An Economic Laboratory

Although the Obama campaign was perfectly willing to run with the Senator’s cult of personality while woman fainted at his campaign rallies and poll numbers gave him 10 percentage point leads, they now decry the obsessive media focus on Sarah Palin and (in a bit of a panic) suggest that it’s time to address the real issues that matter. Number one on their list is the economy.

In an article in The Wall Street Journal, Phil Gramm and Mike Solon use an interesting approach for analyzing the candidates' economic plans. They contend that each of the states “exercise substantial freedom in pursuing their own economic fortune -- or misfortune. As a result, the states provide a laboratory for testing various policies.”

Using 16 policy variables developed by the American Legislative Exchange Council (ALEC), they examine a “competitive index” which indicates that "generally speaking, states that spend less, especially on income transfer programs, and states that tax less, particularly on productive activities such as working or investing, experience higher growth rates than states that tax and spend more."

For 10 years culminating in 2006, per-capita income growth and job creation were highest in Texas, Florida and Arizona—all states with low taxes, right to work laws that blunt the power of unions, relatively low minimum wages, and relatively modest wealth transfer programs (e.g., state welfare programs). One third of all new jobs in the US were created in these states.

States with the poorest per-capita income growth and job creation were Illinois, Ohio and Michigan—high tax states with strong laws providing advantages to labor unions, high minimum wages and aggressive wealth transfer programs.

Gramm and Solon comment:

What explains this relative performance over the last 10 years? The simple answer is that governance, taxes and regulatory policy matter. The playing field among the states was not flat. Business conditions were better in the successful states than in the lagging ones. Capital and labor gravitated to where the burdens were smaller and the opportunities greater.

It costs state taxpayers far less to succeed than to fail. In the three most successful states, state spending averaged $5,519 per capita. In the three least successful states, state spending averaged $6,484 per capita. Per capita taxes were $7,063 versus $8,342.

At first blush, fevered talk about “taxing the rich” and “making them pay their fair share” (the top 1 percent currently pays almost 30 percent of all income taxes collected, but apparently, that’s not fair enough for Barack Obama) has an appeal to the vast majority the electorate.

But as the states clearly demonstrate, high taxation, regulation, and government growth do little to improve our economic conditions. Gramm and Solon believe that the country as a whole will follow the lead of the states, at least as far as economic policy is concerned:

So what do the state laboratories tell us about the potential success of the economic programs presented by Barack Obama and John McCain?

Mr. McCain will lower taxes. Mr. Obama will raise them, especially on small businesses. To understand why, you need to know something about the "infamous" top 1% of income tax filers: In order to avoid high corporate tax rates and the double taxation of dividends, small business owners have increasingly filed as individuals rather than corporations. When Democrats talk about soaking the rich, it isn't the Rockefellers they're talking about; it's the companies where most Americans work. Three out of four individual income tax filers in the top 1% are, in fact, small businesses.

In the name of taxing the rich, Mr. Obama would raise the marginal tax rates to over 50% on millions of small businesses that provide 75% of all new jobs in America. Investors and corporations will also pay higher taxes under the Obama program, but, as the Michigan-Ohio-Illinois experience painfully demonstrates, workers ultimately pay for higher taxes in lower wages and fewer jobs.

Mr. Obama would spend all the savings from walking out of Iraq to expand the government. Mr. McCain would reserve all the savings from our success in Iraq to shrink the deficit, as part of a credible and internally consistent program to balance the budget by the end of his first term. Mr. Obama's program offers no hope, or even a promise, of ever achieving a balanced budget.

Mr. Obama would stimulate the economy by increasing federal spending. Mr. McCain would stimulate the economy by cutting the corporate tax rate. Mr. Obama would expand unionism by denying workers the right to a secret ballot on the decision to form a union, and would dramatically increase the minimum wage. Mr. Obama would also expand the role of government in the economy, and stop reforms in areas like tort abuse.

The states have already tested the McCain and Obama programs, and the results are clear. We now face a national choice to determine if everything that has failed the families of Michigan, Ohio and Illinois will be imposed on a grander scale across the nation. In an appropriate twist of fate, Michigan and Ohio, the two states that have suffered the most from the policies that Mr. Obama proposes, have it within their power not only to reverse their own misfortunes but to spare the nation from a similar fate.

The empirical data seem to indicate that although Senator Obama’s rhetoric suggests a “new politics,” his economic strategy is virtually identical to the thread-bare ideas of the past. If implemented, it would lead to even greater economic hardship.

If you don’t believe me, ask the people of Michigan, Ohio, and Illinois.