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State Tax Levels Do Impact Economic Growth


The bottom line is this: the overall tax burden does matter to economic growth and, contrary to what ITEP would have its readers believe, low tax states such as Texas are thriving economically because their governments demand less of their citizens, both job creators and workers.

On June 25, Bloomberg Businessweek ran a piece entitled, “States Lacking Income Tax Get No Boost in Growth: BGOV Barometer.” This article, and similar pieces in other venues, detailed a February 2012 study by the Institute on Taxation and Economic Policy (ITEP), a liberal non-profit foundation. ITEP’s study, “‘High Rate’ Income Tax States Are Outperforming No-Tax States,” makes the claim that state income tax levels have no impact on economic growth.

ITEP’s main object is to rebut the notion, largely popularized by economist Dr. Arthur Laffer, that high taxes are a drag on the economy. Laffer sets out his arguments in “Rich States, Poor States” along with Stephen Moore and Jonathan Williams.

Laffer’s book, now in its fifth edition, presents ten tables in its “Policies for Growth” chapter contrasting states’ income taxes, severance taxes, corporate income taxes, sales taxes, the total state and local tax burden, right-to-work laws and other factors. Using these ten tables, Dr. Laffer makes a well-documented case that lower taxes lead to greater employment growth while encouraging people to move from high-tax states to low-tax states.

To counter Laffer, ITEP focuses on one table of the ten, a data set showing the nine states with the highest personal income tax rates and the nine states with no personal income taxes. ITEP then states:

…residents of “high rate” income tax states are actually experiencing economic conditions at least as good, if not better, than those living in states lacking a personal income tax. ...the nine “high rate” states identified by Laffer have actually seen more economic growth per capita over the last decade than the nine states that fail to levy a broad-based personal income tax. Moreover, while the median family’s income, adjusted for inflation, has declined in most states over the last decade, those declines have been considerably smaller in “high rate” states than in those states lacking an income tax entirely. Finally, the average unemployment rate between 2001 and 2010 has been essentially identical across both types of states.

As a former California lawmaker who recently moved to Texas—from a “high rate” income tax state to a state with no income tax—I respectfully disagree with ITEP’s claim that the economic conditions in the Golden State are as good, if not better than they are in the Lone Star State.

To arrive at this counterintuitive assertion, ITEP doesn’t dispute Dr. Laffer’s data, rather, they simply replace Laffer’s comparative economic data with their own data for one of ten tables, then ignore the other nine. The replacement complete, ITEP then claims that Laffer’s conclusions aren’t valid.

There are two main problems with ITEP’s approach: it ignores the fact that Laffer presented a host of other data in making a comprehensive case that state tax policies impact economic growth; second, ITEP’s three economic measures—the average annual unemployment by state, the growth in per capita real gross state product, and real median household income growth—are inadequate to measure the impact that state tax policies have on the economy.

As one glaring example of ITEP’s shallow approach, they cite Oregon as a “high-rate” income tax state that performed the best of the 18 states in one of their three selected measures, per capita real gross state product growth from 2001 to 2010. It’s true that Oregon’s increasingly high-tech, export driven economy did well by some measures in the 2000s, but, ITEP failed to note that Oregon is one of four states that levies no sales tax and, as a result, is listed by the Tax Foundation as having a mid-range combined state and local tax burden.

Further, in one out of three measures ITEP employs, Oregon turned in the worst performance: the average annual unemployment rate. It is difficult to reconcile a state doing well in growth in per capita real gross state product but poorly in average unemployment, pointing out the weakness in using unemployment as measured over a period of time in state-vs.-state comparisons.

Still, ITEP uses the average 10-year unemployment rate to assert that there is no tax rate difference within their 18 state sample. The problem with this assertion is that there is a difference. To arrive at their conclusion, ITEP simply takes the average unemployment rate of the nine high income tax rate states and the nine no income tax states and claims them to be the same: 5.7 percent. Aside from the fact that ITEP did not properly round the average, understating the high rate state unemployment rate by 0.1 percent, they committed a greater statistical flaw by giving equal weight to each state. This makes little sense, since tiny Vermont has only 1 percent of the workers in the high-rate states while California has 38 percent of the total. Similarly, among the no-tax states, Texas has 40 percent of the total workers while Wyoming and Alaska have 1 percent each. This is why Dr. Laffer weighted his findings in the book ITEP superficially criticizes.

Weighting each of the 18 states by the total number of employed workers in December 2010 gives a different result, with the no-tax states having a weighted unemployment average of 6.04 percent vs. 6.44 percent for the high-rate tax states—a large enough difference to be statistically meaningful, but still not huge (6.44 percent is about 6 percent higher than 6.04 percent when expressed as a ratio).

But all of this ignores that comparative average unemployment is a poor tool by which to measure economic vitality for two reasons: people move to where the jobs are and, in so doing, take their unemployment with them to new states, at least temporarily; and, different states have different levels of generosity when doling out unemployment checks and other public assistance—what the state subsidizes, it gets more of.

Rather than unemployment rates, the total job base gain or loss would be a more accurate measure of economic health. ITEP’s nine high-rate states saw total employment fall by 1.45 million from January 2001 to December 2010 while states without an income tax saw an employment increase of 1.13 million (Texas was 79 percent of this increase). This presents a stark contrast to the benign story ITEP wishes to tell about tax policy.

