Lessons from the States and the Past: How to Fix Deteriorating Economic and Fiscal Situations

By at 12 October, 2022, 1:44 pm


by Raymond J. Keating – 

Federal spending stands far above where it was pre-pandemic, and actually has been notably on the rise for the past eight years – before and during the pandemic. Federal debt outstanding has topped $31 trillion. To say that federal spending and debt are out of control would be an understatement.

But it gets worse.

The Federal Reserve, after running unprecedented loose money since 2008, is now jacking up interest rates to cripple the economy in order to fight inflation. Meanwhile, the monetary base – currency plus bank reserves, and the portion of the money supply that the Fed has direct control over – has been on a general decline in 2022, but still remains at stratospheric levels relative to any kind of historical norm. And higher interest rates, of course, will increase the burden of federal debt and spending due to increased debt service costs.

And then there are President Biden and Congress who actually are working hard to make matters worse via higher taxes and increased regulation, along with maintaining protectionist trade policies (that got rolling under President Trump) and failing to address the need for spending restraint.

To sum up, our elected officials in Washington, D.C., and their appointees are doing nearly everything wrong in terms of economic policy. Stagflation – that is, the combination of recession or slow growth with high inflation – finds its origins in anti-growth tax, regulatory and spending policies, and too much money chasing too few goods. It’s unclear how any points in the current Washington policy agenda would redress this problem.

What to do?

The most prominent example to follow would be the 1980s policy combination of substantive tax and regulatory relief that boosted incentives for entrepreneurship, investment and work, which, in turn, spurred growth forward and helped reduce inflation (along with improved monetary policy).

While the White House and Congress continue to ignore these critical lessons, assorted state officials understand. For example, Missouri just voted to reduce its top state income tax rate from 5.3 percent to 4.95 percent, with revenue triggers that could bring the rate down to 4.5 percent in 2027. Of course, immediate, surefire tax relief is far preferable to phased-in efforts with question marks. Also, Missouri mistakenly put aside an effort to cut the state’s corporate income tax 4 percent to 2 percent, with the possibility of eliminating the tax, according to The Wall Street Journal. But nonetheless, the debate and policy are pointed in the right direction in Missouri.

Also, according to the Tax Foundation, “21 states have enacted or implemented individual income tax rate cuts since 2021 while only New York and the District of Columbia have raised rates.” That’s great news for small businesses (with most being pass-through entities in terms of taxation) and state economies (well, except for New York and D.C.).

On the negative side, California also just passed a measure that raises the state’s already sky-high top individual income tax rate by lifting the wage cap on a 1.1 percent payroll tax to fund state family leave. That’s a brutal combination of spending, regulatory and tax policymaking all rolled up into one misguided and costly measure.

For good measure, Massachusetts voters will be confronted with a ballot measure in November that would add a 4 percent surtax to the state’s 5 percent income tax, raising the top rate for high-income earners to 9 percent (while also eliminating the state’s constitutional flat-tax requirement). Let’s hope the Massachusetts’ voters are wise enough to reject this tax increase that would hit small businesses owners and the state’s economy hard.

On the federal level, the answer is not to follow states like California and New York, and instead, to follow the lead of the states that have been reducing income tax rates and moving to flat taxes, as well as killing destructive levies altogether. For example, eight states impose no individual capital gains taxes – Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas and Wyoming. (The state of Washington is in court over the constitutionality of a 7 percent capital gains tax recently imposed. If the state’s supreme court rules the measure unconstitutional, as many expect, then the previous 0 percent tax rate would prevail.)

In the end, the policy mix needed to put the U.S. back on a solid growth path is clear: low taxes, light regulation, free trade, limited government spending, a welcoming immigration system for entrepreneurs and workers, and monetary policy focused exclusively on low inflation.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.


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