In the summer issue of National Affairs, Joshua T. McCabe notes that some states have higher “fiscal capacities” than others, meaning they have richer residents and better economies and can thus raise more money through taxes — even with the exact same tax rates. As a solution, he proposes no-strings-attached federal grants to all states with below-average fiscal capacities, big enough to bring them halfway to the average, paid for by eliminating the state-and-local-tax deduction.
Obviously, there’s a political question here of whether the federal government should be doling out money to state governments not to achieve any concrete policy goal, but just to “equalize” states’ fiscal situations. But even if we set that aside, McCabe’s analysis falls short for two reasons: It doesn’t account for cost of living, and it doesn’t take a serious look at all the ways the federal government already does what he wants. Killing the state-and-local-tax deduction is a great idea, as it’s a subsidy for rich people in high-tax states, but this is the wrong way to spend the proceeds.
McCabe compares Massachusetts with Kansas as a way of illustrating the effect of varying fiscal capacities. He notes that the former has a per capita income of $36,600, while the latter has a figure nearly a quarter lower, $27,900. He informs us that despite this difference in incomes, “the costs of providing basic services — education, law enforcement, social assistance — are not that much lower in Kansas than in Massachusetts.” He further believes a man would be treated unfairly if his company moved him from Massachusetts to Kansas while keeping his salary the same, because Kansas would have to charge him higher taxes to provide the same services.
This seems obviously wrong to me. The cost of living is something like 15 to 30 percent lower in Kansas than it is in Massachusetts (depending on which adjustment you use), which in turn makes it cheaper to operate the government there. Police officers and high-school teachers are each paid about 30 percent less, for example, while the median home costs less than half as much and the median rent is 30 percent cheaper too. Unless you prefer Massachusetts for subjective reasons, you should absolutely jump at the chance to move to Kansas with no cut in pay, because your salary will go a lot farther there, and your tax dollars will, too.
McCabe’s cost-of-living blind spot doesn’t just make his anecdotes stumble; it steers his entire policy proposal in the wrong direction. Though he doesn’t credit the think tank, he bases each state’s “fiscal capacity” (and thus the money it should receive from other states) on a report from the Tax Policy Center. To create those estimates, however, all the researchers did was look at each state’s taxable resources (incomes, retail sales, etc.) and calculate how much revenue those activities would generate if the state levied the national average tax rates on them. There’s no adjustment for how far the money will go in the state. As a result, the apparent differences in fiscal capacity partly just reflect cost-of-living differences, with some allegedly low-capacity states able to collect less money but then getting more bang for their buck.
I’m not arguing, obviously, that no state is genuinely poorer than any other. But I am saying that the differences are less than they appear in overall income and “fiscal capacity” statistics, and that correcting those statistics so that the federal government can “equalize” state governments’ ability to provide services would be a complicated, subjective, high-stakes project.
The cost of living is something like 15 to 30 percent lower in Kansas than it is in Massachusetts (depending on which adjustment you use), which in turn makes it cheaper to operate the government there.
Indeed, the TPC researchers themselves assumed this burden. They didn’t just estimate fiscal capacity and call it a day; they then estimated the needs that each state has — kids of school age who require education, poor people who need health care, and so on — and the cost of meeting those needs, starting with the national averages but accounting for “state differences in the costs of labor and other inputs.” Then they subtracted states’ needs from their capacities to see which could meet their needs comfortably and which had shortfalls.
If you wanted to start a federal program to subsidize the state governments that need it most, estimates along these lines would be a better place to start — though I am personally skeptical of the TPC results, as the estimates of “need” are eerily consistent from state to state. They vary only from $7,315 per capita in Hawaii (a state with astoundingly high cost of living, and a high poverty rate as well when that cost of living is taken into account) to $9,411 in Mississippi (a state with very high poverty but a low cost of living), and 39 states and D.C. fall between $8,000 and $9,000. By contrast, the per capita estimates of “capacity” extend from $4,776 (Mississippi again) to $11,404 (D.C.).
The other major wrinkle here is that the federal government is already subsidizing states in various ways (as Josh Barro pointed out to me on Twitter last week). In the TPC analysis, while 44 states had needs that exceeded their own revenue capacity, only 26 still had a gap when federal grants were included. More broadly, to return to McCabe’s Kansas/Massachusetts example, Kansas sees $1.11 in federal spending for every dollar its residents pay in taxes, while Massachusetts gets 92 cents. Mississippi gets $4.70.
Medicaid is an obvious program that dumps money into poor states’ budgets. For every dollar that Mississippi spends on the program, the federal government kicks in another $3.11. In Massachusetts, it’s $1.00, the minimum allowable under the formula, which is based primarily on states’ average income. Kansas gets $1.21.
Other poverty programs, from food stamps to cash welfare to the Earned Income Tax Credit, give money to poor individuals that will be spent in the states where they reside. Further, the federal eligibility thresholds for these programs are not adjusted for cost of living, meaning benefits are easier to get in states that are cheaper to live in. In fairness I should note, however, that 9 percent of Kansas residents but 11 percent of Massachusetts residents receive food stamps. (Mississippi? 19 percent.)
At the top of the income ladder, richer states also get hit harder by the highly progressive federal income tax, which takes an increasing percentage of one’s earnings as they rise. This is arguably unfair to states with high cost of living, because higher incomes there do not solely reflect higher well-being. Somewhat offsetting this for the wealthier residents of those states, admittedly, is the (again, abominable) deduction for state and local taxes.
There is something attractive to the idea of helping poorer states compete with richer ones. But in the end, it would be an impossible and contentious task, and one the federal government is already de facto accomplishing in other, more defensible ways. If life in some states is still dramatically better than life in others, the best thing to do is just let the market handle it, and watch people move from the latter to the former.