Progressive News, Opinion, and Analysis
Sam Bell did such a good job putting together this series on what went wrong with Rhode Island’s economy over the past several years, I thought the least I could do is make it really easy for everyone to access.
What is so sad about the mess Rhode Island has fallen into is that it was completely avoidable.
Governor Carcieri did not have to launch a jihad against public sector employment. Nor was it necessary to hand massive tax breaks to the wealthy. Had we avoided those tax breaks, we wouldn’t have had to slash municipal aid and send property taxes through the roof. Had we not raised property taxes, we would have a stronger housing market, and had we not engaged in massive austerity, the rest of our economy would be doing better as well. If our unemployment insurance tax rate were less punitive, then fewer businesses would have gone under. None of this had to happen.
It seems that things are finally looking up for the Rhode Island economy. Unemployment is falling, despite a regional recession, and numerous other economic indicators are showing positive signs.
There remain many road blocks ahead for our economy, as we deal with the aftermath of 38 Studios, municipal budget disasters, and other legacies of the Carcieri era, so it is by no means clear that these positive trends will continue, but there is certainly more cause for optimism now than we have had for quite some time.
As Leonard Lardaro, an economist at URI, puts it, we’re “in a recovery the magnitude of which almost nobody in this state seems to fully comprehend.” But we should not take this as evidence that the economy of the Ocean State is suddenly being managed well. Rhode Island is a severely depressed economy with relatively strong fundamentals. If you don’t keep kicking it, it will recover, even if the transition is only from terrible to mediocre leadership.
Carcieri is gone, it is true. But the very conservative General Assembly was fully complicit in Carcieri’s blunders, earning them effusive praise from the Wall St. Journal. As Dan Lawlor puts it, “it is remarkable how much of his vision was enacted, sometimes excitedly, by the Democratic General Assembly and its leaders, specifically Gordon Fox and Theresa Paiva Weed.”
There is much truth to this. Although it is hard to argue that pro-choice, pro-marriage Fox isn’t at least a moderate improvement over his predecessors, as House Majority Leader, he was a major proponent of the income tax cuts at the heart of Rhode Island’s problems.
After a bruising reelection battle, Fox made mild noises about potentially being more open to sensible tax reform, but given his past record, it is unclear whether anything will come of this. Nominally a Democrat, Paiva Weed shares Fox’s rather extreme economic conservatism, but she does not share Fox’s more moderate social views. Indeed, she is probably the primary obstacle to marriage equality passing in 2013.
Although Chafee is pushing for some distinctly insufficient reforms, they will probably mostly fail, and it is hard to imagine the General Assembly putting together anything remotely up to the task.
What must be done is actually quite straightforward. We need a jobs bill and tax reform: We need to reverse Carcieri’s austerity by rehiring the teachers, firefighters, and policemen whose jobs he cut. We should also make new investments in critical areas, restoring our crumbling roads and bridges, creating bicycle infrastructure and commuter rail lines, expanding and improving URI, and building tons of medical schools to take advantage of the extreme demand for new doctors. We should begin paring back property taxes and fixing budgets by restoring aid to cities and towns and allowing them to levy local income taxes to offset property taxes.
To pay for all this, we should restore the pre-2006 income tax rates and create new brackets for the wealthy, with a top marginal rate of at least 13%. We also need to restructure the hugely regressive unemployment insurance tax as a simple and constant flat, low rate, a reform that could easily raise revenue while making the tax code much less regressive and much more business-friendly.
With the current conservatives in office, almost none of this will happen. But it is definitely worth fighting for.
The devastating effect of property tax hikes and the less significant effect of a high unemployment insurance tax, discussed in previous columns, probably explain most of the portion of the unemployment gap that’s not explained by austerity. However, there is one more factor that might play a minor role in weakening our economy with respect to other states’. That factor is competitiveness. By competitiveness, I am not referring to the argument popular among conservatives that Massachusetts somehow has a more “competitive” individual income tax rate than Rhode Island. All that’s necessary to debunk that myth is to plot the tax rates:
What I am referring to is actual competitiveness. Although the Ocean State GOP would have you think otherwise, Rhode Island is not the poorest state in the union. Actually, we rank a bit above the average. The issue is that we are much poorer than the other blue states that surround us, as the rankings of states by median household income show.
