State Budget Deficit: Raise Taxes or Reduce Spending?

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State lawmakers have two primary options to erase the State’s massive budget deficit: 1) raise taxes or, 2) cut government spending. Both have a negative impact on Arizona’s economy, but according to a new analysis by the L. William Seidman Research Institute at ASU’s W. P. Carey School of Business, one option is less economically harmful than the other. Tom R. Rex, associate director of the Center for Competitiveness and Prosperity Research, explains.

Ted Simons: Arizona's budget shortfall for the rest of this year and fiscal year 2012 is estimated to be nearly $2 billion. Just about anything state lawmakers do to balance the budget will have a negative impact on Arizona's economy. But some choices are not as bad as others. That's according to analysis by the Seidman Research Institute, part of ASU's W.P. Carey School of Business. Here to talk about the research is Tom Rex, associate director of the school's center for competitiveness and prosperity research. Good to see you again. Thanks for joining us.

Tom Rex: Thank you.

Ted Simons: All right. Judging from what -- my impression of the research, what you're saying is that you've got a choice. You can cut a whole lot or you can raise revenue a whole lot, and you're saying that raising revenue a whole lot may be the better option?

Tom Rex: Well, it's always the better option. It's especially better in this particular situation because of the plan to cut the AHCCCS funding, which means you lose twice as much federal monies. That's going to be very damaging and it's going to be damaging to the private sector, not to government employees like me.

Ted Simons: So talk about the research. What you were looking for, what you were looking at, and what you found.

Tom Rex: Well, we have economic models that are designed to measure the impact of things like this. So we put in the numbers from the governor's plan to determine how much of a loss there would be. We put in the numbers for an alternative being let's raise revenues instead. That too is a negative. There's no way out of having a negative impact. For whatever you do, it's going to be negative. It's a matter of, do you want to try to minimize the negative impacts. And there's a difference of some 33,000 jobs or so between the two alternatives. Again, it's unusually large because we're going to lose so much federal funding, over a billion dollars of federal funds would be lost in on the to do a $540 million cut to AHCCCS with state money.

Ted Simons: We have lawmakers and legislative leaders on the program, and they say that they understand that spending $2 to make $3 or get back $3 from the federal government makes sense, but they say we don't have the $2 to spend in the first place.

Tom Rex: Well, we do. I mean, our tax burden in this state is the lowest it's ever been. It's dropped dramatically over the last 20 years. We don't have to put it back to where it used to be to come up with the billion dollars that we would need for next year. So it's an option. It's a matter of choice. It would seem that the political leaders are just choosing to off the cuff say, that is not an option to raise revenues. Obviously you don't want to do that during a recession. You never want to do that. But you're back in a corner. We backed ourselves into -- the state into a very deep corner by the actions that have been done over the last 20 years. We've benefited at the time, and now we have to pay the price.

Ted Simons: There are some, and some economists as well, most of the lawmakers on the show say it's not only a bad thing to raise taxes during a recession or something that resembles a recession, it's the worst thing you can do. Do you agree?

Tom Rex: No. Because -- basic economics tells you, no, that isn't case. We ran it through two models to prove that, no, that isn't the case. Yes, you don't want to raise revenues in a recession. There's a negative impact. But folks, the negative impact is even bigger if you reduce spending by the magnitudes we're talking about. Again, that's always going to be the case. In the short-term recession, it's always worse to cut spending.

Ted Simons: So you're saying when critics say the more taxes, less spending on goods and services, you agree with that , that but you also kind of mention, I thought it was interesting, that because we would be spending -- it's a little more distant as opposed to government cuts which is a little more immediate.

Tom Rex: Yes.

Ted Simons: Explain that.

