THE FISCAL NOTE

An Examination of Tax and Fiscal Matters by the Arizona Free Enterprise Club

Economic Stimulus: What to Embrace, What to Avoid

Former U.S. Treasury economist Stephen Entin wrote: There is no such thing as a quick, temporary fiscal stimulus for the economy that does not lead to offsetting damage down the road. The only worthwhile tax changes that are beneficial in the short run are those that are also beneficial in the long run, ones that lead to a tax system with fewer obstacles to production.

There has been much discussion recently around designing an “economic stimulus” package for Arizona. It is easy to see why. Revenues for fiscal year 2008 will be up only 1%, and we’ll be lucky if 2009 is any better. What to do? Given the backdrop from Mr. Entin, here are some suggestions.

AVOID: Do not incur additional debt to “stimulate” construction activity. A plan being circulated by universities and contractors to borrow $1.4 billion to facilitate construction at Arizona’s three universities is not an economics stimulus package. Here’s why. If the state needs to issue additional debt to cover the activity of construction, it is simply borrowing the economic benefit created by the construction, leaving no additional benefit to the public, since they (we) own the debt. Arizona already faces a state and local debt burden of $32 billion, which is 16th highest in the country as a percentage of personal income, and the state has a $3 billion budget deficit. The added debt from this proposal will be extremely painful long-term.

AVOID: Do not advance a plan comprised of tax credits, new spending items, and new debt packages. In the face of Arizona’s huge budget deficit, a plan being discussed in the House to add new credits, grants, and spending would exacerbate the problem. With mounting debt and flat revenues, adding new subsidies and spending items will further choke off economic growth. Economic stimulus packages require an incentive effect. When tax rates are cut, for example, the incentive to earn the next dollar increases, since the return on investment is now greater. Tax credits, like rebates or subsidies, have no incentive effect, do not increase output or demand, and simply leave fewer taxpayers to pay for existing services.


SUPPORT: Make the 2006 state equalization tax cut permanent. Isn’t it ironic that proponents of a construction “stimulus package” are some of the same people who oppose making permanent the temporary elimination of the state equalization rate? There is no compelling reason to not make permanent a tax cut that lawmakers and the governor saw fit to provide in 2006. There is no negative impact to the state’s general fund next year by passing this permanent moratorium. Raising taxes $250 million in an economy that is already experiencing anemic growth, however, will further slow economic recovery. It will drive up expenses for everyone from latte drinkers to the construction industry (and everyone in between). Any economic stimulus plan that doesn’t include making this tax cut permanent isn’t a serious plan.


Given the state’s $3 billion budget deficit for 2008 and 2009 and the membership of the House and Senate, it is well-understood that asking for more than the permanent repeal of the state equalization tax is pushing the envelope. If, however, there is interest in other stimulus plans that will have both a short and long-term benefit to our economy and tax code, here are two:

SUPPORT: Reduce Arizona’s business personal property tax. Reducing the tax on business equipment, or allowing for immediate expensing, would spur new spending on plants and equipment, increase wages, increase jobs, and ultimately increase tax revenue to the state. A recent study completed for Idaho by Stephen Entin at the Institute for Research on the Economics of Taxation demonstrates the economic benefits of this rate cut.

SUPPORT: Reduce Arizona’s corporate income tax rate. Arizona’s tax on corporate income is 6.968% and is among the highest in the west (behind only California and New Mexico). Corporate taxes affect three things: 1) customers, through prices; 2) shareholders, through returns on invested capital; and 3) employees, through employment opportunities and wage growth. According to a new study by Fritz Foley and Mihir Desai of Harvard and James Hines of the Univ. of Michigan, workers share between 45 and 70 percent of the corporate tax burden. Reducing corporate taxes down to 4.76%, the average among western states, would instantly make Arizona more competitive in the region and across the country, increase after tax profits, increase employment opportunities, and increase wage growth. Reducing this tax to 4.54% would place the corporate income tax on equal footing with Arizona businesses and individuals who file income taxes in the state’s highest personal income tax bracket. In a fair tax system that encourages growth, neutrality is paramount.


Finally, the adage of “First, do no harm,” applies to this debate. Cutting taxes on capital would be the preferred tax changes to help Arizona’s economy both short and long-term. Short of that, however, doing nothing is far better than some of what’s being discussed at the Capitol.

###

The Arizona Free Enterprise Club is a 501(c)(4) non-profit organization whose mission is to advance policies that promote a strong and vibrant Arizona economy. The Club believes that entrepreneurs and private enterprise are the principle drivers of our economy. The Club lobbies Arizona lawmakers in support of policies that allow the market to flourish and vigorously opposes policies that hinder private industry. Visit us at www.azfec.org.