Creating Economic Opportunity in DC

By Jonathan Williams

About the Author

Jonathan Williams is the director of the Tax and Fiscal Policy Task Force for the American Legislative Exchange Council (ALEC). Prior to joining ALEC, Jonathan served as staff economist at the non-partisan Tax Foundation, authoring numerous tax policy studies.  His work has been featured in many publications including The Wall Street Journal, Forbes and Investor’s Business Daily. Williams co-authored Rich States, Poor States: ALEC-Laffer Economic Competitiveness Index. He has been a contributing author to the Reason Foundation’s Annual Privatization Report and has also written for the Ash Institute at the Kennedy School of Government at Harvard. In addition, Williams is a contributing author to In Defense of Capitalism (Northwood University Press, 2010). The views expressed in this article are his own.

Introduction
Today, many state and local governments face their toughest budgetary climates in a generation, and the nation’s capital is no exception. This article outlines steps the District of Columbia can take to produce a responsible budget and avoid financial meltdown, while enhancing competitiveness and economic opportunity for all.

In these trying times, elected officials need to do everything in their power to make their jurisdictions more competitive. If D.C. is to improve its economic outlook, the incoming administration of Mayor Vincent Gray and the City Council must follow an important principle of the medical profession: First, do no harm. D. C. taxpayers cannot afford additional tax increases, which have always proven to discourage economic growth and would make the District even less competitive.

What Washington, D.C. Can Learn From the States

As former Supreme Court Justice Louis Brandeis famously said, the states should serve as “laboratories of democracy.” In that spirit, D.C. policymakers can learn valuable lessons from the successes and failures in the 50 states. I recently co-authored the study, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, which documents case studies from the 50 states to examine the effects of fiscal policy on economic competitiveness. [1]

Rich States, Poor States offers a roadmap to economic recovery and job growth, based on commonsense fiscal policy reforms.  The correlation between poor policy and poor economic results in the 50 states is indisputable.  Our research shows that states with responsible spending and competitive tax rates enjoy the best economic outlook. States, or any jurisdiction for that matter, do not enact changes in a vacuum—every time a given jurisdiction increases the cost of doing business within its borders, its brand immediately loses value.

Rich States, Poor States adds to a growing body of evidence that clearly supports the roadmap to state prosperity. States that eschew imposing punitive tax rates and allow for responsible growth in public expenditures are well positioned to recover from the current economic downturn. Policymakers who believe they can bring about economic recovery by increasing government intervention and taxes are sadly mistaken. I like to summarize the thesis of Rich States, Poor States in one simple sentence: Government cannot tax its way to prosperity. The best solution to budget woes is to control overspending and promote policies that foster job creation and economic development.

The Condition of Fiscal Policy in Washington, D.C.

Recent projections by the District’s Chief Financial Officer, Natwar M. Gandhi, estimate that the District faces a budget gap of $175 million in fiscal year 2011, which began on October 1, 2010. [2] Given the District of Columbia’s poor fiscal condition and the expectation that tax receipts will continue to decline in the immediate future, the Gray administration and the City Council could find themselves facing a long road ahead in trying to solve the looming budget shortfalls.

The District is not the only jursdiction with a budget in the red. Many cities and states are facing shortfalls in their current budgets. [3] These budget gaps are an abrupt turnaround from just three years ago, when a vast majority of locations enjoyed budget surpluses. [4]

Some pundits and politicians will blame D.C.’s budget problems exclusively on a reduction in tax receipts, but a look at the facts suggest otherwise. Some jurisdictions budgeted responsibly and saved for a rainy day. However, not all did. Many states and localities spent every last dime of surplus funds. Thus, as their economic fortunes changed for the worse, their financial situations turned dire. When budget shortfalls arise, taking a look at historical spending trends can provide valuable insight as to the root of the problem.

Table 1 ($ in thousands)

Fiscal Year	Total Expenditures	Total Revenue
2002	$6,449,625	$5,919,991
2003	$6,691,760	$5,976,561
2004	$6,900,547	$6,665,116
2005	$7,244,431	$7,141,164
2006	$8,221,484	$7,635,282
2007	$8,914,401	$8,489,718
2008	$10,053,453	$8,619,977
2009	$10,134,792	$8,988,423
2002-2009 growth	$3,685,167	$3,068,432
Percentage Change	57.14%	51.83%

Source: Office of the Chief Financial Officer. Comprehensive Annual Financial Report (CAFR), Fiscal Year 2009. Exhibit 2-h, Statement of Revenues, Expenditures and Changes in Fund Balances – Government Funds, Page 45. Available at:
http://cfo.dc.gov/cfo/frames.asp?doc=/cfo/lib/cfo/cafr/2009/cafr_2009_financial_trends_153-158.pdf

As Table 1 shows, D.C.’s total revenues grew by 51 percent between FY 2002 and FY 2009, but total spending increased by 57 percent, despite relatively no growth in population. [5]

In the wake of the economic downturn, some D.C. politicians now argue that previously passed tax relief needs to be rescinded and additional tax hikes need to be considered. However, if legislators rightly keep the debate framed in terms of economic competitiveness, they will avoid asking taxpayers for more. The District doesn’t suffer from lack of taxes. Rather, it suffers from  a spending addiction. Increasing taxes will never solve the fundamental problem of overspending in our nation’s capital.