Tom Rex: Well, what you really need to do is track the dollar. If you have spending cuts, what's being cut? Government employee jobs, they lose their salary, they live right here in Arizona, they spend their money in Arizona. Or in the case of this plan, you're going to be cutting money that goes directly to the health care providers. And again, same way. They live here, they spend their money here. That's gone right off the top, first step, it's gone. The alternative is -- in terms of raising revenue, is that if you increase taxes or fees, first there would be some people, those making quite a bit of money, they're not going to reduce their consumption. They've got plenty of savings, they've got plenty of income. So there's no negative economic impact from those folks. The rest of the people, yes, they do have to cut their spending, but so much of that spending is on consumer goods that aren't manufactured here in Arizona, and the money goes out of the state immediately, and that too then has a lesser impact than the spending reduction.

Ted Simons: It sounds like what you're saying here, and your study was focusing on the current situation, yet again, there are those, there's a line of thinking that what Arizona, the budget right now, the structural deficit, the whole nine yards, it's broken. And now is the time to fix it. Not only for now, but to fix it for upcoming years. We simply can't afterward to keep doing what we're doing.

Tom Rex: Absolutely. That would be the desire. We would argue that we need to do a complete revamp of the revenue system, and that's a part from deciding whether you want to raise or lower your revenues. You just need a revamp because our system is not working for the 21st century.

Ted Simons: Governor's office says we can't handle another tax hike after the one one-cent sales tax. The state simply can't handle that.

Tom Rex: And I'd argue, not just me, but simple economics argues that's not the case. The tax burden is so low today, compared to what it used to be, if people like us and a lot of people that are making reasonable amounts of money that have been hardly affected by the recession, and yet we're being asked to contribute far less than we ever did before to the state revenues. Why is that? Why is it that -- I can pay more taxes, I'm sure you can, I'm sure an awful lot of people could, yet the governor and others are saying that no, we can't do that. There's a lot of people that can pay this money -- if you're really concerned about that, then you want to be careful how you do your tax increases to minimize the impact on the lower income people, the people that are struggling, and there are ways to do that. The personal income tax is the one that's gotten cut most over the last 20 years. Lower income people pay almost nothing or nothing in income taxes once they get their refund check. So as the people making the higher wages, that can afford it, pay the tax.

Ted Simons: So when critics say it's better to create an environment to grow jobs as opposed to create an environment or keep an environment that is described by many as a welfare state as opposed to getting your fiscal house in order, how do you respond?

Tom Rex: Well, you certainly don't want to increase service taxes. I fully agree with that. We overtax businesses as it is in this state relative to individuals in particular. So passing a tax increase on individuals doesn't harm the economic climate at all. And in fact the extra money is then used to spare education. Education qualified work force is the most important single factor for businesses. They would be willing to pay, they are willing to pay if the money goes to something --

Ted Simons: This obviously, this report is opposite, quite opposite from a lot of what we hear coming out of the legislature, and the legislative leaders on the show. My question to you is, what kind of response are you getting on this? Because I gotta tell you, when we do interviews, this sounds like a nonstarter as far as the current make up of the legislature is concerned.

Tom Rex: Yes, it does seem like it, and I Frankly can't imagine a study like this that -- [inaudible] They -- have decided some years ago that further increases are simply not under consideration regardless. I would suggest to them that cutting thousands and thousands of private sector jobs, which is what they'll end up doing under this plan, might be something they should consider. I think they're probably hearing from the hospital association and other medical groups that, you know this, is going to really, really hurt.

Ted Simons: Last question, real quickly, if it means losing those jobs in the short term to increase the chance of getting exponentially more in the long-term, a gamble worth taking?

Tom Rex: I didn't follow that, I'm sorry.

Ted Simons: The idea is if you get the fiscal house in order, many more jobs will come down the pike as opposed to keep muddling along as we are.

Tom Rex: You need to get the fiscal house in order. It doesn't have to be done on the spending side. I would argue the severe cuts to education affect -- the fact K-12 is already near the bottom in spending, and you're now sending the Universities down that same route is not going to be a positive for economic development and it will probably to the higher wage jobs, the jobs that purportedly we'd like to have here, Arizona is not -- in consideration by those companies.

Ted Simons: Thanks for joining us.

Tom R. Rex:associate director of the Center for Competitiveness and Prosperity Research;

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