J. Scott Moody & Wendy Warcholik, Ph.D. | June 30, 2009
Government Is Crowding Out Oklahoma's Private Sector
J. Scott Moody & Wendy Warcholik, Ph.D.
Personal income is an important economic measure of a state's well-being. Higher levels of personal income mean that a state's residents are able to buy more goods and services such as homes, cars, education, and health care. It is also a very useful way to gauge the ability of a state's residents to pay taxes.
Fundamentally, personal income comes from two sources: the private sector and the public sector. The distinction between the two sectors is important because only the private sector creates new income. The public sector can only redistribute income through taxes and spending.1
Chart 1 shows that in Oklahoma, the share of personal income generated by the private sector in 2008 (68.2 percent) is hovering just over the all-time low mark of 66.8 percent set in 2003. The private sector has declined dramatically from its peak of 92.8 percent set in 1929-a 27 percent drop. In 2008, Oklahoma now has one of the smallest (38th largest) private-sector shares of personal income in the country.
Private Sector Share of Personal IncomeThe decline in Oklahoma's private sector is due to the crowding out created by higher government spending on personal current transfer receipts (Medicare, Medicaid, Social Security, etc.) and government employee compensation (federal, state, and local).
Chart 2 shows that in 2008, personal current transfer receipts made up 17.2 percent of all personal income-the 19th highest percentage in the country. This is a record high for Oklahoma and for the nation as a whole (15.5 percent), and stems from the 2008 "stimulus" package enacted under President Bush.2
Chart 3 shows that in 2008, total government compensation to employees in Oklahoma (federal, state, and local) made up 14.6 percent of all personal income-the 16th highest in the country.
In particular, this article will examine more closely the role of Oklahoma's state and local governments (S&L) in the crowding out of the private sector. Chart 4 reveals a pattern for S&L compensation very different from that of total government compensation (which includes federal military and civilian employees).
State and Local Government CompensationAfter surging during the Great Depression, S&L compensation dropped dramatically, reaching an all-time low of 3.2 percent of personal income in 1944. Since 1944 S&L compensation has steadily increased and set an all-time high of 10.4 percent of personal income by 1993-an increase of 224 percent over the 1944 level. By 2008, S&L compensation had shed nearly a full percentage point and now stands at 9.5 percent of personal income.
However, the full extent of the increase in S&L compensation is masked when looking at it only from the perspective of its share of personal income. A more relevant and interesting comparison is directly with the private sector. Chart 5 does this by showing comparative growth indices for S&L compensation versus the private sector.
In Chart 5, the index shows that the years between 1929 and 1944, while diverging greatly between the endpoints, were mostly a wash by 1944 with both S&L compensation and the private sector having nearly identical index values. However, growth rates dramatically diverged between 1944 and 1983 with S&L compensation clearly outpacing the growth in the private sector, yielding an almost exponential-like growth curve in the late 1970s and early 1980s. Since 1983, the growth in S&L compensation has moderated considerably but not by enough to allow the private sector to catch up.
Interestingly, a closer examination of the growth data shows a disconcerting pattern of extreme growth rates between S&L compensation and the private sector as defined by growth rates below 0 percent or over 10 percent. Since the end of World War II, the private sector has had three times as many negative growth years as S&L government (nine years versus three years). Additionally, S&L compensation had three years of 10-plus percent growth whereas the private sector had zero. Keep in mind that these are inflation-adjusted growth rates so these represent growth rates beyond that of inflation alone.
In essence, with each passing business cycle, S&L compensation enjoys a "ratchet-up" effect relative to the private sector since S&L compensation declines only once for every three declines in the private sector. This is an especially odd dynamic given the fact that it is private-sector taxpayers who bankroll S&L compensation. This is also a significant amplifying effect of the crowding out of the private sector by the public sector.
Additionally, the size of S&L compensation can vary widely by county, as shown in Table 1. The county with the highest level of S&L compensation in 2007 was Love County at a whopping 30.1 percent of personal income, followed by Payne (29 percent), Cherokee (28.6 percent), Cotton (24.4 percent), and Bryan (23.7 percent).3 On the other hand, the county with the lowest level of S&L compensation was Wagoner County at 3.2 percent of personal income, followed by Washington (4.6 percent), Tulsa (5.3 percent), Canadian (6 percent), and Osage (6 percent).
