Editor’s note: Talk Business solicited four state business leaders to construct a fairer state tax code. This guest commentary, written by economist Greg Kaza of the Arkansas Policy Foundation, is the second in the series of four. It appears in the latest magazine issue of Talk Business Arkansas, which you can read online at this link.

Equity means the equal opportunity to work and earn an honest living. Working Arkansans and those seeking honest work understand the problem better than some officials. It’s a more difficult task in a weak jobs market where paychecks fail to keep pace with basic household living expenses.

One example: the most recent Arkansas median household income reading (2011) is barely above the 2007 level, Census data shows.

The U.S. economy, in June, entered its fifth year of expansion, according to the National Bureau of Economic Research in Cambridge, Massachusetts. Expansion is the natural state of the economy, which has expanded 692 months since the end of World War II, while contracting in only 124 including the Great Recession (December 2007-June 2009), the longest contraction since the 1930s.

Payroll employment, a broad economic indicator, increases in an expansion. The current expansion is no exception. National employment has expanded by 5.5 million jobs, U.S. Bureau of Labor Statistics data shows. Yet there is a sense of economic unease among Arkansas small business owners, and the construction and production workers I talk to.

“When is the economy going to get back to normal?” they ask. One possible explanation is that Arkansas employment has expanded at about half (2.2 percent) the U.S. average (4.2 percent), while the state’s Construction and Manufacturing sectors have recorded negative growth. Arkansas jobs creation (5.2 percent) also lagged the U.S. (5.4 percent) in the preceding expansion (November 2001-December 2007). In sum, Arkansas jobs creation has lagged the national average for more than a decade.

The problem is akin to a football team with consecutive losing seasons. The team keeps running the same plays, while other teams adjust and move forward. It’s a myth to argue that Arkansas cannot compete with other states in terms of job creation. A remarkable coalition of Arkansas business leaders, starting in the mid-1950s enacted economic measures to recruit industry.

Their hard work paid off in the 1960s. Arkansas employment expanded (48 percent) versus the U.S. (33 percent) in the February 1961-to-December 1969 expansion, the longest in American history at the time. Arkansas per capita personal income also expanded as paychecks grew, increasing from 64 to 68 percent of the nation, U.S. Bureau of Economic Analysis data show. Arkansas, in economic terms, recorded consecutive winning seasons. Appropriately, the Arkansas Razorbacks also achieved the 1964 college football championship as the nation’s top team.

Some officials contend there are limits to their ability to create a favorable Arkansas business climate that generates jobs and paychecks. They have a point. There are limits, in terms of monetary and international trade policy, to officials’ ability to affect a state’s economy.

Yet another limitation, rarely acknowledged by officials is their inability to overcome the ‘knowledge problem’ identified by F.A. Hayek, the 1974 Nobel Economics Laureate. Hayek spent part of 1950 at the Univ. of Arkansas-Fayetteville. He argued officials’ face a knowledge problem in attempting to allocate factors of production as efficiently as market-based agents.

Hayek’s knowledge problem is especially relevant to centrally-planned economies. A 2006 CIA paper described the issue as follows:

“Hayek, criticizing central planning in 1945, sought an answer to the following question: how does one effectively aggregate disparate pieces of information that are spread among many different individuals, information that in its totality is needed to solve a problem? Hayek’s answer was that market prices are the means by which those disparate pieces of information are aggregated.”

Hayek’s knowledge problem is also relevant to mixed-market economies like the U.S., and states such as Arkansas.

Should officials attempt to allocate factors of production? Or should they encourage a non-arbitrary regulatory climate; property rights, the rule of law and freedom of contract? Should officials attempt to pick economic winners and losers using taxpayer funds? Or should they step aside and insist market-based agents allocate production factors, while officials focus on development factors such as a skilled workforce (education), infrastructure (transportation), and competitive tax rates?

Why is Arkansas payroll employment lower today than in January 2007 if programs like the Quick Action Closing Fund are really working? Yes, Arkansas officials could not prevent job losses caused by the Great Recession. The countervailing argument is that the Fund has not generated positive employment growth.

Arkansas policymakers have improved the workforce by expanding charter schools including science, technology, engineering and math (STEM) programs. Infrastructure is being addressed. But competitive tax rates are another matter.

Arkansas entrepreneurs are at a competitive disadvantage with border and regional states that do not tax capital gains. These include Texas, Tennessee and Florida, and six others. States that do not levy capital gains, analyzed as a group created private jobs at percentage rates greater than the U.S. in the last four economic expansions (1982-1990, 1991-2001, 2001-2007). They’ve also outpaced the U.S. in the current expansion.

Capital flight from Arkansas has forced policymakers to address the problem. A 30 percent exemption in the capital gains tax was enacted by a Democratic-controlled legislature and Republican governor in 1999. A measure enacted earlier this year by a Republican-controlled legislature and Democratic governor increases the exemption to 50 percent.

The state DFA estimated revenue losses at $9.7 million (FY 2015) and $19.7 million (FY 2016). Thus, the prudent course is a multi-year phase-out. The grocery tax has been reduced from six to 1.25 cents in a similar manner. Market-based economists have opposed food taxation since the 18th century.

Reduce the Fund or earmark up to five percent of surplus state revenues to pay for a capital gains tax phase-out. Surpluses totaled $300 million (2012-13), $146 million (2011-2012) and $94 million (2010-2011).

Arkansans, compared to their high-growth state counterparts face unequal opportunity to find jobs and paychecks. The problem will continue until Arkansas tries a new economic play.

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Talk Business Staff