Friday, May 9, 2014

Taxpayer Return on Investment

My attention was turned onto a report that ranks states according to the returns they provide to taxpayers. Economist Scott Sumner at The Money Illusion makes the observation that states with no, or low, income tax rates tend to rank better with regard to their public services. He checked for a political bias in the ranking organization, but found that Republican and Democrat leaning states were evenly mixed throughout the rankings. The organization providing the rankings is called Wallethub. Their mission statement says they provide financial information for consumers and small businesses. The report was produced by professors of political science, economics, and public policy at various universities across the country.
So what does the report say about West Virginia? The state ranked 46th of 51 (D.C. was included) in return on taxpayer money. The good news is that the tax rate rank is not oppressive. West Virginia was ranked 18th, top 35%, in terms of how much taxes its citizens pay annually. Wallethub estimated that the average West Virginian pays $6,598 annually in taxes, which is 5% below the national average. The bad news is that our overall government services rank 47th, according to this organization.
There are a few graphics that break down the metrics by government service. West Virginia is featured in two of them.
Click to enlarge
That is interesting given the chemical spill that tainted Charleston's water supply in January 2014, but before that West Virginia had been nationally ranked with the best water quality. It is assumed they ignored the recent spill and looked at the larger picture of the state's past and future water quality when conducting the report. More troubling is that WV was ranked last in terms of quality hospital systems. The explanation for this is not readily available. One could reason that the lack of health care options in rural areas across the state lead researchers to rank the state last. Their sub-metrics in determining health care provision were: the number of state and local hospitals per 100,000 residents; a public hospital system rank; the average life expectancy; the infant mortality rate; out-of-pocket medical costs; and the average health insurance premium. The average life expectancy could be more due to lifestyle choices, but the other areas are somewhat within the state's purview. And it can be noted that the quantity of hospitals does not always mark their quality. Still, a low health rating certainly made WV look like a bad return on taxes invested.
However, there is a bigger point to be drawn from this report. Could West Virginia improve its quality of public services by increasing or reducing the tax rate? Given that the state already collects below the national average in taxes, one might say that raising the tax rate to the national average or beyond could give the government more resources with which to improve health services, reduce crime, or build infrastructure. This makes good sense, but the state by state picture muddies this clear reasoning a bit.
Look at how convoluted this graph appears. Putting the same data into Microsoft Excel shows that there is a small negative correlation (-0.22) between lower tax rates and higher government services. But it is far from clear that higher taxes necessarily provide a state with better government services.
West Virginia would hope to move downward on the above graph. That would indicate better public services. The trend line would indicate that increasing taxes marginally would help that. However, the chart shows plenty of states with low taxes and high government service rates. Look at the cluster of five states in the lower left hand corner that rank in the top ten in low tax rates and in the top twenty in government services. Those states are: Wyoming, South Dakota, North Dakota, Washington, and Colorado. Of those states, South Dakota, Washington, and Wyoming have no income taxes. On the other end of the spectrum, the state with the highest tax rate rank, New York, has the 25th best public services. So New York has high tax rates and is in the middle in terms of services. California has the second highest tax rate rank and is 38th in public provisions.
Complicating the relationship further are states with high tax rates and highly rated government services. Iowa, Nebraska, and Vermont all rank in the top ten highest tax rates and provide top ten quality public services. All three states have a progressive income tax that is steeper than West Virginia's.
So what is the lesson from all this data? Should West Virginia lower or increase tax rates? And if so, which ones should it lower or raise? The main moral seems to be that rates are not as important as quality decision making. The efficiency with which a state government spends money is more important than the amount collected. Finding cost effective ways to improve infrastructure, schools, air and water quality, and health services is the best route. That is easier said than done though. Building bridges or hospitals takes money. Increasing safety requires better training or more officers or both. And improving education starts with better teachers and teacher training. It requires as much dedication from the populace to provide these services as it does the state to facilitate them. Teachers and police officers taking pride in their work and looking for innovative ways to improve their community are just as important as the politicians hoping to effectively parse through the tax code.