As a blue state with a long history of unusually conservative government, this is to be expected. It does, however, have some consequences for our economy. By being a moderately wealthy state surrounded by much more successful states, we get many of the disadvantages of affluence with few of its benefits. One way this manifests itself is the strength of our currency. Because the Northeast is a wealthy region, it has a strong dollar, but this is more of a regional trend than a state-based one. A strong currency makes it harder for a state to compete in trade, which is why we want the Chinese to let their currency strengthen. This probably results in a trade deficit for Rhode Island, but the government does not track the trade positions of individual states, so it is impossible to know for sure. At the same time, we also suffer from competition with wealthier neighboring states, which can offer both lower taxes and better government services because of their wealth, as Josh Barro points out in Forbes. Competition probably explains a small portion of our unemployment gap, but the bulk of the blame falls on massive austerity and unusually silly tax polices.
Another singular component of Rhode Island’s tax system is unusually high unemployment insurance taxes. Unemployment insurance taxes don’t get very much attention (they are excluded from the graph of the distributional effect of taxes in the previous column, for instance), but they can have a very real effect on the economy, particularly in a time of high unemployment. The unemployment insurance tax system is hideously complex, with four different components and rates that go up when the company conducts layoffs. The result is a payroll tax that hits the working class far harder than anyone else, as this graph shows.
High unemployment insurance taxes can help exacerbate an economic collapse because once a business is forced to make layoffs, its tax rate can skyrocket. This tends to help push struggling businesses over the line, and Rhode Island’s high unemployment insurance tax rate pushed us over the line. In the Tax Foundation’s 2013 Business Tax Climate Index, the gold standard for biased conservative tax climate rankings, the unemployment insurance tax is the only tax category where Rhode Island ranks last. There is relatively little evidence that a better tax climate ranking helps a state become more competitive, but there are real competitiveness issues that do matter, and they are the subject of tomorrow’s column.
In the previous installment, I discussed the large income tax cuts for the rich that hit Rhode Island in 2006, a major change to the economy that was followed by an early plunge into recession. Unlike the federal government, states can’t offset income tax cuts with debt. So they have to offset them by either cutting spending or raising other taxes. Rhode Island took both approaches.
A critical mechanism for financing the income tax cuts for the rich was slashing the aid that the state government sends to the cities and towns. These severe cuts resulted in a wave of municipal budget crises that we are all too familiar with. Cities and towns closed part of the gap through severe cuts, but they also responded with drastic property tax hikes. Property taxes are notorious for being unusually bad for the economy. Even the Tax Foundation, a very conservative think tank, agrees that property taxes have a bigger effect on business location decisions than any of the other major taxes. Simply put, property tax hikes are very hard on business. The pain is not distributed evenly; property taxes hit small businesses especially hard. The problem is especially severe because the aid cuts were worst in Providence and Woonsocket, where businesses are disproportionately located, so the property tax hikes were worst in areas with the most businesses.
The other side of the economic devastation wrought by property taxes is the property tax on families, which squeezes budgets hard and reduces demand. Because the middle class is more likely to spend its money in ways that are good for the overall economy, shifting the tax budget to the middle class is a big blow to the economy. Redistributing wealth from the middle class to the rich is an especially bad idea when the vehicle is property taxes, because higher property taxes do extensive collateral damage. In the long term, property taxes create perverse incentives that lead to bad urban planning, extensive sprawl, and economic segregation of schools, but they also do serious damage to the housing market. The primary cause of the second Bush recession was the bursting of the housing bubble that inflated during most of Bush’s term in office. Like every state in the union, Rhode Island saw its housing market collapse. This was not the time to raise property tax rates sky high.
In much the same way as austerity begets more austerity by crashing the economy, property tax hikes can lock an economy into a vicious cycle, where higher property taxes depress the housing market, which in turn reduces revenue and requires higher property tax rates. States with large property tax burdens are particularly vulnerable to this feedback loop. Rhode Island, of course, is one of those states with large property tax burdens. Here’s how our tax revenue breaks down by the kind of tax:
One of the consequences of our high property taxes is that our tax system is even worse than usual about taxing the 99% at a higher rate than the 1%. In Rhode Island, the bottom 20% pay a rate of 11.9%, and the top 1% pay a rate of only 5.6%. You can see how the burden breaks down in this (slightly out of date) graph from the Institute on Taxation and Economic Policy’s “Who Pays?” report. (For a fuller discussion of how this works, see Ted Nesi’s excellent piece in Providence Business News.)
In the previous installment I discussed the devastation wrought by massive austerity, which was the principle cause of Rhode Island’s terrible jobs picture. The traditional justification from austerity apologists is that those public sector cuts were necessary, and Rhode Island was forced to make those layoffs. Of course, this argument makes no sense in Rhode Island not just because the cutbacks began before the second Bush recession but also because the government found the money for a huge income tax cut for the rich, cutting the top rate from 9.9% to 5.99%. This brings me to the subject of today’s column: taxes.
