OP-ED: A Recipe for Higher Taxes?

By Sven R. Larson, Ph.D.

There are some signs here and there that the New Jersey economy is recovering. One of them is a slow uptick in private-sector employment. According to the Bureau of Labor Statistics, in June 2012 there were 3,346,000 private-sector employees in the state, up from 3,275,000 two years earlier. Admittedly, an increase of 71,000 jobs in two years is not much, and we are still nowhere near the 3.5 million jobs in the private sector we had five years ago. But every new job is welcome, and hopefully the upward trend is here to stay.

One of the worries that come with private-sector job growth is that the extra tax revenues will encourage government to take on more employees. There are good reasons to worry about this: during the good years between the Millennium Recession and the Great Recession state and local governments in New Jersey hired new workers faster than the private sector did:

• Between 2001, the bottom of the Millennium Recession, and 2007, right before the Great Recession started, the private sector added a net of 36,600 jobs in New Jersey;
• During the same period, the state and local governments added 49,300 jobs.

These numbers tell us two things. First, the Millennium Recession was not nearly as bad as was sometimes suggested at the time. Secondly, the relative growth in government jobs to private jobs was staggering:

• In 2001 there were 158 state and local government employees per 1,000 private-sector employees in New Jersey;
• In 2007 there were 171 state and local government employees per 1,000 private-sector employees in New Jersey.

You don’t need a degree in economics to realize that this implies higher taxes. Common sense says that when the ratio of government workers to private-sector workers goes up, so will our income taxes, property taxes, sales taxes, use taxes, wealth taxes…

Ultimately all the taxes we pay come out of our current earnings; no one pays his taxes out of his savings account (except in emergencies). Therefore, the growth in the government-to-private employee ratio is in effect an increased burden on our personal incomes.

But not only has the number of government workers been growing fast – their compensation has also outpaced compensation in private jobs. If we combine the employee data from the Bureau of Labor Statistics with employee compensation data from the Bureau of Economic Analysis, we get a troubling picture:

• Between 2001 and 2007 per-employee compensation in the private sector in New Jersey grew from $52,380 to $64,420, an increase of 23 percent;
• Between 2001 and 2007 per-employee compensation in government in New Jersey grew from $50,632 to $65,412, an increase of 29 percent.

Again, we have a recipe for higher taxes. In fact, if we take the total effect of growing government employee compensation and the growing number of government employees during the period 2001-2007, the total effect was big enough to require a two-percentage-point rise in taxes on private workers in New Jersey.

This does not mean, of course, that New Jersey private employees literally paid another two percent of their earnings in taxes directly to feed state and local government workers. Government workers also pay taxes. But this experiment illustrates how a rapid expansion in government payrolls inevitably increases the tax burden on the private sector.

To make matters worse, the trend of growing government payrolls did not stop in 2007. In 2009 there were 181 state and local government workers in New Jersey per 1,000 private workers, again up from 158 in 2001. Total government payroll obviously kept growing with it. State and local government employee compensation was:

• 15.3 percent of private sector employee compensation in 2001;
• 17.3 percent in 2007; and
• 19.0 percent in 2009.

The past two years have seen a reversal of this trend. There are fewer government workers in the Garden State today than there were in 2009 and private employment has gone up. But the cost of government payrolls to taxpayers is still notably higher today than it was some ten years ago. In 2011 there were still 175 government workers per 1,000 private workers, a ratio that is 10.5 percent higher than it was in 2001.

Put differently: if the state and local governments had kept their number of employees at the 2001 ratio of 158, New Jersey taxpayers would have saved $3.9 billion in 2011.

Now that the private sector is growing again, it is time to consider measures that will prevent runaway government growth again. One such measure could be to tie government payrolls to the ability of taxpayers to afford them. This can be done in many different ways, such as total budget caps or similar so called TABOR rules.

Another approach, used in some European countries, is a pay parity rule: if the employee compensation in the private sector goes up by, say, three percent per employee, then state and local government workers can receive a raise of no more than three percent.

All measures have their merits and problems and some rules that are in place elsewhere may not suit New Jersey. But now that we are (hopefully) past the worst of this recession it is time to discuss long-term solutions so that the cost of government does not run amok again.

Sven R. Larson, Ph.D., is Senior Fellow in Economics at the Wyoming Liberty Group and a guest contributor for Common Sense Institute of New Jersey. He holds a Ph.D. in social sciences with major in economics and has taught economics at colleges in three countries. His research on health policy, taxes, and government budgeting and entitlement reform has been published by free market think tanks across the country.