Competitiveness: Where Does the District Rank?
It is important to note the consequences of raising taxes. Every time a jurisdiction changes its tax policies, it directly and immediately influences its competitive position for personal and business investment.

One of the major roadblocks to future economic growth in our nation’s capital is its elevated tax burden. For starters, as Table 2 shows, D.C.’s burdensome 8.5-percent personal income tax—one of the highest in the nation—kicks in at just $40,000 of income. This does not bode well for future economic growth and development.

Table 2
Personal Income Tax Rates in DC

Income Level*	Rate
>0	4%
>$10,000	6%
>$40,000	8.5%

Source: Office of the Chief Financial Officer
* Excludes Social Security income and maximum $3,000 exclusion on military retired pay, pension income, or annuity income from DC or federal government [6]

D.C. has depended on personal income tax revenue since 1939. [7] However, as research published in Rich States, Poor States shows, high income tax rates are some of the most economically damaging sources of revenue. The study tracks economic growth in the nine states without personal income taxes and compares it with the growth in the nine states with the highest income taxes. The results are illuminating. Over the past decade, non-income tax states enjoyed more than 44 percent greater income growth, more than 115 percent greater job growth and an astonishing 152 percent greater population growth. [8] Americans are voting with their feet, and they are voting strongly against jurisdictions with high income tax rates.

Some progress has been made to reduce personal income tax rates since 1976, when D.C. had a top tax rate of 11 percent. [9] Unfortunately, some D.C. Council members want to reverse these slight improvements and raise taxes on D.C. residents making more than $500,000 per year. [10] However, as Jeff Coudriet, clerk of the Council’s Finance and Revenue Committee said “Your bread is buttered by rich people… We spent 40 years chasing them away, and we saw how that worked.” [11]

Not only is D.C.’s personal income tax uncompetitive, the District’s flat corporate tax rate of 9.975 percent is one of the highest in America. Add that on top of the 35-percent U.S. corporate rate, and a business looking to invest in the District will face the prospect of paying a combined tax rate that is grossly uncompetitive by international standards.

Recent studies from non-partisan Washington, D.C.-based Tax Foundation show how DC’s tax policies measure up historically. As Table 3 clearly outlines, the total burden on D.C.’s taxpayers has historically ranked among the top 10 nationally. The current 10.3-percent tax burden is well above the national average of 9.7 percent. The Foundation reports that D.C. taxpayers shoulder a local tax burden of $7,308.00 per capita, annually. In fact, on only one occasion has the Tax Foundation ranked D.C.’s tax burden outside of the top 10 highest taxed states—back in 1977, the first year it collected its data.

Table 3 (DC Tax Burden historical)

Year	DC Tax Burden	National Rank (1 = highest tax burden)
1977	10.9	11
1978	11.5	4
1979	11.3	2
1980	11.5	2
1981	12.2	1
1982	12.2	1
1983	11.4	2
1984	11.5	4
1985	11.3	2
1986	11.3	3
1987	11.6	2
1988	11.8	2
1989	11.4	2
1990	11.4	2
1991	11.4	2
1992	11.4	4
1993	11.4	5
1994	11.4	6
1995	11.1	5
1996	11.2	6
1997	11.1	3
1998	11.3	3
1999	11.2	2
2000	11.2	1
2001	10.9	2
2002	10.7	3
2003	10.5	6
2004	11	4
2005	10.9	6
2006	11.2	4
2007	10.8	4
2008	10.3	8

Source: Tax Foundation http://www.taxfoundation.org/taxdata/show/336.html

The Tax Foundation also issues an annual report, State Business Tax Climate Index (SBTCI), which carries out a specific analysis of tax systems. [12] As it notes in its introduction: “The Index compares the states in five areas of taxation that impact business: corporate taxes; individual income taxes; sales and gross receipts taxes; unemployment insurance taxes; and taxes on wealth, including residential and commercial property.” The SBTCI’s 2011 edition ranks D.C. ahead of only 12 states nationally. Among adjacent states, Maryland ranks 44th and Virginia 12th.

The Tax Foundation drills down even further, evaluating tax policies that have a direct impact on business, including corporate income tax rates and bases. Its corporate tax sub-index singles out D.C.’s business tax system as one of the worst in the nation. By this metric, D.C. ranks ahead of only 10 states in the corporate tax sub-index. This poor ranking, places D.C. dead last among neighboring states. Virginia, by contrast, enjoys a top 10 ranking.

