Restrictions on state finances exacerbate income inequality

April 20, 2021

Restriction on state spending often perpetuate race-based income inequality going back decades. (AP Photo/Victor R. Caivano)

Restricting state tax revenues or spending exacerbates income inequality, making these limitations "bad public policy," the researcher behind a new study says.

The U.S. has a long history of "tax revolts," and most of the country has some kind of taxation and expenditure limit, many of which were passed by citizen votes. The tax limits intentionally hinder the fiscal flexibility of states, thus hindering the state's ability to address rising income inequality, the researchers argue. 

This study, published March 24 in Economics & Politics, measured the restrictiveness of the tax and expenditure limits in 35 states that have them, then analyzed income inequality in 49 states overall from 1992 to 2010, omitting Nebraska because of data incompatibility. 

States with no or less restrictive taxation and expenditure limits tended to have lower measures of inequality. For example, in the 2010 data, states with no or less restrictive limits, such as Wisconsin, Illinois and Iowa, had significantly less income inequality by one measure than states such as Rhode Island, Utah and Florida, which have more rigid limits.

Across four different measures of income inequality tied to both individual years and the whole 19-year study period, the researchers consistently found that in states with taxation and expenditure limits, "the more restrictive you have them, the more they tend to lead to higher income inequality," said Steven Deller, the lead author of the paper and a professor at the University of Wisconsin, Madison. 

"None of the models gave us conflicting results," he told The Academic Times. "None of the models said that a more restrictive tax and expenditure limitation led to lower income inequality. We did not get that result. We got either statistically insignificant or bigger income inequality."

The researchers controlled for other factors that influence income distribution, including the unemployment rate, the union membership rate, the percentage of people over 65, the percentage of people who went to college and the percentage of households with a woman as head of household. 

Income inequality has increased dramatically since 1960, as sources of income have changed. According to the Pew Research Center, upper-income households had 29% of U.S. income in 1970, while middle-income households had 62% and lower income households had 10%. By 2018, upper-income households had 48% of the U.S. income and middle-income households had 43%; lower-income households had only 9%.

"Most people think the majority of income comes from work, which would be wages and salaries from proprietor income," Deller said. "That was true maybe back in the 1960s and 1970s. But it's not true today." 

From 1958 to 1960, 79.8% of personal income was from net earnings; by 2015, only 63.9% of total income came from net earnings. During those years, income from transfer payments — such as money from pensions, annuities and Social Security — went from 6.2% to 17%, while income from dividends, interest and rent rose from 14% to 18.8%. The increases in non-work-related income came partly from an aging population reaching retirement, and they also reflect money flowing to people who already have enough excess income to invest in the stock market. 

"Why do we have this growing pool of billionaires? It's the stock market," Deller said.

Previous research in the Public Finance Review has indicated that growth in income increases the likelihood of a taxation and expenditure limit being passed, as do increased property values that lead to to increased tax revenue from property taxes specifically. An increase in total tax revenues, however, makes it less likely for a limit to pass. This could be explained by wealth: People with more wealth, including property, are less likely to urgently need services from government, and so they may support defunding government. For example, a rich person may be able to afford to send their children to private school, so they feel their family is unaffected by a decline in tax revenues that weakens schools primarily attended by their lower-income neighbors in the state, the researchers wrote.

Deller said his co-author, University of Missouri economist Judith Stallmann, had argued "that there's this underlying racist sentiment in some of these things going back historically."

Indeed, researchers pointed out in a 2018 Center on Budget Policy and Priorities report that the first time a state required a "supermajority" vote for tax increases — but no equivalent for tax cuts — was in 1890 in Mississippi, through legislation championed by a politician who was explicitly stripping political power from previously enfranchised Black men. One of the oldest property tax limits in the nation is Alabama's, a law enacted at the turn of the 20th century to protect white property owners from Black politicians in the event that they returned to power and wanted to better fund public services. 

Moreover, Deller said that when he was involved in Wisconsin's discussions of whether to implement a taxpayer bill of rights modeled on Colorado's restrictive taxation and expenditure limits, he found that many legislators were disingenuous. 

"There were a handful of politicians that thought it was actually good policy," he said. "Those folks I respected. We could agree to disagree. But there were a lot of politicians in Wisconsin that knew it was bad public policy, but it was good politics. Those are the ones that I would campaign to get voted out. They're playing political games." 

And while limiting the government's ability to levy taxes or spend money may score politicians points, especially with more affluent and influential voters, Deller begged, "please don't do that."

The study, "Do tax and expenditure limitations exacerbate rising income inequality?" published March 24 in Economics & Politics, was authored by Steven Deller, University of Wisconsin, Madison; Craig Maher, University of Nebraska, Omaha; and Judith Stallmann, University of Missouri.

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