As I noted in the first column, the bottom fell out of the Rhode Island economy in late 2007, nearly a year before the second Bush recession began. Perhaps it is just a curious coincidence that this happened as the effect of the income tax cuts for the wealthy passed in 2006 began to kick in, but I suspect not. Indeed, there is considerable evidence that it was these tax cuts that triggered the collapse of our economy.
The details of the tax cuts are slightly complicated. The original tax cut passed in 2006 and imposed an alternate flat tax rate that you could choose to pay instead of the traditional tax brackets. This rate started at 8% and fell by 0.5 percentage per year, hitting 6% in 2010, but in 2010, the government overhauled the tax code again in a tax cut aimed primarily at the upper middle class. You can see the three different rate schemes in the graph below.
Perhaps the most troubling aspect of these tax cuts is that they were pushed largely by Democrats, an act of conservatism that elated the Wall St. Journal’s editorial board. Although they are often called the Carcieri tax cuts, and he vigorously supported them, much of the impetus came from General Assembly Democrats like Speaker of the House William Murphy (D-West Warwick) and Majority Leader Gordon Fox (D-Providence). Fox predicted that “this new tax rate, as it did in Massachusetts, is certain to create new jobs, spur economic development, put money back in taxpayers’ pockets, and otherwise bring Rhode Island to a position of twenty-first century economic leadership in the region and, indeed, in the country.” To say that did not happen is a severe understatement.
Income tax cuts for the wealthy at the national level provide mild, if inefficient, stimulus for the economy because they are offset by increasing the national debt. (Of course, there are much better ways to spend our nation’s money.) At the state level, however, it’s a different story. Because state taxes are deductible from national taxes, which tax the wealthy at a higher marginal rate, state level income tax cuts for the wealthy result in increasing national income taxes. The tax cuts also made it harder for Rhode Island to capture revenue from Rhode Island residents who have income in other states. Because so many wealthy Rhode Islanders work in Massachusetts, this is a serious issue. States can only tax out of state income if their tax rate is higher than the tax rate in the other state. So lowering Rhode Island’s income tax rate for the wealthy results in Rhode Island collecting less revenue from other states and other states collecting more revenue from Rhode Island, on top of sending more taxes to Washington. The net result is a considerable flow of capital out of the state, which is not good for the economy.
The real devastation from income tax cuts for the rich, though, comes from the spending cuts and property tax hikes that offset them. The previous section discussed the spending cuts, and how they accelerated after the tax cuts. The next section deals with the property tax hikes.
I ended my previous post on a promise to dig into the mechanics of how Carcieri orchestrated the downfall of the Rhode Island economy. Naturally, we begin with something Carcieri took great pride in—laying off huge numbers of public sector workers. To show just how severe the public sector cutbacks were under Carcieri, I’ve plotted the Ocean State’s public sector workforce alongside the national numbers since 2000. (Both are normalized to 100 at January 2000.)
Before Carcieri’s cuts began to bite, Rhode Island public employment tracked the national numbers fairly closely, but once his policies were in place, Rhode Island’s public sector decoupled from the national public sector and took a precipitous nosedive. The bleeding has continued ever since. The pace of the widening of the gap accelerated in late 2006 after the passage of the 2006 budget, with its infamous tax cuts for the rich, but things didn’t end there. Even though public employment began falling all around the country in the aftermath of the recession, we still lost 7.75% of state and local public sector employees between January of 2008 and April of 2012—the second highest drop in the nation.
In conservative junk economics, laying off those greedy public sector workers is always a great idea, but of course, in the real world those layoffs can have devastating effects on the economy. To begin with, the jobs lost in the public sector are themselves jobs the Rhode Island economy has lost. If public employment in Rhode Island had followed the same trajectory as it did in the nation since 2000, we would have almost 9,000 more jobs in the public sector than we do now, and the unemployment rate would be 1.6 percentage points lower. Roughly half of our unemployment gap is the direct result of mass layoffs in the public sector.
The devastation caused by public sector layoffs does not end there. When public workers are laid off, their finances are devastated, and they start spending much less, driving down the demand for goods and services in Rhode Island. They also don’t have the money to buy new houses and can often wind up in foreclosure, which has devastating effects on the housing market. Rhode Island also ceases to benefit from the work that the public sector workers used to do. As Scott MacKay notes, Carcieri oversaw a general breakdown of government services that Chafee has spent much of his term in office trying to clean up.
