Iowa’s hocus-pocus tax cuts – The lesson: There is no free lunch

Letter to the Editor
Des Moines Register
July 14, 2002

The question of Iowa’s budget deficit today dominates political discussion.  The general perception is Iowa’s deficit is a result of the sluggish economy.  In a recent article, a Register reporter made reference to the “unexpected slowdown in tax collections” and budget turmoil as factors in the race for governor.  A Register poll participant is also quoted as “wondering where the state’s money went.”

Without question, the economy is a factor, but the reductions should not have been unexpected.  From 1995 to 2000 Iowa played the tax-cut game hard and fast -and Iowa lost!

Between 1995 and 2002, the Legislature ignored the fact that boom times do not last forever and that there are business cycles.  It made 43 separate tax cuts.  Their impact has grown.

In 1997, $259.8 million was eaten from the surplus.  By 2000, the loss totaled $724.8 million, and the surplus was almost gone.  By 2002, the impact had grown to $875 million and the surplus had vanished into a large deficit black hole.

The cumulative impact of the tax cuts is now more than $3.75 billion.

Legislators locked in the long-term tax cuts on the assumption that by reducing taxes, the state’s economy would be so stimulated that growth would generate more than enough revenue to offset the lower tax rates.

That economic theory was articulated in a “study” by the Beacon Hill Institute, a Boston-based group associated with Suffolk University.  It claimed that over a four-year period, a 15-percent income-tax cut would increase the amount of capital available in Iowa by $1 billion and add almost 44,000 Iowa jobs.  The study further found that the loss in revenue would be offset by an additional $101 million in new revenue from the economic effect of the cuts.

The Beacon Hill report, which Speaker of the House Ron Corbett had purchased, was circulated to all legislators and frequently cited by them in support of the tax cuts.  The chair of the House Ways and Means Committee, Representative Dwight Dinkla, told the House that the income-tax cut alone would increase the rate of revenue growth by 20 percent to 30 percent.

Projections by the Legislative Fiscal Bureau and a University of Iowa economist that showed otherwise were dismissed by Gretchen Tegeler, director of the Department of Management under Gov. Terry Branstad.  Her argument was that their projections were “static” and did not take into account the dynamics of the positive impact of the tax cuts on economic or revenue growth.

Adjustments to marginal tax rates can stimulate an economy, particularly at the federal level.  But I questioned whether reputable economists thought the changes being debated by the Legislature could have the impact on Iowa’s economy the Beacon Hill study promised.  Just to be sure, I sent a copy of the report to my son, Art, an economist who was at that time completing his doctorate at the University of California at Berkeley.  (He is now an assistant professor at Columbia University.)

Art was scandalized.  He pointed to three very questionable assumptions in the report: (1) that all of the money no longer collected in taxes will go into savings and will be invested in Iowa; (2) that Iowans, since taxes are lower, will produce more taxable income because they will work harder; and (3) that most of the money generated by the tax cut will go into new job-creating capital in Iowa.

The Beacon Hill conclusions, he found, all hinged on an arithmetic trick.  In short, the study was rigged.  There was no way that the conclusion could have come out differently.  Art wrote categorically that the “analysis” was worthless.  Indeed, using their “method,” any numbers plugged into their formula would have produced the result that tax cuts would generate free-lunch growth.

As a side note, he questioned the governor’s budget office basing its revenue projections on an assumed continuation of 6 percent growth rates.  He observed that “these represent past rates based on Iowa’s emergence from recession. They are without question unsustainable.”

Art’s response was given to some legislators – to no effect.  The Legislature passed the tax cuts with only a few dissenting votes.  Legislators were attracted to the idea of getting more with less.  Or as the Lovin’ Spoonful says, “Do you believe, like I believe, in magic?”

What happened to that growth? Where is the new revenue the “dynamic” projections forecast?

The results are in.  Next year, the problem will be worse, and some are promising more cuts.  The deficit problem is like a growing elephant squatting in the corner of your living room.  You can’t ignore it.  It must be dealt with.

The Legislature must re-examine its fiscal assumptions and Iowa’s tax code.  Business cycles will not go away, and hocus-pocus economic theories will not eliminate their impact.  Iowa must build in a bigger rainy-day fund and, when it rains, use it.

Also, the state should occasionally be willing to solicit honest advice from outside objective economists on such matters of obvious great significance.

Politics in the United States is shifting away from an emphasis, begun in the New Deal days, on social welfare.  It is replacing it with what is often called “opportunity.”  But the key to opportunity is education.  Almost two-thirds of Iowa’s budget goes for education.  If revenues are reduced too much, education and opportunity must suffer.  As the archconservative economist Milton Freidman instructs us, there is no free lunch.

ARTHUR SMALL, an Iowa City attorney, was a Democratic state representative and state senator, 1971-1986.  He served as chairman of the Senate Appropriations Committee.