TWO R.I. 'REFORMS' HAVE DESTABILIZED  ECONOMY

The Providence Journal, Commentary Page, May, 1999

For anyone unfamiliar with economic development in Rhode Island, large projects are always labeled as "grand slam home runs" by various persons in state government, our legislature, or our governors. I must confess that I have never understood why this designation has been used so frequently. Do our "grand designators" think Rhode Islanders are so unsophisticated they can't see the likely benefits or costs of these projects? Do they think only "grand slam home runs" will be acceptable to our population? Whatever the reason for this, what I will show is that where I was born and raised (New Jersey) we apparently scored things very differently than what has become the standard classification in Rhode Island. This follows from my continual urging for accurate assessments being at the heart of fiscal policy.

Despite how well we might be doing now, Rhode Island has been one of the worst performing economies in this decade. So, at most, we have had one person on base. A home run, if it does occur, therefore cannot be a grand slam. But that's not the end of the world.

The first alleged "grand slam" from the last legislative session that I will discuss is the proposed phase-out of the auto excise tax. Should this tax be eliminated? Yes it should. Can we afford this phase-out? No, we can't.

Focusing only on the direct costs involved, excluding the dominant indirect costs in terms of foregone income and wealth by not using this money for education, the current "best" estimate is that this phase-out will cost $195 million per year from the seventh year onward. Keep in mind that our largest annual surplus has been only about one-third of this estimate for only the direct cost. Given that we are one of the most cyclically sensitive state economies, our downside risk is large. Let's not forget the report by the Federal Reserve Bank of Boston noting that Rhode Island is the only New England state that can be expected to experience serious revenue problems even with a moderate slowing of economic growth. So, is it any surprise that fiscal policy discussion now preaches that we must direct all of the annual tobacco settlement funds into the general fund, allowing us to continue implementing this legislation? How will we bridge the gap between revenues and next year's required funding? This gap will only get wider.

A major problem with this legislation is thus the unreality of its presumed funding. Actually, it's worse than that. The adoption of this measure was done in a piecemeal fashion, evaluating it separately from other measures that were proposed (absent this we get the triple play below).  Using the legislative report card I published in June of last year, it is possible to contrast this with the inventory tax elimination that also passed.

Inventory Tax Reduction: this focuses on the problem, it is a long-term solution, it is investment  oriented, and it uses an existing funding source.
Score: 10.

Auto Excise Tax Phase-out: this legislation gets a very different score. It treats the symptoms of a problem (high property taxes) with a short-term "fix" that is consumption oriented. While it intends to use an existing funding source, and, recently Governor Almond indicated he would allocate all of the tobacco settlement money to fund this phase-out, funding adequacy is still somewhat speculative. Focusing only on the direct costs involved, this requires three times our best annual surplus in this upturn.
Score: 6.

If this legislation is a home run, we must be playing in a very small park. So, adequate funding for this will be unattainable even before the next recession occurs since there are more pressing uses for these funds. When we find ourselves unable to fund this, even in fairly good times, the death of this former "grand slam home run" will quite possibly have a substantial negative impact on consumer confidence, hurting cyclical measures such as retail sales that have propelled us forward over the past several years (translation: one out). In passing, let me remind readers that this legislation recently earned Rhode Island a grade of "D" on its fiscal report card. Perhaps persons in state government here refuse to see how unaffordable this legislation is. Unfortunately for Rhode Island, many persons beyond our borders can.

The second alleged "grand slam home run" is the recent reduction of the taxable wage base for Unemployment Insurance (UI) from its $19,000 value last year to $14,000 as of January 1999. This will clearly lower UI taxes for employers. Estimates of the cost savings are about $45 annually. That's quite a saving! So far, so good.

Unfortunately, no limits on benefit growth were imposed. The maximum benefit rose in July of last year, it will rise again this July and the July following that. And, our ability to sustain the lower taxable wage base will be determined by the amount of money in the trust fund used to finance benefits. When this falls below a threshold level, the taxable wage base will once again be increased.

This legislation is yet another vivid example of treating the symptoms and not the problem, emphasizing the short-run over the long run. Why was our taxable wage base so high? Was it some bizarre coincidence? No, the unemployment experience of unemployed Rhode Islanders helped to  determine this. While the persons who studied this issue generally blamed the wage base on a generous weekly benefit amount, which is part of the problem, apparently the topic of the quality of education here and the (in)appropriateness of the skills of our unemployed never emerged as part of this discussion! Once again, piecemeal policy wins out.

But this legislation is a double play waiting to happen. If proponents of this measure had considered the effects of this policy both in the current recovery stage and in the (eventual) next recession, they might not have been so enthusiastic. When Rhode Island 's economy slows, the number of unemployed will rise, causing the number of persons collecting UI benefits to increase, drawing down the trust fund. It takes time to draw down the fund enough to ratchet the wage base back up very much. So, with our ever-increasing weekly benefit amount and a rising number of benefit recipients, we will attain outflows sufficient to raise the wage base either as the recession is ending, or, more realistically, just after the next recovery has begun. Raising labor costs during a recession! Is that a prescription for success in the information age, or something Herbert Hoover might have done (that's two outs)?

The final part of this relates to who will see their UI tax bills rise the most. The answer is those industries with the highest tax rates. Who are these? Generally, manufacturing and construction. What do they have in common? Very large multipliers. So, the industries that have the most "muscle" in terms of multipliers will be the industries hit the hardest by this legislation, possibly dragging Rhode Island back into a recession. Don't forget that as the economy falls from this, the loss of confidence from having to abandon the auto excise tax phase-out will likely exacerbate problems by hurting consumer confidence and retail sales growth. That completes the triple play.

Putting all of this together, the interaction of the auto excise phase-out and the new "reform" to Unemployment Insurance have actually destabilized Rhode Island's economy. This combination virtually guarantees that our next recession will be longer and deeper than it would otherwise have been. Is this any way to enter the next millennium?

Fortunately, this is not the end of the world for Rhode Island. As I stated earlier, we are in a window of opportunity where we can plan proactively if we have the political will and courage. In the final part of this series, I will outline what I view as viable steps that Rhode Island must pursue.

by Leonard Lardaro