Governor, Legislature, withdraw your swords!

Governor, Legislature, withdraw your swords! You’re fighting the wrong battle. The battle isn’t against each other, it’s against other states.

Today, there are multiple combat lines being incised between a number of fiscal, economic and ideological forces. Of all the various combatants, the U.S. states are emerging on the frontlines of the fight. And some of their tactics are encouragingly following free-market principles. Let’s pick up the story with some recently published data.

The corporate income tax rate drives revenue overall

It’s no secret that U.S. states in general are facing large budget deficits, and a dozen or so in particular are in dire straits. State tax revenue has fallen dramatically since the real estate bust and subsequent recession. Although the National Bureau of Economic Research, the official arbiter of recession dating, declared the nation’s downturn had ended in June 2009, the rest of the country knows better.

Let’s look at the three tax revenue sources: corporate income tax (CIT), personal income tax (PIT), and the sales tax (GRT).

Of the three revenue sources, CIT is the one to watch and will determine the path of PIT and GRT growth. A sustained fall in corporate taxes remitted to the state signals company profits are falling or remain negative. Declining or non-existing company profits do not encourage hiring – and absent rising employment, both PIT and GRT revenue stagnate.

Yes, PIT and GRT revenue have shown signs of life for 2010 through September. However, whether this rise was due to income tax rebates and other one-time stimulus schemes or organic growth in employment and wages is hard to determine. Time will tell. The fact remains, the unemployment rate is proving harder to lower than the decibel level on Fox News.

State vs. state: Let the battle begin

Recent events suggest that a battle for tax revenue has commenced – pitting high-tax states against low-tax states.

In January, Illinois, faced with a gaping $13 billion hole in its budget, $8 billion in unpaid bills, and addicted to its corrupt spending ways, raised its personal income tax rate 66 percent and the corporate tax rate 46 percent.

The reaction from neighboring Wisconsin Governor Scott Walker was immediate. “Escape to Wisconsin,” said Walker, borrowing from an old state tourism board campaign slogan, and urged Illinois businesses to move to his state.

Wisconsin’s Walker was not alone. Indiana Governor Mitch Daniels, Michigan’s Rick Snyder, and even Chris Christie in faraway New Jersey have been promoting their states as a haven for businesses that want to flee the tax-and-spend culture.

This rivalrous trend is not limited to the big three tax revenue targets – PIT, CIT, and GRT – with some states getting very creative. The latest twist on beggar-thy-tax-neighbor targets cigarettes in the hope of drawing smokers from other states to buy in their state and increase revenue.

This is the age-old border town strategy. States with geographically small footprints and/or those with large towns on or near their borders will entice neighboring state residents to make the short drive and save on sales, use or excise taxes.

My prediction: At some point, states will begin reducing their tax on gasoline to draw motorists from across the border.

Inter-state tax competition

Tax competition is here and it is real, not merely conjecture based on anecdotal evidence.

If you want to increase your tax take, lower your tax rate. As counter-intuitive as that sounds, it’s true. Free-market competition has entered the tax sector.

Unfortunately, New Mexico has a higher corporate tax rate than any of its neighboring states – Texas, Arizona, Colorado, Utah – according to The Tax Foundation figures.

The recently concluded legislative session did absolutely zero to address this inter-state competitive tax competition.

The border town strategy is turning today’s state lines into tomorrow’s revenue battle lines. The New Mexico taxpayer will be the ultimate winner if the Legislature and the governor stop competing against each other and start competing against other states for revenue and jobs.

Molitor is a regular columnist for this site. You can reach him at tgmolitor@comcast.net.

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