FEB. 19, 2010 – Raising taxes in a down economy sounds counterintuitive, but it is a viable strategy that may be better than simply cutting spending, according to a new report on budget strategies.

Merely cutting spending as a budget solution can be harmful, writes Iris Lav of the Center on Budget and Policy Priorities in Washington. Why? Because it cuts services that people really need such as meals-on-wheels for seniors and some school programs. School hours are cut. College aid is tougher to get. Layoffs and contract cuts cause rippling impacts to the economy. With less money spent on services or salaries, there’s less money floating around, which reduces demand from the economy, the report says.

“The anti-tax argument does not take into account the reality that cuts in spending are problematic policies during an economic downturn because they can make the downturn deeper in the state,” Lav writes. She admits tax increases also can reduce demand in the economy, but not to as much of a degree in the short run – particularly if taxes are on higher-income households that can pay from savings or money that might be spent out of state.

“There is no shortage of voices making the claim that raising taxes is the worst strategy during a recession. But this conventional wisdom has little basis in fact.”

Lav says a balanced approach that balances various strategies is something state legislators should consider now. In our state’s 2010-11 budget now being developed, lawmakers face revenues of $5.1 billion – about $1.5 billion less than just two years ago. If spending stays the same as now, budget wizards at the state have to come up with $563 million just to keep thing like they are.

With an eye to the enormity of the challenges ahead, Lav’s report says budget makers should engage multiple strategies to make headway:

• Do things differently. The report says efficiencies can be gained by accelerating the release of some state prisoners – just what S.C. lawmakers are considering in a current sentencing reform proposal. State budget writers also could examine some economic tax breaks and incentives to see if they’re really working because evidence shows they don’t always do what they’re expected to – and often cost more than projected. Example: A New York study found the state could actually save millions by hiring state employees to do work being done by expensive consultants.

• Review credits, deductions and exemptions. South Carolina currently doesn’t collect more than $2.5 billion in sales taxes due to special-interest exemptions. If the state reviewed exemptions, tax credits and deductions, it likely would find some that weren’t working – and that it could turn into more revenue.

• Improve collections. Lav writes most states don’t do a good job in collecting sales tax from catalog and Internet sales. Both could be improved here.

• Prioritize. South Carolina could prioritize spending based on need – a kind of zero-based budgeting – and fund things high-priority things that it had money for. While the process is difficult, she writes, it can help restore balance.

• Modernize tax systems. The state could benefit by broadening the tax base by taxing more services. Currently, only about three dozen of 160 categories of services are taxed in South Carolina. That means some services are getting preferential treatment. A fairer way to treat businesses is to have more services taxed, which will generate additional revenue that can patch shortfalls – or (and this is a big one) reduce the sales tax rate.

• Update corporate income taxes. There are several strategies that can make corporate taxation more equitable and modern, she writes. (In the past, we’ve suggested getting rid of corporate income taxes completely, although some complained that corporations should pay something because they and their employees use roads and government services as a part of doing business.)

Bottom line: State lawmakers should scrutinize spending and employ a battery of balancing tools to deal with this year’s budget shortfalls and lean times. This should include the possibility of raising some taxes so the state can deliver needed services.

Andy Brack is publisher of Statehouse Report, where this commentary first appeared.