Major League Tradeoffs

Posted on by John Payne

Would you work one year for $1 million? Before you answer, you should know that your work would be playing Major League Baseball for the reigning champion San Francisco Giants. Most people would leap at the chance both for the money and the experience, but not Edgar Renteria. Renteria mostly played off the bench this season, but in years past he was a premier defensive shortstop and handy with the bat, hitting the walk-off single in game seven of the 1997 World Series for the Florida Marlins. (He returned to the Fall Classic as a Cardinal in 2004, where he also initiated the final play of the series — a ground out to finish off the awful four game sweep by the Red Sox — but that incident was not indicative of the quality of his play that year or in that series.) Despite struggling in the regular season this year, Renteria bounced back in the World Series with two home runs and earned the series MVP award, which might be why he was expecting a bit more than $1 million:

“To play for a million dollars, I’d rather stay with my private business and share more time with my family,” he said. “Thank God I’m well off financially and my money is well invested.”

Now, many people will look at this and see an example of an overpaid sports star, greedily seeking an ever larger pile of money, but I think it nicely illustrates two economic concepts: diminishing marginal utility and opportunity cost. Playing Major League Baseball is a major time commitment (162 regular season games per year, 81 of them on the road), and, according to his statement, his next-most-valued use of that time is spending time with his family in Colombia, so giving up family time was his opportunity cost to earn those huge salaries. However, Renteria has earned many millions of dollars over the years, and apparently he has invested it wisely, so each additional $1 million is worth far less to him than the first million he made. As his baseball salary dwindles, the amount of time he has left to spend with his family is also shrinking, so that good is becoming ever more valuable. Whereas $1 million was easily worth the opportunity cost for a childless and dramatically poorer Renteria in the early nineties, it’s simply not worth the effort now that he is financially comfortable with a family to tend to.

In a similar fashion, income taxes artificially encourage people with the means to opt out of the labor market to consume more leisure. There’s nothing wrong with that choice, but, as a consequence, society will be a little poorer without the wealth that this labor would have created. Consequently, we should minimize the distortionary effects of taxes by keeping them low and let markets signal what people need and want through prices.

Actions Speak Louder Than Words

Posted on by Christine Harbin

Not only is Gov. Jay Nixon communicating opposition to recommendations from the commission that he created (as I have discussed previously), he is continuing to issue targeted tax credits to companies. From an article in the Columbus Business Journal:

Incentives from the state of Missouri are helping Scotts Miracle-Gro Co. build a new production and distribution facility there.

The Marysville-based lawn and garden care company will receive more than $350,000 in tax credits and grants in exchange for investing $8 million in a new fertilizer production operation in Wright City, Mo., expected to employ 14 upon opening and 25 once fully operational.

Actions speak louder than words. Although the governor may vocalize opposition to tax credit programs in Missouri, his actions suggest otherwise.

Income Taxes Decrease Economic Growth, Prosperity

Posted on by John Payne

With the 2010 Census complete, Congress will soon reapportion seats in the House of Representatives, and it appears that Missouri will lose one of its nine congressional districts. According to a new report by Americans for Tax Reform, our state shares a feature with the other nine states likely to lose representatives: relatively high state income tax rates and government spending. Four of the eight states gaining seats — including the biggest winners, Texas and Florida, with four and two new seats, respectively — have no income tax at all. The average top income tax rate for all eight states is 2.8 percent, compared to 6.05 percent in the losing states, which is just higher than Missouri’s top rate of 6 percent. The governments of states that gained representatives spent only $4,008 per capita — almost 22 percent less than their counterparts in the states that lost seats, which spent $5,117. These figures suggest that high taxes and government spending tend to drive people away. They also lower the standard of living for those who remain. Two new studies released by the Show-Me Institute explain why and suggest alternatives that can once more set Missouri on a path for growth.

