I learned a lot of fascinating economic facts during the recent election campaign. I found out that a local politician raised my taxes so many times that I now pay all my income to the state. I learned that by cutting state or local taxes we can create massive numbers of jobs and balance the budget at the same time. I discovered that by getting rid of waste and fraud, our budget problems will be solved magically.
Unfortunately, most of the information I got is hazardous to our economic health.
While the political ads are absurd, probably by design, some voters do get their economics from those commercials. And that is a real concern, because politicians simplify complex economic issues that require difficult trade-offs. Bad economic policies result.
Economic Fact #1: Economists walk this earth only because we live in a world of scarcity, and since there is not an unlimited supply of everything, we have to make hard choices.
Most people have to allocate their limited income. Spending money on one thing means we give up the opportunity to use those funds for something else. Economists call that "opportunity cost," and it drives all economic decisions.
Unfortunately, politicians don't talk about the idea that their spending and taxation decisions require trade-offs. But they do. On the spending side, the issue is obvious. If you build an aircraft carrier, hire another firefighter, or provide health care, that money is not available for purchasing other goods or services.
The issue of raising or lowering taxes is no different. Some politicians argue that taxes should never be increased. Does this make sense? Only as long as it is recognized that not increasing taxes has consequences.
The best example is gasoline taxes and road construction. Who doesn't want good roads? Unfortunately, increasing vehicle mileage is moderating gasoline demand, and falling gasoline tax revenue is bankrupting highway trust funds. The consequence of not raising the gasoline tax - or paying for improvements by borrowing money or increasing fees or tolls - is that our highway infrastructure will deteriorate.
Economic Fact #2: Tax cuts reduce revenue immediately, but the potential economic increases happen over time.
Nothing shows that fact more clearly than property tax changes. What politician hasn't suggested that we have to cut property taxes to improve the economy? Sounds great, right? But businesses or households don't suddenly relocate to an area that has reduced its property tax. Consequently, business or property taxes don't rise quickly - if they do at all.
Property tax cuts reduce revenue immediately. Since the cost of providing services is not falling, the result is a potential budget deficit.
There is nothing wrong with cutting property or any other tax as long as it is recognized that the budget must be reduced as well. State and local governments cannot run deficits. They must either raise revenue or decrease spending - called "starving the beast." There is always "doing more with less" or "cutting out fraud and waste," but politicians have been supposedly balancing budgets that way for centuries. It hasn't succeeded yet and it is hard to see how it will going forward.
So, when you exclude tax increases, the only way to balance the budget is to reduce services. Accomplishing that is the problem. Should we lay off police or firefighters? Maybe we should freeze wages or slash aid to the elderly or poor. Don't like those options, how about closing a park, a community center, or ending trash collection? Cutting state or local taxes means spending has to be reduced with some group paying the price.
Too often, though, the trade-offs needed to offset tax cuts are politically unpalatable, so governments opt to use gimmicks. That is why New Jersey became a financial basket case. Twenty years ago, taxes were slashed but spending wasn't. Trust funds were raided, pension plans were underfunded, and a huge, almost intractable structural budget deficit was created. Similarly, the nation went from running a large budget surplus to a large deficit because taxes were cut while spending soared. No amount of growth could overcome that disastrous combination.
Political ads telling us we can have it all without anyone getting hurt are great political theater. But they make rational budget policies difficult. What those ads don't point out is the most basic fact of state and local public financial management:
Just as we have to pay for more spending, there also is no such thing as a free tax cut.