Diary

Three Tax Lessons the Left Keeps Failing

It’s no secret that lefties love taxes. Problems arise, however, when in its unending defense of the tax-and-spend playbook, the Left simply chooses to ignore facts and good data.

The Joint Economic Committee (JEC) recently held hearings on the policy markers for economic growth. My friend and colleague, Dr. Arthur Laffer, made important observations at that hearing on some topics we have collaborated on over the years. Jared Bernstein recently took to the Washington Post to respond in “How tax falsehoods flourish,” April 25.

Despite Bernstein’s cordial chiding, there should be no mistake: important work conducted by Dr. Laffer, and others, on the need for pro-growth state economic policy is indeed based upon years of evidence. Each year, I partner with Dr. Laffer and Stephen Moore of the Heritage Foundation to produce the study Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, which shows the connection between free market policies and economic competiveness across states. Many of Bernstein’s criticisms levied at Rich States, Poor States are drawn from statistically-insignificant single-year snapshots, which fall prey to short term trends, like the significant decline in natural resource prices. The data in support of our work, found below, is buoyed by multi-year windows and rigorous statistical analysis, which gives a much more illuminating and accurate perspective.

Rich States, Poor States Is Reliably Predictive

Dr. Randall Pozdena, formerly the research vice president at the Federal Reserve Bank of San Francisco, was the lead author of Tax Myths Debunked, and in this research he compared Rich States, Poor States economic outlook rankings to the Federal Reserve Bank of Philadelphia’s state economic health index from 2008 to 2012. Pozdena’s research found a distinctly positive relationship between Rich States, Poor States economic outlook rankings and both current and subsequent state economic health:

The formal correlation is not perfect (i.e., it is not equal to 100 percent) because there are other factors that affect a state’s economic prospects. All economists would concede this obvious point. However, the ALEC-Laffer rankings alone have a 25 to 40 percent correlation with state performance rankings. This is a very high percentage for a single variable considering the multiplicity of idiosyncratic factors that affect growth in each state––resource endowments, access to transportation, ports and other marketplaces, etc.

Less Income Tax Means More Growth

In our annual American Legislative Exchange Council (ALEC) study, Rich States, Poor States, as well as Dr. Laffer’s important work in The Wealth of States, we also compare the nine states with no income taxes on personal wage income with an equal number of the states with the highest income taxes. At present, there are nine no-income-tax states (two of those nine states, Tennessee and New Hampshire, currently tax so-called “unearned income;” the other seven are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). As one goes back further and further in time, at least as far back as 1960, 11 other states had no income tax but subsequently adopted one.

These state income tax facts are deeply important windows into the inner workings of states’ quests for prosperity. From them, we not only have a head-to-head comparison of no-income-tax states with the equivalent number of the highest earned income tax rate states, but we also can see what happened to the 11 states that actually chose to institute an income tax over the past 55 years.

For the head-to-head comparisons, our research used a 10-year rolling period to smooth out extraneous noise and one-off events in order to highlight the long-term systematic effects taxes have on state economic performance. The results were remarkable. Comparing the nine current no-income-tax states to the nine highest tax rate states for the 2005-2015 period, we found the results highlighted in the table below.

Nine Zero Earned Income Tax States vs. Nine Highest Earned Income Tax (PIT) Rate States

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On average over the past 10 years, the nine states with no income taxes significantly outperformed the nation as a whole, as well as the nine highest income tax states. Population growth, nonfarm payroll growth, personal income growth, gross state product growth and even total state and local tax revenue growth were greater in the no-earned-income-tax states. Further illustrating the point, the nine highest tax rate states underperformed the nation in all categories except state and local tax revenue growth. It would be difficult to find more reliable evidence than this that state taxes really do matter.

Personal Income Grows Faster in No-Income-Tax States

Using the same methodology, which for data reasons allows us to only go back to 1970, we plotted the 10-year growth of personal income for the zero-tax-rate states, the equivalent number of the highest tax rate states and the growth premium for the zero-tax-rate states. The results are found in the figure below.

Ten-Year Real Personal Income Growth Rates for Zero Earned Income Tax States

And Highest Income Tax Rate States

(Annual, personal income deflated with GDP implicit price deflator, 1970-2015)

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As Dr. Laffer noted in his testimony before the JEC, in every single year, the no-income-tax states outperformed the states with the highest income tax rates. They not only outperformed the equivalent number of the highest income tax states every year in personal income, they also outperformed in population growth and, yes, even in state and local tax revenue growth. How much more evidence would it take to convince the doubters?

States Can’t Tax Their Way to Prosperity

In his testimony, Dr. Laffer proceeded to describe our analysis (also in The Wealth of States) of the 11 states that adopted a state income tax between 1961 (West Virginia) and 1991 (Connecticut). The other nine states were Rhode Island (1971), Maine (1969), New Jersey (1976), Pennsylvania (1971), Ohio (1972), Michigan (1967), Illinois (1969), Indiana (1963) and Nebraska (1968).

Here again, the results are shocking. We looked at each of the primary economic metrics (population, employment, personal income, gross state product and state and local tax revenues) in each of the 11 states for the four years prior to adopting the income tax plus the actual year the income tax was adopted relative to the subsequent years. We then looked at the latest year, which in The Wealth of States was 2012. Each and every one of the 11 states declined relative to the rest of the nation in each and every economic metric used above, including state and local tax revenues. Some of the declines were dramatic. Michigan’s gross state product went from 7.86 percent of the 39 states to only 3.35 percent in 2012. Ohio and Pennsylvania also fell sharply, as did West Virginia.

Perhaps the most illustrative example is New Jersey. In 1965, New Jersey had neither an income tax nor a sales tax. It was one of the fastest-growing states in the nation, attracting individuals and businesses from everywhere. New Jersey also had a balanced budget. Today, New Jersey has exceedingly high sales, property and income taxes, one of the slowest-growing economies and suffers more domestic out-migration more than all but a handful of states. All of this is on top of its $850 million deficit, which looms large over any economic competitiveness outlook, proving that no state can tax and spend its way to prosperity. As far as facts go, Dr. Laffer’s work has proven itself time and time again: state tax rates and economic policies matter for economic competitiveness.

Jonathan Williams is vice president of the ALEC Center for State Fiscal Reform. Along with fellow economists Arthur Laffer and Stephen Moore, he is the author of Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index. Learn more about the American Legislative Exchange Council at www.alec.org.

Joe Harvath, a Tax and Fiscal Policy Analyst for the ALEC Center for State Fiscal Reform, contributed to this article.