Tuesday, June 7, 2011

Adding to the Deficit – Through Subtraction

Throughout the debate on the budget repair bill and most of the debate on the biennial budget, we have heard lawmakers argue for the importance of sacrifices that will eliminate Wisconsin’s structural deficit and get the state’s fiscal house in order. Until last week the Joint Finance Committee (JFC) seemed genuinely committed to eliminating the structural deficit, at least while the committee was deliberating on spending issues. But that commitment was no longer in evidence last week when the topic turned to taxes.

The biggest surprise came late on Friday night as the committee was finishing up its work. On a 12-4 party line vote, the JFC approved a motion that adds substantially to the structural deficit by nearly eliminating the income tax for many corporations that produce goods in the state. (See the June 7th Journal Sentinel article by Kathleen Gallagher.)  It will have the effect of slashing the tax rate for manufacturers from 7.9 percent down to just 0.4 percent – phasing in a 95 percent reduction in their income taxes over a four-year period. Though the cost is minimal in the current biennium, the price tag will grow to $129 million per year – requiring deeper spending cuts in future years or a shift in taxes to other taxpayers. 

In subsequent blog posts, the Budget Project will dig deeper into the merits of the proposed $129 million per year corporate tax cut. In light of other aspects of the corporate tax code, is this change likely to attract manufacturers to Wisconsin? And does it make sense to enact a 95 percent tax reduction for one particular segment of corporations? But for now, our focus is the theme of “fiscal responsibility” that had been such a steady refrain over the last six months or more.

Some politicians and pundits seem to think that structural deficits can always be attributed to phased-in spending increases or short-term budget-balancing measures (such as “raiding” other funds or restructuring bonds). They overlook the fact that delayed or phased in tax cuts can also produce or add to structural deficits. The short-term political expediency that sometimes leads lawmakers to approve deferred spending increases that they cannot currently afford can also induce them to approve tax cuts that are now unaffordable, and the effects on the structural deficit can be the same .

As we pointed out in a Budget Project paper in late December, past legislative actions created delayed tax cuts that accounted for $320 million of the structural deficit in the current biennium (including $210 million from changes that took effect on January 1, 2011). Those tax cuts are in addition to the $200 million in new tax cuts proposed by the Governor during the Special Session and in the biennial budget bill.

The last minute amendment in the Finance Committee Friday was the second of two measures approved last week that contribute to the structural deficit in 2013-15 and beyond. Earlier in the week, in the same motion that raised taxes on low-wage workers by cutting the state Earned Income Tax Credit, the committee approved a change in the capital gains tax that will disproportionately benefit the very wealthy. The cost won’t be felt until 2017, but will gradually grow to $79 million per year.

The new tax break for manufacturers, referred to as the “domestic production activities credit,” is a more targeted and far more generous version of a poorly designed tax deduction for domestic production activities that was ended two years ago. The $10.1 million cost in the second year of the 2011-13 biennium is almost completely offset by the additional revenue that will be generated by restoring some Dept. of Revenue positions for auditors and field investigators that had been slated for elimination. But as the cost of the tax break increases between now and 2017, it will add about $96 million to the structural deficit in the 2013-15 biennium, and $213 million in the following biennial budget.

In the next week or two, as the full legislature works on the budget bill, we’ll get a better sense of whether all the pontificating we’ve heard about structural deficits was genuine, or if it was largely just an argument to justify cutting spending and downsizing government.

Jon Peacock

1 comment:

  1. At least with some other credits, the business is required to do something (create jobs, invest in plant and equipment) in order to qualify. With this one, they don't have to do a darn thing more than what they are doing now. In fact, a business would still qualify even if they slash their payroll. Mind boggling, to say the least.

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