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A Fair Share for New York City: A Case for Equity

Opinion pieces and speeches by EPI staff and associates.


A Fair Share for New York City: A Case for Equity

by  Max B. Sawicky

I would like to thank the city council for the opportunity to offer my views at this hearing. We begin with the simple fact that the nation’s economy will not recover unless our cities recover. Cities are the economic engines of metropolitan regions, and metro regions account for the overwhelming bulk of the U.S. economy.

The federal government is not facing up to its responsibilities. Presently there are nearly three million more unemployed than in 2000, before the recession began. Even worse, the length of time people now spend out of work has been lengthening. This means increasing cases of bankruptcy, mortgage foreclosure, loss of health insurance, homelessness, hunger, and assorted social afflictions.

President Bush has promised that employment will exceed 137.6 million by the end of 2004 if his tax cut is passed. Starting in July, this will require approximately 300,000 new jobs a month. The most recent change in jobs (non-farm employment) is a reduction of 48,000.

Following the president’s lead, the Congress diverts itself with pointless, wasteful proposals that could cause employment to fall, rather than rise. A minimal goal of economic stimulus is to speed up job growth. The proposed tax cut on dividends, however, could have the opposite effect – its phase-in could cause business firms to delay paying dividends until next year. Of course, if companies did pay out more dividends, they would have less of their own money to invest. We are told that the stock market could go up if the bill passes, thereby spurring consumer spending through a “wealth effect.” Directly affecting the wealth of ordinary folks who don’t bother following the market is a much more reliable route to elevating consumer confidence. The logic of the dividend exclusion befuddles on every level but that of rewarding the wealthy.

For failing to take the economy seriously, politicians ought to be held accountable. Our mandate today is to propose sound alternatives. I am here today to discuss two of them – general fiscal assistance and the Earned Income Tax Credit. I note them together to make the point that there is one important quality that both policies have in common – low overhead. The costs of administering these programs are extremely low. That means they can be launched or expanded quickly, an important consideration in fiscal policy.

Simple administration at the federal end means maximum flexibility at the receiving end, another factor that facilitates speed of execution. State and local governments or individuals have complete discretion as to the use of the aid – big money without big government.

General Fiscal Assistance 

The dire condition of state and local governments is well known. On top of the continuing effects of recession is the burgeoning responsibility for homeland security. States have resorted to every available measure to cover their expenses, including tax increases, service cuts, and drawing down reserves.

The fiscal effects on homeland security are especially troubling. It is an odd army that responds to attack by drawing down its forces, but that is exactly what has been happening. Even more puzzling is the ubiquitous exception to the constant refrain that we should all lead our normal lives, lest the terrorists enjoy a victory. That exception is of course the failure to maintain public services. Should we make it a point to keep our plans to visit Disneyland while city governments are closing police and fire stations?

The budget gap facing state governments has been estimated at between $40 billion and $90 billion. We could expect a similar magnitude for local governments, who bear the principal weight of financing what we have come to call “first responders.” It would be nice to have better information on this count, but here again the federal government has not interested itself in maintaining timely information on the fiscal condition of local or state governments. It’s an odd general staff that takes little interest in the condition or provisioning of its troops.

For legal and economic reasons, state and local governments are obliged to close budget gaps with spending cuts and tax increases. These painful measures also have negative side effects – they slow down economic growth at the least opportune time. The reason is simple. Tax increases and spending cuts reduce consumption spending, and lower spending inhibits job growth. To reverse this, we need more spending by consumers, business firms, and state and local governments.

In an important sense, how we got to this point is totally irrelevant. Only the national government can offset the ‘fiscal drag’ that results from state and local fiscal policy. Unfortunately it is doing just the opposite – limiting the growth of grants-in-aid and enacting tax cuts that will automatically widen state and local budget gaps.

The line heard most often in response to this goes something like this: “It would be wrong to reward the states for their lack of fiscal discipline.” Coming from any member of Congress who voted for the 2001 tax cuts, much less any who plan to do it again this year, such exhortations to virtue only bring to mind people like Bill Bennett.

That aside, the tale of spending excess by the states is a myth. Consider the previous business cycle, which began in 1990 and ended in 2001. In 1990, state and local spending was 11.6 percent of GDP. In 2001, it was 12.2 percent. Six-tenths of a percent increase over ten years is not the stuff of profligacy.

In hindsight, it would certainly have been wiser for states to forego tax cuts during the 1990s and build up more reserves. A problem with the conservative criticism is that these same voices routinely denounce any such precautionary policy as ‘over-taxation.’ A more general reason is that the states’ revenue shortfall was in large part due to the fall in the stock market, a development that many failed to foresee.

In any case, the answer to the caution against rewarding states for bad fiscal policy is that one need not do it. A general assistance program properly considers a state’s fiscal capacity, not its fiscal behavior. Fiscal capacity reflects a state government’s ability to raise money, much as income is seen as a measure of an individual’s ability to pay taxes. You can tax income without regard to whether a taxpayer has been either a spendthrift or providential.

It is easy to devise an aid formula that provides aid to states on the basis of low fiscal capacity, high unemployment, and poverty. Such a formula would be neutral with regard to governments’ good or bad fiscal behavior, but it would take account of their bad economic luck.

