Category Archives: Fiscal Issues

The Kansas Red State Experiment is Failing: Drastic Tax Cuts Have Not Led to Higher Employment Growth

Posted on by

State Employment Growth Relative to US, Kansas and others, Jan 2011 to Aug 2014

A.  Introduction

Republican Sam Brownback was elected governor of Kansas in 2010 and is now running for re-election.  An extreme Tea Party conservative, he has pursued a radically right-wing agenda in Kansas with little constraint from a Republican controlled state legislature (especially after he led a successful effort to purge relative moderates from his party by more extreme conservatives in the 2012 primaries).

Central to his program were drastic tax cuts enacted in 2012, with a further round of cuts in 2013.  They were one of the largest tax cuts ever enacted by a state in percentage terms, and were labeled by Brownback to be a “real live experiment” of the conservative vision of small government leading to fast growth.  The tax cuts would be like a “shot of adrenaline into the heart of the Kansas economy” he asserted, employment would boom, and the faster growth would lead to greater total tax revenues generated (despite the lower rates) due to a then larger economy.

But it has not happened.  Employment in Kansas has fallen relative to the rest of the US since Brownback took office.  This post will first describe in more detail the tax cut measures, and will then look at the impact on employment.

B.  The Brownback Tax Cuts

The tax cut measures have (so far) come in two major waves.  The first were passed in early 2012 and signed into law by Brownback in May 2012.  The second were passed and signed in mid 2013.  The first were the more important, and included:

a)  Cuts in personal income tax rates, especially for those in the higher brackets:

Income Bracket Old Rate New Rate % change
>$60,000 6.45% 4.90% -24.0%
$30,000 – $60,000 6.25% 4.90% -21.6%
<$30,000 3.50% 3.00% -14.3%

b)  Elimination of state business taxes for most companies in Kansas.  This covered over 200,000 firms in the state, and while purportedly aimed only to benefit small businesses, the definition included at least several of the subsidiaries of Koch Industries (owned by the multi-billionaire Koch brothers, which is based in Kansas and which has provided strong financial support to the campaigns of Brownback and other Tea Party favorites).  No other state has eliminated such taxes.

c)  And partially offsetting the personal income tax cuts, the state sales tax rate was raised.  Such a tax increase affects the poorest the most.

Tax rates were then cut further in 2013.  Among other measures, the rate for the top personal income tax bracket is being phased down from the 4.9% of the 2012 law to just 3.9% by 2018, a cut of over 20%.

The Institute on Taxation & Economic Policy along with the Center on Budget and Policy Priorities has calculated the impact of these tax changes by household income category.  They are hugely regressive.  The figure below (calculated from the ITEP and CBPP figures) shows the impact as a percentage of taxes previously due.  While the combined effect of the tax changes will lead to a 37% reduction in taxes due for the richest 1% in Kansas (whose average household income in 2010 was $1.025 million), the poorest 20% have seen their taxes go up by 14%:

Impact of Kansas 2012 and 2013 Tax Cuts by Income Category

And the regressive tax cuts came on top of a system that already taxes the poor more than the rich.  The poorest 20% will now be paying close to 11% of their income in state and local taxes in Kansas.  Those in the middle (between the 20th to the 80th percentiles) will be paying between 8 and 9%.  But the richest 1% will be paying less than 4%.

The tax cuts have not, however, led to an increase in government revenues.  As will be discussed below, employment has not gone up as a result of the cuts.  Rather, tax cuts have led to cuts in tax revenues received.  While most of us would find this not at all surprising, Brownback was advised by Arthur Laffer, famous for the so-called Laffer Curve, which posits that tax cuts will lead to such an increase in employment and income that tax revenues will rise despite the lower rates.  It has not happened.

A recent report from the Rockefeller Institute of Government found that state tax revenues in Kansas between the second quarter (April to June) of 2013 and the second quarter of 2014 fell by 22% in total, and fell by 43% for the state personal income tax only.  These reductions were larger than in any of the other 50 states.  The 2012 tax cuts went into effect as of January 1, 2013, and the taxes collected in the second quarter of that year will then mostly reflect what was due on incomes earned in 2012.  The reduction in revenues due and collected in the second quarter of 2014 (primarily on incomes earned in 2013) will then represent the first year impact of the 2012 law.

