Unintended Consequences: 2020 Update: Literature
The Unintended Consequences: How Saclig Back Public Pensions Puts Government Revenues at Risk: 2020 Update estimates state and local revenues generated by pension check spending and pension fund asset investments. It then compares these tax revenues with taxpayer contributions to public plans to determine whether public pensions are net revenue positive, revenue neutral, or revenue negative. In this section we review literature on two relationships. One, between the economy and revenues. And two, among pensions, the economy, and revenues.
Unintended Consequences: 2020 Update: LiteratureThis study estimates state and local revenues generated by pension check spending and pension fund asset investments. It then compares these tax revenues with taxpayer contributions to public plans to determine whether public pensions are net revenue positive, revenue neutral, or revenue negative. In this section we review literature on two relationships. One, between the economy and revenues. And two, among pensions, the economy, and revenues.
The Economy and RevenuesWhat grows the economy? Most of the literature in this area has focused on the debate about whether tax cuts grow the economy and enhance tax revenues. According to a 2015 National Tax Journal article, “The Relationship between Taxes and Growth at the State Level: New Evidence,” the effects of state tax policy on economic growth, entrepreneurship, and employment remain controversial. While conservatives argue that tax cuts grow the economy, most of the literature and data do not support this finding.
It is common sense that when governments cut taxes, they will have less revenue. When they have less revenue, they must cut programs or borrow money. The expected positive impact of tax cuts on the economy is thus wiped out by the negative impact of spending cuts and/or borrowing. More often than not, the net effect of tax cuts on the economy is negative. Consider the fact that as president from 2001 to 2009, George W. Bush presided over two major tax cuts, yet the outcome was the Great Recession, which lasted from December 2007 to June 2009.
In a 2003 New York Times Magazine article titled “The Tax-Cut Con,” economist Paul Krugman described what was already a well-established conservative strategy of bait-and-switch. First, lawmakers would ram through huge tax cuts for corporations and the wealthy, claiming that lower taxes would actually increase revenue via the magic of supply-side economics. Then, when budget deficits soared, they would declare that the nation's dire fiscal straits demanded draconian cuts in social programs, such as safety net programs, health care, and education.
Krugman noted that given how many times this taxcut con job has been tried, one might reasonably expect that conservatives would eventually take a different tack. But it turns out to be an unkillable zombie of a political strategy. Early in President Trump's term, even before the 2017 tax cut was passed, Krugman predicted that it would blow up the deficit and Republicans would then revert to the pretense of being deficit hawks, demanding cuts in Social Security, Medicare, and Medicaid. We can see that happening now, in the years since President Trump signed the 2017 tax-cut legislation passed by the Republican-controlled House and Senate.
Remember the argument that tax cuts will grow the economy? In return, it says, tax revenues will grow, and the tax cuts will be a wash. Unfortunately, the outcome has not matched that argument; instead, it has been consistent with the previous tax-cut experiences described by Krugman. The 2017 tax cut has increased the federal deficit to more than a trillion dollars, and the economy has slowed down after an initial bump in 2018. Figure 1 shows the nation's real gross domestic product (GDP) growth from 2017 to 2021. Between 2017 and 2018, the economy grew from 2.37 percent to 2.93 percent. But in 2019, it grew by only 2.20 percent. Growth is projected to be 2.00 percent in 2020 and 1.90 percent in 2021[of course these projections were done before the COVID-19]. History has taught us that the best way to grow the economy is through a progressive tax system and investment in education and infrastructure, as we did during the post–World War II period.
On the question of what drives revenues, there is again a dearth of literature. Among the few recent studies addressing the question is one by the Tax Foundation. Based on data from The Economist, this study implied that economic growth is a key driver of revenues — when the economy is doing well, tax revenues grow, and vice versa. For example, the study noted that during the mid-1980s to late 1990s the economy grew. So did tax revenues. On the other hand, during 2007 and 2009, the economy declined.
So did revenues.
Our own analysis, however, shows that state and local revenues lag economic growth. If the economy grows by 1 percent, state and local revenues grow only by about 0.8 percent. That is because state and local governments have made their revenue systems more regressive by cutting stable and progressive taxes, such as income and property taxes, in good economic times and filling the revenue shortfall in bad economic times through risky revenue schemes such as casinos and excise taxes.
Do pension fund assets contribute to economic growth? The literature on this subject is in short supply. One study that has addressed this question focused on 38 countries, including both European Union countries and emerging economies. The study found a positive correlation between growth in pension fund assets and growth in the economy.
Another study that showed a positive correlation between pension assets and economic growth focused on 69 industrial sectors in 34 Organization for Economic Co-operation and Development (OECD) countries over the decade of 2001–2010. The authors of this study concluded that a higher level of pension assets has a significant impact on economic growth through growth in the sectors in which the assets are invested.
Studies examining the relationship between pension fund assets and economic growth in individual countries are even rarer. A study focusing on Kenya took an in-depth look at data on the growth of pension fund assets and economic growth during the period 2002–2011. It found a positive relationship between pension assets and economic growth.
Pensions, the Economy, and RevenuesOne of the best-known studies that regularly assess the impact of pensions on the economy and revenues is conducted by the National Institute on Retirement Security (NIRS). This study, popularly known as “Pensionomics,” assesses the economic and revenue impact of benefits paid to retirees by public and private defined-benefit pensions in the United States. In 2016, the NIRS study found, about $578 billion was paid in pension benefits to 26.9 million retirees, generating $1.2 trillion in total economic activity. This economic activity, in turn, generated $202.6 billion in federal, state, and local revenues. The NIRS study also assessed the impact of public pensions on a state-by-state basis. However, it did not assess the economic and revenue impact of investment of pension assets.
Several individual pension plans conduct economic impact studies for their respective states. For example, the Teacher Retirement System of Texas does such a study on a regular basis. The 2019 study showed that the system paid $19.1 billion in retirement benefits to more than 420,000 retirees, which contributed $22.4 billion to economy and generated $1.6 billion in state and local revenues.
Similarly, a 2018 study conducted by the Colorado Public Employees' Retirement Association (PERA) showed that the system provides significant economic benefit to Colorado. This economic benefit amounts to more than $6.5 billion, which in turn generates $343 million in tax revenue for state and local governments.
The foregoing review of studies on the economic and revenue impact of public pensions suggests that these studies focus on only part of the equation — benefits paid to retirees — and omit the economic and revenue impact of investment of pension fund assets. Two pension plans, however — the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS) — have conducted studies on the economic impact of investment of their assets on the California economy.
In the absence of studies such as those done by CalPERS and CalSTRS, from other states or the nation as a whole, it is necessary to develop a methodology to assess the economic and revenue impact of investment of pension fund assets as well as pension benefits paid to retirees for all 50 states. Next week's blog post will describe the methodology used in this report.
*all citations are in the full report