Kristi Noem will address the Republican convention tonight. South Dakota’s governor leads one of the freest states, according to this analysis. South Dakota has one of the lowest state-local tax burdens in the nation, and Noem has helped to keep it that way.

South Dakota has no individual or corporate income tax. Sales taxes account for 83 percent of state-level tax revenues, which creates exceptional budget stability over economic cycles. An analysis by Pew found that South Dakota has the lowest revenue volatility among the states. By contrast, the revenues of states such as California gyrate widely because they are dependent on capital gains taxes and soak-the-rich income taxes.

Many news stories are claiming that state budgets face Armageddon because of the recession. But states can prepare for downturns by moving away from income and capital gains taxes toward more reliance on sales taxes. This NPR chart shows the high stability of South Dakota’s tax collections during this year’s recession.

Aside from being a more stable revenue source, sales taxes are less harmful to economic growth than income taxes, as discussed here. Also, federal tax reforms have heightened tax competition between the states, which is a further reason for states to transition away from high-rate income taxes, as discussed here. With no income taxes, South Dakota enjoys a net inflow of people and their capital, while most of its neighbors suffer net outflows.

Governor Noem discussed her state’s sound finances in her State of the State address in January 2020:

The taxes that we do have to fund state government are stable and predictable … In addition to my commitment to not raising taxes, our constitution requires a two-third vote in both chambers to raise taxes. In short, if you’re worried about tax increases, you needn’t be – your business is safe here…. Government in South Dakota lives within its means. We balance our budget without accounting gimmicks or tricks…. I’m proud of our AAA credit rating, and our state pension plan is fully funded. That means businesses that move here don’t need to worry about surprise charges, fees, or taxes to make up for an unfunded pension plan like our neighbors in Illinois.

The Wall Street Journal has published a biased news story regarding state budgets. The piece by Kate Davidson and David Harrison reflects only Keynesian thinking, exaggerates the plight of governments, and only quotes analysts in favor of more federal bailouts.

Here are some of the problematic aspects of the piece:

“State and local governments spent or invested $2.33 trillion in 2019.” That statement is false. The $2.33 figure is the state-local portion of GDP (BEA Table 1.1.5). But total state-local spending and investment in 2019 was $3.1 trillion (BEA Table 3.3).

“Michael Strain, director of economic policy studies at the conservative American Enterprise Institute, said Congress should take similar steps to fill the budget hole for state and local governments, which have seen revenues decline by 15% to 20% in some cases.” It is an error to conflate the budget situations of state and local governments. State governments may face a revenue decline of perhaps 10 percent, on average, but most local governments likely face little decline. Almost three-quarters of local tax revenues are from property taxes, and housing values remain buoyant so far during the recession. During the last recession, overall local government revenues did not fall for that reason.

The article cites analysts at liberal think tanks Brookings, TPC, and CBPP. It quotes a GOP senator who is one of the few Republicans in favor of another big state bailout. It quotes a scholar at conservative AEI who has a big-government view on this issue. And it cites Moody’s Analytics, which has a Keynesian economic model programed to show that government spending boosts GDP. Thus, the story cites six people in favor of another bailout and none against.

The article focuses on the most exaggerated estimate of state budget gaps, which is the Moody’s two-year figure of $500 billion. Why do they add two years together other than to produce a big-sounding number? The authoritative source of state budget data, NASBO, reports data on an annual basis.

The article includes a lower budget gap estimate by TPC, but excludes other recent lower estimates by Tax Foundation and economists Christos Makridis and Robert McNab. The Tax Foundation study shows that these three estimates are similar, and lower than the Moody’s outlier estimate highlighted by the WSJ.

The WSJ does not mention that the “gaps” and “shortfalls” it discusses are differences between pre-crisis forecasted revenues and current forecasts. If a state had forecast 2021 revenues to grow 5 percent but now expects 0 percent growth, the gap is said to be 5 percent and translated into dollars. The state would need to keep its 2021 spending flat to keep its budget balanced. That is not a crisis, especially after state general fund spending grew 5.5 percent in fiscal 2019 and 5.8 percent in fiscal 2020.

An alternative way to report budget gaps is to compare expected 2020 and 2021 revenues to actual peak 2019 revenues. That approach shows smaller gaps, as shown in the Tax Foundation study.

The WSJ article highlights Moody’s claim that without more federal aid, state budget gaps will “shave more than 3 percentage points off U.S. gross domestic product and cost more than 4 million jobs.” The Moody’s model reflects the Keynesian view that government spending boosts GDP. But other economists disagree. WSJ reporters might have interviewed Hoover Institution economists whose recent study found that cuts to government spending would boost GDP.

More broadly, Keynesian macro modeling ignores many microeconomic distortions caused by government spending that undermine GDP. I explore such distortions here. At minimum, reporters should note that the supposed stimulative effects that groups such as Moody’s claim are short-term impacts and do not include the longer-term costs of government spending.

The other day, WSJ publisher Almar Latour criticized “agenda-driven reporting” and said his paper’s “news coverage stands as a beacon.” I love the Journal and read it every day, but there is room for improvement in the news department.

