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May 13, 2010

Vermont Dares to Lower Taxes as Stimulus Funds Wane

Last night, before the Vermont state legislature adjourned, it did an extraordinary thing: it LOWERED both capital gains and estate taxes. Vermont is investing in its own future (see the Associated Press story here). Especially in the midst of a revenue crunch, this move makes great economic sense even though it defies conventional political wisdom on a couple of fronts.

 

Vermont, like most states, is cutting costs in the face of declining tax revenues and the imminent end of federal stimulus dollars. But most states are also raising taxes. Why not Vermont? There are two good reasons:

 

  1. We’re already among the most highly taxed populations in the country; we simply don’t have room to raise taxes.
  2. In the not-very-long-term we’ll get more revenue by lowering taxes and would simply lose revenue by raising them further.

 

Suppose you own a business which is losing customers to low-priced competition. Would you raise prices to make up for the revenue you’re not getting from your lost customers? Of course not, you’d just lose more customers and more revenue.

 

You have to lower your prices to get your customers back; that’s obvious. But many companies whose products are overpriced also have an inflated cost structure. They can only lower prices if they can also reduce costs. Companies that can’t reduce costs and can’t match their competitors’ prices go bankrupt (see General Motors except your business probably won’t get bailed out).

 

Vermont’s not a business but it does have customers – the people who pay taxes – both visitors and permanent residents. A lot of them – us – are here because of Vermont’s quality of life. We’re willing to pay some premium for that; Vermont doesn’t have to be a bargain basement state to attract people. In fact, if we degraded our environment or became a seriously unfriendly place, we’d certainly lose our customers,

 

But we have become overpriced!

 

 Last year the legislature raised both the capital gains and estate tax. That seemed to put us past a tipping point. Increasingly training for Vermont accountants includes a substantial segment on how to help your clients change their tax residence. People who pay lots of taxes, start businesses, and create jobs are more and more afraid to live here. They’re terrified of dying here.

 

So we reversed much of last year’s tax increases even as other states – our competitors – are being forced to raise taxes. It’s a small step but a very big change in direction. Eventually tax cuts will bring us more revenue as the tax base grows and makes further cuts in tax rates possible. The national news about Vermont now is that we are reducing taxes to prepare for future success – a good story for a state with a reputation for high taxes.

 

But there’s still the question of costs. If we’re going to continue to reduce the price of state government, we have to bring costs down. That’s why Challenges for Change, a program to reduce the cost of state government through structural change, also passed the legislature this year. More on that in my next post.

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