Governors and Mayors Should Be Begging for Trump’s Tax Cut
These are brutal days for state governments, especially progressive ones. Last week Illinois passed its first budget in two years, raising taxes by $5 billion—despite already having a state and local tax burden that’s among the highest in the nation. Connecticut’s deficits are so big, according to the fiscal watchdog group Truth in Accounting, that every taxpayer would have to pony up an extra $49,500 to pay off all the liabilities. In Oklahoma, where low oil prices have tanked state revenue, some public schools open only four days a week.
Liberal groups warn that President Trump’s proposals would make things worse by reducing the funds Washington sends states under programs like Medicaid. Governors and mayors, the argument goes, would be forced either to slash social services or raise taxes to make up the difference.
But focusing on federal support obscures the real problem. The biggest cause of states’ budget woes is the anemic condition of the national economy. Over the past eight years, growth in state and local revenue has slowed to a crawl. In fiscal 2017, total state revenue rose by less than 1% after adjusting for inflation, according to the National Association of State Budget Officers.
What states need most to regain fiscal health are national policies that accelerate the growth of the economy. Governors and mayors should be lobbying nonstop for the tax cuts proposed by Mr. Trump, which would revitalize state finances.
When the federal government cuts taxes, more money is left in the hands of businesses and workers. The Trump plan would free up an estimated $2 trillion to $4 trillion over 10 years—an enormous influx of cash for state and local economies.
Compare state finances during the go-go Reagan years with President Obama’s tenure, beginning after the end of the recession each president faced. After the recession of 1983, the national economy grew an average of more than 4% a year through 1990. During the Obama recovery between 2009 and 2016, the economy grew just over 2% annually. Remember that those effects compound: Strong growth year on year increases the size of the economy over time.
If state and local tax revenue had grown under President Obama at the rate it did under President Reagan, receipts in 2016 would have been greater by about $650 billion, or 26%, according to national income and product account data. If the economy in the Obama years had grown at 3.5% to 4%, the average rate for postrecession recoveries, states and cities would have had about $430 billion more. Think what they could do with nearly half a trillion dollars in additional tax revenue each year.
Even if Republican tax reform eliminates the federal deduction for state and local income taxes—a move we support—its effect on states would still be overwhelmingly positive. When federal income taxes were high in the 1970s, people could write off as much as 70% of their state and local taxes. Slashing rates in the 1980s brought that figure down to as low as 28%. Yet state fiscal health improved dramatically in the ’80s. The main effect of eliminating the deduction today would be to reduce the federal subsidy to high-tax states.
Critics will say this forecast for economic and revenue growth is wishful thinking, but it is based on the historical record. In the seven years after the Kennedy tax cuts, real state and local receipts grew by more than 60%, according to data from the Federal Reserve Bank of St. Louis. In the seven years after the Reagan rate cuts, the real increase was 37%. After Mr. Obama’s tax increases, real growth was a meager 10%.
The nonpartisan Tax Foundation estimates that after 10 years the Trump tax reform would increase America’s long-run gross domestic product by up to 8.2%. State and local governments capture about 13% of GDP in taxes according to 2016 Internal Revenue Service data, meaning the growth spurred by the proposed cuts would give them about $200 billion more each year by 2027 to balance their budgets, reduce taxes, or spend on education and social programs.
With the Trump tax cuts in place, the cumulative increase in state and local revenue over the following 10 years would be roughly $1 trillion. Could any imaginable tax increase raise that kind of money?
Amazingly, the bean counters at the Congressional Budget Office and Joint Tax Committee completely ignore this effect when they tally the “cost” of tax cuts in terms of forgone revenue. Almost a third of the lost federal revenue from Mr. Trump’s tax reform would be recouped by states and cities.
We only have one question: Why aren’t more governors and mayors—especially those in economically depressed areas—demanding the Trump tax cuts?
Mr. Laffer is chairman of Laffer Associates. Mr. Moore is a senior fellow at the Heritage Foundation. They are co-chairmen of the Committee to Unleash Prosperity.
Appeared in the July 14, 2017, print edition.