Red Tax, Blue Tax

From the Wall Street Journal (subscription site, but -- unlike Tim -- I can afford such things):

Of all the Democratic complaints about the presidential election, the most interesting and ironic came from Lawrence O'Donnell, a leading party strategist and former aide to Sen. Pat Moynihan. He complained on MSNBC that, "The segment of the country that pays for the federal government is now being governed by the people who don't pay for the federal government." Mr. O'Donnell added for good measure, "Ninety percent of the red states are welfare client states of the federal government."

...

Consider deep blue Connecticut and vivid red Oklahoma. Both have roughly the same number of people, five Congressmen and seven electoral votes. Last year, 1.66 million Connecticut tax filers paid $19.1 billion in personal taxes on $107 billion of adjusted gross income. That makes for an average tax rate of 17.9% in Connecticut. In the same year, 1.5 million Oklahoma tax filers paid $6.6 billion in personal taxes on $54 billion in adjusted gross income; an average tax rate of 12.2%. Democrats like Mr. O'Donnell seem to want the rich to pay more in taxes, but not for rich states with rich people to pay more taxes. It's unclear how one accomplishes this mathematically.

...

But this "blue-state tax blues" problem is much more than just an issue of fairness. It also contributes to a pernicious economic and fiscal cycle for the Northeast and other high-cost, high-tax regions. ...As higher-wage jobs leave the overtaxed, higher-cost areas, both the local economy and the state's tax base decline. This often creates a need to raise state and local taxes still further, making those states and regions still less competitive.

Often, the next step in the lament is to observe that the deductibility of state and local taxes from one's federal income tax exacerbates the problem by creating a moral hazard (i.e., giving high-tax states and cities less incentive to reduce their own income tax rates, since "it's deductible anyway"). Calls to replace the federal income tax with a national sales tax also often highlight the "Red Tax, Blue Tax" phenomenon.

The problem with such an analytical framework is that it only considers tax inflows to Washington and not outlays. Stated differently, it would be perfectly logical to say "Connecticut has more rich people, so of course Connecticut should 'pay' more income tax" -- if and only if we had a strict correlation between "federal versus state taxation" and "federal versus state expenditures" (or, to coin a term, "fiscal federalism").

Under "fiscal federalism," the national government would do national things and pay for them with national taxes, while state governments did state things and paid for them with state taxes and local governments did local things and paid for them with local taxes. In the early (pre-modern?) history of our country, that's exactly how fiscal policy worked (cf., McCulloch v. Maryland, 17 U.S. 316 (1819))

Unfortunately that is not the American model of public finance today (if you like, "federalism is dead" while "all politics is national"). Monies flow into and out of Washington from so many different pipes as to be practically untrackable in the aggregate, Social Security taxes pay for non-Social Security programs (i.e., the fraud of the "Lockbox"), tax policy is used for purposes other than to raise revenue, etc. To focus on one singular aspect of the system and cry foul is not only myopic, but also impractical.

As government gets more expansive in determining what it should do, it also gets more expansive in how it should pay for it. Focusing on individual "inequities" in tax revenues, block grants, subsidies, regulations, etc., miss the point entirely and only serve to distract from the real debate -- just how big should government be in the first place?

To lament disparities, inefficiencies or inequities in tax policy, without simultaneously analyzing the corresponding inequities in government spending, is counterproductive. It's like the old story about a table where one leg is shorter than than the rest, so you try to fix it by shortening the other legs but get it wrong, so you go back to the original leg, and on and on until all you have is a hopelessly ruined piece of wood. Maybe it's time instead to re-examine the factory that produced the defective furniture in the first place.

POST SCRIPT: Connecticut's tax base declining? Where have we heard that before?

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