A blog written by Amy Edmonds and me (“Tax Revenues Suffer from Sluggish Wyoming Economy”) about the tax revenue structure of the Wyoming state government gave rise to important questions. Among them, some people have questioned why we simply cannot run state government on equity-based revenue and quit taxing people altogether.
It is logical that this question arises. After all, who would not want to get something for free?
There is a case to be made for making the state more dependent on capital gains, severance taxes and dividends. If the state could replace our state general sales taxes with, say, dividends from the state’s investments, taxpayers would get to keep up to $1 billion per year. If we could also get rid of the state property tax we would leave another $300+ million in private citizens’ pockets.
Superficially, it looks like this would be an enormous boost for the Wyoming economy, with job creation enough to completely wipe out unemployment. The problem is: where are we supposed to get $1.3 billion per year?
Even more important is the question: where are we supposed to get $1.3 billion per year that we can rely on as safely as the revenue from sales and property taxes?
The first step toward answering this question is to decide what revenue sources would be realistic. If we do not want to replace one tax with another we would have to rely on investments or federal funds. The latter is a bad idea for a host of reasons, one being the federal government’s notorious deficit problems. We also know that if there would ever be any changes in the federal government’s generosity toward Wyoming, it is going to be squarely negative for our state.
At first glance, investments seem like a tempting alternative. Money in the bank, rightly invested, will yield both capital gains and dividends that can be used to pay for all sorts of government expenditures. In fact, the Legislative Service Office’s April 25 Memorandum on the state government’s revenue situation makes the case for spending capital gains. While not explicitly suggesting that the capital gains would replace an existing tax, the LSO makes an indirect case for that by proposing capital gains be used to pay for regular government expenditures.
There are two problems with using capital gains toward regular expenditures. The first should be rather obvious: capital gains are irregular and unreliable, both in size and in duration. Even the best investors will stay far away from guaranteeing capital gains for their clients.
On top of that, capital gains are “spendable” only to the extent that they exceed the gains needed to assure that an investment portfolio is protected against inflation. It takes savvy investments to create a sustained stream of “spendable” capital gains. Such investments would inevitably pose a challenge to our state government, as big capital gains tend to be associated with big risks (anyone who was around during the dot-com frenzy can testify to that).
The second reason not to use capital gains to pay for education, welfare, infrastructure and law enforcement is that it puts a barrier of anonymity between the user of the services – the Wyoming citizen – and the funder, namely the executive branch of the state government. When citizens no longer pay for the services they get, what right do they have to exercise influence over what government provides them?
The original American model for school funding used property taxes for a simple reason: wherever there was a need for a school there would be property owners who would send their children to that school. If they paid for that school they would not only have an incentive, but a right to have a say in how that school was run.
If the case against using capital gains for regular government spending are this strong, then what about the merits of using dividends? After all, they are more regular than capital gains, especially if the state would invest its wealth specifically with the goal of securing a steady stream of dividends. (For clarity, this is not discussed in the aforementioned LSO Memorandum. We are back to a general conversation about replacing taxes with asset-based revenue.)
The second objection to capital gains also applies to dividends. In addition, in order to build a sizeable stream of dividends the state needs to have a lot of money in the bank, so to speak. If we, again, assume that we want to replace sales and property taxes with asset-based revenue, we would need $1.3 billion per year in reliable dividends or interest.
High-yielding investments are rare in today’s financial markets. It is unrealistic to assume that the state could invest for dividends and get anything higher than seven percent. To get more dividends the state would have to engage in higher-risk investments not suitable for a state government.
To get $1.3 billion per year in dividends the state would have to invest:
· At 7 percent: $18.6 billion;
· At 5 percent: $26 billion;
· At 3 percent: $43.3 billion.
These numbers do not take into account that the state would need to use part of its dividends to secure its investments against inflation. They also show that the state would have to increase its wealth by several billions of dollars just to pursue the highest-yielding opportunities.
Where would the state get that money from? One way or the other taxpayers would have to cough up that money.
A strict macroeconomic analysis, focusing only on the potential for growth in jobs, income and prosperity, would come out in favor of replacing sales and property taxes with asset-based revenue. However, such an analysis does not take into account the significant element of uncertainty that is added to the government budget when spending depends on how the stock market does from one month to the next.
When we add the democratic problems associated with asset-based revenue, the conclusion is that whatever state government we want we should pay for with regular taxes.