The reduction in tax revenues generated as a consequence of the sharp tax rate cuts should surprise few.  The non-partisan Legislative Research Department of the Kansas state legislature has estimated that, as a consequence of the tax cuts, state revenues will fall by an estimated $730 million in FY14, and by a cumulative $5.2 billion by FY18.  These are large amounts for a small state.  The predictable result has been sharp cuts in the government budget.  Much of this has been borne by education, which is close to inevitable simply because it constitutes such a large share of the state budget.  State funding for K to 12 education has been cut by over 15% during Brownback’s term in office, and he has proposed another 2% cut for FY2015.

Despite such expenditure cuts, the state budgetary situation is now precarious.  This has led to cuts in Kansas government bond ratings by Moody’s and S&P.  It will now be more expensive for Kansas to borrow for public investment and other needs.

C.  Impact on Kansas Employment

Governor Brownback claimed that the massive tax cuts would lead to a boom in Kansas employment.  The chart at the top of this post shows that relative to the United States as a whole, as well as relative to such Democratically controlled states as Colorado, California, Minnesota, and Massachusetts, Kansas has lagged since Brownback was inaugurated (in January 2011).  The data is from the Bureau of Labor Statistics.  The states chosen reflect two near-by states to Kansas with important agricultural sectors and with also Democratic control of the state political machinery (Democratic governors as well as Democratic majorities in both chambers of the state legislatures:  Colorado and Minnesota), and two normally Democratic states from the two coasts who are often charged as having especially high state tax rates (California and Massachusetts)

The chart shows what has happened to employment in each state expressed as a share of total US employment, normalized so that the January 2011 shares are all set to 100.  Thus it will show whether employment in the state grew at a faster, or a slower, pace than overall employment in the US.  The share will go up if employment in the state grows at a faster pace than in the US as a whole, and the share will go down if employment in the state grows more slowly.

Kansas has not performed well.  Its share in US employment has fallen, and more or less consistently fallen, since Brownback took office.  There is no indication that the massive tax cuts, passed into law in May 2012 and expected well before, have led to employers shifting to the state or expanding there.  In contrast, the Blue States of Colorado and California have done especially well, while the Blue States of Minnesota and Massachusetts have seen employment grow at roughly the same pace as the US as a whole.

D.  What This Does and Does Not Say

There is thus no evidence that the massive tax cuts Brownback was able to have enacted have led to the boom in employment he asserted would follow.  It was not a “shot of adrenaline into the heart”, as he asserted it would be.  But it is also important to be clear on what the evidence we have so far does not say:

a)  First, while there is no evidence that the tax cuts led to a boom in employment, there is also no clear evidence that the tax cuts led (at least so far) to major reductions in employment.  Rather, employment in Kansas has trended steadily downwards over this period relative to the rest of the country, with the tax cuts having little effect one way or the other.  State level employment depends on many things, and the state tax regime does not appear to be a terribly important one.  What matters more will likely be state structural issues, such as the mix of particular industries in the state (including agriculture), the age distribution of the population in the state, the mix of high skilled vs. low skilled workers in the state, and so on.

b)  While Kansas performed poorly relative to the other states depicted in the chart above, there were fifteen states that did even more poorly than Kansas over this period.  Overall US employment grew by 6.4% over this period as a whole (1.75% at an annualized rate), while employment in Kansas grew by only 3.7% (1.0% annualized).  But of the 50 states, employment growth was worst in Alaska, with growth of only 1.6% over the period (0.4% annualized).  As noted above, state specific structural issues will matter.

c)  Finally, one should recognize that the period so far has been short.  While Brownback can clearly no longer claim that there will be an immediate or even near-term positive impact on employment, he is (not surprisingly) now claiming that it will take more time.  One can of course not disprove this until more time has passed, but the question is how long does one need before one recognizes the failure.  But we do know that the tax cuts have devastated state finances, leading to the rating downgrades and to budget cuts that are slashing expenditures in important areas such as education.  There is good reason to expect that such cuts in education will have adverse impacts on employment in the longer term.  When the current generation of students graduate, a larger share will not have the level of skills required for good jobs, if any jobs.  Potential employers will shun a state where they cannot hire staff with the skills they need.  I would wager that the long term impact will be negative, not positive.

But what one can say now with confidence is that the evidence is clear that massive tax cuts of this Red State “experiment” have not led to a near term boom in jobs.  It is also clear that such tax cuts do lead to cuts, not increases, in tax revenues.  The experiment has failed to fulfill the claims originally set out for it.

