01/23/2013 Civil War -- first shot cuts states by 20%

So far we’ve been looking at the effect of Federal tax rates on Federal revenues.

For some people it’s a hard sell – even if you give them all the source data and invite them to figure out a way it doesn’t fall as I’ve demonstrated.

Now for something simpler: the states.

If the Federal government raises rates, what happens to STATE revenues?

It’s not pretty:

(source list)

The true size of government isn’t measured by how much of your life it can control, but in how many real dollars it can raise.

By reaching too far, our government will starve itself and the states from the very power it is trying to seize.

The states will respond by raising their own rates in a tax war with only one target: us.

The red line is a clearer picture of the economy as well, since it shows the raw effect of the Federal power grab.

Some states COULD, in theory, just ride it out.  But as Nate Silver commented recently, states have their own unfunded liability problem, with pensions growing in size faster than the working population.  On the total government spending chart Nate provides, we have now passed the critical threshold of 35% GNP.

It’s mathematically impossible for a government to grow after it passes 35% of GNP.  It can go all the way to 100% and it will get smaller in total wealth the entire way.

In theory, states can put up a good fight.  Federal spending has risen to 25% of GNP and the states to 15%.  That means that a state hike of 5% will only have the economic impact of a 3% hike for the Federal rates.

The bad news is that they have more to make up for.  The Federal rate hike from 35% to 43.8% was a 20% rate hike.  The states will get a 20% revenue cut.  To make that up they will try to raise state taxes by 20% at first, which will further depress their economies and revenue by an additional 4%, which means that states will not be able to stop until after they have raised rates by more than 25%.

But the worst news for the states is that their wealth is more mobile than wealth under Federal jurisdiction.  A person can leave one state for another without having to pay a penalty, and he won’t continue to be taxed like an American living abroad would be taxed on the Federal level.  The most vulnerable states – typically the “blue” states – will be far more damaged than less progressive “red” states.

The first cannon of a civil tax war has been fired.

It’s not over by a long shot.

And we’re all in the crosshairs.

Tim