An analysis not nearly
as rosy as the state's says—
tax changes could result in
only 400 new jobs

By Rob Perez
Star-Bulletin

Gov. Ben Cayetano's top man on the economy believes the state tax overhaul his boss is pushing will create as many as 5,200 new jobs annually in Hawaii.

A liberal Washington, D.C., think tank says the state would be lucky to get 400 -- and, more realistically, should expect far fewer.

Why such a big difference between Seiji Naya's forecast and the one by the Center on Budget and Policy Priorities?

That's because predicting the economic effects of state tax changes is little more than educated guesswork, though elaborate computer models, complicated financial theories and data from past economic trends are used to crunch numbers and spit out forecasts.

Adding to the uncertainty, experts don't even agree on whether cutting state taxes leads to economic growth -- the basic premise of Cayetano's Economic Revitalization Task Force package.

What's more, the magnitude of changes proposed -- the largest income tax cuts in state history, coupled with a hefty increase in the general excise tax -- is so great and largely unprecedented in Hawaii that no one knows for certain how people's spending and saving habits will be affected, making economic prognosticating all the more uncertain, state officials acknowledge.

"We're trying to create the best estimates we have given the information we have," said Christopher Grandy, an economist with the Department of Business, Economic Development & Tourism, the agency Naya heads.

As the centerpiece of the task force package before the Legislature, the tax recommendations are designed to shift millions of dollars from government to consumers, create a friendlier environment for business and stimulate new investment in Hawaii.

Its main proposals: cutting personal income taxes 25 percent to 40 percent and corporate income and franchise taxes 30 percent. The plan also calls for a 19 percent increase in the excise tax, partly to offset some of the money the state will lose from the tax cuts.

Naya predicts the tax changes will stimulate investment increases of 5 percent to 10 percent annually, helping create between 2,540 and 5,230 jobs a year.

At the high end, that would represent only a 1 percent growth in jobs -- hardly an unrealistic rate, Naya said.

Hawaii has lost jobs each year since 1993.

Nicholas Johnson, a policy analyst with the Washington think tank, predicts the tax changes would result in fewer than 400 new jobs per year. He even raises the possibility that Hawaii could lose jobs overall because of anticipated cuts in government services.

Johnson's forecast was based on the task force's original tax plan, which has since been revised. But the projections shouldn't change much under the revised plan, he said.

Ironically, Johnson and the state came up with their vastly different forecasts relying largely on data from the same 1991 book by Michigan economist Timothy Bartik. Bartik's findings are considered significant among those who analyze the murky relationship between state tax changes and economic development.

After reviewing 75 studies, Bartik concluded that, on average, if state or local taxes were reduced 10 percent, a state could expect employment to grow about 2.5 percent more than it otherwise would have over a long period.

Naya accuses the Washington center of erroneously applying Bartik's findings to arrive at its job forecast.

Bartik, in a phone interview, declined to say whether the center's application of his work was flawed.

But he did note that predicting economic growth based on tax changes is difficult because not much is known about that relationship. For a remote state like Hawaii, where taxes probably aren't as important as in the 48 contiguous states for companies' relocation decisions, the difficulty likely would be magnified, Bartik said.

Johnson defended his forecast, saying he applied Bartik's findings correctly.

Determining the reliability of the two forecasts is important because thus far they provide the only numbers on the potential economic effects of the task force package.

For legislators and others to decide whether to support the package, experts say, they should have an indication whether the plan indeed will stimulate the economy and whether the potential gains will be worth the expected costs.

Some don't have enough information to make such decisions.

The Hawaii Society of Certified Public Accountants, for instance, last week expressed concern because the proposed tax measures "are not supported in certain areas by sufficiently refined, detailed and substantiable data in order to accurately quantify the economic impact of those measures."

The group said it supported the task force's general recommendations but had reservations about detailed proposals, especially pertaining to taxes.

To be sure, the question of whether tax cuts lead to economic growth is not readily answered.

While changes in federal tax policy are more easily linked to subsequent changes in the national economy, that isn't the case at the state level, said Moody's Investors Service analyst Robert Kurtter. He called the relationship between state tax cuts and job growth tenuous, reflecting the opinions of other experts, including Johnson, and said Hawaii shouldn't bank on growth resulting from the cuts.

Naya acknowledged that some studies show an unclear relationship between tax changes and economic growth. But that's because taxes since the 1980s have become similar from state to state and play less of a role in economic development, Naya said.

Hawaii's taxes, however, are so much higher than those in most other states that it stands to gain greater benefits by changing the rates, he said. But, Naya added, changing the tax structure isn't the only answer.

Like the task force recommends, Hawaii needs to improve its regulatory climate, reform the public education system and implement other changes to make the state a more attractive place to do business, Naya said.

Even if experts are divided on whether tax changes lead to job growth, economist David Ramsour says the changes should be made on the hope they turn the economy around. Realistically, he said, Hawaii has no other options.

If changing the tax system "has got anything of a chance of succeeding, we've got to try it," Ramsour said. "In essence, what I'm saying is we may be without hope, but (the tax system) is the only thing I know of we can manipulate to make a difference."