Some Tax Wisdom from Minnesota

Confronted by a tough economy, Minnesota Governor Tim Pawlenty (R) has an interesting idea – tax relief business.

As reported on TwinCities.com on January 16, Pawlenty called for a variety of business tax cuts in his State of the State address.

The key measures were reducing the corporate income tax rate from 9.8 percent – which is third highest among the 50 states – to 4.8 percent and allowing businesses to expense the cost of capital expenditures in the year the assets were purchased.

These would go a long way in boosting business and investment in Minnesota – though his proposed six-year phase-in on the corporate tax cut is way too long, and will only serve to delay the economic benefits.

Other seemingly more targeted measures included $50 million in small business tax credits; a 25 percent refundable tax credit for small-business owners that reinvest in their firms quickly; and a capital gains exemption for qualifying investments in small businesses.

On the “Small Business Survival Index 2008,” which ranks the states according to their public policy climates for entrepreneurship, Minnesota came in at a dismal 46th. These Pawlenty tax cuts would clearly improve the frigid policy climate for business in Minnesota.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

States Looking to Increase Gas Taxes

Consumers, small businesses and the economy are bruised and battered.

One of the very few plusses since the summer has been the drop in oil and gas prices. The average price of gasoline at the pump, for example, dropped from $4.11 in mid-July to $1.78 early this week.

Unfortunately, there are politicians who want to spoil this bright spot in an otherwise dismal economy. On January 14, The New York Times reported:

Several states are considering the rare step of raising gasoline taxes to help fill growing budget gaps and potholed roads. Politicians in California, Massachusetts, New Hampshire, Illinois and Oregon, for example, are introducing bills that would raise gasoline taxes for road and bridge repair, as state legislatures around the country begin their new sessions. In Iowa, top legislators in both houses would support an increase. And in Ohio, a state task force last week recommended raising the gas tax by 13 cents a gallon.

It would be far better for taxpayers – including small businesses – and the economy if elected officials stopped looking to drain more revenues from the private sector, and instead, get serious about reining in the size and scope of government.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Protectionist Threats

Is protectionism on the rise?

Writing in the January 12 Wall Street Journal, columnist Bob Davis declared: “A wave of protectionism is swelling around the world that could further damage struggling economies.”

Davis noted that “the World Bank forecasts that global trade will shrink by 2.1% this year, the first decline since 1982.” He pointed out a variety of developing problems:

• “Under World Trade Organization rules, countries establish formal tariff levels, which are often very high, and then apply lower tariffs. That gives them leeway to boost tariffs without violating WTO rules.” Ecuador, India and Russia (not a WTO member) have recently increased tariffs.

• So-called “dumping” complaints (that is, products being sold below a certain price deemed appropriate by competitors and government bureaucrats) are on the rise.

• Other means of protectionism are in the works. “Indonesia is requiring importers to get special licenses as a way to control imports of clothing, shoes and electronics.”

Protectionism, of course, is never good for the economy. Trade shrinks as government barriers rise. Economic opportunity is lost. Lost competition and reduced consumer choice leads to higher costs.

There are two ironies here.

First, there is a great deal of talk around about the threat of another depression. The Great Depression, of course, was sparked and/or deepened by the protectionist policies of President Herbert Hoover and the Congress at the time. The massive Smoot-Hawley Tariff Act worked its way through Congress, and the market crashed. Congress passed the measure, Hoover signed it, other nations retaliated, and world trade collapsed.

Second, even though trade is crucial to U.S. economic growth, President-elect Barack Obama sent out protectionist vibes in the Senate and on the 2008 campaign trail, including voting against CAFTA and declaring his desire to rework NAFTA.

If the U.S. and other nations head down the path of protectionism, it would only make a bad economic situation far worse.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Stop the Federal Tobacco Tax Hike

Unfortunately, it is not taking very long for the Democrat-controlled U.S. House of Representatives to try to start hiking taxes. Can you help to stop them?

As various media reports have noted, the U.S. House of Representatives is getting set this week to vote on a bill expanding the State Children’s Health Insurance Program (SCHIP). The bill would wind up boosting the number of individuals enrolled in the program from 6.6 million to more than 10 million.

That, of course, means rising costs for taxpayers. The proposal would increase the federal tobacco tax, with the levy on a pack of cigarettes jumping by 156 percent, from 39 cents to $1.

