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How does taxes affect the economy

how does taxes affect the economy

How does the recession affect state and local governments?

Barely a day goes by that we don’t hear something on the news about the ailing economy. But the more you look around, the more you’ll begin to actually see effects of the economic downturn in your hometown.

In Philadelphia, large retail stores and small boutique shops are going out of business. High rent leaves those storefronts and properties vacant. This is echoed in the nearby suburbs and across the state of Pennsylvania, where large companies – such as the Pittsburgh-based Alcoa Aluminum - are also instituting sweeping layoffs. Likely, you or someone you know has been affected by employers cutting their budgets. And whether it’s within the walls of the state capitol in Harrisburg, or in your own local municipal halls, governments are being hit just as hard.

The budgets of state and local governments rely on tax dollars - whether it’s income tax, sales tax or business tax - to fund their day-to-day operations. When the economy is in a downturn and businesses are doing poorly, that filters fewer tax dollars to the government; businesses that close cannot pay business taxes, people who are out of work cannot pay income taxes, and they cannot shop as much, which means less sales tax. And a decrease in tax revenue means a decrease in state or municipal services.

In Philadelphia, drastic cuts have had to be made to city services such as libraries, pools and snow plowing. Cuts were also imposed on the state budget, where legislators have instituted a hiring freeze and eliminated pay raises as a means of dealing with the recession.

What is a recession?

A “recession” (different from a “depression”) means that, overall; the economy is experiencing a decline in growth that lasts from a few months to a couple of years. These happen from time to time and are thought to be normal features of the economic cycle (we last experienced one in the United States from 2001-2003). A depression is a severe form of recession in which the effects are much more pronounced and last much longer - we haven’t had one of those since the Great Depression from 1929-1939.

Economic growth is measured by many factors, including rates of employment and the cost of goods. But the Gross Domestic Product (GDP) is the primary measure; the GDP is a gauge on the health of the national economy that represents all the goods and services produced over a period of time. Essentially, the GDP is the size of the economy.

When the national economy is in a recession, it generally means:

Fewer jobs are being created and more people are losing their current jobs.

Factories and industries are not producing as many goods as they were in prior months.

Banks lend less money to customers. This leads to difficulty in getting loans for homes, cars and other expensive items. Those industries begin to suffer as well.

As other businesses begin to feel the crunch, the GDP declines, and the growth of the economy slows.

When the economy is in a recession, you might find it harder to find a part-time job. Not only are many companies trying to cut costs, more people are unemployed and looking for work. If you do have a job, the prices of goods will likely go up, meaning that your dollar will not go as far as it did in the previous months

A State Perspective: how Harrisburg copes

In Harrisburg, lawmakers are facing a severe budget shortfall, and with no end to the recession in sight, it could keep growing. Gov. Ed Rendell’s initial projections of a $1.6 billion deficit have grown by an additional $100 million in the past months, according to The Philadelphia Inquirer .

“The problem is very daunting,” Rendell told reporters at a Philadelphia news conference. “Virtually every department will feel the pinch.”

The legislature has been forced to deal with the budget shortfalls through a number of venues. In order to cut costs, Gov. Rendell drafted a budget that eliminates pay raises for state employees during 2009 and imposes a hiring freeze across the board, leaving some 5,000 open positions vacant in various departments across the state. Rendell plans to seek aid from the federal government as well, but the one of the biggest ways the state hopes to save money is through cuts in specific programs and overall state agencies. Among them:

The Department of Community and Economic Development, with a budget of over $600 million, is seeing its budget slashed by 5.6 percent, the largest departmental cut. The Health Department will cut funding for smoking ban enforcement by 15 percent, or $300,000. The Scranton School for the Deaf, the only state-owned school for the hearing-impaired, will cut its budget by 10 percent, or $754,000. State cabinet secretaries were ordered to rope in spending by 4.25 percent; in the state tourism program, this amounted to $318,000.

The amount of cuts has expanded in step with the budget deficit, from $311 million to $464 million. Some state legislators, like Rep. Eugene DePasquale of York County, have protested, saying in interviews that some departments such as health care and education should be off the table when it comes to cuts.

But Rendell sees the cuts as a necessary evil in spite of protests. “We are going to do everything we can to get through this with as little harm as possible,”

he said in a press conference. “But I also want to remind people that the cuts are coming, and I don't want to hear any whining.”

