The Maine Wire

by Scott Moody on December 10, 2013

in Uncategorized

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Recently, the Sun Journal published an op-ed titled “Repealing Income Taxes Won’t Help State Economies” written by Carl Davis at the leftist Institute on Taxation and Economic Policy (ITEP). He concludes:

“The bottom line is this: no-tax states aren’t booming, and lawmakers should not expect their states’ economies to improve if they join the no-tax or low-tax club. In fact, in terms of the economic factors that matter most to families — income levels, and whether or not they can find a job — the states with the highest top income tax rates are, in most cases, doing better than the no-tax states. If the economy is really the concern of lawmakers railing against the income tax, it’s time for them to put away Arthur Laffer’s tax cut snake oil.”

Dr. Laffer, et al, has responded to these attacks in a new study titled “Economics 101″ published by the good folks at Oklahoma Council of Public Affairs. They make five counterpoints:

1) First, they state that: ”Just because some high-tax states perform well from time to time does not mean that high tax rates do not retard growth. The issue whether high tax rates raise or lower the likelihood of a state achieving prosperity–not whether there is the occasional exception.”

More specifically, they examine the population growth rates between 1970 and 2010 which shows that no-personal income tax states enjoy a significant population growth premium over the highest-personal income tax states.

2) They delve into a couple of case-studies which show that economic performance was worse after the enactment of an income. In both California and New Jersey, economic growth slowed after putting their personal income tax in place.

3) ITEP’s criticism centers on the exclusion of population growth in determining “economic success” because  population is influenced by more than just taxes. Laffer counters by showing that taxes affect both income growth and population growth. In fact, the two are so intertwined that it is impossible to talk about one without the other–which is why Maine’s Demographic Winter problem needs much more attention.

4) While ITEP claims that population flows are more related to climate, Laffer counters that since climate doesn’t change then why would there ever be any shifts in population flows? The reality is that population flows to change when economic policies change. For instance, Oklahoma is now seeing an influx of people in-migrating from California–did California’s weather suddenly change for the worse?

5) Finally, Laffer challenges ITEP to “provide a theory that shows why tax rates, or increasing income-tax rates, increase economic growth.” Naturally, such a theory is impossible since “economics is all about incentives” and taxes simply reduce the incentive to migrate, work or start new businesses.

Laffer summarizes:

“From a theoretical perspective and in everyday life, incentives drive all economic behavior. Taxes are a negative incentive. People do not work, invest, or engage in entrepreneurial activities in order to pay taxes. They engage in such economic activities in order to earn after-tax income. When government increases its share of the income earned by its citizens, the incentive to engage in growth-enhancing economic activities falls; alternatively, the disincentive to these activities rises. The higher the tax on the next dollar earned (the marginal tax rate), the larger the disincentive.”

Unfortunately, Maine has a front-row seat in seeing these economic differences in action by simply looking at the differences in economic performance with New Hampshire (which has no personal income tax or sales tax). As shown in the chart below, Maine’s economic growth has slowed relative to New Hampshire’s each time Maine enacted a new tax–first the sales tax in 1951 and then again with the income tax in 1969. Repealing the income tax is simply the first step on the road to economic recovery.

Chart Showing Differences in Economic Performance in Maine versus New Hampshire

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In December, I released a study that showed raising taxes to cover the budget shortfall at the Department of Health and Human Services would cost private sector jobs–or an estimated 6,463 jobs. Of course, the so-called “Maine Center for Economic Policy” disputed the obvious crowding-out of the private sector by public sector spending.

So, when I received this study in my inbox from the National Bureau of Economic Research I knew the MECEP folks would be thrilled with their conclusions. The study is titled “Government Spending and Private Activity.”  From the abstract:

This paper asks whether increases in government spending stimulate private activity. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use two different methods to adjust for tax effects. Neither method suggests significant effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.

In a nutshell, government spending crowds-out private sector spending and all you end up with is a composition shift away from the private sector and toward the public sector. This is what I’ve been showing for years with the chart below showing Maine’s private sector share of personal income on a perpetual downward trend.

Chart Showing Maine Private Sector Share of Personal Income 1929 to 2010

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Recently, I had my meeting for the Maine Consensus Economic Forecasting Commission (CEFC) where we were to update our economic forecast for the state–here is the link to the February CEFC report. Unfortunately, there was no data to suggest that Maine is coming out of the recession. Rather, it appears as if the economy is stuck in neutral.

This quote below succinctly states the economic conundrum the CEFC grappled with:

There has been little change in the job market since the CEFC met in late October. From the start of the recession through the summer of 2010, Maine lost nearly 30,000 nonfarm jobs on a seasonally-adjusted basis. Annual benchmark estimates to nonfarm payroll jobs estimates (to be released in early March) indicate the number of jobs to be virtually unchanged from September 2010.

The unemployment rate in Maine has declined to 7.0 percent in November and December, after peaking at 7.8 percent in June 2011. However, changes in the unemployment rate over the course of 2011 were driven in large part by changes in the labor force participation rate, not due to changes in the number of jobs.

Overall, we stayed the course with our former forecast showing virtually no employment growth in Maine’s economy over the coming year. There are still some troubling, persistent negatives in Maine’s economy. For instance, heating oil prices are stuck at historically high levels and there was a surprising uptick in foreclosure starts. Naturally, the two may be related as heating costs may have pushed distressed homeowners over the edge.

