California When had a Magnetic Tax System
Excerpt from:
"Opportunities for International Financial Centres in the 21st
Century"
Mason Gaffney
Keynote banquet address at the Conference on the
Fundamentals of International Legal Business Practice, hosted by
The Bahamas Bar Association, in association with The
International Bar Association, The Bahamas Financial Services
Board, The Organization of Commonwealth Caribbean Bar
Associations, and The Inter-American Bar Association. Superclub
Breezes, Nassau, July 16, 1999.
The OECD says a "harmful tax regime" is one that "attracts
mobile activities." Many of us see that, rather, as a mark of a
good system, but I'll return to that. First, let's follow them
along a way. Right away we think of low taxes, and that is what
the OECD means - on p.27 they specify low income taxes. They,
and allied international organizations like the EU, also have a
history of jumping nations whose VAT is too low to suit them.
That view is too simple by far. Mexico, for example, has
very low taxes, but repels both capital and labor anyway. A
nation may also attract mobile activities and factors in two
other ways. One is by offering superior public services. That,
for example, is how many of us became Californians, lured by the
State University. The other is by a tax structure that favors
mobile activities without stinting on public services. This may
be done simply by targeting taxes on IMmobile resources. Let's
inspect those points closer.
B.
Magnetic tax structures
The U.S.A. is a great laboratory for testing tax
structures. It contains 51 or more separate systems, with free
migration of labor and capital guaranteed by The Constitution.
The extraordinary growth of California from about 1900 to
1978 shook and recast the economy of the U.S.A., and parts of
the whole world. It was not done with low taxes and skimpy
public services. It was in part the product of a tax structure
that was Magnetic (compared with other states). California's
natural advantages (a mixed bag) did not promote much growth
after the 1849 Gold Rush and the Civil War, when California
growth lagged badly for 20 years or more. Neither did the
transcontinental rail connection, completed in 1867, promote
much growth. Eventually, though, INTERNAL growth-oriented
forces prevailed. California provided superior public services
of many kinds: water supply, schools and free public
universities, health and mental health services, transportation,
parks and recreation, and others. It held down utility rates by
regulation, coupled with resisting the temptation to overtax
utilities.
That all required tax revenues. California had oil, but
did not tax severing it, and still doesn't. Its wine industry
went virtually untaxed. There was and is hardly any tax on its
magnificent redwood timber, either for cutting it or letting it
stand. There was no charge for using falling water for power,
or withdrawing water to irrigate its deserts. Most of those are
good ideas, but they are not what California did.
Its main tax source was another kind of immobile resource:
ordinary real estate. Its tax valuers focused their attention
on the most immobile part of that, the land, such that by 1918,
land value comprised 72% of the property tax base - and on top
of that there were special assessments on land.
People
response to
and a major
products up
insurance.
C.
and capital flooded in, for they are mobile in
opportunities. California became the largest state,
or the largest producer of many things, from farm
to the "tertiary" services of banking, finance and
Was this tax competition "harmful"?
California became the largest producer of cotton, for
example, displacing a good deal of eastern cotton. The damage
to eastern producers was offset by an equal gain to cotton
processors and consumers, with a net gain from higher usage due
to the lower price. Eastern cotton lands were released for
other uses, like reforestation of lands marginal for cotton.
(To the extent this was due to subsidies, and racing for cotton
quotas during the Korean War, I do not vaunt it - but there are
few pure examples of anything in this complex world.)
California attracted eastern workers, tending to draw up
eastern wage rates. The damage to eastern employers was offset
by an equal gain to their workers, with large net gains from two
sources. One is a more equal distribution of wealth; the other
is a drop in welfare costs and social problems like crime that
would have ensued had the "Okies," for example, had to remain in
the Dust Bowl instead of finding new lives in California. Even
the braceros, the Hispanic "guest-workers" who toil in the
fields, send money home, relieving problems in their homelands.
It would be better yet if they could become small landowners and
work their own farms, but in this imperfect world we observe
what is, without denying that it might and should be better.
