The LePage administration’s Q2 analysis gets it wrong

Economic impact analysis is not an exact science. It is rife with assumptions. Bad assumptions result in bad analysis. And bad analysis yields bad public policy.

Look no further than the “Kansas experiment” for the disastrous consequences of policy based on such junk science. The mastermind behind the Kansas tax reform, Arthur Laffer, is notorious for peddling an economic theory that has no grounding in the real world. He based his recommendations on flawed assumptions about how the economy works. As a result, the tax cuts for the wealthy based on the Laffer model have devastated the Sunflower State’s schools and economy.

The latest entrant in the “garbage in, garbage out” impact analysis competition comes from Maine’s Office of Policy and Management (OPM) housed in the governor’s office. OPM claims to have analyzed the potential economic impacts of the 3 percent surtax on incomes over $200,000 created by the education funding initiative or Question 2 that voters approved last fall. Not surprisingly – and in keeping with Governor LePage’s rhetoric that this would be a disaster for Maine’s economy – the OPM study predicts job losses in the thousands, population declines in the hundreds, and a reduction in state GDP and disposable income in the hundreds of millions all as a result of the new surtax.

The OPM analysis makes a huge assumption unsupported by any credible evidence.  OPM’s estimates assume that 5% of the 16,000 Maine residents affected by the education surtax will flee the state en masse.  A large and growing body of economic research fails to support such sizable or significant impacts of state tax policy on cross state migration patterns. The Center on Budget and Policy Priorities’ evidenced-based research confirms that tax-induced out-migration, especially at the level suggested by OPM, is a myth.

OPM claims major negative economic impacts will occur within the first year that Question 2 is implemented. For those who are keeping track, Question 2 took effect this year. Many wealthy households are already paying the surtax. For OPM’s estimates to hold, more than 750 wealthy people would need to flee the state in time for their absence to trigger a significant downturn in economic activity that would need to be felt almost immediately. This is farcical thinking that makes for a specious model.

There are more credible ways to model the impacts of Question 2 that don’t rely on such far fetched assumptions and are more consistent with how we know the economy actually works. Question 2 will raise almost $150 million through a 3 percent surtax on annual income above $200,000 and invest that $150 million to boost education spending and, over time, also help to support local services or limit increases in property taxes. The simplest way to model this would be to subtract $150 million from the total incomes of households with income above $200,000 and allocate it to education spending. When MECEP did this using IMPLAN, a modeling software similar to the software used by OPM, the outcome is very different from that OPM purports.

The net effect of Question 2 based on this approach yields the creation of approximately 1,800 new jobs and an additional $127 million in economic activity. The reason for the net gain in employment and output is simple. Wealthy people are more likely to sit on their money and are less likely to buy goods and services with that extra dollar of income than poor and middle income Mainers. Stated differently, a dollar in the hands of a rich person is less likely to be spent than a dollar in the hands of someone who makes less and needs to spend a greater share of income to provide for his or her family.

In the case of Question 2, the $150 million in new revenue will support teachers’ salaries and equipment and materials used in the classroom. As teachers spend more to buy groceries and other necessities, the effects of these purchases will ripple through the economy and multiply much more than if those dollars weren’t available.

Clearly the model above is overly simplistic and is intended to be illustrative. A more accurate accounting of the economic impacts of Question 2 would take into account the fact that it is unlikely that the entirety of the $150 million will represent new spending on education. As more state dollars are available towns may choose to cut back their local contribution to education thereby offsetting some of the increased state funding. Some towns may then use the dollars made available by this change to increase funding for other services like snowplowing or public safety. Other towns may use the same dollars to reduce property taxes for residents and businesses. These are all assumptions that can be included in a more complex model and they would still result in a net gain in economic activity.

Going back to OPM’s core assumption, we can even assume out-migration in our model. In order for Question 2 to have a net negative impact on jobs and the economy, we would have to assume that close to 400 wealthy people accounting for over $340 million in income will leave the state as a result of the surtax. That also assumes that those people do not have a part-time presence in Maine (i.e., they’ve left the state for good) and that no one with income above $200,000 moves into the state for any number of reasons (e.g., quality of life). A net out-migration of this size is still far greater than the research supports.

OPM’s analysis simply misses the mark. This is of particular concern since it has the potential to influence future economic and revenue forecasts for the state. While forecasters should try to account for changes in policies on the state’s economy, they should also be wary of any analysis that is flawed in its approach and relies on unfounded assumptions.

We strongly encourage the media and state forecasters to recognize the flaws and misconceptions of OPM’s analysis and demand a more credible and sound alternative.