem is made worse, not better, by tax hikes.

Many states are beginning to see the dismaying consequences of using targeted tax hikes, massive borrowing, and budgetary tricks to prop up unnecessary increases in government spending. Michigan and California, for instance, have been trying the targeted tax approach for the better part of a decade. The money is never enough, and their economies are sputtering.

Some states, including California and New Jersey, have recently targeted high-income earners for especially burdensome taxes. But over-reliance on a small percentage of wealthy taxpayers makes state tax revenues even more susceptible to economic booms and busts. When the economy goes through a downturn, those states have far steeper budget deficits than they would have if their tax code consisted of broader, flatter taxes.

At the onset of the recession in 2008, for instance, Maryland implemented a “millionaire’s tax” instead of adopting spending reforms. A year later Maryland was home to one-third fewer millionaires. The state is expected to face yet another $1.5 billion deficit in 2011. In New Jersey, by contrast, Gov. Chris Christie recently vetoed an extension of the state’s surcharge on high-income earners and has made a commitment to real spending reforms.

Product-specific excise taxes – so-called “sin taxes” – are another bad idea. These taxes unduly burden low-income taxpayers, and revenues tend to fall short of projections. Oregon officials recently admitted they had overestimated tobacco tax revenues by $14.5 million. Washington, DC just announced cigarette tax collections were down 23.6 percent during the six months following a 50 cents-per-pack increase.

The same is true in many other states. With tobacco tax proceeds running dry from coast to coast, revenue-hungry lawmakers and special-interest groups have in their cross-hairs products such as candy, soda, plastic bags, and bottled water.

Studies show these taxes have little if any positive effect on public health or the environment, but state and local policymakers continue to pass them in the hope of identifying the one goose that will lay a golden tax revenue egg. When the miracle revenue fails to materialize, the tax-hikers set their sights on some other product.

Rather than seeking revenue miracles, policymakers should learn to live within their means: to govern resourcefully and provide services efficiently, cutting or privatizing non-vital government services. They should adopt reasonable spending limits tied to population growth plus inflation. On the revenue side, they should keep taxes transparent, broad-based, and low.

Policymakers who continue to focus on revenues rather than spending will only prolong their states’ budget problems and make the ultimate reckoning even more painful.

John Nothdurft ([email protected]) is the budget and tax legislative specialist for The Heartland Institute.

This op-ed was originally published in the Superior Telegram.