Time to Dismount Your High Horses

Update: I've thought about this some more and worked with the numbers and have concluded that there are minor errors in my methodology. I don't think those errors will have a substantial effect on the results, but at this point, I'm not sure. I'll post a new entry with an update when I figure it out. The main problem is that I assumed an intercept at (0,0) for Adjusted Federal Expenditures versus GSP per capita which may not be correct. I guess I should get off my high horse too!

Update 2: I definitely need to get off my high horse. The data does show the effects of progressive taxation. Thus the rest of this post below is incorrect and should be ignored.

Andrew Sullivan links to a post on TaxProf Blog titled "Red States Feed at Federal Trough, Blue States Supply the Feed." It shows two tables which follow:

States Receiving Most in Federal Spending Per Dollar of Federal Taxes Paid:

1. D.C. ($6.17)
2. North Dakota ($2.03)
3. New Mexico ($1.89)
4. Mississippi ($1.84)
5. Alaska ($1.82)
6. West Virginia ($1.74)
7. Montana ($1.64)
8. Alabama ($1.61)
9. South Dakota ($1.59)
10. Arkansas ($1.53)

States Receiving Least in Federal Spending Per Dollar of Federal Taxes Paid:

1. New Jersey ($0.62)
2. Connecticut ($0.64)
3. New Hampshire ($0.68)
4. Nevada ($0.73)
5. Illinois ($0.77)
6. Minnesota ($0.77)
7. Colorado ($0.79)
8. Massachusetts ($0.79)
9. California ($0.81)
10. New York ($0.81)

The States in bold letters in the top table tend to vote Republican and the States in bold letters in the bottom table tend to vote for Democrats. The general idea is that the top ten states in terms of federal spending per federal tax dollar are being subsidized by the bottom 10 states.

There are many possible implications, almost all of them negative towards middle America and Republicans. Indeed, Andrew Sullivan writes "A new study reveals just how welfarist much of Middle America is" regarding TaxProf's post. Sullivan's post with this derogatory comment can be found in the entry "Bush's Conservatism".

But before we get carried away about welfare queens in middle America and evil Republicans screwing states that vote Democrat, we should consider if maybe there is a perfectly straightforward explanation for the data. It turns out that there is.

First, let's imagine what a perfectly fair system of federal expenditures and taxation might look like. In such a system, each state would receive identical per capita federal expenditures, including government contracts, entitlements, etc. In other words, if a state had twice as many people as another, it would get twice as much federal spending as the other.

On the tax side, it's a little tricker. In some sense, for perfect "fairness", if a state has twice as many residents, those residents should pay twice as much federal tax. Under this scenario, every man, woman, and child would pay about $5,000 in taxes per year, regardless of income or wealth. However, this would require that the poor (and children) pay a far, far higher percentage of their income and wealth in taxes, in some cases greater than 100%. This is extremely regressive and very few people would consider that to be fair.

A less regressive structure would be a flat tax and/or consumption tax. Then everybody pays the same percent of what they make or consume. In this case, the total federal income tax paid by the residents and businesses within that state would be very close to a constant percentage of the State's total income (or of a closely related measure called Gross State Product). That's still much more regressive than our current tax system. Nonetheless, it seems quite fair for each state to pay an equal percentage of it's Gross State Product.

In the following table, I've shown by State, the Gross State Product Per Capita and Adjusted Federal Expenditures Per Dollar of Taxes. After the table comes my analysis.

State	2001 Gross State Product ($ millions)	2000 Population	Gross State Product Per Capita ($)	Adjusted Federal Expenditures Per Dollar of Taxes by State
Alabama	121490	4447100	27319	1.61
Alaska	28581	626932	45589	1.82
Arizona	160687	5130632	31319	1.20
Arkansas	67913	2673400	25403	1.53
California	1359265	33871648	40130	0.81
Colorado	173772	4301261	40400	0.79
Connecticut	166165	3405565	48792	0.64
Delaware	40509	783600	51696	0.85
Florida	491488	15982378	30752	1.00
Georgia	299874	8186453	36631	1.01
Hawaii	43710	1211537	36078	1.52
Idaho	36905	1293953	28521	1.34
Illinois	475541	12419293	38291	0.77
Indiana	189919	6080485	31234	0.99
Iowa	90942	2926324	31077	1.22
Kansas	87196	2688418	32434	1.14
Kentucky	120266	4041769	29756	1.46
Louisiana	148697	4468976	33273	1.44
Maine	37449	1274923	29374	1.31
Maryland	195007	5296486	36818	1.20
Massachusetts	287802	6349097	45330	0.79
Michigan	320470	9938444	32245	0.90
Minnesota	188050	4919479	38226	0.77
Mississippi	67125	2844658	23597	1.84
Missouri	181493	5595211	32437	1.32
Montana	22635	902195	25089	1.64
Nebraska	56967	1711263	33289	1.19
Nevada	79220	1998257	39645	0.73
New Hampshire	47183	1235786	38181	0.68
New Jersey	365388	8414350	43424	0.62
New Mexico	55426	1819046	30470	1.89
New York	826488	18976457	43553	0.81
North Carolina	275615	8049313	34241	1.07
North Dakota	19005	642200	29594	2.03
Ohio	373708	11353140	32917	1.02
Oklahoma	93855	3450654	27199	1.47
Oregon	120055	3421399	35089	1.00
Pennsylvania	408373	12281054	33252	1.08
Rhode Island	36939	1048319	35236	1.06
South Carolina	115204	4012012	28715	1.32
South Dakota	24251	754844	32127	1.59
Tennessee	182515	5689283	32080	1.24
Texas	763874	20851820	36633	0.92
Utah	70409	2233169	31529	1.14
Vermont	19149	608827	31452	1.12
Virginia	273070	7078515	38577	1.47
Washington	222950	5894121	37826	0.91
West Virginia	42368	1808344	23429	1.74
Wisconsin	177354	5363675	33066	0.87
Wyoming	20418	493782	41350	1.05