The Long-Term Downward Trend in Federal Government Employment Has Continued Under Obama

Posted on by

Fed Govt Employment as % of US Population, Jan 1953 - June 2014

 

A.  The Long-Term Downward Trend in Federal Government Employment

Previous posts on this blog have reported on the fall in total government employment (federal, state, and local) during Obama’s presidential term, in stark contrast to the increases seen during the term of George W. Bush as well as during the terms of other recent presidents.  The same pattern, of government jobs falling under Obama and rising under other presidents, is seen when one takes as the starting point the beginning of an economic downturn rather than the date of inauguration.  Government jobs have been cut compared to what they were at the start of the most recent downturn, in contrast to the increases approved in previous downturns.  These cuts in government jobs during Obama’s tenure, as well as the cuts in government spending, are of course exactly the opposite of what one should do during an economic downturn.  An earlier post estimated that if government spending been allowed to grow at the pace it had under Reagan, the economy would likely have reached full employment output already in 2011.

In terms of overall fiscal impact on the economy, a focus on total government employment and spending makes sense.  The total impact depends on what is being done at all levels of government – federal, state, and local.  But a president has only limited influence on what is happening at the state and local government levels.  It is federal government employment and spending that a president, together with the congress, determine.  Hence in terms of assessing the direction of policy during different presidential terms, limiting the analysis to the federal level makes sense.  The question to be addressed is whether, as many conservatives charge, the number of federal employees has grown sharply under Obama.

The chart at the top of this post shows federal government employment as a share of the US population going back to January 1953, the month Eisenhower was inaugurated.  The government employment figures come from the Bureau of Labor Statistics.  Note that federal government employment excludes active duty military personnel (but includes civilian employees of the Department of Defense).  The population numbers come from the Census Bureau (most conveniently accessed via FRED).

The chart shows that federal government employment as a share of the US population is now well below what it has been historically, and that it has fallen further during the presidential term of Obama.  Federal government employment is now only 0.85% of the US population, or over a third less than the 1.3% share it averaged from the second half of the 1950s through to the end of the 1980s (more than a third of a century).  There were sharp cuts at the start of the Eisenhower administration as the Korean War came to an end, and significant increases in the mid-1960s due to the Vietnam War and Great Society programs, but the averages, over any of the decades, were each still within round-off of 1.3%.  [Note:  While the government employment figures exclude active duty military, there are still major increases in government civilian employment during times of war in the Department of Defense and elsewhere.]

But since the mid-1960s (with the major exception of most of the Reagan term), federal government employment has been on a downward trend, most sharply during the presidential terms of Clinton and now Obama.  The recent fall during Obama’s term might be less of a concern if it was a reversal from a recent sharp increase, or as a reversal of an upward trend.  But government employment is already a third below (as a share of population) where it was through the 1980s, and is being cut further.  A fall by a third is huge.

B.  Federal Government Employment in Specific Presidential Terms

While government employment as a share of population is most appropriate when examining long term trends, some might want also to see the figures in terms of absolute numbers of employees over the course of presidential terms.  Here are the recent ones:

Number of Federal Government Jobs
       (numbers in thousands) Start  End
Reagan:  Jan 1981 to Jan 1989 2,961 3,158  197
Bush I:  Jan 1989 to Jan 1993 3,158 3,092 -66
Clinton:  Jan 1993 to Jan 2001 3,092 2,753 -339
Bush II:  Jan 2001 to Jan 2009 2,753 2,786  33
Obama:  Jan 2009 to June 2014 2,786 2,713 -73

As has been noted before, federal government employment rose sharply during Reagan’s presidential term.  It then fell during the term of Bush I, although not by enough to offset the increase under Reagan (when Bush was the Vice President).  There was then a sharp fall under Clinton, which was reversed to an increase under Bush II.  But federal government employment is now falling again under Obama.

Reagan and Bush II have been celebrated by Republicans as small government conservatives.  But federal government employment rose during their terms.  Clinton and Obama have been denounced by conservatives as big government liberals.  But federal employment fell sharply during their presidencies.  And federal employment also fell during the term of Bush I, the most moderate of recent Republican presidents.  The facts are simply not consistent with the stories told of these presidents.

