RALEIGH – If you seek to measure the cost of a government – federal, state, or local – its budget is a good place to start. But your search won’t end there. Only some of the costs imposed by government in any given year show up in the government’s annual operating budget.
When North Carolina policymakers and journalists say “the state budget,” for example, they typically mean only the General Fund share of the state budget – the agencies and programs traditionally funded by income and sales taxes, plus some fees and charges, while leaving out federal funds, highway funds, other fees and charges, and accrued liabilities.
Because of federal bailouts, most of North Carolina’s recent state budgets have consisted of non-General Fund expenditures. If you think “the state budget” is about $20 billion, then, you are mistaken. It’s closer to $50 billion. Keep in mind that the vast majority of that spending is still being paid for by North Carolinians, in current or future taxes and fees.
But even that broader definition of the state budget does not fully account for the cost of government in North Carolina. It leaves out at least two off-budget items: the cost of regulation and the deadweight loss of taxation.
Unlike direct taxation, in which the government confiscates someone’s income and then spends it on a program or service, regulation confiscates income indirectly. When the government orders a firm or household to expend resources to comply with a rule, it has an economic effect similar to a direct tax. But it doesn’t show up on the government’s books.
For example, rather than levy a tax on local residents to finance the construction of sidewalks, a municipality might require new developments to include sidewalks as a condition for being permitted. The cost of those sidewalks will mostly be borne by the incoming residents, in the form of higher down payments, mortgage payments, or rents. These are very real costs imposed by government, despite the fact that they remain entirely off the municipality’s budget.
This is just an observation, not an argument. Perhaps new neighborhoods should include sidewalks. Perhaps it ought to be hard to get water-discharge permits or comply with public-health standards. Whatever you think of North Carolina’s current regulatory code – that it is too burdensome, not burdensome enough, or just right – you have to recognize that it has costs as well as benefits. They have to be included in any comprehensive consideration of the total cost of North Carolina government.
Similarly, while the direct costs of taxation are obviously included in a governmental budget, there are other costs that typically remain off the books. Economists call these costs either deadweight losses or excess burdens. When you raise or lower tax burdens, you are raising or lowering prices for labor, land, capital, and other resources. Firms and households respond to these signals. If it becomes more expensive to purchase certain highly taxed items or engage in certain highly taxed activities, people will respond accordingly.
As with regulatory costs, no serious person doubts the existence of deadweight losses from taxation. The debate is about the magnitude of the effect. While some politicians and activists exaggerate the deadweight losses – falsely claiming that most tax hikes so reduce economic activity as to result in net revenue losses, for example – most confine themselves to making the correct observation that tax changes don’t raise or lower government revenue as much as static models would indicate, because the models leave out the deadweight losses of tax hikes or the positive incentives from tax cuts.
Chris Conover, a scholar at Duke University’s Center for Health Policy and Inequalities Research, wrote a paper published a couple of months ago by the Cato Institute that uses the best-available economic research to estimate the deadweight losses of changes in marginal tax rates.
Conover found the losses are greatest for federal income taxes – in the range of about 50 cents on the dollar – but that state and local taxes also have significant off-the-books costs. Specifically, he estimated that, on the margin, changes in sales taxes had deadweight losses of around 26 cents on the dollar, while property taxes imposed 18 percent losses.
So, if you want to know the real cost of government in North Carolina, you’d start with the state budget, the whole state budget, and then keep adding many more billions to the total.
Hood is president of the John Locke Foundation.