In his new policy study, “A Review of Cross-Country Evidence on Government Fiscal Policy and Economic Growth,” University of Missouri–Columbia economics professor Shawn Ni compares economic growth and taxation rates, along with government spending, for a number of countries. He finds that taxes reduce economic growth by discouraging businesses and entrepreneurs from creating the capital that raises productivity and, ultimately, wages. Ni estimates that a 10-percent cut in the corporate income tax rate will lead to a 1- to 2-percent increase in the rate of GDP growth. This may not seem terribly significant, but if two economies started at the same level and one of them grew by an extra 2 percent each year, it would be twice the size of its rival in a little more than 35 years.

The Nobel laureate economist Robert Lucas once remarked when contemplating the differences in international economic growth rates, “The consequences for human welfare involved in questions like these are simply staggering: once one starts to think about them, it is hard to think about anything else.” A similar idea is expressed more succinctly by a quote usually (but inaccurately, in all likelihood) attributed to Albert Einstein: “The most powerful force in the universe is compound interest.”

Long-term economic growth rates are affected not only by the rate of taxation, but also by the form of taxation. Show-Me Institute Chief Economist and University of Missouri–Columbia professor Joseph Haslag, along with Washington University economics doctoral student Grant Casteel, argue in a new essay that replacing Missouri’s income tax with a sales tax will lead to a higher growth rate and therefore higher lifetime consumption than we would have under the current system. Casteel and Haslag concede that shifting the tax burden to a broad-based sales tax would result in consumption falling initially, because it would increase total prices for goods and services. However, eliminating the income tax provides a greater incentive for people to create new income — and, therefore, wealth — for society as a whole. This translates to a higher economic growth rate.

The authors estimate that, absent the state income tax, the average annual growth rate for Missouri would rise from 0.6 percent to 1.4 percent. Over time, consumption would rise along with people’s real incomes. Within nine years, consumption would be as high under the sales tax system as under the income tax — and it would continue to rise. After a generation (29 years), according to Haslag and Casteel’s calculations, consumers would derive more overall satisfaction in a sales tax system, with even bigger gains to come in the future.

Using statistics from Gapminder, we can see that in 1910 Russia and Japan had very similar per capita GDPs: $1,731 and $1,736, respectively, adjusted for inflation. However, after a century of marginally better than average GDP growth, the average citizen of Japan enjoys a standard of living more than twice that of the average Russian. If we want to give Missourians a higher standard of living, we should strive for better economic growth by keeping taxes and spending low and broadly based. Furthermore, the few necessary taxes should not be designed to punish people for creating new wealth, thereby slowing down the engine of economic growth, as the income tax has been shown to do. Over time, small changes can make a huge difference.

John Payne is a research assistant for the Show-Me Institute, a Missouri-based think tank.

 

More Freedom, Please!

Posted on by Audrey Spalding

This past Sunday, Russian journalist Oleg Kashin wrote in the New York Times about just how abusive the Russian government can be. Kashin was beaten with steel rods on the night of Nov. 6, likely because of his intrepid work to uncover government wrongdoing. In his op-ed, Kashin lists several theories for why he may have been beaten. Most disturbing, he concludes, is the following:

What strikes me about the theories is that, in each case, the ultimate perpetrator is the state. And for some reason that seems acceptable to most Russians: practically no one here has questioned the right of the state to resort to extra-legal violence to maintain power, even against journalists.

What amazed me about Kashin’s story was the possibility that he had been beaten for writing something that in America seems unimportant to the point of boring: A proposed highway that city residents oppose but local authorities want. Show-Me Daily authors frequently blog about transportation boondoggles because there’s so much material. We get excited if commenters even bother to respond, and when we go home at night, we don’t bother to check under our cars for stray wires.

Chess champion Garry Kasparov, at a recent Show-Me Institute lecture, spoke about how he has spoken out strongly against government tyranny in Russia in recent years. Stories like his and Kashin’s make me thankful that, despite all of the waste and favoritism in Missouri, at least I, my coworkers, and anyone else can write about it.

But I shouldn’t get too warm and fuzzy about how great it is that bloggers and policy analysts aren’t beaten for criticizing Missouri government. There have been recent cases when the politically powerful have worked either to quash the rights of those who aren’t so well connected to government power, or simply used the system to their own benefit.