Finally, Chart 6 illustrates why Oklahoma's policymakers should be very concerned about the role S&L compensation has played in the crowding out of the private sector. Chart 6 reveals the significant positive correlation between per capita personal income and the private-sector share of personal income for 2008. In other words, the bigger the private sector share the greater the per capita personal income.
States with larger private sectors will grow faster over time than states with smaller private sectors. Connecticut, the state with the largest private-sector share (79 percent), has a per capita personal income of $56,248, whereas West Virginia, the state with the smallest private-sector share (58.7 percent), has a per capita personal income of $30,831. To put it another way, Connecticut's per capita personal income is 82 percent larger than West Virginia's.
County and RankSome may argue that the Connecticut versus West Virginia comparison is unfair since the two states diverge in so many different ways-climate, age, sex and race composition, education, urbanization, and so on. So let's compare two states-New Hampshire and Maine-that are virtually identical in every way except for the size of the private sector. New Hampshire has the 2nd largest private sector (78.7 percent) and the 9th highest per capita personal income ($42,830), whereas Maine has only the 41st largest private sector (66.4 percent) and the 33rd highest per capita personal income ($35,381).
Overall, this article uncovers the alarming trend that, nationally and in Oklahoma, the composition of personal income has significantly shifted away from the private sector and toward the public sector. More disturbingly, the long-term trendline is pointing toward an ever-shrinking private-sector share of personal income. In the not-so-distant future, the current trends may lead to the day when the majority of personal income is derived from the public sector.
Unfortunately, there will be an economic price to pay as the private-sector share continues to shrink. The transfer of resources from the private sector to the public sector imposes a very large "deadweight loss" on the economy.4 Since only the private sector can create new income, the future may well bring a declining standard of living. Keep in mind that it was entrepreneurial action in the private sector that brought a six-fold increase in living standards in just the last 78 years.
However, the future is not written in stone. Oklahoma's own entrepreneurial spirit has helped to reinvent the state's economy many times through the years. Proper public policy that embraces secure property rights, low taxes, and fewer regulations will lead to an environment where entrepreneurship can thrive. More specifically, reining in the costs of the state and local government bureaucracy5 is critical in aiding the recovery of the private sector and entrepreneurship.
1. For a more thorough discussion of "private" versus "public" sectors, see J. Scott Moody and Wendy P. Warcholik, "Oklahomans' Personal Income: An Analysis of the Private and Public Sector Components," Perspective, July 2008.
2. For more analysis on the effects of the so-called stimulus package, see J. Scott Moody and Wendy P. Warcholik, "Crowding Out Oklahoma's Private Sector," Perspective, March 2009.
3. These counties are home to a large number of Indian-owned casinos which, depending on the specific organizational structure, are treated by BEA as functions of local government, i.e., tribal councils.
4. For an explanation of deadweight loss, see J. Scott Moody and Wendy P. Warcholik, "Weighing the Costs and Benefits of Oklahoma's CareerTech System," Perspective, March 2008.
5. For a more detailed examination of Oklahoma's state and local government employment, see J. Scott Moody, Wendy P. Warcholik, and Brandon Dutcher, "Overcrowding on the Government Gravy Train," Perspective, December 2008.
J. Scott Moody (M.A., George Mason University) and Wendy P. Warcholik (Ph.D., George Mason University) are OCPA research fellows.
J. Scott Moody
OCPA Research Fellow
OCPA research fellow J. Scott Moody (M.A., George Mason University) serves as chief executive officer of State Budget Solutions. Formerly a senior economist at the Tax Foundation and a senior economist at the Heritage Foundation, he has twice testified before the Ways and Means Committee of the U.S. House of Representatives. Moody is the co-creator of the Tax Foundation’s popular “State Business Tax Climate Index.” His work has appeared in Forbes, CNN Money, State Tax Notes, The Oklahoman, and several other publications. This article is an updated version of an analysis published in 2008.
Wendy Warcholik, Ph.D.
OCPA Research Fellow
Wendy P. Warcholik (Ph.D., George Mason University) is an OCPA research fellow. She formerly served as an economist at the U.S. Department of Commerce’s Bureau of Economic Analysis, and was the chief forecasting economist for the Commonwealth of Virginia’s Department of Medical Assistance Services. She is a co-creator (with J. Scott Moody) of the Tax Foundation’s popular “State Business Tax Climate Index.”