Taxes Matter VI . . . more than “Public Investment”


In a classic example of Orwellian Double-Think, “government spending” in now “government investment.” Naturally, this implies that government spending has a surplus benefit above and beyond the taxes raised to finance the spending. There has been a firestorm in academia debating whether or not this is true. A recent article published in the Review of Regional Studies by Stephen Brown, Kathy Hayes and Lori Taylor titled “State and Local Policy, Factor Markets and Regional Growth” sheds new light on this issue–find article here. The working paper, essentially an early draft, can be found on the Federal Reserve Bank of Dallas’s website here.
Let’s start with their conclusion:
“Consistent with the previous literature, we find that some state and local government expenditures more than offset the negative effects of the taxes used to finance them. Most do not.” p. 53
“Apparently a large public sector crowds out and substitutes for growth of private labor and capital.” p. 53
“We also find that the increased provision of public capital may discourage labor in-migration . . . some forms of state and local public capital have been increased to the point that (for the average state) further increases reduce private output. The net effect is that the increased provision of state and local public capital appears to reduce private gross state product–although total output may be higher.” p. 53
This is precisely the result that I have discovered in Maine’s Public versus Private Sector share of the personal income–report here. Since 2000, the public sector has accounted for all the growth in personal income while the private sector has actually shrunk. This appears to be a real-world example of the public sector crowding out the private sector as found by the authors. So when evaluating the “virtues of government investment” just remember that the “dead-hand of taxes” often outweigh the benefits of spending.
To read more great quotes from the paper, click “continue reading” below.

“. . . states where public capital stocks are growing rapidly tend to experience less private sector growth than other states. None of the types of public capital are positively associated with growth in the private factors of production or with rising private sector output. Growth in highway capital and water and sewer capital is significantly negative in all three equations. Growth in other public capital also has a significantly negative relationship with private employment and output.” p. 48
“. . . few public services appear to be systematically under provided. There is no combination of rising taxes and rising public spending that is positively associated with growth in private capital. ” p.48
“Private capital is attracted to states where higher education spending is growing, but only if it is financed through tuition charges; higher education spending financed by taxes is generally unattractive.” p. 49
“If anything, most public services do not appear to justify the taxes needed to finance them. Any tax savings financed by slower growth in environmental services, health and hospitals, or elementary and secondary education is positively associated with growth in private capital. Similarly, any tax savings financed by slower growth in public safety or education spending is positively associated with growth in private employment” p. 50
“. . . this finding would seem to imply that other state and local public capital has been increased to the point of negative returns, perhaps because a growing stock of other public capital is indicative of an increasingly intrusive government.” pgs. 51 and 52