High tax rates ≠ high revenues
Lower tax rates incentivize economic activity and therefore expand the tax base. High tax rates do the opposite
This morning, I had the pleasure of speaking before the House Ways and Means Committee on HF150, which would require that the inflation rate be included in the state economic forecast. My remarks were based on the information below.
Inflation is a problem because it erodes the purchasing power of a unit of currency over time. At high rates of inflation, it can do so over short periods of time. Even at low rates, it can do so over long periods.
But this is not Weimar Germany. It is not Zimbabwe. It is not Venezuela. It is not even America of the 1970s when inflation hit 13% in 1980. Since 1983, inflation in the United States has averaged 2.7% annually. In the last ten years, it has averaged 1.6% (See Figure 1).
Figure 1: Inflation, consumer prices for the United States, Annual, Not Seasonally Adjusted
And this is expected to continue. As of Friday (2/21/20), according to the Federal Reserve Bank of St. Louis, the 5-Year Forward Inflation Expectation Rate is 1.63% (See Figure 2).
Figure 2: 5-Year Forward Inflation Expectation Rate, Daily, Not Seasonally Adjusted
Remember, high inflation over short periods can erode the purchasing power of money. But, with inflation at the low levels we have seen over the past 37 years, the two year period of the biennium just is not long enough for this to be a significant factor.
Because inflation is so low and the forecast period is short, we aren’t actually talking about much money here.
At the end of the 2019 legislative session, Minnesota Management and Budget forecast the state government’s total General Fund Fiscal Year Total spending for 2020 to come in at $24 billion. If, in the meantime, there has been inflation of 1.6%, then, in 2019 dollars, that spending will be $23.6 billion. In effect, the state government’s spending will be 1.6% – or $383 million – lower in real terms than forecast in 2019. For 2021, with a forecast spend of $24.5 billion and inflation of 3.2% since 2019, the state government’s spending will be 3.2% – or $785 million – lower in real terms than forecast in 2019.
But, to repeat, in 2020 this is real terms spending reduction of 1.6%. It is a reduction of 3.2% in 2021. Over the biennium, that adds up to a reduction of real terms spending of 2.4% ((383 million + 785 million)/(24 billion + 24.5 billion)). Are we really supposed to believe that Minnesota’s state government is such a leanly efficient beast that its spending couldn’t be 2.4% lower over the biennium without returning us to the horse and buggy days?
That is hard to accept from a state government that:
And that is just the last couple of years.
Not surprisingly, Minnesotans don’t think so. In the fall 2019 issue of our magazine, Thinking Minnesota, we asked Minnesotans “What percentage of state spending is wasteful?” Among Republicans, the answer was 36.5%. Among Independents, the answer was 25.4%. Among Democrats the answer was 24.4%. Overall, Minnesotans believe that 28.2% of state government spending is wasteful. In their view, the state government should have no problem whatsoever finding savings of 2.4%.
I would like to put this into some context.
Between 2010 and 2019, Minnesota’s state government General Fund spending increased – in real terms because we’re looking over a decade – by 35%. Spending in 2019 was higher than ever before in the state’s history (See Figure 3).
Figure 3: Total General Fund spending, 2010 to 2019, billions 2019$
Source: Minnesota Management and Budget and Center of the American Experiment
Of course, the state’s population has grown over that period, but only by 6.2%. As a result, in per capita terms, adjusted for inflation, state government spending increased by 27% between 2010 and 2019. Once again, in real terms, Minnesota’s state government has never spent more money per resident than it does right now (See Figure 4).
Figure 4: Total General Fund spending per capita, 2010 to 2019, 2019$
Indeed, in 2019 dollars, even accounting for inflation, 2020 and 2021 are set to be the state government’s highest spending years in history. When we look at Fiscal Years 2022 and 2023, the numbers from the Budget and Economic Forecast show that, even accounting for inflation, those years will set new records for state government spending.
So, again, the idea that savings of 2.4% over the biennium are unthinkable just doesn’t add up.
John Phelan is an economist at the Center of the American Experiment.