In a recent piece at AIER, I argue that the last stimulus didn’t stimulate:

Mailing $1,200 checks to 159 million people, adding $600 to weekly unemployment benefits and rationing forgivable 1% loans for five years did, of course, raise personal income. Relatively small tax credits lifted after-tax (disposable) income slightly more. “Disposable personal income increased $1.53 trillion, or 42.1 percent, in the second quarter,” reports the Bureau of Economic Analysis (BEA). Yet contrary to stimulus promises, consumer demand fell even more than income increased: ‘Personal outlays decreased $1.57 trillion… The [34.6%] decrease in outlays was led by a decrease in PCE [personal consumption expenditures] for services.”

Presidential candidate Joe Biden is planning large tax increases if elected in November. One proposal would raise the top federal long-term capital gains rate from 24 percent to 43 percent. In the Wall Street Journal, Mark Bloomfield and Oscar Pollock discuss why that policy change would be damaging.

One of their points deserves elaboration. There is a strong behavioral response to changes in capital gains taxes, such that increases in the rate substantial shrink the tax base. A large federal rate increase will shrink the base dramatically, which would undermine both federal and state tax revenues. Bloomfield and Pollock say, “States like New York and California (and some municipalities, notably New York City) rely heavily on realizations of capital gains, which would drop significantly,” under Biden’s plan.

Consider California. The top 1 percent of taxpayers pay half of the state’s individual income and capital gains taxes. Capital gains tax revenues account for about 10 percent of the state’s overall general fund revenues (p. 157). During the recession a decade ago, the plunge in capital gains taxes from wealthy individuals hit the state budget hard.

California is dependent on capital gains tax revenues because of its highest-in-the-nation top tax rate of 13 percent and its dependence on the wealth generated in Silicon Valley. Not only would California state revenues be hit by Biden’s capital gains tax increase, so would the state’s high-tech economy. California policymakers should be lobbying the Biden campaign to rescind his capital gains tax proposal.

The interaction of tax bases in the three levels of government is an underappreciated factor in public policy. Federal, state, and local governments compete as they tax capital gains, individual income, and corporate income. Higher tax rates at one government level shrink the tax bases and revenues at the other levels. Biden’s proposals to raise capital gains taxes, individual income taxes, and corporate income taxes would shrink state and local tax bases and revenues.

Here is a related concern. A general rule in economics is that the harm of a tax rises by the square of the rate, such that a 40 percent tax rate causes four times the economic damage as a 20 percent rate. Federal and state tax rates pile on top of each other, and it is the combined marginal rate that affects taxpayer behavior. Biden wouldn’t be raising the capital gains rate by 20 percentage points starting from zero. Rather, he would be pushing up the top federal rate to 43 percent and the combined federal-state rate to more than 50 percent in California and other high-tax states.

How many high-tech entrepreneurs and angel investors will put their time, effort, and money into long-term, illiquid, and highly risky startup investments if, in the 1‑in-10 chance they hit it big, governments take more than half the return?

I am surprised that Silicon Valley isn’t up in arms with Biden’s capital gains tax proposal. If enacted, American technology industries would suffer major damage.

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There is a caveat. Under section 1202 of the federal tax code, entrepreneurs and angel investors may exempt from tax investment gains from some types of startups that are held for more than five years. It is not clear whether Biden’s proposal would eliminate that benefit or not. Perhaps Silicon Valley leaders think they can retain this break even as the overall capital gains tax rate rises, but that is a risky political assumption to make.

The two parties are far from agreement on another aid package, so President Trump has decided to take tax and spending measures by executive action. Here are a few thoughts:

Unemployment Benefits. Democrats want to extend extra unemployment benefits of $600 per week, and Trump has gone part way by extending them at $400 per week. The benefits create a work disincentive and will undermine the recovery. Even without the extra benefits, regular unemployment benefits cover 30 to 50 percent of prior paychecks. That is the level of benefits workers would expect, and they should have built their personal savings to help cushion the blow from possible unemployment.

When employed, workers at every income level should save. A WSJ piece discussed Ronald Read of Brattleboro, Vermont, who spent his career pumping gas and sweeping floors. His pay was low, but he was frugal and ended up saving $6 million and leaving it to charity when he died. There is no reason why government benefits should cover 100 percent or more of lost wages. When people are working, they should follow Read’s example and save.

Government benefits are not a freebie. Showering cash on people today comes at the cost of higher taxes on people tomorrow. As such, government aid generates ethical problems, not just microeconomic damage.

Payroll Tax Cut. Trump’s action defers payment of some Social Security payroll taxes, with a possible cancelation of the taxes later on. But if government continues spending on the program’s benefits, then the tax costs will simply be pushed forward. Why should politicians be able to impose the costs of today’s spending onto tomorrow’s workers? This year’s crisis has created huge economic damage. Deficit-spending can move costs to the future but can’t make costs disappear. The nation will have other crises to deal with down the road. It is unfair that people in the future will have to pay both the costs of the crises that will hit them and the costs of past crises. Trump and Congress should offset any payroll tax cuts by cutting Social Security benefits or other spending.

