Tax hikes slightly better for Minn. economy than budget cuts, experts say

There's a big debate nationally and in Minnesota over how to resolve government budget deficits.

In Minnesota, DFL Gov. Mark Dayton wants to tackle the state's projected $5 billion deficit in part by raising taxes on the wealthy. The GOP-controlled Legislature Republican is only discussing spending cuts.

Which approach is better for the state's economy?

Jonti-Craft, a Wabasso, Minn.-based company, sells a lot of furniture to schools. Nick Schwartz, Jonti-Craft's head of marketing, said if the state's education spending is reduced as part of a deficit-reduction plan, his company's product could be a casualty of those cuts.

Schwartz said even if furniture budgets aren't dashed entirely, contracts for furniture could be directed to the lowest bidders. He fears local companies like Jonti-Craft could lose out.

"The sad result of that is cheaper foreign goods often end up making the lower-priced option," Schwartz said.

That could hurt business, and the company's ability to keep 150 full-timers on staff.

But all this puts Schwartz in a bind. The alternative to budget cuts is a tax hike.

Dayton wants to push the top tax rate from 7.85 percent to 10.95 percent for top earners. That rate would kick in at taxable incomes of $85,000 for single filers, $130,000 for heads-of-household, and $150,000 for joint filers.

As a conservative, Schwartz opposes tax increases on principle. But because he also dreads budget cuts, would he actually prefer a tax hike?

"It's certainly hard for us to say," he said. "I think education should be the last on the block."

So far, Republican legislators have pointed their budget paring knives in a few directions, including health and human services programs, state aid to cities and counties, higher education, and government agencies. They'll release more specifics this week.

Some experts are concerned that state spending cuts would be harmful to Minnesota's economic recovery. Their logic is that taxpayer dollars buy goods and services and pay wages. Laying off government workers, slashing programs, or dinging government vendors like Jonti-Craft will reduce the overall demand for goods and services. That hurts the state's GDP.

"If a program is cut that allows an individual to come in and buy groceries and they no longer have the wherewithal to do that, it's going to have an impact on businesses as well," said Steve Hine, the state's head labor market analyst.

Some prominent economists have also made this argument at the national level concerning proposed federal budget cuts. Federal Reserve Bank Chairman Ben Bernanke calculated that those cuts would kill 200,000 jobs. The firm Macroeconomic Forecaster estimated 500,000. Mark Zandi, the chief economist of Moodys.com, put the figure at 700,000.

In Minnesota, several economists say that in terms of reducing the economic toll, higher taxes are "slightly better." That highly qualified endorsement comes from State Economist Tom Stinson. He does say that raising taxes on high earners would be better for the economy than budget cuts. But it's not a big difference.

"We're not talking about hundreds of billions of dollars better or anything like that. We're talking about just marginal changes here," Stinson said.

Both Stinson and Hine argue that top earners don't spend all their income. They save a lot. So raising their taxes won't dramatically change their spending habits. That means overall demand for goods and services, the engine of the economy, will not take a big hit.

But the argument is theoretical. Stinson said he can't offer any proof, just some inscrutable math.

"I can show you algebraically," Stinson said. "But that's not going to make any difference to you."

It's definitely not going to make a difference for Dan Huber. He owns a janitorial service in Shakopee and is vehemently against tax increases because he said they chase business out of the state.

"When someone builds a manufacturing facility in Alabama or takes it to India, that's one less building for us to compete for, to clean," Huber said.

Narayana Kocherlakota, the head of the Federal Reserve Bank of Minneapolis, sees that logic. He said both tax hikes and will pinch, but job creation and economic growth will continue.

"Are these things going to be happening as fast as we'd like? Probably not. But I don't see the rate of change being significantly retarded by the factors you mentioned," Kocherlakota said.

Economists generally agree that keeping taxes as low and broad based as possible while adequately funding government programs is best for the economy.

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