Dr. Vedder Testifies before the Ohio Senate Finance Committee

TESTIMONY OF RICHARD VEDDER

GENERAL GOVERNMENT SUBCOMMITTEE

OHIO SENATE FINANCE COMMITTEE

Good morning. I am Richard Vedder, Distinguished Professor of Economics Emeritus at the Ohio University, and also serve as an Adjunct Scholar at the American Enterprise Institute in Washington. I am representing no one but myself. I am here to talk first briefly about state fiscal policy and the budget, and then to speak about the need to streamline and simplify state governmental operations.

          In meeting the needs of the people of Ohio, the State must tax the citizenry. The magnitude and characteristics of that taxation can materially impact on the well-being of present and future generations of Ohioans. The Buckeye State has income levels below the national average, whereas 75 years ago, in 1940, this was a relatively high income state. Over the past three-quarters of a century, economic growth has been lower in Ohio than the nation as a whole. This growth deficit is arguably Ohio’s premier problem. It is true that in the past five years or so, Ohio has looked pretty good, not only sharing in the admittedly somewhat sluggish national recovery from the recession ending in 2009, but outperforming the nation in several key indicators.

          In 2008, when we were in the midst of the last recession, Ohio’s personal income per person was almost 11 percent below the national average, whereas last year it was only 7.7 percent below. Put differently, 30 percent of the income deficit between the Buckeye State and the nation was eliminated. Moreover, the record is particularly good the last couple of years. From 2012 and 2014, in inflation-adjusted terms, personal income per capita rose an anemic one percent nationally, but well over twice as fast, 2.6 percent, in Ohio.

          No doubt many factors have entered into the recent superior performance in Ohio. One of them, however, is that Ohio is beginning to shed its reputation for having high taxes and regulation. This reputation, generally well deserved, led to a net out-migration of both human and capital resources throughout recent decades. With difficulty, the state balanced its budget through the economic downturn, and subsequently has cut taxes to boot. Paraphrasing an Ohio promotional motto of decades ago, “profit is no longer a dirty word in Ohio.” In 1982, the income tax, which had not existed a decade before, had a top rate of 9.5 percent. It is now 5.33 percent, and the Kasich administration has proposed a dramatic reduction, which, I understand, the General Assembly wants to scale back in order to avoid some tax increases that the Administration has proposed.

Still, the General Assembly appears poised to reduce the overall tax burden further, in particular the income tax. For this you are to be highly commended. The overwhelming body of scholarly statistical evidence suggests that high marginal income tax rates are inimical to economic growth. In general, economic growth has been far more robust in no income tax states like Texas, Tennessee and Washington than in high income tax jurisdictions such as California, New Jersey or, increasingly, Illinois.

          The Tax Foundation’s 2015 Business Climate Index has Ohio ranked a lowly 44th, at least 10 ranks below all of our neighboring states; Indiana ranks a very high 8th. The Small Business Tax Index, however, ranks Ohio a very good 9th, compared with 18th just three years earlier. The tax relief for small business incorporated in recent budgets is no doubt responsible for this good ranking. The state income tax in our big neighbors –Indiana, Michigan, and Pennsylvania –all with flat rates, ranging between 3.07 and 4.25 percent range, are still well below proposals in the coming budget here in Ohio.  The House bill lowers the top marginal rate on the income tax to 4.9 percent, an improvement over the current rate. I wish the income tax reduction were somewhat larger, which I think could be obtained by some reforms in Medicaid funding. I question the expansion of Medicaid that the state took at the Governor’s insistence in the current budget. That is going to start costing us in the coming budget, and a good case can be made that that decision should be reconsidered.  Beyond that, seeking waivers to issue Health Savings Accounts and other ways of offering low income consumers some role in their health care decisions can both increase human dignity and save money. The top marginal tax rate on the income tax at the very minimum should fall 10 percent or more from current levels, to no higher than 4.8 percent. That is doable. I am not going to get into a detailed examination of the tax system today, but must add I have always been disturbed by the Commercial Activities Tax, a levy that is particularly obnoxious to economists because it violates very basic principles of tax neutrality through its pyramiding features. Increasing that tax is not wise and it is one reason, no doubt, that we are mired at 44th in the Tax Foundation’s Business Climate index.

