Contributors
Gary M. Galles - Contributor

Mr. Galles is a professor of econmics at Pepperdine University.

Taxes and Spending Are Not Created Equal
The hidden costs of legislative spending...
[Gary M. Galles] 12/2/03

Governor Schwarzenegger has proposed the first small installment of spending cuts that will be necessary for California to start closing its budget chasm. In response, he is being pilloried for how unfair each cut is. And the Democrats in Sacramento are using (if not orchestrating) the outcry to maneuver for their still-favored tax increases instead, especially since a Republican can be forced to bear the heat.

But the constantly repeated Democratic mantra that any spending cut is too costly to bear (which implies that the alternative of tax increases is not!) has it backwards. Government spending and taxes are not created equal. In fact, tax increases are far more costly than reining in spending. The taxes to fund a dollar of government spending cost Californians far more than a dollar.

Where do the extra costs of government spending arise?

An appreciable part of both expenditure programs and the taxes that finance them go to cover administrative costs, so that providing a dollar of services to beneficiaries requires that this added cost must be covered as well.

Large compliance costs are also imposed on both taxpayers and recipients by the often very complex rules they are forced to follow, costs which are real, even though they are omitted in government budgets.

The ever-changing rules also introduce substantial added risks of future alterations, which can turn virtually any good decision into a bad one at the whim of a legislator, judge, or bureaucrat.

The most important surcharge to the cost of a dollar of government spending, however, is the added social cost of raising the tax revenue to fund it. Taxes introduce a wedge between the value to buyers of the goods and services provided and what sellers receive after taxes are taken out. And the wedge created by California's taxes come on top of the burdens from federal taxes and state and federal regulations. This eliminates many jointly productive transactions that would otherwise take place, and the wealth they would have created. And the higher this cumulative burden, the greater the destruction of wealth.

Suppose someone faced a 40% combined tax rate on added income, far below the rate for many, given that multiple, often hidden taxes are often imposed on the same stream of income-creating services and the purchases they finance. That would mean that every transaction that provided $100 of value to the buyer but cost more than $60 that would be left to the seller government's "cut" would no longer be made. In other words, every arrangement in which the gains were less than 40% would be wiped out, and the gains they would have generated disappear with them. Raising taxes further would destroy still more wealth creation.

Including all these largely hidden costs of taxation implies that the true social cost of even a "well spent" state budget dollar substantially exceeds a dollar. Therefore, even if it could be demonstrated that a particular spending program generated more in benefits than their dollar cost (which, of course, has not been demonstrated for the programs in question), it still would not justify tax increases rather than spending cuts.

To be justified, the benefits of spending would have to exceed not just the dollars spent, but all the costs entailed, including the added administrative, compliance, and uncertainty costs, plus the very substantial costs from gains wiped out by the greater tax wedge necessary to fund that spending. The list of spending that can meet such standards is very short.

So when the Democrats assail Governor Schwarzenegger, perhaps he can ask THEM to justify the hidden costs of the boundless spending that has become the sorry hallmark of California's legislature.

copyright 2003 Gary M. Galles

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