While Congress and the President currently debate the best path to hold off the upcoming fiscal cliff, many states across the country have already tackled similar challenges this year. Some states took up the challenge of passing tax reform, but others decided to follow failed tax-and-spend policies. The hard-fought battles for lower tax rates and broader tax bases will benefit taxpayers and businesses struggling in this weak economic recovery. Instead of applauding these changes, opponents have relied on a faulty analysis to claim that lower taxes do not promote economic growth.
Two states, Kansas and Maryland, illustrate the diametrically opposed views. In Kansas, lawmakers fought to secure the largest tax cut in the state’s history. The state is consolidating its three income tax brackets into two, lowering their rates to 4.9 percent and 3.5 percent, and also cutting rates for small business owners. In Maryland, on the other hand, the state dramatically increased taxes on the so-called “rich” instead of cutting their bloated state budget. The Old Line State’s tax change raises rates on those making more than $100,000 a year to an astounding 8.95 percent.
Opponents in Kansas and other states looking to lower tax rates, such as Nebraska and Oklahoma, argued that lower tax rates do not encourage economic growth. They argue that empirical results do not show the benefits of lower tax rates. But, their analyses rely on selective samples and counterintuitive methods.
One such study was published in February by the Institute on Taxation and Economic Policy (ITEP) titled “High Rate Income States are Outperforming No-Tax States.” The study claims that nine states with high income taxes grew faster than nine with no income taxes whatsoever.
The study compares the real growth in per capita GDP. The nine high-tax states grew by 10.1 percent versus 8.7 percent for no-tax states, they claim, but there are several problems with this analysis.
First, one of the high-tax states is Oregon, which grew by more than 25 percent. Oregon’s growth is solely attributable to one company, Intel. From 2000 to 2010, the subcategory of real GDP which contains Intel’s economic contributions grew by 1,450 percent. That dramatic growth will pull any average upward. Ironically, one of the reasons Intel is located in Oregon is the state government’s massive tax subsidies sheltering it from their high taxes. These tax credits and subsidies are an explicit acknowledgment that the Beaver State’s tax climate is uncompetitive.
Similar arguments can be made for other high-tax states like Maryland, which is home to numerous government agencies and contractors which fuel the states’ economy. Maryland’s economy has grown rapidly in recent years — not because of its private sector, but because of its proximity to a seemingly unlimited pot of wasteful government spending in Washington, D.C.
Additionally, ITEP’s analysis relies on per capita growth rates. In general, there is no problem with utilizing per capita growth rates, as they show the benefit of economic growth to each citizen. In this case, however, the nine high-tax states are experiencing much slower population growth than the nine no-tax states. During the decade of 2000 to 2010, the no-tax states’ population grew almost three times faster than the high-tax states. As such, growth on a per capita basis will happen slower in any state whose population is growing that rapidly. On paper, the high-tax states are in essence benefiting from individuals fleeing destructive tax climates.
Recalculating the analysis using real GDP figures from 2000 to 2010 for the same groups of nine states illustrates the argument for low income taxes. During that time period, the nine no income tax states grew by 26 percent — well above the national average of 19 percent. The nine high-tax states grew by only 17.8 percent.
Further, much more determines a state’s competitiveness than personal income tax rates. States compete on a multitude of tax rates, like sales or corporate income, as well as low tax complexity. For instance, there are more than 9,600 sales tax jurisdictions within the fifty states. An item as simple as a candy bar could be taxed at numerous rates in one state based on whether its primary ingredient is sugar or flour. Studies that ignored these realities are far from convincing.
By reforming tax systems, individuals and businesses are able to keep more of their hard-earned money, increasing their ability to spend and save, as well as increase their incentive to earn more. While not all things are within the control of state lawmakers, they can work to create a welcoming environment for economic growth. Instead of relying on faulty analysis, states should follow the lead of Kansas and reform tax rates for all of their residents.