          The bottom line is that people respond to incentives, and the disincentives imposed by state taxes are relevant to explaining variations between states in economic growth. I commend you for the direction you are moving, but wish you would move in an even bolder fashion with respect to income taxation.

          Let me talk a bit about the organization of state government. I decided to count the number of entries under “State Agencies” on the State of Ohio web site and came up with 172. To be sure, some of those are programs within the same agency –but do we really need to have a Grape Industries Committee? What does it do? Run a cartel for grape growers?  More generally, I strongly suspect that many of the agencies not only spend money but do harm to consumers. Doesn’t the Cosmetology Board restrict entry of qualified persons into the business of cutting hair, for example, as does, no doubt, the Ohio Barber Board? Do we really need two boards restricting entry into the profession in this area? State licensing boards on balance probably hurt, not help, consumers because they are regulators who are captured and controlled by those regulated. To be sure, they probably are funded by fees charged to those regulated, but this is a function that government could largely shed, improving competition, lowering consumer prices, and simplifying Ohio government.

          The last time I checked, there were 15 executive departments in the U.S. government, an organization that is by most measures well over 50 times as large as Ohio state government. The President’s cabinet consists of 23 persons, the largest number in history, and many think some of those persons, such as the head of the Small Business Administration, really should not be considered cabinet-level appointments. Yet Governor Kasich, running a much smaller operation, has 25 in his cabinet, a number I suspect most management experts would say is far too large to work as a team in making good decisions. Some Ohio departments deal with similar issues and arguably should be consolidated, the best example being the Ohio Department of Education and the Ohio Board of Regents.

          Over the last seven decades, there were two worthwhile efforts made to reform the unwieldy federal government –and, by the way, they are overdue for another. After World War II, the Hoover Commission, directed by the former president, made useful recommendations to streamline the federal government, for example, merging the Department of War and the Department of the Navy into one Department of Defense. In the 1980’s, the Grace Commission similarly made useful recommendations to streamline the government organizationally.

          It strikes me that it might be useful to have a little Grace Commission here in Ohio. As one who has served on a major federal commission tasked to recommend reforms, I have some experience about how such a commission should look. First, you want to bring fresh faces and ideas to the process of reorganization, so don’t have it dominated by politicians currently in office. The Commission I served on did have a retired Governor, a retired cabinet member, and so forth, but no sitting congressmen or governmental officials, although three cabinet members served in an ex-officio capacity. Pick mainly business persons with experience with large organizations, perhaps a couple of retired persons with a political background, maybe an expert or two in management, etc. Keep the commission relatively small, under no circumstances larger than 20. Don’t be partisan about the appointments –be sure you have a healthy number of Republicans and Democrats, and maybe a healthy number of persons whose politics you don’t even know.

 Appoint someone with a good reputation as chair. A name that comes to mine is former Governor George Voinovich, who had a reputation as a good manager and worked well with people in both parties. Maybe make Governor Voinovich and former Senator John Glenn co-chairs, analogous to the Simpson-Bowles federal budget commission that did stellar work a few years ago but whose recommendations lamentably were ignored. Or perhaps appoint a former head of a major company like Procter & Gamble or Sherwin Williams. Give the commission a small budget so it can research efforts in other states and nationally to reform governmental operating processes. Give the Commission a little time, but not too much time, to gather information, deliberate and make recommendations –a year is about optimal, I would think. Have a few hearings, including ones in Cleveland, Columbus, and Cincinnati. Let the public express themselves but put limits on witness participation and don’t allow lobbyists to dominate the proceedings with their pet ideas.

          Professors love to talk in 50 minute sound bites. But diminishing returns are setting into my testimony, so I will quit while I am ahead and say thank you and of course answer any questions.