Friday, September 05, 2008

A Reply to Brian Griffiths on the State Budget

Brian Griffiths, leader of Red Maryland, believes that the tax package passed during last year’s special session is causing Maryland’s budget problems. He accuses me of covering for Governor O’Malley and the General Assembly by not blaming them for their “irresponsible tax hikes.” But Griffiths did not bother to check the economic data or my prior work before expressing his opinion. Nor does he understand the relationship between fiscal policy and economic growth.

Even casual readers of the news know that Maryland’s economy has suffered along with the rest of the nation. The causes of American economic stagnation are well known: a bursting real estate price bubble, resulting problems in financial markets and rising fuel prices exacerbated by a weak dollar. (The weak dollar is caused in part by immense federal budget deficits driven by the war in Iraq.) Those national problems affected Maryland. According to the Bureau of Labor Statistics’ Current Employment Survey, job growth in Maryland slowed from 36,000 in 2005 to 28,500 in 2006 to 24,600 in 2007. That is not the fault of either Governor O’Malley or Governor Ehrlich – it is merely a reflection of national economic problems that impacted the state’s economy.

The slowing economy laid bare an underlying truth: the state had a structural deficit and was on track to spend $1.10 for every $1.00 it received in taxes. As I said nearly a year ago in a blog post ignored by Griffiths, the cause was two-fold: a 10% income tax cut in 1997 and billions of additional spending on education (commonly called the Thornton Plan) started in 2002. Both of these events occurred during the Glendening administration, but Governor Ehrlich did nothing to reverse them. It therefore fell to Governor O’Malley to devise a solution to the problem in the face of a bad economy. I was unenthusiastic about the ultimate outcome, but it was an honest attempt to right the state’s fiscal ship.

Griffiths said the following about my post yesterday on the budget:

If Pagnucco was being an honest broker, he would note that the decrease in revenues is directly caused by the irresponsible tax hikes enacted by O'Malley and Annapolis Democrats last year, and that the current structural deficit has been caused by irresponsible discretionary spending increases. But, for reasons that shall remain obvious, he refuses to place any blame whatsoever on O'Malley and his band of merry tax hikers.
Griffiths’ assertion that the tax hikes caused a decrease in revenue is directly contradicted by state budget officials, as reported by the Examiner:

David Roose, director of revenue estimates, said that the slowing economy had lowered receipts from the income and sales taxes. If the sales tax hadn’t risen from 5 percent to 6 percent, “receipts would have been essentially flat, the worst performance since 1991.”
There are of course limits to the usefulness of sales tax increases in a small state with lots of neighbors. The Sun’s Jay Hancock and a recent Post article speculate about whether cross-border shopping has cut into sales tax revenues. But Griffiths should do his homework: I criticized the special session sales tax hike from the very beginning and recommended a crackdown on tax-cheating employers instead.

Griffiths implicitly assumes that tax hikes hurt the economy while government spending cuts do not. Here he demonstrates a basic ignorance of every macroeconomics course taught to college freshmen. From the perspective of economic growth, it does not matter whether the government implements a tax hike or a spending cut as a deficit reduction measure. Both reduce aggregate demand in the economy, especially when taking into account a reverse multiplier effect. A big tax hike and a big spending cut are equally damaging to the state’s economy in the short term, but because the state cannot deficit spend (as the federal government does), policy makers must pick one, the other, or both. After next year’s round of spending cuts is added to last year's tax package, we will have both.

The best thing the state government could do to revitalize Maryland’s economy is to increase its investment in infrastructure, even if it means taking in additional revenues. The Montgomery County Chamber of Commerce recommended raising $600 million for the Transportation Trust Fund this year, a step that was unfortunately not taken by the General Assembly. The business community and building trades unions believe that infrastructure construction creates jobs, long-lasting physical assets and abundant opportunities for private sector growth. Those things in turn will stabilize the budget over the long term. If only conservatives like Brian Griffiths could agree.