STAMP: Showing How State Taxes Matter

THIS NOVEMBER, MASSACHUSETTS VOTERS used the ballot box to do what the Legislature refused to do. By a margin of 59% to 41%, they voted to roll back the state’s income tax rate from where it currently stands, at 5.85%, to its 1989 level of 5%. In a state that is, by all accounts, one of the most liberal in the country, this was a significant turn of events.

A coalition consisting of the Massachusetts Teachers Association, the National Education Association, the Tax Equity Alliance of Massachusetts (representing various public employee unions) and assorted labor organizations raised a record $3.5 million to fight the tax cut. Proponents raised only $1.2 million.

How could a campaign that was outspent three-to-one, that was fighting a tax-and-spend mentality and that was vigorously opposed by almost every elected state government official succeed? There are several reasons. First, Republican Governor A. Paul Cellucci campaigned vigorously in favor of eliminating a tax increase originally marketed to the voters as “temporary.” Second, with the economy sound and state coffers bulging, taxpayers simply liked the idea of money being returned to them.

Third, economic analysis favored the proposed cut. Of the two sides, only the proponents offered an argument grounded in rigorous economic theory and analysis. Opponents relied on ad hoc, unsubstantiated arguments about the importance of “investing in schools, health care, our communities, and our people.” They also railed against tax cuts for the “wealthy.”

The Massachusetts Model

The economic argument for the tax cut was based on an economic modeling capability developed by the Beacon Hill Institute in Boston. BHI used its Massachusetts State Tax Analysis Modeling Program (Massachusetts STAMP) to analyze the consequences of the tax cut for the state’s economy.

BHI first developed and applied STAMP in 1994 during a vigorous campaign on the part of public-employee unions to institute a graduated income tax structure in Massachusetts. The proposal was subsequently turned down by the voters. Since then, BHI has applied Massachusetts STAMP to numerous other proposed tax-law changes in the state, demonstrating in every case and at a high level of statistical confidence the negative consequences of raising taxes.

STAMP is a dynamic, econometric model of a state’s economy. It is founded on archetypical economic principles and employs state-of-the-art statistical and econometric methods. Using an Excel spreadsheet, users can simulate the effects of changes in state tax policy on jobs, wages, capital spending, tax revenue and other economic indicators. Policy changes include changes in tax rates on personal and corporate income, on sales, and on property.

When applied to this November’s ballot question, Massachusetts STAMP showed that lowering the income tax rate to 5% would put 93,000 workers into Massachusetts jobs by 2003, when fully implemented. BHI further demonstrated that state government could maintain all existing services, even with the tax cut and even with a recession. Thus, proponents were able to buttress their arguments with evidence of the economy-wide benefits of the tax cut to the state.

Building a STAMP Collection

With the success of Massachusetts STAMP and with the broadening recognition that state taxes exert important effects on state economic activity, in 1996, BHI began to develop STAMP models for other states. Its first venture was the development of an Oklahoma STAMP at the request of the Oklahoma Department of State Finance. In 1997, BHI built STAMPs for New Jersey and Ohio.

Ohio STAMP, like Massachusetts STAMP, would play a key role in a contentious debate over a tax issue. The Ohio Supreme Court had ruled that funding for poorer school districts in the state must be brought closer to the statewide average, entailing additional state spending of about $1 billion. The proposal that emerged as the most likely candidate to raise these funds called for a 1% sales tax increase. Supporters and detractors faced off, with Governor George Voinovich arguing the merits of the tax increase and detractors, like the National Taxpayers Union of Ohio and the Buckeye Institute, in vigorous opposition.

In January 1998, the Beacon Hill Institute weighed in on the debate. Ohio STAMP showed that the proposed 1% increase in the state sales tax would, at a minimum, result in the loss of 99,000 jobs, cause a shrinkage of $3 billion in state payrolls and leave Ohio’s capital stock $8.8 billion smaller. The tax increase would eliminate 1.7% of the jobs in the state causing the unemployment rate to rise from 4.4% to as high as 6%.

The Ohio Legislature used the analysis in debating and later defeating the proposed tax increase. The electorate ratified the legislature’s decision in a subsequent referendum.

Since the Ohio sales tax debate, the Beacon Hill Institute has built STAMPs for three State Policy Network sister organizations: Texas STAMP, for the Texas Public Policy Foundation in 1999; Virginia STAMP, completed in 2000 for the Thomas Jefferson Institute for Public Policy; and California STAMP, completed in 2000 for the Pacific Research Institute (PRI). PRI used California STAMP as part of a successful effort to stop a proposal to tax e-commerce in the state. A Minnesota STAMP, to be used by the Center of the American Experiment, is currently under construction.

In 1999, the Beacon Hill Institute and the Heritage Foundation’s Center for Data Analysis formed a strategic partnership to combine STAMP with the Heritage Foundation’s federal and state tax analysis capabilities. As a first project in that effort, in 2000 BHI applied STAMP to four more states: Arizona, Michigan, New York and Pennsylvania.

The Tax Policy Myth

There is an enduring myth that reducing taxes won’t stimulate the economy. STAMP has helped dispel this myth by identifying the economic consequences of the penalty that taxes impose on decisions to supply labor and capital. Lower taxes stimulate the economy by reducing the costs to firms of hiring labor and of expanding capital.

How does this work? Consider a reduction in the state personal income tax. A tax cut of this kind reduces the before-tax wage rate that a prospective employee must receive in order to be willing to take a job. By reducing the penalty that an income tax imposes on work and by thus making labor cheaper, the tax cut induces the employer to hire more labor and thus to expand the economy.

STAMP also dispels a myth about how tax cuts affect tax revenues. Opponents of tax cuts like to argue that, in deciding whether to enact such cuts, policy makers should consider only “static” effects – revenue losses resulting from a reduction in the tax rate. In fact, however, tax cuts also bring about increases in the tax base – for example, the wages from which personal income taxes are collected – and therefore increases in tax revenues. When these “dynamic” effects are considered, a tax cut will therefore be found, on balance, to reduce tax revenues by less than a purely static analysis would suggest.

These are some of the principles that underlie STAMP. Also important is the fact that, as an “econometric” model, STAMP bases its results on the application of statistical methods to actual data representative of the state economy and tax system. Also, it can be applied to other policy issues involving broad-based changes in business costs. In Massachusetts, for example, it has been applied to a proposed reform in tort law and a proposed institution of universal health care.

Economist Friedrich Hayek argued that our view of the world depends on how we “model” it in our minds. We can perceive the world only after we have imposed some model or classification system on reality. STAMP provides one such model, involving the reaction of economic entities to changes in the penalty that taxes impose on economic activity. When voters (or other decisionmakers) are given a systematic way of looking at a complicated problem, they are able to make decisions rooted in evidence and order, and not just rhetoric.

That’s what Massachusetts voters did in November, against the odds and to the benefit of the state’s economy.

Ms. Foley is Director of Communications for the Beacon Hill Institute at Suffolk University in Boston.