Our next meeting won’t be until the fall and hopefully the economic picture will become clearer, especially in regards to the European debt crisis. At the same time, the Presidential elections will create its own uncertainty as the federal government struggles with the budget crisis. Never a dull moment for the CEFC :-)

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A few months ago when Forbes released their annual “Best States for Business” ranking showing Maine as dead last in the country, there were a lot of folks who dismissed it simply because the source is biased in their opinion.

Well, let the gnashing of the teeth begin again as I just discovered CNBC’s “Top States for Business” ranking which puts Maine at a lowly 40th in the country.

While some may try to pin CNBC as part of the “great right-wing conspiracy,” maybe the truth is much simplier–Maine has a poor business climate.

Interestingly, the top four states–Virginia, Texas, North Carolina and Georgia–are all right-to-work states . . .

Additionally, the Tax Foundation also just released their annual State Business Tax Climate Index with Maine ranked as only the 37th best in the country.

Keep in mind that none of these indexes reflect any policy changes under Gov. LePage. For instance, the recent reduction in the top marginal income tax rate to 7.95 percent from 8.5 percent will not take effect until 2013. So it will be a few more years before such changes even begin to be reflected in these metrics.

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In a previous blog, I showed how Maine’s economic woes are more significantly affecting our younger workers. And while one commenter pointed out that this is not just a Maine phenomena, it is more of a concern in Maine because these folks are Maine’s young families who are raising the next generation of workers. Recent data from the U.S. Census Bureau shows that Maine’s net natural growth (births minus deaths) in 2011 was a mere 180 people.  Maine simply needs to work harder than other states to keep our young families.

However, even the unemployment rate by age chart is optimistic because it is based on the “standard” unemployment definition. Did you know that there are actually many different definitions of unemployment? The chart below shows the various “alternative unemployment rates” as published by the Maine Department of Labor (Excel File).

The green line, representing the “U-3″ definition of unemployment, is the official unemployment rate you read about in the newspaper which hit a high of just over 8 percent in 2010. For a person to be counted in U-3 you have to be unemployed but actively seeking work.  Loosen the definition a bit, and the unemployment rate begins to explode.

U-4 includes U-3 but counts folks who have simply given up looking for work called “discouraged workers.” U-5 includes U-4 and folks that are able to work but haven’t done so in quite awhile. Finally, there is U-6 which includes U-5 and all the folks who are working part-time but would rather be working full-time.

Overall, you get a very different picture of Maine’s unemployment rate depending on which definition one uses. If you use the official, U-3, definition then unemployment does not look so bad and has leveled off in 2010 (more recent Maine unemployment rate data shows it now falling for 2011).

Yet, looking at U-6 you see that not only is unemployment rate nearly twice the U-3 rate, but also a pattern of continued growth in the unemployment rate into 2010 (albeit at a slower pace than pre-2009). This suggests U-6 might still be growing into 2011 though we won’t know for sure until the new data comes out. In any case, U-6 paints a more dismal unemployment picture than the official U-3 metric . . . just thought you should know.

Chart Showing Maine's Alternative Unemployment Rates 2003 to 2010

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In case you missed it, my 2012 economic forecast is featured in Mainebiz’e annual “5 on the future.”

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On January 18, the New Hampshire legislator is taking up a constitutional amendment that would permanently ban a personal income tax in the state. The good news for Maine is that it is not a ban on a sales tax . . . it is the lack of sales tax in New Hampshire that is currently costing Maine border counties up to $2.2 billion a year in lower retail sales (and, correspondingly, Maine state government hundred of millions in lost revenue).

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In my previous blog about Maine’s population growth (or lack thereof), I alluded to data that would highlight the economic woes of Maine’s young people.

The chart below is from the Maine Department of Labor and it shows the unemployment rate broken down by major age group between 2000 and 2010. As you can clearly see, in 2010, the highest unemployment rates are for those between the ages of 16 and 19 (21.8 percent), 20 to 24 (15 percent) and 25 to 34 (9.4 percent). Naturally, these are Maine’s young families and this economic distress is falling the hardest on their shoulders.

This may also be why the most recent data from the Internal Revenue Service is now showing a net out-migration of taxpayers. This is an important metric because these young folks, i.e., taxpayers, are just beginning their productive careers and the lack of opportunity may be forcing them to find greener pastures.

Chart Showing Maine's Unemployment Rate by Age 2000 to 2010

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As I pointed out in my last blog citing the latest data from the U.S. Census Bureau, Maine’s net natural population increase (births minus deaths) was a mere 180 people. A simple projection of the past 20 years worth of data suggests that next year could be the first year of net negative natural population growth in Maine. Demographers have a new term for this which I’ve mentioned before . . . “Demographic Winter.”

In a nutshell, Demographic Winter is when there are too few young people, or at least having too few babies, to sustain the current level of population. Maine appears headed for such a scenario, barring a huge influx of fertile domestic or international migrants. This will create a strong headwind for future economic growth.

I recently became aware that the movie titled “Demographic Winter” has been posted on YouTube in its entirety. It runs for about 50 minutes, but I promise it is worth the trip . . . check it out. Though I wouldn’t advice watching it while eating your lunch :-)

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