There are many problems with this tax increase. In a January 9 letter to each member of the House of Representatives, SBE Council President & CEO Karen Kerrigan explained four reasons for opposing this tax increase:

First, small retailers would get hit hard by this large tax hike. Higher taxes translate into reduced sales, less foot traffic and fewer purchases of other goods, and lower earnings. That means less money available for investment, expansion, and hiring and paying employees. Already, many small firms and retailers are teetering on the financial edge. During this extraordinarily difficult economic period, Congress needs to focus on legislative efforts that create jobs, and revenue increasing opportunities for U.S. small businesses. Raising the cigarette tax runs counter to what needs to be done for small retailers.

Consider that the National Association of Convenience Stores has reported that cigarettes account for 38.6 percent of all in-store sales, with revenues totaling $41.1 billion, or $392,050 per store. Meanwhile, convenience stores employ 1.7 million people. Based on these numbers, the association calculates that cigarette sales are equivalent to more than 656,000 jobs in the industry alone. That business and many of those jobs would be lost if a tax increase were passed.

Indeed, the negatives would spread throughout the economy. For example, in February 2007, assessing a possible 50 cents increase in the federal excise tax, the Congressional Budget Office noted: "Because excise taxes reduce the tax base of income and payroll taxes, higher excise taxes would lead to reductions in income and payroll tax revenues."

Second, it should not be forgotten that this federal tax increase would come on top of very large cigarette tax hikes in the states in recent years. Consider, for example, that from 2000 to 2008, 44 states and District of Columbia raised cigarette taxes, and the average increase over this period was 287 percent. Unfortunately, more excise tax increases are being considered in the states this year. It's already bad enough for consumers and small businesses without the federal government piling on more.

Third, the combination of high federal, state and local cigarette taxes means that incentives are boosted for counterfeiting, and for moving supply and purchases underground. That means subsidizing all kinds of criminal activity, including smuggling and terrorism. A 2004 GAO report declared: "Many states ... have increased cigarette taxes, resulting in a large difference in the wholesale price and the price paid by consumers at the retail level and creating potential illicit profits of $7 to $13 per carton of cigarettes." It continued: "As cigarette taxes increase, so do the incentives for criminal organizations, including terrorist organizations, to smuggle cigarettes into and throughout the United States." Taxpayers naturally have to pick up the tab to fight such criminal undertakings, while expanded black market purchases mean additional lost business to small retailers.

Fourth, it is crucial to recognize that the cigarette tax is not a reliable revenue stream. That is, consumption, and therefore sales and tax revenues, are on the decline. Combine this fact with the negative revenue effects of smuggling, underground transactions, and declining business, incomes and jobs, and it is clear that tobacco taxes are not reliable revenue sources for government.

Time and again, revenue projections from tax increases fail to meet expectations. According to a study by Fiscal Planning Services, out of 57 tobacco excise tax increase from mid-2002 to mid-2007, 16 matched or exceeded the expected revenue estimates, while 39 fell short of projections. In New Jersey, for example, a 2006 excise tax hike was expected to increase revenue by $30 million, but the state actually lost revenue due to a larger than expected drop in sales.

Given that spending on health care programs like the State Children's Health Insurance Program (SCHIP) surge upward, there is no way that a higher cigarette tax would provide sufficient revenues over time. That means additional tax increases will be necessary.

In 2007, President Bush vetoed bills to expand SCHIP and impose higher taxes. Unfortunately, President-elect Obama supports the idea.

How about weighing in with your member of the House and your two U.S. senators on this bad idea? The U.S. Capital switchboard phone number is 202-224-3121. The operator can connect you with your House member, and/or senators. Why not give them a ring, and let your small business voice be heard?

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

North Carolina’s Economy

So, how’s the economy in North Carolina? A January 9 Wall Street Journal article summed it up this way:

The Tar Heel State lost a bigger percentage of jobs, 1.1%, than any other state from October to November 2008, shedding 46,000 positions, according to the Bureau of Labor Statistics. A record number of people in the state are now out of work, and its unemployment rate of 7.9% for November was the highest in 26 years, up from 7.1% in October and 4.7% in November 2007. Some state economic observers are predicting double-digit unemployment for 2009.

The story correctly notes some of the larger economic trends at work that have hit North Carolina hard.

But it also is worth noting that policymakers in North Carolina could take steps to improve the state’s climate for entrepreneurs and investment. On SBE Council’s recently-released “Small Business Survival Index 2008,” which ranks the 50 states and District of Columbia according to their public policy environments for entrepreneurship, North Carolina ranked a poor 39th, or 13th worst.

What troubles the state? Well, among negatives are high personal income and individual capital gains taxes; imposition of a state death tax; fairly high unemployment taxes; a large number of health insurance mandates that drive up costs; a high crime rate; a large number of state and local government employees; and high gas and diesel taxes.

Those are all measures that elected officials can change for the better. If they choose to do so, North Carolina’s economy will only benefit.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council