by Lawrence J. McQuillan, PhD
The Center for Tax and Budget Accountability (CTBA) wants taxes raised on hard-working Illinoisans by at least $2.4 billion annually through a progressive personal income tax, which taxes individual income at ever-higher marginal tax rates. Currently, Illinois has a flat 5 percent income tax.
In a recent report, the CTBA argues for this tax hike by asserting that “for every dollar spent by the state, Illinois’ private sector economy gets a benefit of $1.36” (p. 6). According to the CTBA, the State of Illinois should collect more tax revenue and spend it because this will lead to significant private-sector economic growth and job creation. The CTBA comes up with this $1.36 figure from ubiquitous TV talking head Mark Zandi.
Zandi, a registered Democrat and chief economist at Moody’s Analytics, applies the old-fashioned “Keynesian multiplier” to arrive at the number. Here’s the thinking behind the multiplier number: First, the government spends more money. The initial government spending becomes someone’s income, and they spend some of it, which becomes another person’s income and they spend some of it and so on. One dollar of government spending cascades through the economy to produce $1.36 in private-sector income, according to Zandi.
But this is what I call “rabbit-out-of-a-hat” economics – people thinking you can get something out of nothing. The “multiplier” tells only half the truth.
What Zandi doesn’t tell you – or doesn’t understand – is that government can’t spend anything unless it first takes it from somebody else through taxes or borrowing. Every government action, especially taxing and borrowing, has an “opportunity cost.” The taking of resources from the private sector has many negative costs – two are especially damaging.
First, as economist Frederic Bastiat first explained in 1850, taking resources from the private sector causes contractions in other parts of the economy, either in private consumption or private investment. These contractions cascade through the economy, too, and offset Zandi’s multiplier. Government spending is largely a shell game – moving money or wealth from one part of the economy to another; from one group of people to another, and lowering society’s total income in the process.
Second, increased government spending creates uncertainty about how much taxes must be hiked in the future to pay for the new commitments. Politicians can’t resist establishing new permanent spending programs, which often are unsustainable – exhibit A is Illinois’ public employee pensions and retiree health care.
Faced with unpaid government debts, unfunded liabilities, new spending programs and higher taxes people become very worried and uncertain as to what future costs and private-property rights will be. In response, people don’t make new capital investments, don’t hire new employees or start new businesses, don’t buy big-ticket durable goods or take that family vacation. Economists call this “regime uncertainty,” and these rational responses cause the economy to shrink. These are the fatal flaws with Zandi’s zany figure. Think about it, if Zandi and the CTBA were correct, America would have had economic nirvana since 2008 with the trillions of federal government spending.
In its zeal to increase taxes on hard-working Illinoisans, the CTBA is applying the flawed Keynesian multiplier to concoct a myth about the benefits of government spending. It makes one wonder what else the CTBA has wrong about the progressive tax. Stay tuned for more.
I debunk myths about the progressive income tax in other commentaries:
Read how the CTBA is misrepresenting Adam Smith