07/29/2014 11:08 am ET | Updated Sep 28, 2014

California vs. Kansas

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In the great economic battle between pro-government and anti-government policies, California vs. Kansas has been the featured contest, and California has won. As highlighted by Nobelist Paul Krugman, among others, California is all-Democratic, while Kansas is run by its ultra-conservative Governor Sam Brownback with a Republican-dominated legislature.

And the results are in. Austerity policies don't work during difficult times, period. Kansas has practiced by the book conservative policies -- cut taxes for business and the highest income brackets, while cutting government spending -- policies that haven't worked in Europe either, which is emerging from its second recession since 2008.

While ultra-liberal California Governor Jerry Brown (though he claims to be a fiscal conservative) has both hiked taxes and spending so that California now has a budget surplus and better than average job growth. Whereas growth has stopped in Kansas and it is facing a looming budget deficit.

The math is extremely simple. Jobs are created by a demand for something. Businesses don't hire more people if they don't see a rising demand for their products. But some products and services can't be produced by the private sector; such as public works, most educational facilities, environmental regulation, education, and much of research and development of new technologies that private industry doesn't see an immediate profit from, such as space travel.

That is precisely where government hiring fits in, and creates those jobs that fill the unemployment void, thus increasing the demand for private sector jobs where employed workers shop and spend their increased incomes.

This should be a no-brainer for conservatives, as well. Even ultra-pro-business Forbes Magazine admits that the Kansas economic experiment has failed. "The business boom predicted by tax cut advocates has not happened, and it certainly has not come remotely close to offsetting the static revenue loss from the legislated tax cuts."

As Forbes recounts,

"From 2013 to 2014, income tax revenue dropped by far more -- by $713 million. Since the first round of tax cuts, job growth in Kansas has lagged the U.S. economy. So have personal incomes. While more small businesses were formed, many of them were merely individuals taking advantage of the newly tax-free status of those firms by redefining themselves as businesses."

Whereas California has a budget surplus and increased both jobs and revenues that have enabled it to hire back at least half of the teachers laid off from the Great Recession. Employment is up 3.6 percent in the past 18 months, compared with a national average of 2.8 percent. At this point, California's share of national employment, which was hit hard by the bursting of the state's enormous housing bubble, is back to pre-recession levels, according to Krugman.

Paul Krugman cites David Cay Johnston, an authority on corporate finance, who highlights what is behind the California improvements. For instance, higher taxes aren't always bad -- in fact, may benefit growth, when applied correctly.

"People may work harder, trying to make more money to achieve a desired after-tax income and may slough off if tax rates are lowered," says Johnston. "This is known to be the case for people who have a savings target for money to leave their children and are subject to estate taxes - they save more to leave the after-tax sum they prefer, but save less when the tax is lowered or no longer applies to them.

"The empirical evidence also shows that the best-paying jobs tend to be clustered in states (and countries) with high taxes. The same tends to be true of wealth creators, including the most money-motivated among scientists, and existing wealth holders not actively engaged in business."

But this is a special case for taxation policies. Lower taxes are warranted with approaching full employment, when savings have plunged to take advantage of investment opportunities. That is the classic full employment "crowding out" argument favored by conservatives that postulates government spending can preempt private investment.

We are not in such a predicament today, however, as we weren't during the Great Depression. Money sits unused during such times. There is a savings glut held by banks and corporations that is being misused in speculative investments, or ridiculously high executive compensation. For instance, we know low capital tax rates shelter much of hedge fund income. It is the reason Wall Street deals in flash trading, sky-high leveraging with borrowed money, and other risky transactions that tend to destabilize financial markets.

The bottom line is that both governments and the private sector have to work together to bring back those jobs lost during the Great Recession.

Harlan Green © 2014