It's Naive to Assume SALT Changes Will Reduce State Spending
Economics very much is about incentives. However, it’s critical to understand that the incentives at work in the private sector are quite different from those operating in government. Unfortunately, it’s rather easy to get sloppy when assessing the impact of changes in public policy on the actions of politicians and their appointees. That includes, for example, recent changes in the deductibility of state and local taxes.
In the private sector, incentives are pretty straightforward. Raise the cost of undertaking some activity, and less of that activity will occur. For example, jack up the capital gains tax, and the result will be reduced or restrained entrepreneurship and private investment. Increase regulatory costs relating to producing and using coal, for example, and less coal will be produced and used. Impose burdensome tax and regulatory costs on entrepreneurship and building businesses in one state, and eventually, that state will suffer relative economic decline compared to less costly states.
When shifting to incentives at work inside government, however, will elected officials react in similar fashion as the private sector when costs increase? Too often, economists, policy experts and elected officials simply assume that to be the case. But, in reality, other incentives – perhaps more powerful incentives – are at work.
To properly reflect on this, we need to wrap our brains around the incentives at work in government. For that, it’s natural to turn to the public choice school of economic thought. James Buchanan, who won the Nobel Prize in economics for his work in the public choice field, once summed up public choice theory as “politics without the romance.” I like that. Buchanan’s point was to put aside the nice political talk about government action, and get down to the hard economics of how government actually works.
Specifically, for our purposes, few, if any, substantive incentives exist inside government to rein in costs. Indeed, when spending other people’s money, why should politicians and bureaucrats be concerned about costs? Quite the contrary, the incentives in government favor rewarding special interests, expanding budgets and staff, and using the vast spending ability of government to reward supporters and to pander to voters.
It requires truly principled individuals to work against such incentives, that is, to work for tax and regulatory relief, and truly smaller government. Hence, we have today’s massive level of government.
That brings us back to issues like tax deductibility. The tax package passed late last year by Congress and signed into law by President Trump limited state and local tax deductibility. This was praised by many who argued that this limitation would create incentives for politicians in high-tax states, like California, New York and New Jersey, to rein in state and local taxes. After all, people will leave those states and elected officials will have to provide tax relief. But in terms of domestic migration, people have been leaving those states for decades, heading to other, less costly states. And yet, government spending and taxes just keep on rising. Why? Part of the answer, of course, is a blind allegiance to a big-government philosophy, which is further reinforced by the incentives at work inside government to spend more. It’s unlikely that will change because of new limits on federal deductibility of state and local taxes.
Similarly, there was a debate about eliminating the tax-free status of interest earned on certain types of state and local bonds, specifically, those used to build stadiums for sports teams. One of the arguments put forth in favor of such action was that the cost of such facilities would increase, and therefore, subsidized stadiums and arenas would become things of the past. Really? Why? Again, given the incentives in government to spend more – especially on high-profile projects erroneously peddled as being good for the local economy – would politicians suddenly become cost conscious? Doubtful.
There are good reasons, for example, to eliminate the tax-free status of government bonds – such as reducing the relative price of and encouraging more private-sector investment – but the idea that profligate politicians incentivized to spend other people’s money will suddenly become penny-pinchers with tax dollars is more romance than economics.