Friday, April 18, 2014

More on Minimum Wage

Many states have taken time during their recent legislative sessions to pass higher minimum wage laws. Whether this is an attempt to keep pace with inflation (which is at historic lows), or battle income inequality is up for debate. I wrote two months ago about the state of inequality. Here are two graphs depicting: 1) the upward shift of the population among income brackets and, 2) the higher concentration of wealth among higher income brackets.
1) Less people in lowest income bracket, more people in $50k - $200k range
2) Less wealth among lowest income bracket, $100k-$200k range grows, $1MM+ bracket grows.
As I mentioned at the time, these trends show a positive movement of the population up the income ladder with the consequence that more of the total state income is held by people making $75,000 or more. But are those making much less, like the minimum wage, cut out of this growth in prosperity?
The unemployment rate has dropped almost linearly from a peak of 17.4% in 1983, with reversals of trend coming after each recession. Widely held economic theory says that raising the minimum wage results in higher unemployment. But that can be difficult/impossible to tell when unemployment rates are much more heavily influenced by macroeconomic conditions (changes in preferences, globalization, technological innovation, etc.). Shifts in the nature of the labor force away from mining and manufacturing toward health care, retail, law, finance, and other technical jobs requiring computer skills ultimately produced new, different jobs that displaced some workers from the labor force while providing new sectors for other workers. Upticks in the unemployment rate seem to follow the path of recessions (crash of 1987, tech bubble, Great Recession of 2008).
By adjusting the state minimum wage by the inflation rate (taken from the Bureau of Labor Statistics CPI rate - table 24), we can see a fairly flat rate.

The current minimum wage of $7.25 is keeping pace with inflation though it is down slightly from a record peak of almost $8.00. Thus, increases to the nominal minimum wage have kept the real minimum wage steady, and increased it somewhat, since 1980. During this time, the unemployment rate of WV has dropped, subject to macroeconomic conditions in the broader U.S. economy. At the same time, the share of taxable income in WV has experienced a shift from earners making less than $50,000 to workers making $75,000 or more. The lowest taxable income bracket of below $30,000 in 1997 and below $25,000 in 2011 (the IRS changed the brackets for some reason) shows a movement of workers out of that bracket. A total of 46% of returns were filed for those making under $30,000 in 1997, while 25% of returns were filed for those making under $25,000 in 2011.
From this information it can be reasoned that workers making under $25,000, around the minimum wage, are not making less in inflation adjusted terms. Not only that, but more and more workers are not in this category. And lastly, that is why the share of total income of the bottom income brackets has dropped; not because they are earning less, but because of the upward mobility of higher earners.
In conclusion, there is an indeterminable relationship between unemployment and minimum wage. It may increase unemployment at the bottom of the income spectrum, but there is not clear data showing this and no way of inferring causality. The minimum wage has stayed constant, in real terms, as unemployment has dropped in WV over the years. It is currently above the 1980-2013 average of $6.55 in 2013 dollars. Increasing it now may slightly increase the share of income going to the bottom tax bracket, but it won't be considerable due to the broader shift of workers up the income brackets and their increasing wages.
This is an issue of importance being hotly debated at the global level. The release of Thomas Piketty's book: Capital in the Twenty-First Century has created a flurry of discussion over inequality and whether it is due to grow indefinitely in the future. Piketty's main thesis is that the growth rate on capital has been higher than the growth rate of labor over the broad course of human history. This makes the people owning capital assets (stocks, buildings, land, machines) wealthier than the people providing goods and services. He uses this point to advocate for a global redistribution of income. While the jury is out on his claim about growth rates, the story for a large amount of people over their lifetimes has been a rising standard of living as they jump up the income scale. The Great Recession may have called this mobility into question, but the numbers have yet to show that it has stopped. There is still wealth to be made for those that can and will work for it.

