Economic Impacts of Possible Tax Policy Changes

1. Economic Impacts of Possible Tax Policy Changes Analysis of CP2C1 Dr. Tony Villamil Dr. Robert D. Cruz Taxation and Budget Reform Commission Tallahassee, Florida March 17, 2008

2. CP2C1 (3/11/2008) • Brief Description • Replaces required local effort (RLE) ad valorem taxes for education with one or combination of the following: • A one cent increase in sales tax rate • Revenues gained from repeal of some sales tax exemptions, and • Offsetting reductions in other components of state budget or set-aside of funds from growth in state revenues • Mandates replacement of RLE in FY2010-11

3. CP2C1 Simulation Parameters • Developing an impact simulation requires a projection of future RLE • RLE grew by 7% from FY2006-07 to FY2007-08 (current). For simulation purposes we projected an increase of 6.4% per year over current RLE to project its value in 2010-11 • The projected required funding to replace RLE in FY2010-11 is $9.52B • Actual growth in RLE will depend on actions by legislature and governor

4. CP2C1 Simulation Parameters • How will the required RLE replacement revenues be raised? • Two simulations are performed, representing the range of possible policy choices • Simulation CP2C1-A • Penny sales tax to raise $4.55B in FY2010-11 • Removing exemptions on “non-protected” goods resulting in projected revenues of $4B • $970M gap ($9.52B less $8.95B) filled by using growth in state revenues or spending reductions

5. CP2C1 Simulation A Parameters • The direct effects from CP2C1 • Elimination in RLE saves Florida households $4.7B on an after income tax basis • Elimination in RLE increases capital income of rental residential and commercial property owners by $2.4B (model takes care of calculating income tax liability) • The projected increase in sales tax revenues falls short of funds needed to eliminate projected FY2010-11 RLE, requiring redirection of funds from state spending. • Eliminating some exemptions broadens the tax base and allows local option tax revenues to rise by $488M.

6. Systems Approach to Tax Policy: The Circular Flow of Income and Expenditures Source: REMI, Inc., REMI Policy Insight User Guide.

7. Advantages of Using a REMI Model for Significant Policy Change • These types of models explicitly recognize the complex interactions that take place within a macroeconomy – spending, income, costs of production, capital investment, population growth and capital migration are all inter-related. • Policy changes are examined within a “general equilibrium” as opposed to a piecemeal, “partial equilibrium” framework. • The impacts from policy changes on productivity and regional competitiveness are explicitly considered. • The effects of policy changes over time are shown through changes in the capital stock, population and productivity. • General equilibrium analysis is the preferred framework among economists, and REMI models are the “gold standard” for regional economic impact analysis.

9. Net migration is driven by state employment prospects relative to those in the rest of the nation, as well as relative real earnings potential.

10. CP2C1 Simulation B Parameters • The actual approach that a future legislature and governor will take to replace the RLE is unknown. • Simulation B considers the case where no additional taxes are imposed and only state revenue growth between now and FY2010-11 are used to replace RLE. • The academic literature does not demonstrate an empirical correlation between property tax rates and either state population migration or economic growth. The view that lower property taxes, by themselves, will stimulate an increase in state tax revenues that can finance the replacement of RLE without a compensating decline in state spending is without sufficient scientific support to be include in the analysis. • If replacement of RLE is financed solely from revenue growth, then the analysis of economic impacts must consider the effect of displaced state spending from what would have otherwise occurred.

11. The greater reduction in economic growth from the baseline occurs because the macroeconomic impact from decline in government spending is greater than the impact from an equivalent level of tax relief.

12. Summary of Results for CP2C1 • Positive economic stimulus from elimination of RLE is smaller than the contractionary effects of increase in sales taxes and net reduction in state and local government spending when a “systems” or “general equilibrium” analytical framework is used. • Florida’s economy grows more slowly than under the control simulation as reflected in lower job growth, lower population growth, lower GDP growth, and lower income growth in absolute and per capita terms. • Reduction in economic growth from CP2C1 increases with greater reliance on reduction in state spending.