Wednesday, November 04, 2009

Another "short" note to G&J 

Dear Dane,

Wow. Thanks for your explanation of your position on why you think Minnesota has tried the less government approach. I had no idea my short note would generate such leverage of your lengthy response! I was not aware of your support for reducing revenue cyclicality, and I thank you and Charlie for point that out. Good to hear we're on the same side there.

I hope you will continue your good humor while I point out two other things. You wrote:

Revenues as a percentage of income are largely a function of tax rates. The shrinkage came from major and permanent income tax rate cuts, then a refusal to significantly raise state tax rates or impose new state taxes during the immediately ensuing shortfalls. Contrary to your argument, tax policies did make a major difference and Gov. Pawlenty himself takes credit for his policies shrinking government when he preaches to his conservative base.

But we would also acknowledge that we would have had shortfalls even if we hadn't cut taxes, because the spending base would have been larger, and downturns always create shortages. That's a point you could have raised, but didn't. So give us points for fairness and good faith.

Points given, but you are in essence begging my question. We can split this in two parts: First, what would have been the revenue generated by the old tax rates (whose, by the way? Ventura's? Carlson's? Perpich's?) if we assume no change in the tax base in response to those rates? That's pretty simple, you can throw that up on a spreadsheet and see who salutes. I don't have the resources (mainly time) to do that right now, but it would be useful. Second, let's relax the assumption and ask what would happen to the tax base if we had higher individual and corporate income taxes? What would happen if we did that and used some part for property tax relief? That's not a number crunch: It's a question of modeling family and business behavior (location, spousal participation and effort, to name three) in response to different tax rates.

There is, unsurprisingly, a great deal of research in that area, some suggesting that it's not a big change, others saying it does make a good deal of difference. Austan Goolsbee, now an Obama adviser, acknowledges that a higher corporate tax rate (holding individual income rates constant) shifts the form of business organization away from incorporation. But he doesn't find it affects overall economic activity. That might be a point in your favor or mine, I don't know. But it would be worthy of another of those hands across the water things you and I like to do.

On your other point, the growth of Minnesota is in fact still impressive, but we can get diminishing returns. We know from economics that growing countries or states tend to converge: Those with lower per capita GDP will tend to grow faster and catch up to those with higher per capita GDP. We also know that it's conditional, but for the several states of our country those conditions should be met. As states begin to receive information created elsewhere they grow faster for awhile, but then slow down. Minnesota and California have converged dramatically, partly because of good policies here and bad policies there, and partly because convergence just happens. It just seems very unlikely that we can grow faster than the rest of the country forever, and efforts to keep us growing faster may be counterproductive. Even investments in human capital hit diminishing returns, as Alwyn Young found for developing Asia in the 1990s.

Always a pleasure to chat, Dane. And thanks for your compliment on the name. 'King' is actually a family name on my mom's side; coolness was never part of the process.

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