I hope that 2011 will be a better year for Missouri government. I hope legislators will come to know that it really isn’t their job to tell people what to wear, do, say, or how to work. And if they don’t learn, I and the super-awesome champions of government restraint that are my coworkers will continue to point that out.

“Wouldn’t You Fight It if the Taxpayer Pays for Your Development Instead of You?”

Posted on by Christine Harbin

Last month, the Post-Dispatch published an article by Tim Logan illustrating the significant lobbying power of the individuals and companies that make a living off of administering tax credits in Missouri. I didn’t see the article when it ran initially, but it contains an important point that I want to highlight on Show-Me Daily. From the article:

When incentives enter the picture, so do an army of specialists, from consultants who help the projects qualify to brokers who turn the incentives into cash. A whole new layer of lawyers and bankers help work out the complicated financing of it all.

Taken together, these people form an industry, one that has flourished in St. Louis over the last decade. Thousands of skilled professionals have made good livings off the $3.5 billion in public money that cities and the state have poured into private real estate deals. And they regularly — and loudly — make themselves heard anytime someone tries to crimp the tap.

The businesses and individuals that directly profit from tax credit programs have a very strong incentive to maintain the status quo. For this reason, they are unlikely to approach tax credit reform measures seriously or substantively. Instead of implementing changes that limit the size of these programs, they will tend to support measures that expand and cement them.

They constitute quite a powerful lobby. This fact was quite obvious to me when I testified before the Tax Credit Review Commission in September at a regional meeting in Saint Louis. Except for me, every other person in who testified at that meeting spoke in support for a program that benefits them.

Again, from the Post-Dispatch:

The lobbying isn’t unusual. Every industry fights for its interests. But the real estate industry has more local clout than most — its bosses and workers all live here — and that, coupled with developers’ promises of jobs and investment, gives them a huge influence in city halls and the Missouri Capitol.

“Developers, bond counsels, retailers, consultants — they have got a powerful lobby between them,” said Les Sterman, former head of the East-West Gateway Council of Governments.

“The developers will fight you every chance they get,” [Sen. Tim Green] said. “Wouldn’t you fight it if the taxpayer pays for your development instead of you?”

In a sense, the proliferation of this army of specialists is a market response to government intervention. It can be amazing to see how markets evolve to address new economic niches, whatever their source.

As a negative consequence, however, this large administrative cost reduces the ability of the program to produce the intended activity efficiently. The Low-Income Housing Tax Credit is an egregious example of this. From a report issued in April 2008 by the Missouri state auditor’s office:

For every $1 in LIHTC authorized and issued, the current tax credit model provides only about $.35 towards the development of housing. The remaining $.65 goes to investors, syndication firms, and to the federal government in the form of increased taxes resulting from the use of state tax credits.

Supporters of tax credit programs might argue that this represents another form of job creation. However, these jobs are not permanent; they will disappear as soon as the subsidy ends. Additionally, these jobs specialize in unproductive activities. They exist largely because of government-created market inefficiency. If tax credit programs were reduced or eliminated, then the individuals currently working in these positions could put their knowledge, skills, and abilities to more productive uses. The economy would be better off if those resources were allocated instead to strong, profitable businesses that exist independent of subsidy.

“We Need You to Work on Saturday, So We Cut Your Pay”

Posted on by Josh Smith

In one of Christine Harbin’s recent posts here at Show-Me Daily, she made the point that having higher sales taxes or excise taxes is a boon for stores just across the state line. A commenter by the name of Dempster Holland cited this to justify using the income tax, rather than sales tax, as a revenue mechanism, because that way the state won’t lose tax revenues from people who cross the border.

