There’s a case for higher taxes, even now

By J. Patrick Coolican

Tuesday, Dec. 23, 2008 | 2 a.m.

The refrain heard often from Nevada elected officials, Republican and Democrat alike and especially Gov. Jim Gibbons, is that a recession is no time for a tax hike.

The reasoning of the first-term Republican governor, long an opponent of taxes, is basically sound: Taxing businesses would limit their ability to spend on new employees or stores or resorts, and taxing families would hinder their ability to spend on new cars or furniture. In both cases, the economy would sink further into recession.

But what’s been missing from the discussion is the corollary: A recession is no time to cut government spending.

To see why, let’s open our Economics 101 textbook and listen to UNLV economist Jeffrey Waddoups: “When we cut spending and, let’s say, we lay off teachers, they go on unemployment. Then they don’t have as much money to spend. Without money to spend, they don’t support local businesses. Local business doesn’t have demand for its products and services, so they lay off workers. Those workers go on unemployment, and so on.”

(And, of course, long-term, lowering the quality of education through teacher layoffs would mean a less productive economy.)

Even conservative economists who prefer less government, such as the Heritage Foundation’s James Sherk, acknowledge the short-term damage of spending cuts: “It’s a bad economic situation, and no matter what you do, cutting spending or raising taxes, it’s going to cause pain. The layoffs occur one way or another,” he said.

Here’s another direct hit to the Nevada economy: cutting the Medicaid reimbursement rate. The state slashed reimbursements to some doctors and other medical providers who care for children by as much as 33 percent. That was essentially the same as a massive tax hike on those surgeons, physical therapists and other providers, taking money out of their pockets.

That money, which they would have spent on food and gas and household items, or new staff and facilities, is just gone.

(Never mind the children who don’t receive care because the doctors can no longer afford to accept Medicaid patients.)

Michael Ettlinger, vice president for economic policy at the liberal Center for American Progress, noted that government provides a stable source of demand in a down economy.

“The last thing you want to happen in a recession is for government to make the problem worse by laying off people and cutting back its participation in the economy. The private sector is compelled to do these cutbacks by market conditions, and you do not want the public sector to feed this, because it fuels a downward spiral, where things get worse and worse,” he said.

So, in a perfect world, government would neither increase taxes nor cut spending during a recession. In fact, it would cut taxes and increase spending, as President-elect Barack Obama plans to do.

The problem, though, is that Nevada must by law balance its budget.

Again, in a perfect world, the federal government, which can borrow all it wants, would offer a bailout to state governments. Ettlinger and many other liberal economists are pushing for this solution, which would provide direct stimulus to local economies.

But politics is politics, and the new administration and Congress may want to put stimulus dollars directly in the hands of the people, telling the states to fend for themselves.

In that case, Nevada is stuck with either a tax increase or massive spending cuts, on the order of 34 percent of the state budget.

So, which would have a less harmful effect on the economy — raising taxes or cutting spending?

Here’s where the real debate ensues.

“I don’t know which is worse. The problem is, the demand for everything is down,” said Waddoups, of UNLV.

Here’s the simplest answer: If you think government would spend the money more wisely, then a tax increase is called for. If you think the private sector would spend more wisely, then it’s spending cuts you want.

Sherk, of the Heritage Foundation, is quite certain that on balance spending cuts are always a better option than tax increases because, as he said, “in most cases it’s best to leave money in private hands.”

The private sector is generally wiser in its allocation of resources, he said.

Many economists disagree with Sherk’s analysis during a recession, mostly because what they advocate is increased demand for goods and services, which comes when you put money in people’s pockets. Private sector actors, meanwhile, will likely save some of the money, which is not what the economy needs in a recession.

Joseph Stiglitz is a Nobel Prize winner and former chief economist for the World Bank, and Peter Orszag is the outgoing director of the Congressional Budget Office and Obama’s new budget director. They wrote a paper during the last recession for the Center on Budget and Policy Priorities in which they argue, “Economic analysis suggests that tax increases would not in general be more harmful to the economy than spending reductions. Indeed, in the short run (which is the period of concern during a downturn), the adverse impact of a tax increase on the economy may, if anything, be smaller than the adverse impact of a spending reduction, because some of the tax increase would result in reduced saving rather than reduced consumption.”

It goes like this: Cut spending, you reduce consumption. Increase taxes, you reduce consumption some, and saving some.

But in a down economy, consumption is more important than saving because you want that money in circulation, not sitting in some safe investment account, where, especially during a financial panic, it’s not doing anything.

Let’s put this another way: All the money government spends will wind up right back in the economy, whether in employee salaries or direct payments to doctors who treat Medicaid patients or money spent on school supplies.

Let’s say there’s no tax increase. Not all that extra money floating around the private sector will get spent in a way that helps Nevada. Some will be spent on vacations in Europe and California, and that doesn’t do Nevada any good.

And, some of it will be saved. So the tax increase would negatively affect the savings rate. But economists don’t want people saving in a recession. They want them spending.

A corporate income tax, like they have in Arizona and Utah, would mean less profit for corporations. But that would hurt — if at all — places such as Bentonville, Ark., which Wal-Mart calls home, not Nevada.

Would it mean Wal-Mart might decide not to open a new store here? Not likely. The tax being talked about here would be on profits, not gross revenue. Moreover, Wal-Mart, with its deep discounts, is actually doing quite well during the recession and is probably eager to set up stores in places where consumers are looking for cheap goods, such as Nevada.

Same with out-of-state gold mining companies, which have made extraordinary profits in recent years with the steep increase in the price of gold. Those companies have nowhere else to go; we aren’t competing with other states for mining companies because all the gold is here. So a tax hike on these companies might mean tougher times for Mercedes dealers in Denver and Toronto, where the companies are based, but probably would have no appreciable effect on Nevada.

In return, we could keep paying teachers to educate students and doctors to treat the downtrodden, and that money would wind up right back in the Nevada economy.