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March 2009 — Vol. 87, No.2

Fiscal discipline, tax policy critical to state’s economic recovery

 

Gov. Rell’s Feb. 4 biennial budget address to the General Assembly was a good sign for Connecticut—and for Connecticut’s business community. The governor’s plan to balance the state budget and position our economy for a strong recovery proposes two key steps:
1. Restructure state government to make it more efficient, responsive, and affordable
2. Avoid tax increases that would threaten Connecticut’s economic recovery
“The governor’s proposed budget reflects an understanding that the state’s fiscal problems can best be solved by doing what’s necessary to get our economy moving again—in particular, by avoiding the kind of tax increases that would further slow economic activity and hinder recovery,” says John Rathgeber, CBIA president and CEO. “At the same time, her proposal provides a useful framework for legislators on both sides of the aisle to negotiate a final budget that streamlines state government so that it can provide necessary services more efficiently and less expensively.”

“I think the governor is right on track,” says Joe Brennan, CBIA senior vice president of public policy. “What we’re hearing is that several other states—for example, Colorado, Missouri, and Minnesota—are actually proposing tax cuts to incent businesses to locate, invest, grow, and create jobs in their states. Connecticut has to make sure it positions itself so that when we come out of this recession, we can grow and get back the jobs we’ve lost. I think the governor is setting the stage over the next two years to make sure we can achieve that.”

Leaner (but not meaner) state government

The state’s budget deficit is projected to reach as high as $10 billion over the next two years. The governor’s proposed budget—which includes spending cuts, the consolidation of state agencies, and other measures—is designed to mitigate, (though not eliminate) the deficit and is the beginning of an effort to reinvent state government.

“We’ve been advocating for a long time that state government reduce its spending,” says Rathgeber. “The state needs to explore every possibility, thoroughly analyzing the effectiveness of all agencies, commissions, and programs and making necessary improvements and cost reductions. This budget proposal is a step in that direction. It’s imperative that the legislature take advantage of this opportunity to eliminate the inefficiencies and redundancies that have been built into the state bureaucracy over so many years.”

Rathgeber is quick to point out that reducing the size and expense of government does not mean reneging on the state’s obligation to provide critical public and social services. “The issue isn’t whether the state is going to continue providing its social safety net—no one is questioning that—but how core services can be delivered more affordably and efficiently. Policymakers need to analyze and prioritize state services and programs based on the impact they have on people’s lives. Where there is inefficacy, redundancy, or inefficiency, programs should be improved or eliminated.

“We’re calling on Democrats and Republicans in the legislature to work together to create a leaner, more responsive state government.”
Will the governor’s vision of a trimmer bureaucracy survive the 2009 legislative session? State Rep. Craig Miner (R-Litchfield), ranking member of the House Appropriations Committee, is cautiously optimistic. “I think we have an obligation—I certainly feel I have an obligation—to help [the governor] achieve that goal,” he says. “The $4 billion [deficit] for next year is not going away on its own. So I think there is a possibility that her goal can be achieved if we as a legislature get serious about where we are.”

Tax increases: what history tells us

Another notable aspect of Gov. Rell’s budget proposal is that it does not raise taxes on individuals—or businesses. “I believe that we cannot raise taxes on employers at this time,” the governor said in her budget address. “Higher taxes could likely be the last financial straw that causes companies to close and employees to lose jobs.”

Rep. Miner agrees. “I think one of the cornerstones of the governor’s thought process is that if we begin to look at this as a revenue problem first and try to shore up declining revenues with new revenues, it’s going to add a tax burden at a time when neither the public or industry can handle it. It just doesn’t make any sense to be looking at increasing taxes first.”

History seems to support Miner’s point. When our business tax system is structured to encourage companies to locate, remain, and expand operations in our state, jobs are created, and the economy thrives. When it’s not, things can get ugly, as in the case of the nationwide recession of 1989–92.

Connecticut had long been seen as an attractive business destination, especially compared with its higher-tax neighbors, New York and New Jersey. That, however, began to change in the late ’80s, when a combination of high overall business costs and rising taxes had Connecticut companies—particularly manufacturers—looking for more business-friendly environs. An April 21, 1992, New York Times report, citing data from the New England Economic Partnership, noted that Connecticut lost 25% of its manufacturing jobs from 1985 to 1992.

Rathgeber remembers that time well, though not fondly. “In the late 1980s, as we were entering into a recession, the state raised the corporate tax rate to the highest in the country and increased other business taxes as well,” he recalls. “Employers responded by reducing the workforce and, in some cases, leaving the state. Connecticut lost nearly 160,000 jobs, and it took years to get them back.”

What research tells us

Rathgeber’s point—that tax increases make economic downturns worse and generally have a negative effect on the economy—is supported by recent research by University of California, Berkeley, economists Christina and David Romer. (Ms. Romer is currently chair of President Obama’s Council of Economic Advisers.) In their landmark 2007 study, The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks, the Romers investigated the impact of tax cuts and increases on economic activity by analyzing all major postwar tax-policy changes. Among their findings were that tax changes, particularly those they refer to as exogenous (tax cuts or increases intended to stimulate long-term economic growth or reduce budget deficits), have a marked effect on economic growth as measured by Gross Domestic Product (GDP). The Romers found that an exogenous tax increase of 1% of GDP reduces real GDP by 3%. They concluded that tax increases “appear to have a very large, sustained, and highly negative impact on output,” owing largely to a strong negative effect on investment. Tax cuts, on the other hand, “have very large and persistent positive output effects.” (For complete results, see http://elsa.berkeley.edu/~cromer/RomerDraft307.pdf.)

“It’s difficult to overstate the importance of tax policy to Connecticut’s economy,” says Bonnie Stewart, CBIA vice president of government affairs. “It has the ability to help or hinder economic development. It can help employers create more jobs and compete in the global marketplace, or it can weigh them down with higher costs and make it harder for them to operate. In a severe recession, like the one we’re in now, making things more difficult for businesses by increasing their tax burden would be disastrous for the state economically.”

Brennan agrees. “There are changes being proposed in the legislature that, if adopted, would make Connecticut much less economically competitive. They range from changing the ways companies report income to postponing investment tax credits to eliminating critical sales tax exemptions. [See box on Page 5.] Legislators need to understand that there are economic ramifications to raising certain taxes. You can’t just look at the dollars they would generate.”

Brennan notes that CBIA members spoke out clearly at a recent hearing, saying that passage of these proposals will make it much harder for them to retain and create jobs in Connecticut. “We’re in a high-cost state, and we must try to avoid increasing those costs,” he says.

“If tax increases are deemed necessary by state policymakers to help close the budget deficit,” adds Brennan, “it’s important that they do not create significant barriers to investment and job creation in the state.”

 

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