Center for Tax and Budget Accountability’s 2008 Annual Fiscal Symposium

Mary Jo WaitsPew Center on the States

January 29, 2008

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Today’s Topic: What States Across the Country Are Doing to Address Severe Fiscal Problems

My Answer: Tinkering While Rome is Burning

Five Shoes Five Shoes Waiting To Drop Waiting To Drop on Arizona’s Futureon Arizona’s FutureArizona Policy Choices, 2001

Mary Jo WaitsMorrison Institute for Public PolicyArizona State UniversityCollege of Public Programs, School of Public Affairs

The Five ShoesThe Five Shoes

A Talent Shake Up Latino Education Dilemma A Fuzzy Economic Identity Lost Stewardship The Revenue Sieve: tax system

is old and full of leaks

What could make or break Arizona’s success in the future?

The Tax System The Tax System Lacks BalanceLacks Balance

The State of Arizona’s dependence on sales tax collections for revenue increased dramatically over the last decade. Today 53% of total revenue comes from this one tax.

--State Revenue FY 1992 & FY 2002

The Tax System is OldThe Tax System is Old

• Shift to service economy moves purchases beyond the reach of sales taxes

• Shift in consumption patterns: buying more services than goods

• E-commerce bypasses the state’s tax system

The Tax System LeaksThe Tax System LeaksThe number of State sales tax exemptions nearly doubled in the 1990s…

Source: Arizona JLBC, Arizona Department of Revenue

The Tax System LeaksThe Tax System LeaksThe number of State income tax credits also proliferated in the 1990s

Source: Arizona JLBC, Arizona Department of Revenue

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Baiting HooksBaiting Hooks: : Tax incentives will always be with us, but Tax incentives will always be with us, but states are finally keeping tabs on what they're getting for their states are finally keeping tabs on what they're getting for their money.money.

Every state that offers tax incentives for Every state that offers tax incentives for economic development monitors their economic development monitors their incentives:incentives: •Eighty percent of states impose a Eighty percent of states impose a penalty on recipients that do not meet penalty on recipients that do not meet their obligations. their obligations.

•Thirty-two states publicly disclose Thirty-two states publicly disclose information about tax incentive recipients information about tax incentive recipients — either identifying the recipients, — either identifying the recipients, identifying the amounts of tax dollars identifying the amounts of tax dollars involved or both.involved or both.

•Eighty percent of states have tax Eighty percent of states have tax expenditure budgets, which provide data expenditure budgets, which provide data on the amount of potential tax revenue on the amount of potential tax revenue lost when exemptions or credits are lost when exemptions or credits are granted. granted.

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Plugging LeaksPlugging Leaks: : A tax policy is only as good as the A tax policy is only as good as the systems that collect the taxes and make it simple for people systems that collect the taxes and make it simple for people to pay them.to pay them.

States have been trying various States have been trying various ways to simplify collection and ways to simplify collection and lock in compliance. The basic kit lock in compliance. The basic kit comes with 5 important tools: comes with 5 important tools:

• effective use of the audit effective use of the audit process, process, •interstate cooperation,interstate cooperation,• e-service offerings,e-service offerings,• a timely and fair appeals a timely and fair appeals process and process and • taxpayer buy-in to the taxpayer buy-in to the design of the system and its design of the system and its administrative procedures.administrative procedures.

Presence of Methods to Continually Review State Presence of Methods to Continually Review State Tax Systems’ Compatibility with State EconomiesTax Systems’ Compatibility with State Economies

IowaIowa

MainMain

MinnesotaMinnesota

MississippiMississippi

NebraskaNebraska

New JerseyNew Jersey

Texas Texas

UtahUtah

ArkansasArkansas

GeorgiaGeorgia

LouisianaLouisiana

North DakotaNorth Dakota

OklahomaOklahoma

VermontVermont

Need ImprovementNeed ImprovementTop PerformersTop Performers

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States that Tax ServicesStates that Tax Services

In the service-based, In the service-based, new economy, states new economy, states face the important face the important question: question:

What services to What services to tax?tax?

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Breathing Room: Breathing Room: States that give localities States that give localities greater leeway to raise revenuegreater leeway to raise revenue

Flexibility:Flexibility:• Do states give cities or counties Do states give cities or counties a local option to control the tax a local option to control the tax rate and use of the revenues they rate and use of the revenues they raise?raise?•Increases global Increases global competitiveness, attracting competitiveness, attracting international companiesinternational companies

Only a handful of states give Only a handful of states give their local governments their local governments control over property, sales control over property, sales and income tax.and income tax.