C.  An Example of The Adverse Impact on Government Capacity

Federal government employment is thus now at a historic low (as a share of population) over a period of at least six decades.  It should not then be a surprise that government programs may be inadequately administered.  One often simply needs more personnel to do it.  A clear recent example of this is the crisis in the Veterans Administration.  The number of veterans has increased sharply in recent years due to the legacy of the Iraq and Afghanistan wars, and veterans from the Vietnam War are now of the age when they most need health care.  A significant number of aged World War II and Korean War veterans also remain and need care.  But the number of doctors, nurses, and other staff at the VA hospitals have been held back from the number needed to provide good care.  And it cannot be said that the existing staff are lazy.  The doctors are fully booked.

Rather than face up to this, lower level staff have for many years now been falsifying records to make it appear that veterans can see a doctor within a reasonable time, when that is not the case.  This of course has made the problem worse, as no one then faced up to the problem and did something about it.  Senior officials in the VA have stated that they were unaware of what was going on.  Having worked in a large bureaucracy myself for most of my career (the World Bank), I can readily believe this to be true.  Senior officials are often unaware of what is common knowledge among front-line staff.  But covering it up by falsifying records only served to make the problem worse.

A bipartisan deal appears to be close to congressional approval to provide additional funding to the Veterans Administration, to go at least some way to resolving the problem.  An additional $5 billion in funds will be provided to hire more doctors, nurses, and other staff needed to provide the care veterans have a right to, while $10 billion will be provided to allow veterans to go to more expensive private health care providers in those cases where they cannot receive a VA doctor’s appointment within 30 days, or when they live more than 40 miles from a VA hospital or clinic.  Whether this funding will suffice is not clear, and has been questioned.  Earlier estimates on the funding needed were far higher.  But Republicans in Congress have refused to approve more, and as of this writing, a final vote on the proposed measure still awaits.  However, any extra funding will at least help.

The veterans issue illustrates well the fundamental problem.  While it is certainly true in any large organization, private or public, that employees exist who are not providing effective service, there are in practice limits to how much one can cut before service suffers.

America’s Underinvestment in Public Infrastructure

Posted on by

Real per Capita Public Investment vs. GDP, 1950-2013

Public infrastructure in the United States is an embarrassment.  This is clear even to ordinary travelers.  Countries in Europe and in much of East Asia enjoy far better roads, highways, public transit, and other forms of public infrastructure than the US does, even though the real per capita incomes of these countries are lower than that of the US.  And this is backed up by more systematic global comparisons, such as in the Global Competitiveness Report of the World Economic Forum.  The most recent report ranked the US as only number 15 in the world in terms of its infrastructure (transport, power, and telecom).  This put the US behind Canada, the major countries of Western Europe, and such countries as Japan, Korea, Hong Kong, Singapore, and Taiwan in East Asia.

The poor quality of public infrastructure in the US should not, however, be a surprise.  As the chart at the top of this post shows, the US is spending no more now, in real per capita terms, than it did over a half century ago in 1960, in the last year of the Eisenhower administration.  The chart draws on data issued in the standard GDP (NIPA) accounts of the BEA of the US Department of Commerce.  Infrastructure investment is taken to be total government investment (at all levels of government – Federal, State, and Local) in structures, excluding such spending by the military.  Most government infrastructure spending in the US is for transport (primarily roads and associated bridges, but also including investment in mass transit, ports, and airports), with a significant amount also for water and wastewater treatment.

Public infrastructure spending in real per capita terms rose during the Eisenhower administration in the 1950s (when the Interstate Highway system was started) and continued rising during the Kennedy and Johnson administrations in the 1960s.  Indeed, during this period, such spending rose at a somewhat faster pace than real per capita GDP, the blue line in the chart.  But starting in 1969, the year Nixon took office, public infrastructure spending was cut.  By the mid-1970s it was down close to the level seen at the end of the Eisenhower administration (in real per capita terms), and then was cut even further at the start of the Reagan administration.  It then began to increase from 1984 with this continuing to a peak in 2002, after which it fell again.  By 2013 it was 2% lower than it was in 1960.  Over this same period, real per capita GDP almost tripled.

In dollar terms, real per capita spending on public infrastructure (in terms of 2009 prices, the base now used in the GDP accounts) was $793 in 1960 and was 2% lower, at $776, in 2013 (about 1.6% of GDP).  Over this same period, per capita real GDP rose from $17,159 in 1960 to $49,852 in 2013.  The increment in real per capita GDP was $32,693 over this period.  None of this growth went to increased investment in public infrastructure.