A Tale of Two Cities: cuts at the local level

On the western side of Pennsylvania last month, the Pittsburgh City Council, in a 6-2 vote, passed a budget that contained no tax increases, continued annual state-mandated reductions in the parking tax and did not drastically change any city services.

“We’re at an all-time high in employment for the region, higher than it ever was even during the war years,” said James Rohr, outgoing chair of the Allegheny Conference on Community Development, in a Pittsburgh Post-Gazette story. “We've done a remarkable job of coming back and prospering.”

This may change with the troubles of the Pittsburgh-based Alcoa aluminum, which recently announced that it would cut 13,500 jobs company-wide to weather tough economic times. But for now, the decline in the regional manufacturer has not trickled down to have a negative effect on the city budget. Not everywhere in Pennsylvania has been so lucky.

At the same time that Pittsburgh was debating its budget last fall, Philadelphia Mayor Michael Nutter announced the drastic cuts that caused an uproar among residents and officials alike. The more contentious points in Nutter’s proposal included: Closing 11 libraries and 68 municipal pools.
  • Cutting back on slow plowing for small residential streets.
  • Discontinuing collection curbside leaf piles, bulk trash and tires.
  • Reducing the number of new police department hires from 400 to 200.
  • Delaying the reduction of business and wage taxes.
  • Shrinking City Government by 800 positions.

Proportionally in Philadelphia, the city’s Office of Housing and Community Development is the hardest hit, with its budget shrinking by 40 percent in the next two years. The Streets Department is next with a 28 percent reduction, followed by the Free Library system, which will experience 20 percent cutbacks. Other departments, such as the prison system, will not loose funding.

“Make no mistake. This will be a mid-year revision of incredible proportions,” Nutter said upon announcing the cuts. “And because this recession will probably linger beyond (2009), we can't look for brief, one-time changes. We need real change, and we need it now.” Compared with the state’s other major metropolis, these cuts seem even more severe. But Rohr suggests that Pittsburgh, historically an economically troubled area of the state since the steel industry fell into decline, “has not maybe enjoyed some of the excesses that other regions had, so we're not as much at risk” by the economic downturn.

Some of the cuts in Philadelphia’s budget will be permanent, according to the mayor. Others cut programs may be reinstated if the economy improves. But Nutter won’t speculate on how soon that might occur.

“We always look to a brighter future,” Nutter said in an  Inquirer interview, “but we have to deal with the day that's in front of us.”

Higher taxes versus rainy-day funds

With plummeting budgets and economically-troubled citizens, it’s difficult to think of raising taxes. But that’s exactly what some economists say is the sensible thing to do in this financial climate.

The Pennsylvania Budget and Policy Center, a liberal think tank in Harrisburg, suggested in a Times-Tribune interview that budget cuts in a bad economy are actually counterproductive.

“They draw money from local communities,” center director Sharon Ward said. “They reduce services at a time when demand for those services is likely to grow, and they put additional pressure on local governments and ultimately local taxpayers.”

Drawing out an example, Ward pointed to Rendell’s proposal to cut funding for a list of higher education institutions by six percent. This will make budgeting at those universities and colleges more difficult, possibly leading to tuition increases. Tuition increases could cause a drop in enrollment, exacerbating the school’s budget problem and ultimately trickling down the state’s budget in terms of tax dollars.

By comparison, Ward points out that the state income tax - 3.07 percent - is the second-lowest in the nation. The sales tax rate at six percent is “in the middle range of states.” It calls for an adjustment in the tax structure away from its current flat tax to a graduated income tax where tax rates increase in step with income.

But many officials are vowing to fight against heightened taxes in any form. “I don’t think it would be fiscally wise to hurt residents with more taxes at a time like this,” Rep.-elect Seth Grove of Dover Township told the Evening Sun. His views are echoed by Sen.-elect Richard Alloway of Chambersburg, who suggests the state tap its reserve of $750 million known as the “rainy day fund.” He favors using the entire fund if necessary.

Rendell has also called upon the legislature to dip into the rainy day fund, and Rep. Dwight Evans of Philadelphia has also urged dipping into the legislature’s own $240 million reserve.

“This is more than a rainy day, it’s a Hurricane,” Evans said in an Inquirer interview.

What do you think?

How should Pennsylvania and its cities deal with the economic downturn? Are deep cuts into programs and services the way to go, or should lawmakers consider tax increase? What about the state’s rainy day fund - should that be spent or preserved in case the economy gets worse? How has the economy affected you and your community? Join the discussion!

Category: Taxes

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