Friday, February 28, 2014

Race Track Subsidies

The WV House recently passed a bill to reduce subsidies to thoroughbred and dog race tracks. It estimates this would save the state $35 million and help reduce a budget deficit. Some delegates objected because they represent districts with dog breeders or race tracks. Do they have a point, or are subsidies to private enterprises like these an unnecessary expense to the state?
Tyler Cowen of George Mason University calls state "racino" legislation that allocates a percentage of gaming revenue to racing and breeding businesses a "triply stupid policy". Why such a harsh endorsement? The first trip up, in his opinion, is that there should not be a separate legal entity for a casino with racetracks, such as Mardi Gras Resort and Casino in Cross Lanes, WV. Secondly, he objects to the nature of such legislation as a response to competition between state lotteries and racinos. State lotteries like to bill themselves as great benefactors to local education. But the effects of all their spending on education is ambiguous while the revenue they generate is often extracted from the lower income residents of a state. And lastly, Cowen finds it bizarre that a private, for-profit enterprise should need state funding to survive. In his words, "how about spending the money on poor people, rather than on sectors which extract money from a disproportionately lower income clientele?"
Delegates arguing against this legislation are doing so to represent their breeders and race track workers. That is all well and good. But what is the cost-benefit of defending these subsidies? It seems fairly intuitive that if a company cannot operate without government subsidies perhaps it should not be in business. And if race tracks are losing out to competition from state lotteries, why not abolish the state lottery? Again, state lotteries extract revenue from lower income residents, on average, and frame their operations as benevolent by funding things like education. These lotteries could be replaced by so called "no-lose" lotteries run by local credit unions. Some states, like Michigan, already allow these "no-lose" lotteries where savings accounts are opened by players and the winners receive extra cash in lieu of each depositor gaining interest in their account. Britain already runs a form of this that they call "premium bonds". That program has been around since 1956.

So while we are reviewing race track subsidies, maybe it's time to throw in some lottery reform as well. It's food for thought. 

Tuesday, February 25, 2014

Income Inequality in WV

A recent news blip on WV Public Broadcasting relays a report that income inequality in West Virginia has grown over the last three decades. Specifically, it focuses on the difference between the top 1% of earners in the state and the rest of the state's earners. It has become popular since the Occupy Wall Street movement to discuss the 1% of top earners and the rest of the public. But what does the broader breakdown of different income brackets look like? How has it changed over time? And what does this mean from a public policy outlook?
The article sights a research paper released from the Economic Policy Institute (EPI). That is a rather bland name that most people will gloss over. The EPI states on its website that it "conducts original research according to rigorous standards of objectivity and, as a result, is a reliable source of information and analysis." But on the same page it mentions this: "EPI proposes policies that protect and improve the economic conditions of low-and middle-income workers and assesses policies with respect to how they affect those workers." The organization states it is releasing objective economic analysis, but then states it has a mission of promoting certain public policies. Having a policy agenda implies having a bias; this makes an organization less than completely objective. Also, note this from their website, "In 2010 through 2012, a majority of our funding (about 60%) was in the form of foundation grants, while another 26% came from labor unions." So this organization will be inherently biased towards policies advocated by the foundations funding it as well as labor unions.
Still, its claim that income inequality is growing in West Virginia deserves to be inspected. The statistic stated in the article is that the top 1% of incomes in West Virginia are, on average, 20 times greater than the average income of everyone else. This alone is not shocking. The smaller the percentile of highest earners, the bigger the multiple. So average incomes from the wealthiest 1% will always be higher than average incomes from the wealthiest 2%. For example, in 2011 the top 0.1% of earners in WV had an average income 67 times that of the average income of all other WV earners. That's basic mathematics.
Another statistic in the article says that WV is one of the states where the top 1% of earners took between 50% and 84% of the income growth from 1979 to 2007. This statistic does seem to imply that the top 1% of earners are capturing all the economic growth in the state. But there are problems with making this basic interpretation. One is that the people who were in lower income brackets in 1979 were not the same people in those same income brackets in 2007. Someone earning $30,000 in 1979 could reasonably be earning $70,000 in 2007. Another person earning $250,000 in 1979 might be earning over $1 million by 2007. Other people may have moved out of the state or passed away since 1979. This is an important distinction. People outside the 1% can move into or out of that bracket over time. An income bracket is not the same people gaining and losing a share of economic growth over time.
Reviewing real data from the IRS is helpful to make these points more salient. Consider the period 1997 to 2011. There were about 61,000 fewer taxable income forms reported in 2011 than in 1997; this signifies outward migration from WV. But more important for discussions of income inequality are the movements between income brackets. In 1997 80% of the tax forms were for individuals earning $50,000 or less, but by 2011 that number dropped to 56%. Meanwhile, the share of individuals in each income bracket above $50,000 increased from 1997 to 2011. For example, in 2011 41% of earners took home between $50,000 and $200,000. Back in 1997 only 19% of workers were in that income bracket. Therefore, the recent evidence suggests that there is income mobility by WV income earners over time. If this is not the case, then lower income workers left the WV labor force and higher income workers entered it.
Having discovered that people are not stationary in income groups over time, one can move on to seeing how income has changed within the groups. Those West Virginians earning above $1 million in 1997 had an average taxable income of $1.93 million. Individuals in that bracket in 2011 earned $2.64 million on average. That is an increase of about 37%. Meanwhile, individuals earning below $50,000 moved from having an average taxable income of $18,000 in 1997 to $13,500 in 2011. This is a decrease of around 25%. And indeed there is a decrease of average incomes in each bracket except for those over $1 million. Other than the under $50,000 income bracket, those decreases were at or below 8%. That still seems like a bad thing.
This only includes "taxable" income, which is why sometimes the average is below the range
Does it mean that income inequality is a rampant problem in the state? Recall that the people earning less than $50,000 in 2011 were not the same people earning less than $50,000 in 1997. Therefore, there are a host of reasons why the average income in this bracket might be lower. We know there are fewer people in this bracket over time. Maybe the type of workers in this bracket changed. The type of worker may have changed from employees working at a plant earning $45,000 a year to service workers earning closer to $25,000 per year. A shift in the nature of the workforce could produce such a change. Maybe there were younger workers in the 2011 $50k group who could not demand wages close to $50,000 whereas those in the 1997 group may have been tenured employees. These are two examples of why averages within income groups change over time. And at least the share of income in groups from $75,000 to $1 million increased over that period.
2011 percentages are more evenly spread than 1997 shares