It is this stagnation in real per capita spending, and huge lag behind income growth, that has led to bridges and highways that are both congested and in poor condition.  People drive more, fly more, and import and export more goods, as their real incomes grow.  Public infrastructure has not kept up.  A 2009 report issued by the American Association of State Highway and Transportation Officials (AASTO) notes that vehicle miles driven between 1990 and 2007 rose by 41%, about double the increase in the US population over this 17-year period (of 20.6%).  Based on the figures in the chart above (which however covers all public infrastructure, not just highways), spending to build or maintain such infrastructure per mile driven fell by over 20% over that period.

The AASTO report also found (based on an analysis of US Federal Highway Administration data) that one-third (33%) of the nation’s major highways was classified as being only in poor or mediocre condition (as of 2007).   Thirteen percent was classified to be in poor condition, with this rising to over 60% poor in some major urban areas.   And roads in poor or mediocre condition deteriorate quickly, leading to much higher costs when the road eventually has to be repaired.  The AASTO report notes that the cost per mile over 25 years is three times higher if roads are left to be reconstructed, instead of maintained on the regular recommended schedule.

This stagnation in real per capita spending on public infrastructure over more than a half century may be surprising to some.  While many might be aware that infrastructure spending has not kept up with real per capita GDP (which has almost tripled), most people would assume that there has been at least some increase in per capita infrastructure spending.  But that is not the case.

Part of the reason for this mis-conception is that when measured as a share of GDP, it might not appear that public infrastructure spending has fallen so far behind.  As a share of GDP, public infrastructure spending (using the figures cited above for public investment in non-Defense structures, from the BEA accounts) was 39% less in 2013 than it was in 1960.  Put another way, public infrastructure spending would have had to increase by 64% (=1/(1-.39)) between 1960 and 2013, to match the GDP share it had in 1960.  But the figures shown above in the chart indicate that public infrastructure spending would have had to triple over this period to match the increase in GDP.

Why this big difference?  The reason is Baumol’s Cost Disease, which was discussed in an earlier post on this blog.  If the price index for public infrastructure spending over this period had matched the price index for overall GDP, then an increase in infrastructure spending of 64% would suffice to bring it into line with the increase in real GDP over the period.  But the cost of building infrastructure has risen at a faster pace than the cost of making goods generally.  This is not because of increased waste, but rather because building infrastructure is by nature labor intensive and hard to automate.  The relative cost of infrastructure will therefore increase over time relative to the cost of goods whose production can be increasingly automated.

The importance of this is huge, but is often ignored in the debates.  As the chart above shows, investment in public infrastructure has stagnated in real per capita terms over more than a half century, and would need to almost triple at this point to catch up with how much real per capita GDP has grown.  This is far greater than the 64% increase (which is itself not small) that one might assume would be necessary by simply focussing on GDP shares.

The fundamental cause of this stagnation in real spending on public infrastructure has been an unwillingness in Congress to pay for it.  The most important source of funding for highway expenditures has been the gasoline tax, which supports the Highway Trust Fund. But as was discussed in an earlier post on this blog, gasoline taxes have been set as so many cents per gallon and are not adjusted regularly for inflation.  The last time the tax was raised (in nominal terms) was in 1993, over 20 years ago.  Since then, even general inflation has eroded this by over 50%.  If one took into account that prices for infrastructure investments rise at a substantially faster pace than general prices (due to Baumol’s Cost Disease, discussed above), the real erosion has been much greater.  As a result, funds in the Highway Trust Fund are far from adequate.

The result has been repeated crises as the Congress passes one short term patch after another to allow even the overly low on-going highway investments to continue.  One such crisis is underway now, where expenditures would need to be slashed on August 1 if nothing is done.  The Senate is currently expected to vote this week on an extension, although it would only be for a few months at best.  If passed and can then be reconciled with a similar House passed measure (passed two weeks ago), spending on highway investment will be able to continue for a few more months.

To provide the needed funds, given that the Highway Trust Fund is far from sufficient (due to the failure to adjust the tax to reflect inflation), Congress has included again an especially stupid provision in the draft bills.  As it did in an earlier authorization in 2012 (see the blog post cited above), Congress would allow corporations to make assumptions on their pension obligations which will in effect allow them to underfund their pension obligations by even more than currently.  The corporations will then show (on their balance sheets) higher profits, which will generate somewhat higher corporate income tax obligations.  These higher tax obligations will be counted as government revenues.  But those reliant on corporate pensions will be at greater risk of not receiving the pensions they are owed.  Ultimately the government may be obliged to cover these pension obligations (through the Pension Benefit Guarantee Corporation).  But these costs latter costs are being ignored.