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All that’s well and good, but…Rome is Burning The tax questions that states will need to

grapple with in coming decades concern Companies that createBorders that disappearBusiness models that change Baby boomers that retireA world that is spiked, not flatQuality place calculus that is complex

Companies that Create

““The first 100 years of our country’s The first 100 years of our country’s history were about who could build the history were about who could build the

biggest, most efficient farm. biggest, most efficient farm.

The second 100 years were about the race The second 100 years were about the race to build efficient factories. to build efficient factories.

The third 100 years are about ideasThe third 100 years are about ideas.”.”

-- Seth Godin-- Seth GodinFast Company, Fast Company, August 2000August 2000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1940-1950 1990-2000

Shifts in the Work We Do

Source: Richard Florida

Production Work41%

Creative Work 16%

Creative Work30%

ProductionWork26%

Service Work31% Service

Work43%

Agriculture12%

Right Brain vs Left Brain Work

Can Stay

Will Go

Ingredients

• Ideas (Intellectual capital)

• Talent (Human capital)

• Money (Financial capital)

Collaboration

• Innovation

• Entrepreneurs

• Networks

Results

• Productivity

• Prosperity

• Cluster vitality

New Growth Theory“In advanced economies, smart people and new ideas are the primary catalysts for economic growth.” Paul Romer

What Matters for Innovation?

How do states generate revenue from the intangible inputs and products of knowledge-based firms?

Council on Competitiveness, Competitiveness Index, 2007Council on Competitiveness, Competitiveness Index, 2007

Borders that Disappear

ManilaCosta Rica

Dublin

BangaloreBombayHyderabadChennaiiPune

Israel

BeijingShanghaiShenzhenGuang ZhouHong Kong

MoscowBudapestPrague

Hsinchu

•Washington D.C.

•Boston

•Minneapolis

•Atlanta

•Phoenix

•Seattle

•Austin

•San Diego

•Portland

•Raleigh-Durham

•Denver

•Sacramento

•Salt Lake

Firms tap talent and capital and serve markets globally, from their start…

……and can easily elude the grasp of taxing authorities and can easily elude the grasp of taxing authorities

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Business Models that Change

From: From: To: To:

Production is more flexible, networked--and hard for states to trackProduction is more flexible, networked--and hard for states to track

A world that is spiked, not flat

Collaborative Economics Inc, Index of Silicon Valley, 2007Collaborative Economics Inc, Index of Silicon Valley, 2007

“America is a Metropolitan Nation”

Brookings Institution, Blueprint for American Prosperity, 2007Brookings Institution, Blueprint for American Prosperity, 2007

Which government is taxing what and how will those taxes be used?Which government is taxing what and how will those taxes be used?

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““Arugula is how I define cities. I go to Arugula is how I define cities. I go to a grocery store, and either you can get a grocery store, and either you can get arugula or you can’t.” arugula or you can’t.”

Cindy CrawfordCindy Crawfordinternational super modelinternational super model

Companies follow Talent

……and High-end Talent is looking for more and High-end Talent is looking for more than low costs and basic entertainment.than low costs and basic entertainment.

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A More Complex Calculus for Quality Place

Natural environment counts for a lot. But natural features aren’t enough. Places must have

distinctive urban amenities as well. Choice (in lifestyle) matters in the talent war. Being a smart, innovative place matters. It’s not just about physical attributes. Intangibles such

as tolerance and entrepreneurial culture are part of the calculation.

Speed is a vital amenity.

Waits, Which Way Scottsdale?, 2003Waits, Which Way Scottsdale?, 2003

.

Tax System in the 21st CenturyIndustrial Economy

Labor, quantity, low cost, stability, control

Natural resources, labor, capital

Mass production

Success Factors

Raw Materials

Enablers

Large corporations, economies of scale

Innovation Economy

Talent, innovation, speed, flexibility, networks

Ideas, patents, brand

Internet, information and communications technologies

Networks, entrepreneurs, small scale, free agents

Organization

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Okay, What’s NextOkay, What’s Next

In the face of new technology, new economy, new demography, new geography, it will not work to redouble our efforts, essentially aiming to do all the same things we’ve always done, but better.

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