Another common criticism of general assistance is that it would increase the size of government or increase the deficit. A temporary program limited to fiscal years 2003 and 2004 would hardly be visible in the long-term Federal budget outlook. A gigantic program of, say, $100 billion for this year would raise interest costs in the neighborhood of $6 billion in future years. The current federal budget is around $2,200 billion. As for state governments, those that are in fiscal straits now would not use the money to expand – only to maintain current services. Those in better shape would be well advised to put the money into reserves, since the aid would be temporary. No government expansion there either.

It is not true that government programs never die. If anything, it is tax cuts that may outlive their welcome, as far as deficits are concerned. There was in fact a temporary program of Anti-Recession Fiscal Assistance (ARFA) in 1980. It ended when the recession did.

Naturally, general assistance should be provided to local governments as well as state governments. There are different ways to design the local component that I could go into, for those interested.

From a fiscal standpoint, local governments are more vulnerable than either states or the national government. It is easier for households and business firms to vote with their feet if services get too low or taxes too high. Disparities in fiscal capacity and social indicators are greater at the local level than between states. Cities are much more prey than states to high concentrations of poverty. Cities are creatures of state governments and often lack the legal authority that would give them full control over their own finances. Urban districts often lack full political voice in state politics. Local governments face higher borrowing costs than states for capital expenditures. They bear the brunt of budget cutting measures by both federal and state governments. Aid to local governments, including for education, has been a common target of cuts for state legislators grappling with budget gaps. I’ve already addressed the security dimension.

In closing, from where I sit general fiscal assistance is one of the pre-eminent ‘no-brainers’ in the arsenal of dedicated anti-recession fighters. I happen to think there is a good argument for it as a permanent matter, but that debate will have to wait for another day, probably with another Congress and a different president.

The Earned Income Tax Credit

The relevance of the Earned Income Tax Credit (EITC) to cities is a bit more obvious as a matter of where the benefits go, then in terms of how it could stimulate the economy. The Brookings Institution did a fine study on the first issue, so I won’t dwell on it here.

It is a commonplace of economic theory that the lower one’s income is, the more of it one is likely to spend rather than save. The data are crystal clear on this as well. It follows that an expanded EITC will do more to boost consumer spending then, say, a tax cut on dividends, or a repeal of the Estate and Gift Tax.

Expansions of the EITC are sometimes dismissed as a welfare giveaway. To the contrary, the EITC only goes to those who work. It is conditional on work. By contrast, many loopholes in the income tax of far greater value do not depend on work.

Another canard is that the EITC goes to those who don’t pay taxes. Of course, all who work pay the payroll tax. In fact, about 70 percent of workers pay more in payroll tax than income tax. So even if a worker owes no income tax, the EITC effectively defrays her payroll taxes. The tax cut mania always seems to pass over wage earners for whom the payroll tax is a greater burden than the income tax.

One option for expanding the EITC would merge it with other tax benefits for working families with children – mainly the dependent exemption and the Child Tax Credit. Presently the taxpayer must cope with dizzying, varied sets of eligibility rules for each benefit. Merging them into a unified, simplified, and expanded credit would be a boon to such families in and of itself. It could also help the economy.

The reason is that the present budget outlook entails endless, rising deficits. Reducing the deficit this year or next would be a bad idea. Replacing part of the 2001 tax cuts with a unified child credit could kill several birds with one stone. Because the cost of such a credit would rise more slowly over time than the 2001 cuts, substituting it would improve the long-term budget outlook. Deficits would be reduced, and possibly long-term interest rates would fall as well. That could stimulate business investment.

The federal government is presently taking two somewhat contradictory steps in this area, one positive and one questionable.

The positive step is to consider unifying the eligibility rules for the EITC, Child Tax Credit, and exemption for children. Assuming ‘no child is left behind’ under the new definitions, this would bring us a bit closer to the possibility of a unified credit.

The problematic step is the expanded enforcement efforts of the IRS in the area of reducing EITC overclaims. I would like to emphasize a few basic principles:

  • Any expanded IRS enforcement activity will deter some inaccurate claims and also some justifiable ones. It would be worthwhile to gauge the latter problem and contemplate remedies, if not pre-emptive steps. 
  • EITC enforcement, existing and proposed, is blatantly unfair in comparison to enforcement in other areas of the income tax, both individual and corporate. Since 1994, the Congress has been urging the IRS to hound EITC claimants and give a pass to other taxpayers whose evasion is much more costly to the Treasury. EITC overclaims is “where the money isn’t.”
  • In general, EITC recipients have been getting a bum rap. There is no data on criminal tax evasion in the EITC program. Available data pertains to what is called “non-compliance,” meaning an inaccurate claim. The source of the inaccuracy is not necessarily intent to defraud the government. The fact is that there are many underclaims for the EITC – those who are eligible for more benefits than they request. At bottom, there is wide agreement among experts that the EITC eligibility rules are just too complicated for a normal person to understand.

Simplification of the EITC rules may be on the way. We should work to make sure that, at the end of the day, and as a matter of simple fairness, all taxpayers will be subject to common rules and penalties. There is no good reason to single out the lowest income class of taxpayers for special oversight. One way to ensure this would be to eliminate the EITC as a separate program, and provide a universal child credit to all families.

Max B. Sawicky  is an economist at the Economic Policy Institute in Washington, D.C.


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