Hence, while we do see higher income among the highest earners in the state, this does not necessarily mean workers in the lower income brackets are worse off than they were two to three decades ago. For one thing, they are not the same people. A Carbide employee from 1980 is not the same person as a recent high school graduate working retail at the Town Center Mall. The high school graduate may not have a family and wouldn't mind earning $10,000 less if it meant having a smart phone, internet access, and a television.
The public broadcasting article goes on to state that this report was released while the WV senate is considering a minimum wage bill. In doing so it implies that the minimum wage has a direct connection to income inequality. But this is far from straightforward. The academic and public policy community is deeply divided over whether minimum wage reduces income inequality or not. It may seem intuitive that if you make a company pay its lowest income workers more, people in the bottom income bracket will earn more. However, employers can simply choose to not hire as many minimum wage workers, or they can fire those they currently employ. Changing what you require a company to pay a worker does not change the productive capacity of that person. In this way economists often predict that increases in the minimum wage will increase unemployment. A minimum wage law may raise the average income in the under $50k bracket, but that would be accomplished by pricing the lowest earners out of the labor market. An employer will simply avoid hiring a worker who does not produce above the level of income required by the government.
Income inequality in a society can be problematic. It can cause social strife and depressed workers and it implies stagnation in living standards. Those are serious problems. That makes understanding the statistics behind inequality very important. Fortunately for West Virginia, the picture is not as bleak as the study released from the EPI would lead you to believe. Unfortunately, the causal link between minimum wage policies and inequality is hazy at best. There is no simple fix to making relatively lower income earners in a society more productive and more valuable to employers. 