State and Local Aid. Congress has provided $150 billion in flexible aid to the states plus more than $280 billion in other state and local aid for health care, education, housing, transit, and food stamps. That is more than enough, and Trump is right to resist further intergovernmental aid.

Despite media stories to the contrary, local government revenues may not fall much, if at all, this year since property taxes are likely to remain buoyant. State government revenues may fall about 10 percent, but the states can handle that by tapping rainy day funds, freezing worker pay, cutting programs, and privatizing assets. State and local governments have enjoyed a decade of growth, and they should have been ready for the downturn.

Politicians always want to do something—anything—in response to downturns. But usually the best path is to leave the economy alone because markets adjust and resume growth by themselves. Indeed, shrinking the government’s footprint by cutting spending and regulations increases market flexibility and speeds the return to growth.

Federal aid is usually counterproductive because it creates microeconomic distortions that delay needed restructuring. More federal spending will undermine a speedy recovery, not help it.

I discuss distortions caused by government spending here, and Hoover Institution scholars model the growth benefits of spending cuts here.

In response to the crisis, federal policymakers have passed a series of aid packages providing hundreds of billions of dollars to state and local governments. Legislation, here and here, has provided $150 billion in flexible aid to the states plus more than $280 billion in other state and local aid for health care, education, housing, transit, food stamps, and other programs.

Congress and the administration are working on yet another bailout package. The House plan includes $1.1 trillion further aid to the states, while the Senate plan includes $105 billion for schools and colleges.

Federal aid to the states is harmful for many reasons. When tax revenues fall during recessions, state governments should tap their rainy day funds, cut low-value programs, freeze salaries, furlough workers, postpone new initiatives, and sell assets. The federal government can help by repealing rules that block the states from cutting spending on activities that receive federal money. Millions of American businesses are tightening their belts, so why not governments? Today’s lean budget climate is an opportunity to improve efficiencies in state and local agencies.

Even if some crisis aid to the states made sense, further aid would be too much. The aid already passed would mainly cover budget gaps if states were allowed maximum flexibility with the funds.

During the last recession, state tax revenues fell 10 percent from the 2008 peak and then began bouncing back. Recent projections suggest a decline this recession of no more than that. Tax Foundation surveyed current forecasts for a dozen states, and found that tax revenues are expected to fall about 4 percent in fiscal 2020 and 7 percent in fiscal 2021 from the fiscal 2019 peak. Tax Policy Center recently surveyed 27 states and found similar estimated declines, as did a recent study by economists Christos Makridris and Robert McNab. The budget gaps were larger when compared to a no-recession baseline of rising revenues.

In the chart, the red line is Census data showing state tax revenues rising for a decade and peaking at $1.09 trillion in calendar 2019. Then the red dashed line assumes a 10 percent drop in 2020 and recovery in 2021 and 2022. Tax revenues would be down $109 billion in 2020 and $55 billion in 2021 compared to the 2019 level, for a two-year loss of $164 billion. The losses would be somewhat larger measured against a no-recession growth baseline. But either way, the aid handed out already would mainly fill state budget gaps if states were allowed to use the money flexibly.

The blue line in the chart shows total federal aid to state governments. The projection, 2020 to 2022, is based on regular aid growing per the pre-virus federal budget, plus the $150 billion in flexible crisis aid already provided. The media has focused on how much state tax revenues might fall, but even if the federal government provided no crisis aid, the large part of state budgets funded by federal dollars would chug along with steady increases.

Lastly, note that while state-level tax revenues may fall 10 percent this year, local government tax revenues may not fall much, if at all. During the last recession, overall local tax revenues were flat for a while and then began rising again.

This year is an extraordinary one for government subsidies. More than 150 million people received $1,200 stimulus checks. More than 25 million people have been receiving the $600 a week boost in unemployment benefits. Almost five million businesses and nonprofits have received aid through the PPP program. All this and other recession-related spending is imposing trillions of dollars of debt—and ultimately taxes—on younger working Americans.

Even during normal times, many Americans are hooked on federal payments of one type or another. The chart below shows the number of recipients of some major subsidy and benefit programs. As a point of reference, there are about 129 million households in the nation.

The data comes from Table 21–3 in the federal budget here. Some of the items are contractual obligations (such as employee pensions and payments to veterans), but most of the items are subsidies that can be, and should be, cut or repealed to fix our massive federal debt problem.

Aside from these programs, there are 2,000 or more other federal subsidy programs for state and local governments, businesses, nonprofits, and individuals. (These are described in a 3,709-page pdf available here). Over the decades, both the size and scope of federal subsidies has expanded, attaching ever more individuals and organizations to the government’s teats. Each program undermines the private economy, generates a bureaucracy, and spawns a web of regulations that micromanage society and reduce freedom.

There is concern about declining free speech in America, and government handouts add to the problem. Individuals and organizations that get hooked on subsidies essentially become tools of the state. They lose their independence and may shy away from criticizing the government and its many failures.

When the economy recovers from the current crisis, policymakers should turn their attention to cutting subsidies and freeing the nation from top-down cash and controls from Washington.

The figure for Medicare is for HI benefits.

Cato intern Camila Goris assisted with this post.