Assuming you agree that fairness would require each State get the same per capita federal expenditure and each State should pay an equal portion of it's Gross State Product in federal taxes, then we might expect some sort of relationship in the data between Gross State Product per Capita and Adjusted Federal Expenditures. In particular, we might expect poor States with low GDP to pay a lower per capita amount in taxes (even though taxed at the same flat rate), yet receive the same federal expenditures per Capita. This would cause the Adjusted Federal Expenditures measure higher for such states. Indeed, this is exactly what happens. The following table shows the correlation between the two last columns in the previous table:

Correlation Between Gross State Product per Capita and Adjusted Federal Expenditures

	Correlation Coefficient	Correlation Coefficient Squared
All States	-0.62	0.38
Excluding Outliers (Alaska, Maryland, Virginia)	-0.76	0.58

The square of the correlation coefficient corresponds to the fraction of the variation of one column that is explained by (or correlates with) the other column. The sign of the correlation coefficient (not squared) tells us if it us a positive or negative relationship.

Sure enough, excluding outliers, 58% of the differences of Adjusted Federal Expenditures can be explained by the differences in per capita income between the States. I've excluded Virginia and Maryland because they border D.C., and do get more federal expenditures than would be expected using the Gross State Product model. I've excluded Alaska because it is an extreme outlier and it has low population and Gross State Product. To leave it in would allow it to substantially skew the results even though it represents a minscule amount of federal expentitures and taxation. That same argument could be made to exclude other small population states such as North Dakota and Hawaii, which would also, it turns out, increase the correlation. But I left the rest of the small States in.

Gross State Product (column 2) comes from the Bureau of Economic Analysis, State Population comes from the census bureau, and Adjusted Federal Expenditures comes from The Tax Foundation (this is what TaxProf linked to). Unfortunately, the data for the various columns are for slightly different years. However, all of this data varies slowly so it is unlikely to have materially changed the result.

So if 58% of the differences in Adjusted Federal Expenditures is explained by Gross State Product per Capita, what about the other 42%? Well, The Tax Foundation lists other possibilities and I'll comment on each.

One factor affecting rankings is that federal spending on defense and other procurement dollars are often funneled to the states of powerful members of congress. Also, state governments can grab more federal grant money by manipulating their spending to comply with federal regulations.

Well, maybe so, but they don't happen to mention which states those might be so I have no way of checking. Funny that the list these first when clearly they are a minor effect at best.

Another factor is demography. States with more residents on Social Security, Medicare and other federal entitlements tend to rank high.

Once again, maybe, but if you look at the data, states you might think likely candidates for this effect such as Florida and Arizona, don't seem to be out of line.

Similarly, high spending levels in Virginia, Maryland and the District of Columbia are explained by the predominance of federal employees.

This one is clear and that is why I eliminated Maryland and Virginia from the mix.

Finally, states with higher incomes per capita%G—%@such as Connecticut%G—%@pay higher federal taxes per capita thanks to the income tax's progressive structure, which increases federal taxes per dollar of federal spending received in return.

But as I've shown, even if the taxes were flat instead of progressive, most of the differences are explained anyway. It's not clear to me that the "progressive" portion of the taxation makes much difference at all.

The Tax Foundation doesn't mention randomness. Sheer chance is going to introduce some differences in Adjusted Federal Expenditures. In other words, the chance that every state has identical Federal Income per capita is zero. In fact, chance could possibly explain all of the rest of the differences.

Anyway, for those on their high horses who see vast republican conspiracies to bleed the blue states for the benefit of the welfarist red states, I think it's time to dismount.