Going over cliff brings some benefits to LA fiscal house

Hopes have dimmed considerably that the federal government will address the “fiscal cliff,” or the combination of tax increases and spending cuts created by last year’s budget deal among Democrat Pres. Barack Obama, a Democrat-led Senate, and a Republican-led House, before the Dec. 31 deadline, after which those go into effect. And that may turn out as a net benefit to Louisiana, at least as far as the direct impact of individual income tax changes.

Some have wailed and gnashed their teeth over the prospect. One estimate argues that the deal would cost the state 28,000 jobs as taxes go up on just about everybody and federal spending is curtailed. In addition, as federal income taxes may be written off from those for the state, an increase in those means less revenue for Louisiana.

Other complain that the impending changes will affect the poor negatively, especially in that Louisiana ties its earned income tax credit and child care tax credit breaks to the presence of the federal ones, which would go away. The former affects only the lowest income earners, while the latter allows disproportionately more money to stay in the pockets of the lower earners and subsidizes a special interest industry.

But when those same forces voice the discredited shibboleth that, contrary to and the reverse in  reality, damage will occur because “Louisiana has a revenue problem, not a spending problem,” you know these claims cannot be taken for face value and deserve genuine investigation. And when doing so, there’s a pretty good argument that both in terms of future economic activity in Louisiana and as far as current state fiscal status go, Louisiana may be better off.

Viewing the three major changes – decreased state revenue due to more federal income taxes, being written off, increased state revenue with far smaller EITC and child care tax credits – predicted changes in these alone will give the state more money. The two credits in 2010-11 cost the state over $62 million, nearly three-quarters of which was the EITC (the second-highest of all, behind only the notorious Motion Picture Investor Credit). Other smaller individual changes would capture $2 million more.

The impact of the paying of increased federal individual income taxes is harder to estimate. In 2010-11, the total size of the deduction – the state’s largest – was $690 million, and would go higher. Roughly, the number of filers in Louisiana can be multiplied by what the left-of-center Tax Policy Center thinks the average increase in total taxes paid, $2,000, for the $40,000-65,000 bracket, in which lies the median Louisiana family income, minus the non-federal income tax portion of that, estimated at about two- thirds of the total increased bite, times the average marginal rate in Louisiana of 2.3 percent, and excluding the six percent of returns that pay no state income taxes. This computes to an extra $26.8 million.

Being that the EITC will decrease by 90 percent in state distributions to its filers, the savings there is half again what savings state taxpayers will realize by the increased deductions. In all, as far as the individual income tax-related components of the “cliff” are concerned, Louisiana’s net change to state finances will be an increase of almost $23 million.

There is one other income-tax related component, certain deductions that would disappear from corporate income tax rates, and would only add to that $23 million increase to state coffers –  which represents about an eighth of the entire 2010-11 corporate income tax take in Louisiana – making the state a net winner with this aspect of the going over the “cliff.” Of course, there is the much broader and bigger picture of all the other components to it that do not directly involve state finances, but which indirectly will serve to put a drag on the economy that, in the short run, likely make this a net negative exercise to state finances in that time frame.

But one of these things won’t be so much decreased federal spending. In fact, Louisiana will feel less of an impact than the majority of states, given the relatively lower amounts of federal grants and spending in Louisiana compared to all others. In sum, Louisiana should fare better than most – and do much better comparatively if tax cuts are maintained while shedding the expensive and economically questionable EITC and unhelpful child care credit.

And over the long term, even with some short-term pain, both the national and state economic situations will be better off by broadening the tax base, which is the most reliable way to stimulate economic growth that benefits all. Even with the increase in marginal rates causing income tax increases for all but the lower earners, dramatically scaling back the EITC and, to a lesser extent, the child care credit, will capture many of these folks as well.

While the economic benefits from tax base broadening are well known, there also is a philosophical/moral benefit as well. By having more people become contributors to the running of government, this does a better job of distinguishing the deserving from non-deserving poor that is fairer to the net payers of the system, and the increased investment of those others who become payers as a result in the system will sharpen their sensitivity and commitment to contemplating and making policy choices on the basis of what benefits the whole, rather than what helps the special interests tied into discrete tax exceptions.

Naturally, Louisiana could produce the same by changing, including by unlinking, these two credits, which may be an outcome of the Revenue Study Commission. But without any of that action, it still may happen by going over the “cliff.” Thus, to achieve saner state individual income tax policy in the long term, as well as to reduce state spending Louisianans should not fear taking a tumble, although at the expense of short-term national economic contraction and personal sacrifice.