A Top Ten Ranking
By Christopher Westley|
JSU Assistant Professor of Economics
(Reprinted from the JSU Economic Update)
JACKSONVILLE -- February 2, 2001 -- Alabama wins in more ways than in college football, or so say some studies of federal income tax receipts and outlays.
These studies, which compare each state’s contribution in federal taxes to its take in fiscal spending, come out every December and are dutifully reported in the local press. The “winner” states are those that manage to receive more than they give. The “donor” states are the losers: they give more than they receive. Unlike college football, the transfer system is a zero-sum game, in that the winner states can only win to the extent that the donor states lose. In 1999, Alabama was ranked tenth among the top ten winners.
How much does Alabama receive? One study, conducted annually by the Taubman Center for State and Local Government Harvard University’s Kennedy School of Government, found that on a per capita basis, Alabama took in $6610 from the federal government in 1999, while paying out an average of $4531. Another study, by the Northeast-Midwest Institute in Washington, finds that for every dollar paid by Alabama residents in 1999, they got back $1.49. (This finding is congruent with that of the Kennedy School.)
Invariably, the press reports these findings as good news for the state. In general, the press bias is that while Alabama culture may be congenitally opposed to a large federal government, the state sure benefits from the system. However, it’s far from clear whether findings such as these are accurate depictions of the fiscal health of the state or of the distribution of benefits.
Nobel Laureate Milton Friedman once argued that increases in the money supply are distributed in the economy through what he termed “the helicopter effect.” If the Federal Reserve increases the money supply by $1 billion, Friedman said that the increase in money would be spread equally in the country, as though it was dropped from a helicopter at a high altitude.
As any undergraduate money and banking student knows, however, that is not true, and Friedman himself has backed away from this analysis. The newly created money isn't evenly distributed among all economic agents. Rather, the groups that benefit from the new money are those that receive it first. By the time the money is spread out among entire economy, its benefits have been lost due to its inflationary impact.
The same is true for fiscal spending as well. Federal spending in the states does not benefit each resident equally. Otherwise, if the results from these studies were to be taken seriously, federal spending in Alabama would be equivalent to each resident receiving a 50 percent federal tax refund. In fact, those individuals who directly receive the money are the actual beneficiaries, so the benefits are not evenly distributed.
In Alabama, the lion’s share of this surplus goes to the military, benefiting areas of the state that house bases, arms depots, and training and testing facilities. But even in these areas, the benefits are not evenly distributed. The benefit is limited to Alabama-based firms that directly and indirectly serve these facilities. Federal spending doesn’t benefit the state if these funds are spent in Georgia or Florida. And it doesn’t help the Black Belt counties that are among the state’s poorest.
Alabama is likely move up to a higher ranking next year if only because of the December 2000 storms that devastated Tuscaloosa and Geneva counties. Millions of FEMA dollars will be added to federal outlays earmarked for the state. If the Hurricane Opal disaster relief is any guide, the funds will go to construction firms that are politically well connected, not to those in the counties where the destruction actually took place or to organizations on the scene that are best situated to deal with crises at hand. Not only does this practice slow the rebuilding process, it also brings with it hidden costs, as private relief efforts that otherwise would have sprung up and promoted a quicker rebuilding effort are squelched.
This is not the type of spending that suggests an improvement in the quality of life, as is inferred by these rankings. It only reflects the kind of growth that results from the destruction of capital. This amounts to forced spending that maintains the status quo. Unfortunately, these are costs that are not easily measured by analyses of fiscal spending.
Another cost not conducive to measurement is the cost of transferring capital from other uses to those deemed necessary by the federal government. Taxation is simply forced capital spending, or the diversion of money from other uses to those necessitated by the transfer state. Alabama might receive some benefit from these capital flows, albeit unevenly distributed, but at a cost to donor states such as Connecticut, New Jersey, and Nevada. (See table.) Individuals have less disposable income in these states to spend on those things they deem important, and it is transferred to support those causes deemed important by the political class. The larger this transfer system gets, then the more force is required to maintain it. Certainly, this is a cost that does not make it into the analyses of the efficacy of fiscal spending.
Besides, it is far from clear that being among the nation’s leaders in net federal spending should be a game Alabama wants to win in the first place. No state ever became rich by depending on federal wealth transfers. If states did, West Virginia and Mississippi would be today’s Incan empires. Policies that create and attract wealth are no secret. States become wealthy by protecting private property, maintaining a stable system of low taxes, decentralizing its infrastructure, and by minimizing intervention in private capital flows. Such policies, from generation to generation, encourage good work habits, longer time horizons, and increased capital from other states where wealth is less secure.
Unfortunately, these are policies that will be pursued by the political class in Montgomery only to the extent that they promote the mobilization of voting blocs that ensure the maintenance of power. As a result, economic and political incentives can be at odds with each other. Unfortunately, policies that reward the existing political class in the short run can hinder a state’s ability to develop a legal and economic infrastructure that promotes long-term capital creation and that encourages capital mobility and investment.
Federal spending can become an enemy of such outcomes. Increasing federal funding to the poor states enables them to avoid these reforms, while at the same time it penalizes rich states for implementing them. Why should a state correct for poor policy prescriptions if the federal government compensates the resulting shortcomings? The long run consequences of maintaining such a system is a skewing of the incentive structure and a diminution of the ethos of wealth creation that allows states to become wealthy in the first place.
Furthermore, on a national basis, forced wealth transfers between states promote a divisiveness that otherwise would not exist. The late Murray Rothbard wrote in his economic classic Power and Market, that in any transfer system, there are two classes that emerge: net taxpayers and net tax consumers. The consumers include anyone whose income is made up of public funds, be they federal, state, or local. In theory, these are people whose purpose in the macroeconomy is to serve the net taxpayers. (Rothbard argued that employees who receive payment in tax dollarsnet tax consumersshould not pay taxes because it represented a wasteful re-transfer of funds back to the government that paid them to the employees in the first place.)
Rothbard's delineation of the tax system could be extended to the state level, in which some states, on the net, pay for federal wealth transfers, and others, on the net, consume them. High income states like California, Ohio, and New York pay out more in federal taxes than they get back in the form of federal spending, while low income states, like Arkansas, Mississippi, and West Virginia, pay out less than they get back. In the process, high-income states are penalized for past policies that reward wealth creation, while low-income states are rewarded for past policies that penalized wealth creation.
Ironically, Alabama’s long-term goal should be for it to become a donor state. This would mean that the state economy had developed in such a way that it had achieved self-sufficiency, if self-sufficiency implies maintaining the current levels of federal spending in the state. The first step toward achieving this goal would be tort reform. Relative to other states, the legal infrastructure in Alabama is biased towards allowing lawsuits. While this may be good news for lawyers, this system gives entrepreneurs caution about bringing capital to the state. The big dollar settlements that have become synonymous with Alabama’s legal system, such as last year’s $3.5 billion judgment against Exxon, will prove to be pyrrhic victories if their long-term effect is to diminish investment here, causing funds to flow to our neighboring states.
Conceivably, donor states could opt out of the federal system and provide their current levels of federal spending out of current tax revenues, and still have money left over. When the state faces this type of problem, we can rest assured that it has made the right choices for the long-run success of its economy and of its future.
See tables below. The results listed show the amount in dollars received in fiscal spending for each dollar paid in taxes.
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