ITEP tries to counter the job creation statistics in low tax states by claiming that the Sun Belt states’ mild weather has encouraged migration which, in turn, has grown the economy and jobs. On the surface, this appears to be true, taking the six states of the 18 in their survey that are below the Mason-Dixon Line as being in the Sun Belt (one can argue about Maryland), we see that those states had a combined employment gain of 430,600 while the 12 in the “bad” weather states lost 759,300 jobs. But, how does this explain California and Texas, both in the Sun Belt, with Texas gaining 892,600 jobs in the period while California lost 711,100 jobs? Further, what about outliers such as Washington State, land of perpetual drizzle, which gained 75,500 jobs?

Another excuse ITEP employs is that energy-related jobs are driving growth. But California has abundant energy resources, with the nation’s third-highest proven oil reserves. But, in addition to high taxes, California has restrictionist policies that keep the oil in the ground depressing production to 1/10th that of Texas. Further, ITEP’s energy excuse doesn’t explain the solid economic performance of oil and gas poor Washington and South Dakota. (South Dakota saw the value of its oil and gas extraction rise to $20 million in 2010—or about 5 hundreds of one-percent of its economy—0.05 percent.)

The second factor ITEP uses to make their case is the growth in per capita real gross state product (GSP). Again, this measurement isn’t ideal when attempting to show economic success due to tax policy. ITEP claims that the per capita real GSP grew by 10.1 percent in the nine states with “high rate” income taxes vs. 8.7 percent in the nine states without a personal income tax from 2001 to 2010.

However, as with unemployment rates, there are major issues with using per capita gross state product growth as a proxy for overall economic performance.

First of all, there’s the issue of the time period being measured, 2001 to 2010. There were weak economic times at the beginning and end of the first decade of the new millennium, making for considerable volatility in the bookend years that ITEP selected for its study. Adding one year to the measurement, going from 2000 to 2010, as does the U.S. Census Bureau, yields dramatically different results, with both Texas and Florida turning in better per capita GSP performance than California when including the extra year. If two more years are added to the sample, going from 2000 to 2011, Texas vaults further ahead of California with a 6.0 percent improvement in real per capita income vs. 1.7 percent for California and 4.9 percent for the U.S. average. These wide-ranging changes in measured outcomes are dependent on just one or two years’ difference in the time selected for measurement.

Considering the GSP performance in New York from 2007 to 2010 provides a case in point as to the weakness in the ITEP approach. According to the U.S. Bureau of Economic Analysis, New York’s economy shrank by 4.3 percent from 2008 to 2009, then rebounded by 5.1 percent from 2009 to 2010. Finance and insurance constituted about 17.2 percent of New York’s economy in 2010. That industry saw a far larger hit at the beginning of the recession, but then a double-digit gain from 2009 to 2010 as $175 billion of federal Troubled Asset Relief Program (TARP) money poured into New York by mid-2009, worth about 15 percent of the state’s 2009 economy. California received the fifth-largest amount of TARP disbursements, with $34.4 billion. No other state in ITEP’s 18-state study was in the top five. The economy-distorting impact of TARP alone would have been enough to significantly change ITEP’s growth in per capita real GSP measurement for the period measured.  

Lastly, ITEP uses the change in the real median household income from 2001 to 2010 to make their case that high income taxes don’t harm economic development. Again, to see the glaring weakness of this statistic, look no further than New York and California, which, during the decade of the 2000s, lost a combined 652,000 jobs. ITEP would somehow count this as a positive as the real median household income in New York (-3.9 percent) and California (-6.4 percent) average less than the decline in Texas (-5.7 percent).

But what does real median household income measure? It is simply the halfway point for household income—the point at which half the households earn more and half, less. This number can be moved a few ways. First, in the way ITEP wishes to infer: the growth in the number of high-paying jobs. But, similarly, real median household income can rise when the economy sheds jobs at the lower end of the scale. In other words, blue collar job loss will cause real median household income to rise to the extent that the people working those jobs give up and move out of state to a place such as Texas.

The irony here is that ITEP is actually touting a statistic that chronicles the pressures working class Americans have faced in places such as New York and California where high taxes, a morass of regulations, and expensive energy policies have accelerated deindustrialization as a share of their economy as compared to Texas, which has seen manufacturing, even sans oil, gas and refining, actually grow in importance since 2000.

Real median household income is also heavily influenced by demographic factors such as race, ethnicity and age. As people gain experience and education, they tend to earn more. This fact alone accounts for about one percent of the difference in household income from 2000 to 2010 between New York and California which aged more relative to youthful Texas and yes, Florida.

ITEP should ask themselves a question: how sustainable are New York’s household income gains made when they’re based on federal bailouts, an aging workforce, and a loss of manufacturing jobs?

The bottom line is this: the overall tax burden does matter to economic growth and, contrary to what ITEP would have its readers believe, low tax states such as Texas are thriving economically because their governments demand less of their citizens, both job creators and workers.

Chuck DeVore served in the California State Assembly from 2004 to 2010 and is a Senior Fellow for Fiscal Policy at the Texas Public Policy Foundation.