Having a competitor like Virginia nearby should serve as a strong reminder that policy changes are not created in a vacuum. The District’s lack of economic competitiveness is a real threat to its economic outlook. Just across the Potomac, thousands of DC’s workers live in the Old Dominion, taking advantage of its lower tax burdens, less burdensome  regulation, and friendlier business climate.

In D.C., many elected officials subscribe to the misconception that the District’s tax burden should fall as much as possible on tourists, commuters and other nonresidents. This “tax exporting”—done through atrociously high hotel, rental car and restaurant taxes—historically leads to overspending by government officials, who are unaccountable to those paying the tax. These tax-thy-neighbor strategies may swell D.C.’s coffers in the short term, but they also invite retaliation and further congressional regulation.

Last but not least, the Small Business Survival Committee’s Small Business Survival Index ranks the states on their “policy environment for entrepreneurship across the nation,” including criteria such as taxes, regulation, electricity costs and workers’ compensation costs.The report’s most recent edition ranked D.C. dead last (51st) in the entire United States. [13]

The evidence is clear that D.C.’s current policy is an obstacle to future growth and economic vitality. The District is a costly place to live, work, and do business. The question then becomes: What can D.C.’s elected officials do about it?

Prioritizing Government Spending

Some suggest that it is impossible to reduce D.C.’s uncompetitive tax rates during a budget shortfall. That line of reasoning is mistaken, as it neglects the possibility of realizing savings and efficiency gains on the spending side of the ledger. Today, a vast majority of states and localities are experiencing budget shortfalls, but before any consideration is given to raising taxes or cutting programs, there are fundamental questions that must be answered. 

The first question is whether government is making the most efficient use of current taxpayer funds. With spending in the billions, there are likely many opportunities to increase efficiency and maintain services at lower costs.  Most years, government budgets are built on last year’s spending plus an increase of a few percentage points. Little, if any, consideration is given to whether past spending has been utilized effectively. 

After the economic downturn following the September 11, 2001 terrorist attacks, state lawmakers in Olympia, Washington, faced a projected budget shortfall of $2.4 billion. Instead of using the traditional budgeting approach, then Governor Gary Locke and a bipartisan majority in the legislature decided to pursue a new method of budgeting. Legislators agreed to build a priority-based budget, funding core functions of government, and building performance measures into state spending decisions. [14] Priority-based budgeting closed the budget shortfall and did not require a dime in tax increases to do so.

Washington State’s priority-based budgeting required budget writers to ask and answer the following questions: [15]

1) How much money does the state have? What is the existing and forecasted revenue?
2) What does the state want to accomplish? What are the essential services we must deliver to citizens?
3) How will the state measure its progress in meeting those goals?
4) What is the most effective way to accomplish the state's goals with the money available?

One of the key aspects of priority-based budgeting is determining whether there is any justification for any one government program to continue.  Before priority-based budgeting, agencies in Washington State were not even required to have mission statements to show how they fit into the state government’s core functions.

The Locke administration identified a set of 10 key results that citizens expect from government:

• Improve student achievement in elementary, middle, and high schools.
• Improve the quality and productivity of the state’s workforce.
• Improve the value of post-secondary learning.
• Improve the health of Washington citizens.
• Improve the security of Washington’s vulnerable children and adults.
• Improve the economic vitality of business and individuals.
• Improve statewide mobility of people, goods, information, and energy.
• Improve the safety of people and property.
• Improve the quality of Washington’s natural resources.
• Improve cultural and recreational opportunities throughout the state.

Another important element of priority-based budgeting is called the “yellow pages test,” which follows the premise that government should not be in the business of providing services which the private sector can provide. The yellow pages test almost always results in services being delivered at a lower cost and higher quality, and is therefore a win-win option for cash strapped states. [16] 

Put Taxpayers Back in Charge

Putting reasonable limits on the government’s ability to overspend tax dollars—through a tax or expenditure limit (TEL)—has proven to be a very effective approach in the states. Colorado, for example, was able to restrain government spending and tax burdens beginning in the early 1990s, through its Taxpayers’ Bill of Rights, limiting the growth of government to a reasonable formula of population growth plus inflation. Taxes could be increased, but it took a vote of the people to do so.

Thanks to its low-tax and limited-government policies, Colorado has developed one of the most competitive business climates in the nation, while giving taxpayers back billions of their hard-earned dollars. [17] Economic growth followed, as Colorado boasted one of the most competitive and fastest growing economies in the nation. [18]

Conclusion

The District of Columbia will be able to fully reach its potential only when it shakes off its reputation as a high-tax jurisdiction. Only then will D.C. compete with the likes of Virginia and other states that are making a concerted effort to remain economically competitive.

With budget difficulties a reality for the foreseeable future, public officials in the District face some difficult choices. However, there are some commonsense starting points that should be discussed in the area of budget reform. D.C. taxpayers deserve a city government that will commit to live within its means and avoid economically damaging tax increases. DC taxpayers deserve a priority-based budget that seeks to maximize the value of tax dollars received. For D.C.’s elected officials, this is not a choice between left and right, but between up or down for the District’s economic development and future growth.