What you tax you get less of
If you want less of something, tax it. Tax pollution and people will reduce pollution-causing activities. Tax smoking and people will smoke less. It also is true that if you tax labor, you will get less of it. And that simple notion will be at the heart of the upcoming election rhetoric as each side debates the taxing issue of taxes.
Taxes are, by their very nature, an infringement on economic freedom. Now, I do not pretend that taxes are not a necessary part of modern life. Many of us enjoy the benefits that taxes bring, from roads to police protection to employment. While we may generally agree that some of these expenditures are worthwhile, others may be less than desirable. Taxes deprive individuals from determining how they would spend their income.
What will be hotly debated is whether there is any benefit to changing the current tax system. Everyone agrees that the current system is broken and should be fixed. The question is how. Some want taxes raised on one set of income earners, others want taxes lowered for everyone, and still others just want a flat tax. Aside from fairness issues, how might a change in taxes affect the economy? Evidence from the states offers some compelling results.
Arthur Laffer analyzed the economic performance of the states over the past decade in the study “Rich States, Poor States.” Co-authored with Stephen Moore and Jonathan Williams, the analysis was published in 2011 by the American Legislative Exchange Council and is available at the ALEC website. Before going further, fair warning: ALEC is funded by right-leaning individuals and foundations. Even so, I use only the factual information provided in the review.
What the statistics reveal is that states with higher than average personal income tax rates tend to suffer economically compared to states that have no personal income taxes. The nine states with the highest personal income tax rates averaged 9.79 percent compared to the national average of 5.68 percent. How did these nine states fare over the past decade compared to the nine states that have no income tax states?
The high-tax states grew more slowly. Total output of goods and services in high-tax states increased an average of 45 percent between 1999 and 2009. In the no-income tax states state output rose an average of 61 percent. High-tax states had slower job growth. Over the past decade, growth in non-farm employment rose only about one-half of 1 percent in the high-tax states, compared to a nearly 8 percent growth in the no-income tax states.
Economic well-being in high-income tax states rose more slowly. Using Gross State Product per person, albeit a crude measure of economic wellbeing, high-tax states saw this measure increase 36 percent compared with a 42 percent increase in the no-income tax states.
With the slower economic growth came slower increases in tax revenues. High-tax states witnessed an average increase of 62 percent in state tax receipts while no-income tax states enjoyed growth of more than 123 percent.
You get the idea: Raising taxes is not likely to spur economic growth. Indeed, those states that adopted an income tax over the past 50 years saw their share of total U.S. output fall.
How do Missouri and Illinois fare? Based on the two states’ economic performance over the past decade, Missouri ranks 38th and Illinois a dismal 48th. The fact that both Missouri and Illinois are among those states with the highest personal income tax rates (and Illinois’ got even higher after the study was published) helps explain their lackluster performance.
There are factors other than just income tax rates that explain a state’s relative success. But the evidence is clear: Personal income tax rates play a critical role in shaping a state’s economic environment and the economic future of its citizens. Changing personal income tax rates to achieve some desired redistribution of tax liability should be weighed against potential negative consequences that could far outweigh any supposed gains.