Pretend you are in charge of state government in New Jersey. You have a nice house in Princeton to live in, a helicopter to leap over traffic jams, and State Troopers to protect you. That’s the good news. The bad news is you also have a giant hole in your budget. It’s your job to fill that hole and some people are saying that whatever you do, you must not raise taxes.

Is that good advice? Not necessarily. Cutting spending on programs that help people actually does more harm to the economy than tax increases targeted to the wealthiest people. In the midst of a budget crisis like the one New Jersey faces now every dollar counts. But when it comes to the impact a dollar can have on the economy and the overall well-being of the public, the truth is that some dollars count more than others.

Let’s examine, then, a tale of two dollars. The first dollar is one that the state can save by cutting a program. The second dollar is one that the state can raise by increasing a tax on the wealthiest residents.

What happens when the state cuts a dollar from the budget? The person or family who would have gotten that buck now has one dollar less to spend. And what happens when the state raises taxes by a dollar? The person whose taxes went up also has one dollar less to spend.

But there the similarities end. A recent report from the Center on Budget and Policy Priorities by Peter Orszag and Joseph Stiglitz points out that the adverse impact on a state’s economy from a tax increase is less than it is from budget cuts—provided that the “right” people are taxed. Lower-income families are more likely than wealthier families to spend every dollar they get (the exception apparently being Enron’s Kenneth Lay and his family). This isn’t because lower-income folks are irresponsible. It’s because just paying for the basics of life spreads the family budget too thin to allow for saving. Keep in mind that while the minimum wage in New Jersey is $5.15 an hour, same as the federal minimum, the “living wage” needed to become self-sufficient is more like $8.50.

When you tax a high-income family the picture is different. Some portion of that dollar is likely to come out of their savings. As the Congressional Budget Office found in a report last month, the higher a household’s income the lower proportion of that income is spent.

Not only do lower-income people spend a greater share of each dollar they get, but they tend to spend it closer to home. People buying refrigerators or school supplies are more likely to make those purchases in New Jersey than those spending on vacations. So budget cuts can dampen the state’s economy more than tax increases would.

Some states are catching on. Colorado, Nebraska and Ohio are exempting programs like Medicaid from budget cuts. Hawaii lowered the number of hours that part-timer workers have to be employed in order to get public assistance. Florida and Virginia are delaying tax cuts that had been scheduled for this year. Virginia also is increasing unemployment insurance benefits, as is California. Alabama, North Carolina and Ohio are raising taxes to help balance their budgets. In North Carolina the tax increase affected only married couples making more than $200,000 and singles over $120,000, while California is considering a new, temporary tax bracket for income over $260,000.

This is a nationwide problem, to be sure. According to the National Governors Association, total state budget shortfalls in the current fiscal year will surpass $40 billion, with New Jersey among a handful of states where the gap is expected to exceed $1 billion. That’s not chickenfeed.

And dealing with the problem isn’t a job for the chicken-hearted. As memories of the boom of the 1990s fade and New Jersey faces up to the sobering task ahead, we would be wise to steer clear of seemingly easy answers like across-the-board budget cuts or “read my lips” pledges against tax hikes. What’s shaping up as the worst budget crisis in 20 years demands a more reasoned approach.

March 4, 2002