What is involved here, in spite of its well-publicized glaring abuses,
and shortfalls, is turning useless and even criminal
people into productive people.
As to capital, California offered a higher return on that,
too. There emerged what people called "the continental tilt of
interest rates," higher in the west, to overcome the frictions
of space and draw eastern capital to where it was more welcome.
Over time, buildings that wore out in the east were replaced in
California.
Did California's vigor seem too ambitious, so as to damage
others? If so, as Shakespeare had Marc Antony say, "it were a
grievous fault," worthy of suppression by an OECD. Most
economists believe, however, that investing is the motor that
drives prosperity, and raising investment opportunities is the
key to the ignition. I certainly agree.
Basically, California's remarkable 20th Century growth
extended the American and the Canadian tradition of the western
frontier, in the spirit of Thomas Jefferson, as a "safety-valve"
for mobile resources oppressed in the older states. It limited
the power of the haves over the have-nots, with net gains all
around.
Was California growth the product of untaxing wealth, and
dumping taxes on poor workers and consumers? The OECD says
competition is harmful because it limits the power of OECD
nations to tax "wealth," thus more-than-intimating that they are
upholding the interests of labor, like good continental European
social democrats. In this, I suggest they have misstated the
issue, setting an agenda for a false and futile debate, fooling
both their friends and their critics, and possibly even
themselves (although I am cynical as to the last point). Their
premise, at least the one they state, is that "wealth" is more
mobile than labor. Some wealth is, of course, but California
relied on the property tax, and, to repeat, 70% of this tax base
was land, pure land, totally immobile. The OECD treats land
like one of those four-letter words that is unmentionable. So
do its academic retainers, who are well-trained to believe that
land is just as mobile as capital. This makes them completely
useless to analyze the OECD allegation that a nation's tax
regime is "harmful" if it attracts mobile resources.
Was California growth the product of southwestern pioneer
vigor? Compare if with New Mexico, not far away. New Mexico
has made itself little more than a Third World Nation
masquerading as an American state. Since before statehood, an
oligarchy of giant landowners, in the million-acre class, have
dominated everything, and kept taxes off their vast lands. New
Mexico raises a lower fraction of its state and local revenues
from the property tax than any other state. Its economic base,
such as it is, is mainly the product of what Senator Albert
Beveridge of Indiana called "the free coinage of western
Senators." New Mexico gets more federal spending per capita
than almost any state, but that and scenery are about it. It is
picturesque: its boosters call it "The Land of Enchantment," but
The Enchanter has cast a sleeping spell on its local enterprise.
It has the highest poverty rate in the U.S., and, in its wide
open spaces, nearly the highest rate of violent death in the
U.S. - itself a violent nation.
D.
Recent changes.
In 1978, California took a giant step backwards by
enacting its "Proposition 13," capping property tax rates at
about 1/3 of their previous level. The national ranking of its
services began a precipitous fall; so did its per capita income.
Struggling to maintain itself, the State has raised sales and
income and business taxes to unprecedented levels. These are
taxes that "shoot anything that moves," and spare immobile
resources that don't. The result has been the rapid
"Alabamization" of California, as we have fallen to join Alabama
with the worst school system in the nation. Inmigration has
changed to outmigration, and of those who stay, California has
by far the largest prison population of any state, so large that
the union of prison guards is now our most powerful lobby, and
building prisons is our fastest-growing construction industry.
None of these people, prisoners or prison-builders or guards,
are producing goods and services for others, but are not counted
as unemployed, and our unemployment rate is above the national
average even without them.
Today if we look for a new frontier we find it in, of all
places, one of the original 13 colonies, New Hampshire, with its
poor soils, marshy peneplains, harsh climate, impassable
mountains, and lack of natural urban confluences. What New
Hampshire has now is the least repellent tax structure in the
nation: it does not tax personal income or sales, while 2/3 of
all its state and local revenues come from the property tax. It
has bucked the national trend toward taxing income and sales,
and IT HAS PROSPERED! (Details are in a Chapter by Richard
Noyes and the speaker in Fred Harrison (ed.), 1998, The Losses
of Nations.)