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The False Claim That State Income Taxes Impede Growth

February 10, 2012 at 3:32 PM

My list of “dos and don’ts to improve state economies” earlier this week advised states to ignore wild-eyed claims that broad-based tax cuts would strengthen state economies.

The Institute on Taxation and Economic Policy (ITEP) has a new report debunking one such claim:  the assertion by economist Arthur Laffer and the American Legislative Exchange Council, recently echoed by the governors of Kansas and Oklahoma, that states with high income tax rates have fared worse economically over the last decade than other states — particularly states with no income tax.

In reality, writes ITEP, the reverse is true:

[R]esidents 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. … [T]he 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 and2010 has been essentially identical across both types of states.

A key flaw in the Laffer analysis is that all of its measures of “economic growth” are really just measures of population growth.  As a state’s population grows, you would expect its total number of jobs and its total economic output to grow with it. But, that’s not the same thing as a state’s per capita performance.  That’s why, to see how a state’s economy is serving its people, you have to strip away the distorting effects of population growth.

As ITEP explains:

The Laffer analysis distorts reality by focusing on a number of variables that are very closely related, including population growth, total employment growth, and total growth in economic output (GSP).  Since a larger population brings with it more demand, it’s only natural that states experiencing the fastest population growth would also experience more growth in the total number of jobs and total amount of economic output.  Simply put, the Laffer analysis is hugely distorted by its failure to acknowledge the importance of population changes to the variables it presents.

State policymakers considering big income tax cuts this year should heed ITEP’s conclusion:  “There is no reason for states to expect that reducing or repealing their income taxes will improve the performance of their economies.”