Oil and Gas Reserve Fund

*Disclosure: I work for a natural gas company.*

The Senate recently passed a bill for what it calls a Future Fund to set aside tax revenue from oil and gas companies. Here are the particulars: the state will maintain $175 million in oil and gas taxes that it can spend. Twenty-five percent of all the oil and gas revenue after that will be placed in a reserve fund. This fund will earn interest for six years before it can be spent by the government. The main issue is whether this is a prudent, fiscally responsible policy to ensure future financial health, or if using the tax revenue immediately would produce more value during tough economic times.
There is a strong case for the implementation of the Future Fund. It rests on an idea known as the resource curse that has plagued West Virginia in the past, but has had economic impacts worldwide. The basic idea is that countries (and states) with large stores of natural resources often end up with lower incomes, employment, and standards of living than surrounding countries. One glaring example is Venezuela, where $100 billion per year in oil revenue has yet to provide a better life for most of its citizens. Likewise, the phenomenon is present in Africa and the Middle East where autocratic governments hoard the wealth from oil revenue for themselves and at the expense of their populace. West Virginia experienced a form of this with the coal boom in the mid-20th century. This rush temporarily produced employment and tax revenue, but after the easily removed coal had been extracted and technology reduced the need for human labor, many coal towns were deserted. To be fair, the coal industry has continued to provide tax revenues to the state to this day. However, had the funds from this resource extraction been saved and invested in a reserve fund, a smoother transition to jobs in different industries may have been available to past generations.
Norway provides a good example of effectively using a resource reserve fund. That country found large oil reserves off its coast in the 1970s. Instead of allowing companies to extract the oil as quickly as possible, the government handed out a few licenses every year. Then, Norway decided to not spend the new oil revenue immediately on social programs and infrastructure. Instead their government put the money into a pension fund. The Norwegians restricted their government from spending anything other than the interest earned on that pension fund. Today the fund contains about $550 billion. Norway's social programs are envied by countries across the globe due, at least in part, to its oil revenues.
The argument against saving funds from oil and gas revenue rests mainly on urgency. Citizens concerned about high unemployment, high Medicaid costs, and failing infrastructure would rather see new tax revenue spent immediately. While this argument carries some weight, the historical evidence from state and national governments does not support it. There are few examples of governments rapidly exploiting resources then benefiting from years of economic growth due to tax revenues. Instead, future generations could benefit from annual state budgets backed up by a reserve fund. The level and timing of what should be saved or spent can be debated, but the existence of the reserve fund itself has solid economic evidence in its favor. 

Monday, February 24, 2014

Launch Pad Legislation

The recent House Bill 4343 introduced in West Virginia's legislature seeks to entice companies with "state-of-the-art" technologies to setup their businesses in the state. Whenever you hear governments talk about encouraging economic activity you have to wonder how they plan to go about accomplishing those ends. Politicians have a finite amount of tools they can use for encouraging business activity. This bill mainly looks to institute tax breaks for manufacturers of certain technologies*. 
So how effective at attracting business activity is the method of offering tax breaks and other subsidies? The effect of this political action can be examined with some basic economic thinking. If a government offers privileges to certain businesses, it stands to reason that those businesses will notice and be more likely to locate within the area of that government. But there are multiple surrounding governments, in this case different states, where a manufacturer can choose to locate a company. If those other states offer the same or similar privileges, the company and its directors have no incentive to choose one state above the other. Therefore, if West Virginia offers a tax break to companies that is similar to a tax break in Virginia, Ohio, and Kentucky a company choosing between the four still has no particular reason to choose West Virginia. Under such a scenario, the best that can be said for the tax break is that it "stays competitive" with the enticements of other governments.
The bill states in its introduction, "West Virginia has not done a good job to position itself for economic development in the new economy, which largely can be located anywhere in the United States or for that matter, the world." If the businesses this bill is trying to attract can be located anywhere in the U.S., then using policies that can be enacted anywhere in the U.S. is not a selling point. It is not a comparative advantage to any particular state. That is, it does not use the existing skill sets and infrastructure particular to a certain people to attract business. For example, if a nanotechnology company is trying to decide where to locate its operations, it will look at a variety of factors. Two of the main factors will be the existing infrastructure and skilled workforce of an area. A nanotechnology company looking at Indiana would see that Purdue University has the Birck Nanotechnology Center that produces the research and educates the students needed for its business. If it then looks at West Virginia and sees no existing research facilities or workers skilled with nanotechnology, it will not be swayed to locate in West Virginia solely by tax breaks.
This is not to say that a state lacking high technology will never host companies producing it. Those states with high-tech companies had to start somewhere. But the path to being the home of specialized industries is more difficult than offering financial incentives. It starts with existing resources. Then, governments or individuals with the necessary funds can concentrate their resources into a very particular sector. That attracts knowledge workers with complimentary skill sets. Out of this base of workers some will create new companies that go on to benefit the rest of the state. This is one logical way to develop new economic activity, but there is no formula or easy fix. If there were an easy policy solution, every politician would use it and garner the praise and respect for instituting it. 

*Among those listed in the bill are: aeronautics, biotechnology, materials science, nanotechnology, homeland security, photonics, and alternative fuel vehicles.