The Skeptical Liberal: 11/18/2007 - 11/25/2007

The Skeptical Liberal

How can we live together in peace, prosperity, and harmony, while retaining our liberties as autonomous individuals who can, and must, create our own values? -- J.M. Buchanan


High taxes can spur growth??

The headline caught my attention: “MSU researcher says high taxes can spur growth.”

The source—MSU’s bulletin of events and news—went on to say that the researcher found that “cities with high taxes and spending on public infrastructure and welfare … tend to experience more commercial growth.” On its own, such a statement might be simply a statement of the fact that vibrant cities will see both tax revenues and spending rise as growth occurs, although it seems to get the causation backwards. But the article suggested that the author’s point was different: the argument about taxes and growth was offered as a defense of high tax policy. The latter claim sounded wrong to me, so I went to see what I could make of it.

Igor Vojnovic's article, “Government and urban management in the 20th century: policies, contradictions, and weaknesses of the New Right,” was published in GeoJournal last December. Vojnovic is a professor of geography at MSU. Turns out that the article has little to do with the relationship between tax levels and economic growth: most of its thirty pages is a critique of neo-liberalism as a philosophical framework for urban development. While I could spend time on Vojnovic’s rather confused understanding of both neo-liberalism and its alternatives, my point in pursuing his argument was to see how he could be lead to believe that high taxes could led to economic growth. So I’ll stick to that argument here. We finally get to the point on page 19. Vojnovic summarizes the claim he is making this way: “Simply, U.S. cities that follow the minimal government strategy are not ranked as top private corporate investment destinations. The urban regions that attract private capital, in terms of concentrations of multinational headquarters and first-level subsidiaries, maintain some of the highest taxes and social service expenditures in the country.”

The leap of logic here confuses me. High taxes and social investment spur growth because urban areas that attract the head-quarters of large corporations and their major subsidiaries have high taxes and significant social investment? What does the presence of the head-quarters of large corporations have to do with economic growth in a region? And perhaps even more importantly, how is economic growth related to the decision of such corporations to set up new office locations? Few companies make significant location or relocation decisions each year (about 6%, if our research can be believed). No location or region could depend upon such relocations as the foundation for economic growth!

Most “commercial” growth, in fact, occurs among small- and medium-sized companies (note that commercial growth does not necessarily translate into growth in per-capita GDP, which is our usual measure of economic growth). Those companies often experience double-digit rates of growth as they go through the early stages of their life cycle. Their growth is quite sensitive to rates of taxation, and often do not depend upon the levels of what Vojnovic calls “social investment.” They tend to be driven by pragmatic issues: proximity to the relevant portion of their supply/value chain; access to human/intellectual capital; etc. Large centers get their share of these companies because of these issues, despite their disadvantageous tax environments! In short, Vojnovic has put the proverbial cart before the horse.

So should we adopt high taxes with correspondingly high levels of social investment to rebuild prosperity in Michigan? We already have relatively high taxes, so that is a moot point! What we need, however, is an environment conducive to the growth of innovative and entrepreneurial companies, regardless of their location within the state. Vojnovic’s development strategy is not helpful for that purpose.

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