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Thursday, December 15, 2016

The Case Against a Corporate Income Tax

Can we get Wyoming out of its fiscal trouble without raising taxes? I sure hope so. With a private sector that is practically hemorrhaging jobs, and most of those jobs being lost outside the minerals industry, the absolutely last thing we need is more burdens on businesses and families here in the Cowboy State. 

Unfortunately, both the governor and the incoming legislative leadership appear to have made a deliberate decision to frame our budget crisis as a crisis in funding education. It is not. It is a general budget crisis that has its origin in too much permanent spending. 

During the heydays of abundant severance-tax revenue a few years ago, the legislature cranked up permanent state spending to a level where they maxed out the revenue that the tax base was capable of providing. There was really no margin in the budget for any sort of downturn; the current budget crisis is a direct consequence of that irresponsible spending policy. 

It is imperative that we understand the nature of our budget crisis, or else we will not be able to apply the appropriate solution. In fact, the wrong approach to this crisis will inevitably make matters worse. 

One way to do that is to fragmentize the analysis of our economy. That is, unfortunately, a widespread habit among my fellow economists. The Wyoming Business Report offers a good example from the Central Economic Forecast Luncheon in Casper:
A robust panel discussion followed UW economics professor Anne Alexander's graphic presentation of the current state of Wyoming's economy at today's annual Central Economic Forecast Luncheon in Casper. The condensed version of the discussion was that, "Things didn't get as bad as everyone expected," according to broker Randy Hall of BrokerOne Real Estate. He noted that although residential construction was down 40 percent, residential sales were only down 13 percent (on top of the five percent drop from the previous year). The high for residential real estate in Casper was 2014, when the average cost of a home was $241,000. The industrial sector was off 17-20 percent in leases and overall sales from the previous year. The bright spot was in retail, where there is a 90 percent occupancy rate. A recent discussion with tenants at the Hilltop Shopping Center revealed that retail sales are on the upswing.
It is great to hear that the crisis did not get as bad as some people had expected, but the metrics used here - real estate sales - is a self-defeating piece of evidence. If the market turns sour because of massive job losses and, as a consequence private-sector earnings decline drastically, there will not be a market to put your house up for sale. People might as well stay for as long as they can; since Natrona county has lost 21 percent of its private-sector wages in one year, the explanation for "less than expected" real-estate sales is that people know there is nobody out there to buy their houses - so why even try?

Again, I do not wish to make this crisis bigger than it is, but I also firmly believe that it is macroeconomic malpractice to portray it as less drastic than it actually is. Even though this was a forum for discussing a part of the state economy, it still misrepresented our state's bad economic conditions. Together with Sublette, Natrona county has been the epicenter of lost private income, a core indicator of the "health" of the economy.

As a general point, which does not directly refer to the Central Economic Forecast event in Casper, let me point out that inaccurate economic analysis leads to inaccurate policy decisions. Sad to say, the world is full of bad economic analysis that has had catastrophic consequences for people. The worst modern-day example is the International Monetary Fund's miscalculations of the Greek economic crisis. The Greek government trusted the IMF's economists, passed the wrong tax policies - and as a direct consequence ten percent of all Greeks, and 20 percent of the young, lost their jobs.

In other words, when economists present their analyses, their words and numbers can have very serious consequences for the world around them. In the case of our state, inaccurate economic analysis, especially the kind that suggests that our state is in better shape than it really is, reinforces the case for new taxes, and increases in existing taxes, that some people are already trying to make.

One of the possibilities is a corporate income tax. For anyone who wants a personal income tax, the corporate income tax is a moral door-opener: if we tax corporations, it is easier to motivate a tax on personal income.

Hopefully, though, our legislators will steer clear of the corporate income tax (as well as any other increase in the state tax burden). There are, primarily, five points that proponents of a corporate income tax need to address to make their case credible:

1. It does not generate very much revenue. If we adopted the average state corporate-income tax, we could - in theory - collect $105 million per year. That, however, is under the assumption that the average state corporate-income tax model is applicable to Wyoming while maintaining the severance tax. This may or may not be possible; will, for example, coal companies survive in Wyoming if, on top of severance taxes, sales taxes and all applicable federal taxes, they also would have to pay a state corporate-income tax somewhere in the 6-7 percent bracket? (That is where the average state corporate-income tax lies.) 

2. We would double-tax minerals companies who already pay severance taxes. We could combine the severance tax with a corporate income tax. Alaska has done that, and in 2015 they collected $228 million from that tax. At the same time, though, they only took in $105 million in severance taxes; we, on the other hand, collected $884 million in severance taxes that year. If we added the Alaska corporate income tax to our severance taxes, we would put a 9.4-percent cost mark up on all businesses in Wyoming, including the already-struggling coal, oil and natural gas producers. How many of them would find it worth the while to stay in business in Wyoming?

3. The "right" tax rate would still drive away jobs. Then again, of course, we do not have to crank up the corporate-income tax rate to Alaska levels. We could keep it where it is palatable to the minerals industry, such as New Mexico where they charge a 6.6-percent tax on corporate income above $1 million. Or we could try to copy North Dakota's 4.31 percent. Again, though, in theory the collections would stop short of $125 million - which should be compared to the $400m deficit that the state is facing in 2018, and the $700m+ deficit in 2020. And we have not even begun talking about the adjustments that corporations would have to make in order to afford that tax.

4. Don't be seduced by a Trump tax-cut loophole. President-elect Donald Trump has pledged to cut both corporate and personal income taxes. If he gets what he wants (and based on his business history it is safe to say that he will...) it is possible for states to raise their corporate income taxes - or introduce new ones - so that the total tax burden on businesses will not increase. That, however, would be a big mistake. There are plenty of other states where businesses are thriving, GDP is growing and the private sector is creating new jobs, not terminating them as is the case here in Wyoming. If we were to introduce a corporate income tax proportionate to the Trump tax cuts, we would create a distinct disadvantage for businesses in our state. Governor Mead's efforts at diversifying the economy, which I have been cautiously supportive of, would suddenly face a major uphill battle.

5. We would preserve the mono-industrial character of the Wyoming economy. Even if our lawmakers found a corporate income tax rate that would be palatable to the minerals industry, that tax would be a hard, heavy burden on other industries. As an illustration of the economic differences between doing business in the minerals industry and doing it in other industries here in Wyoming: the average non-minerals job pays $36,000 per year, less than half of what you can earn on an average job in the minerals industry. A tax that a minerals company might be able to pay could be the straw that breaks the camel's back in retail, food services or construction.  

Hopefully, a corporate income tax will not happen. I am, however, far from convinced that the discussion about tax increases in general will stop this side of the legislative session. On the contrary, it will more than likely carry on through the 2017 session and beyond. 

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