Monday, April 12, 2010

Maryland’s Fiscal Future: Is There Trouble Ahead?

On April 8, the American Legislative Exchange Council (ALEC) released its Rich States, Poor States report, which ranks and compares the economic competitiveness of all 50 states. The study examines two categories: 1. economic performance over the last ten years, based on three factors heavily influenced by state policy – personal income; migration; and non-farm employment; and 2. economic outlook, the projected state performance based on 15 policy variables.

The study is co-authored by Arthur Laffer, inventor of the Laffer Curve. And despite its simple beginnings (it was initially drawn on the back of a napkin), the Laffer curve has proven an important economic concept. Simply put, as taxes rise people make decisions that reduce their tax burden. The curve itself does not say whether an increase in taxes will result in more or less revenue – there are many factors that influence this decision, such as the burden of the tax itself, how long the tax will last, etcetera. Generally, as the burden becomes higher, people are more likely to find alternatives, such as holding on to stocks longer in the hope that the capital gains tax will fall, or avoiding state taxes by leaving that state, or making purchases elsewhere.

A prime example of this is Maryland’s cigarette tax. On January 1, 2008, Maryland doubled its tax on cigarettes to $2.00 a pack, but only realized a fraction of the increase. In fact, this 100% increase in tax resulted in a 45.8% increase in revenue, much less than expected. The District of Columbia also tried to bridge its bloated budget by increasing its cigarette tax to $2.50, which actually resulted in less total revenue than before the hike. As the rate went up, people sought out alternatives, such as buying cigarettes somewhere else, or modified their activity, either by quitting, reducing the amount of cigarettes they smoked, or shifting towards cheaper brands.

But back to the ALEC report. How did Maryland do? Not that great, but not too bad either. Just fair to middling, Maryland was 20th in “economic performance,” which takes into account how the state has performed over the past decade, and 28th in “economic outlook,” which factors in Maryland’s fiscal policies and how they are likely to play out in the coming years. (Lower rankings are better). And there are some positive factors; from 1998 to 2008 Maryland’s non-farm employment has grown 11.7%, which ranks 17th nationwide, and Maryland also ranks 7th on sales tax burden (but considerably higher on other tax burdens).

But that’s not to say that the state’s outlook is rosy - there is certainly cause for concern and much room for improvement. Maryland ranks among the worst for top marginal personal income tax rates, the rate that the wealthiest pay on their next dollar of income, at 44th nationwide, and in the recently legislated tax changes category, where it ranks 40th. And as one of the study’s authors has noted, when the top marginal tax rates are raised, the rich move away.

And raise taxes Maryland has. Maryland passed a $1.3 billion package of tax increases in November 2007, as the Free State Foundation pointed out before. And while Maryland isn’t in the same financial dire straits as California is now (thankfully), the state should look toward the future, and seriously examine the consequences of its current actions.

More than many other states, Maryland faces a unique challenge in that its surrounding states offer close and easy alternatives. Live in the D.C. area and fed up with Maryland? You can move to Virginia (which ranks 4th in Economic Performance and 8th in Economic Outlook) or the District of Columbia easily, and you can even commute from Pennsylvania and West Virginia. Heck, Maryland’s regional rail even runs to West Virginia!

Baltimore, Hagerstown, and Cumberland also offer relatively easy extra-territorial commute options. Couple this ease of access with other factors, such as the general increase in telecommuting, and the potential trouble is apparent. As new tax packages and higher rates become more oppressive, other states become more attractive - leaving Maryland with less people and with less tax revenue. We can already see the beginning - Maryland has lost over 79,000 people the last decade, garnering a rank of 40th in the nation in terms of migration. In other words, in the bottom fifth!

And to add further fuel to the fire, what if the Federal Government actually shrunk? Quit laughing. After all, there is another election in 2012 and who knows what could happen. With office space in the D.C area costing more than that of New York City, what would happen if a portion of those high-paying lobbying and professional jobs were to disappear? How would Maryland’s tax revenue look then?

So Maryland may not face an imminent California-style crisis, there is considerable cause for concern. Let’s hope that Maryland doesn’t continue to move down this path of higher taxes and outmigration, and moves towards fiscal responsibility, both for today and for the future.