Everyone has their favorite story of mistreatment at the hands of our government, but mine is the angry letter I received accusing me of not paying my state income tax. When I called up to protest that Rhode Island had already removed the money from my bank account, the woman I finally reached explained to me that they didn’t really have the staff to check whether everyone they were sending these letters to actually hadn’t paid their taxes.
Estimating the magnitude of the collateral damage from Rhode Island’s public sector mass layoffs is difficult, but it is probably fair to say that does not explain all of the rest of the unemployment gap between Rhode Island and the U.S. average. Part of the rest comes from other public sector cuts, many of which were far more savage than the national average. Pensions cuts, stagnant wages, and reduced morale most likely took their toll by reducing demand, but these cuts happened in other states as well, and much of the pain is spread out over several decades, so it remains unclear how much they added to our unemployment gap (probably no more than a few tenths of a percentage point).
Although the Rhode Island media are reluctant to use the word, what happened in Rhode Island was basically European-style austerity. When governments decide to throw out a century of economics and pretend that taking a chainsaw to the public sector will somehow magically not wreck the economy, the results aren’t pretty. This is partially because serious austerity measures like Carcieri’s public sector cuts can lock an economy into the austerity death spiral, where austerity weakens the economy, prompting more austerity. This is a lesson being learned not just in Europe, but also in states like Rhode Island that went all in for the same bad economic policies. All across America, the states that opted for austerity during the recession performed worse than states that did not. When conservative extremist Scott Walker took over in Wisconsin and implemented a severe austerity package that prompted mass protests, Wisconsin’s unemployment rate exploded. A similar wave of job losses is currently blowing through the Northeast region as governments from Maine to Pennsylvania opt for mass layoffs. Because Rhode Island’s recent public sector layoffs have been more in line with the national average, we have largely escaped this regional recession.
Comparing us with the broader Northeast region, however, does not usually paint Rhode Island’s economy in a very flattering light. In fact, because most of the Northeast region did not do as badly as the rest of the country, Rhode Island’s singularly bad record is even worse than it looks. So while public sector cuts explain most of our unemployment gap, alone they do not explain all of it. Some other factor must be at work here, a factor that will be the subject of tomorrow’s post.
It may be hard to remember now, but ten years ago, Rhode Island’s unemployment rate was below the national average. Today, of course, it’s the second highest in America. Only Nevada has a worse jobs picture. Clearly, something went very badly wrong. The question is what.
In a multi-part series that will be published throughout this week, I’ll get into the weeds on the specific reasons Rhode Island fell behind. A common theme will be how so many (but not quite all) of the problems originated with the man who is now, as Scott MacKay puts it, “retired in his Saunderstown manse by the sea, hiding from the media and the taxpayers he so avidly fleeced.”
A cursory glance at the unemployment rate graph points to a likely culprit. What is perhaps most striking about Rhode Island’s decline is just how closely it corresponds with the tenure of Donald Carcieri. In his first few months, Rhode Island performed reasonably well. As America surged to the peak of the first Bush recession, unemployment jumped half a percentage point between January and June of 2003, but in Rhode Island, unemployment inched up by only 0.2 percentage points.
But giving Carcieri credit for his first few months makes about at much sense as blaming Obama for losing jobs during his first few months. The real test of a leader is how the economy performs once their policies have had a chance to take effect. In mid-2003, things began to turn around. Although America’s recovery was relatively anemic, with the unemployment rate falling by only 1.9 percentage points from the peak of 6.3% in June of 2003 to a low of 4.4% in March of 2007, things went much worse in Rhode Island. During that period, unemployment in our state dropped by only 0.7 percentage points, from 5.5% to 4.8%. In June of 2005, we crossed the national rate. Our jobs picture has been below average ever since.
Up through early 2007, Carcieri’s Rhode Island was in a slow, but not unprecedented, decline. State economies fluctuate, and our slide in the mid-2000s was nothing out of the ordinary. But things were about to get worse. A lot worse. In late 2007, the bottom fell out of the Rhode Island economy, and unemployment soared. Surprisingly, much of the damage was done before the broader US economy began to collapse a little less than a year later.
By April of 2008, when the second Bush recession began in earnest, Rhode Island’s unemployment rate was already at 6.9%—far above the national rate of 5%. Over the next few years, that gap widened from 1.9 percentage points to a peak of 3.3 percentage points in April 2012, but most of the damage was done before the national recession even began. Clearly, something very, very bad happened in Rhode Island in 2006 or early 2007 to spark this collapse.
There is no magical fairy who pummels the economy whenever conservative Republicans find themselves in office. What devastates the economy is the policies they enact. Tomorrow we’ll begin to dig into the details of those policies and why they were so destructive.
