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Does Your State ROT?

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eye on the news

Does Your State ROT?

High-spending state and local governments don’t provide citizens a good “return on taxes.” May 19, 2021
Economy, finance, and budgets
Politics and law

The Biden administration is sending states and municipalities an unprecedented $350 billion in stimulus money, even as local tax collections are bouncing back quicker than expected. This combination of federal funds and recovering tax revenue will provide governments with extraordinary amounts of money to spend. Many are planning to use the windfall to fashion a post-pandemic “great reset,” with vast new investments in everything from basic infrastructure to high tech systems to human capital. Locally, officials claim they will “invest” this money to solve problems ranging from inequality to intergenerational poverty, while creating new “green” energy industries that reshape the economy. But how likely is it that the money for this ambitious—indeed, unprecedented—agenda will be well spent?

Not very likely, suggests analysis by the financial website WalletHub. The study measures how much states take in from taxes and how they rank on dozens of different measures of public services like infrastructure, education, public safety, and health care. It finds that states that tax (and hence spend) the most rank at best average on many of these measures—and occasionally, as in the case of California, well below average. Meantime, a host of states with low tax rates score as well or better than those with the biggest tax bite. The results suggest that citizens don’t gain much from extraordinary levels of government taxing and spending. That doesn’t bode well for the coming deluge of municipal investment, much of it on programs of untested value.

Advocates of higher taxes and more government spending say that merely rating places on how much they tax (as WalletHub also does) is misleading because citizens want “investment” by government. Several years ago, when Texas began inviting citizens and businesses from New Jersey to relocate to the Lone Star State, governor Phil Murphy responded that staying in Jersey would be the better option because he planned to use the money from increasing taxes on business for “investment” in things that businesses want, like better public education. More recently, when executives in a survey ranked California as the least business-friendly state because of high taxes and regulation, defenders of its tax regime implied that all that taxing created a better business environment: “[N]o intelligent CEO is going to prefer a state with potholed roads and dysfunctional courts to one with serviceable transportation infrastructure,” wrote the Los Angeles Times.

The flaw in this argument is that it assumes higher spending always delivers more value. I’ve been suspicious of that assumption for years, especially when I started seeing low-tax states show up on nonpartisan lists of the best infrastructure in America. The WalletHub study examines this question closely, going beyond basic infrastructure and ranking states on a range of metrics in five key areas. On health care, for instance, it looks at quality of hospitals, affordability of health care, and life expectancy of residents. On the economy, it examines not just overall growth but also poverty levels, unemployment, and underemployment. On safety, the study looks at violent crime, property crime, and highway deaths. It then rates the states on return on investment (ROI)—a financial measure. The only problem with this term is that it misleadingly assumes that government taxes you in order to invest your money. I prefer the term return on taxes, or ROT.

Of the top-ten states ranked on overall return on taxes, seven are low-tax places. New Hampshire takes the prize with the second-lowest taxes per capita and the ninth-best ranking for overall government services. The state ranks in the top ten in health, safety, and overall economic performance. Other low-tax states in the top ten for ROT are Florida, South Dakota, Missouri, Texas, Ohio, Georgia, and Tennessee. Many rate as average on services, but those services come at a cost far below what most other states charge residents. Tellingly, no government with a tax burden higher than Nebraska’s, which is just average among the states, has a strong enough record on services to make the top-ten list for ROT.

Some high-tax states offer residents services that range from mediocre to awful. New York, with the eighth-highest taxes per capita, ranks only nineteenth on services. Hawaii taxes citizens at the nation’s second-highest rate but is thirty-third in quality of services. California, with the sixth-highest tax bite, is a woeful thirty-seventh in quality of services because of its higher-than-average poverty and unemployment rates and low rankings on public safety and infrastructure. But a few low-tax states score so poorly on services that they have a low ranking, too. Louisiana has only the eleventh-highest tax bite, but it ranks fiftieth in services.

What accounts for the disconnection between taxes and services? Two factors, I believe. Government is always spending other people’s money, but when there’s more of it to go around, there’s a greater temptation to use it on untested programs or payoffs to political groups. At some point, then, there’s a diminishing return to raising taxes.

In addition, steep tax rates are part of a political philosophy that includes heavy regulation. Poor governance is about more than just wasting tax dollars. In the extreme, such as the regulatory environment in California, states actually create new problems, which they then try to address using tax dollars. Before the pandemic, for instance, a booming stock market provided California with a budget surplus. Governor Gavin Newsom devoted $3 billion of his fiscal 2020 budget to a homelessness problem that advocates blame on a housing shortage. But what caused the housing shortage in the first place? The state’s own heavy-handed zoning and environmental regulations, which resulted in California producing new homes at only half the rate necessary to meet its needs. A federal study, for instance, found that a single unit of “affordable” housing in California costs on average $750,000—the highest rate in the country. Newsom’s budget also included nearly $1 billion to help school districts make their increasingly burdensome pension payments, thanks to years of California officials awarding public-employee unions with rich, irreversible pension benefits.

Even when steep spending produces better outcomes, it can become counterproductive in other ways. New Jersey and New York, for instance, spend well above the national average on education, creating better-performing schools—along with dizzying property taxes. Not coincidentally, the two states also rank among the leaders in outmigration of young adults. It seems that no sooner do these places educate their young people than the young go off to seek opportunities elsewhere. Even state officials acknowledge that high taxes for schools are a big part of the problem.

Investing is how individuals and businesses deploy their assets to create new wealth. Government has appropriated the term to suggest that taxes can produce substantial additional wealth, but increasingly the result has been spending on dubious projects that waste money and distract from the core missions of government. That’s how you wind up with three of the highest-taxed states in the nation—New York, New Jersey, and California— consistently rated as having among the worst roads and bridges in the country.

When politicians tell us they’re spending to invest it our future, it’s time to start asking: what kind of return will we get?

Photo: ImagePixel/iStock

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