I countered with the idea that when analyzing the effect of taxes at the margin, we must consider that, although sales taxes push consumption into other states, income taxes reduce production. It is also true that income taxes will push some production into other states, but for people near the border it’s easier to keep your job and change the state in which you shop. Holland responded to this with a highly unexpected comment: “I [believe] that higher income taxes cause people to work more in order to secure more take-home pay. This would increase production.” He went on to say, in a later comment:

On the income tax question, think through the following thought experiment. You are earning a certain income, with certain tax deductions and therefore a certain take home pay. From that take home pay, you have developed a certain spending pattern. Now your taxes go up. You can either reduce your standard of living, borrow money or earn more income. One thing you would prefer is to earn more income, and that means more work and therefore more productivity in society.
At some point. of course, the extra work won’t be worth it–but I would bet that is when you hit 80 per cent or so. In any event, not many people would work less, even the well off who are basically type A people to begin with

The idea that people will work more when their take-home pay is reduced is obvious at face value, but begs for analysis, because it falls apart on deeper examination.

The work that anyone does — the thinking, lifting, moving, and showing up — are the price that you pay in exchange for something you want: your paycheck. Workers then use their paychecks to get things they want or things they need, always aware of their limited resources: time and money. To suppose that someone will work longer hours when their wage is reduced is analogous to saying that people will buy the same number of potatoes when the price of potatoes rises. It will be true for some, and not true for others. Very important in this analysis is the idea that leisure time has value. When you work, you get value from the wages your receive; when you are not working, your time is your own to spend in a way that allows you to get the most enjoyment out of it that you can.*

If somebody has the option of working 41 hours instead of 40, and they earn $10 per hour, they must consider that extra $10 worth giving up their time to work that 41st hour, rather than going home to do chores, say, or spend time with friends or family. If the employer is willing to pay that amount for that much work, it reflects that the employer is getting at least that much value out of the worker’s efforts, and the worker can thus make the decision to work or not to work. At the margin, things are efficient in this scenario. Workers work until their leisure-time value exceeds their work-time value, and no more.

Now let us introduce an income tax. If suddenly each worker’s take-home pay is reduced by 5 percent, should we assume that everyone will work more to make up the difference? If you have the choice between working an extra half day at work every week, in order to make up the lost money, or reducing consumption instead — for instance, by staying home instead of going out one weekend per month — many people will choose to spend less rather than work more. In fact, the reduction in pay will likely make many people work less than they did before, because the relative value of their free time has increased in comparison to their new, lower net wages.

It would be wonderful from a benevolent planner’s perspective if every income tax increase led to a commensurate increase in productivity, but this is not the case — and, indeed, it would be lamentable if it were. We are fortunate that we live instead in a world where people can work fewer hours for more money as time goes on. The contention that people will work more hours if their pay is cut is, in economic terms, an argument that the supply of labor is inelastic — that is, that a decrease in the price for labor will result in very little decrease in the quantity of labor supplied. Different types of labor have different elasticities, and different people at different times have different levels of willingness to sell their labor at different prices.

One last point: Holland brought up the idea of taxing wages instead of sales in response to the idea, often repeated by our scholars, that Missouri would experience faster economic growth if it were to replace its state income tax with a broad-based, revenue-neutral sales tax. For the reasons I have just said, income taxes are problematic, but there’s one other reason that Missouri should prefer sales as a source of revenue: volatility. Any responsible state budget must account for the volatility of revenue streams. If your revenue in a given year is half of what it was in the previous year, budgeting becomes very difficult. The relative stability of sales taxes, compared to income taxes, is one of the best reasons to prefer them for state revenue.

* A slightly more technical point about the value of leisure time: Everybody can spend their time in two broad ways — working or taking leisure. We assume that people derive some utility from their leisure and some utility from the money that they receive for working. If their pay is cut, the relative value of their leisure hours goes up, subject to diminishing returns. Therefore, for many people, we can expect that they will work less when their pay is reduced.

Encouraging Job Creation in Claycomo, Mo. Louisville, Ky.

Posted on by Christine Harbin

Contributors to Show-Me Daily have previously discussed the state subsidization of the Claycomo Ford plant, which secured $150 million in tax credits from the state government over the summer.

It appears that the company figured out how to secure tax credits from the state government without increasing the level of employment. Ford is sending one line to Kentucky, but it is starting a new line in Kansas City. Although the number of jobs will remain constant, the company will continue to receive financial assistance from the state. Failing to deliver on promises, in terms of job creation and economic activity, is unfortunately a pervasive problem in Missouri. From an article in the Kansas City Business Journal:

The automobile side of the Kansas City Assembly Plant will cease production sometime during the fourth quarter of 2011, soon after the Louisville Assembly Plant in Kentucky begins production of the next-generation Ford Escape.

The effect on the 3,700 hourly employees in Kansas City remains unclear. However, Missouri state officials seem to expect some downtime at the Kansas City Assembly Plant in Claycomo, Mo., creating an opportunity for a big retooling in preparation for a new product.

Ford has a long history of pitting states against each other, so this news is not particularly surprising. The company has a pattern of securing millions in incentives from state governments, then shutting down operations and leaving the state unless it can secure additional incentives. Taxpayers, of course, are left to pick up the tab.

Don’t forget that the state of Michigan issued $909 million in incentives to Ford in October.

I find it disconcerting that the state government has a working relationship with the company in its operations. According to a statement from Gov. Jay Nixon’s office:

We have been working closely with senior Ford officials for months to make sure the vehicles of the future are manufactured at the Claycomo plant, and it’s clear that our hard work will pay real dividends for Kansas City and suppliers in communities across Missouri. We look forward to putting the finishing touches on this agreement in the coming weeks. Automotive manufacturing has a bright future in the Show-Me State.

Government officials can attempt to anticipate what the most efficient solution to a given problem will be — but, in all likelihood, they will get it wrong. This is because no individual has access to perfect information. As the Show-Me Institute’s editor Eric Dixon explained in the comment section of a recent post, the likelihood that an individual is wrong increases as he becomes further removed from the decentralized feedback loops that markets provide. Nixon and state policymakers are too far removed from the business of manufacturing vehicles to know the optimal state of the market. Missourians would be better off if the state government stayed out of this particular market, and instead allowed market forces to work.

This reminds me of the following concept that Henry Hazlitt describes in Economics in One Lesson. I cite this classic work frequently because it relates to many public policy issues in Missouri. I referenced this passage in a recent post in which I argued that government non-intervention is the optimal job creation strategy. Hazlitt wrote:

When providing employment becomes the end, need becomes a subordinate consideration. “Projects” have to be invented. Instead of thinking only where bridges must be built, the government spenders begin to ask themselves where bridges can be built.

Would the Claycomo plant stay open in the absence of the subsidy from the state of Missouri? If it would not, then the plant is, essentially, an invented project that is maintained because it can be, rather than because it satisfies a market demand. The fact that the new line has yet to be determined makes me wonder whether the project is in the process of being invented.

Obamanomics: Growing the Pie or Dividing the Pie?

Posted on by Jeffrey Miron

Jeffrey A. Miron, senior fellow at the Cato Institute and director of undergraduate studies in the Department of Economics at Harvard University, discusses the economic impact of the federal government’s 2009 stimulus package. Miron says because tax liabilities accompany any government spending program, last year’s stimulus package may not have expanded the output of the American economy, but instead simply redistributed the economy’s output. This lecture was presented in conjunction with Saint Louis University’s John Cook School of Business on March 17, 2010.

Miron’s area of expertise is the economics of libertarianism, with particular emphasis on the economics of illegal drugs. He has served on the faculty at the University of Michigan and as a visiting professor at the Sloan School of Management, M.I.T. and the Department of Economics, Harvard University. From 1992-1998, he was chairman of the Department of Economics at Boston University. He is the author of Drug War Crimes: The Consequences of Prohibition and The Economics of Seasonal Cycles, in addition to numerous op-eds and journal articles. He has been the recipient of an Olin Fellowship from the National Bureau of Economic Research, an Earhart Foundation Fellowship, and a Sloan Foundation Faculty Research Fellowship. Miron received a B.A., magna cum laude, from Swarthmore College in 1979 and a Ph.D. in economics from M.I.T. in 1984.

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