State Personal Income Tax Cuts: Still a Poor Strategy for Economic Growth

Policymakers in a number of states, including Alabama, Maine, Montana, North Carolina, and Ohio, are promoting deep cuts in personal income taxes as a prescription for economic growth.  This approach is not supported by the preponderance of the relevant academic research and has not worked particularly well in the past.  The states that tried deep income tax cuts over the last three decades have not seen their economies surge as a result.

• Four of the five states that enacted the largest personal income tax cuts in the last few years have had slower job growth since enacting their cuts than the nation as a whole.
• Four of the six states that cut personal income taxes significantly in the 2000s have seen their share of national employment decline since enacting the cuts.  The exceptions ― New Mexico and Oklahoma ― grew mostly because of a sharp run-up in oil prices in the mid-2000s.
• States with the biggest tax cuts in the 1990s grew jobs during the next economic cycle at an average rate only one-third as large as more cautious states.

These facts illustrate an important finding from a multiplicity of empirical academic studies by economists over the last 40 years.  The large majority of these studies find that interstate differences in tax levels, including differences in personal income taxes, have little if any effect on relative rates of state economic growth.  Of the 15 major studies published in academic journals since 2000 that examined the broad economic effect of state personal income tax levels, 11 found no significant effects and one of the others produced internally inconsistent results.

Despite the evidence that cutting personal income taxes does little to boost state economies, states may still be tempted to take the risk.  That would be a mistake.  With revenues in most states still weakened by the recession and reserves only partially recovered, states have little margin for error.  Gambling on a personal income tax cut would put fundamental public services, which in most states depend significantly on personal income taxes, at risk.  And with the federal government on track to impose further reductions in funding for schools and other services states provide, states have additional reason to protect their own revenue to limit damage to public services. 

Past Personal Income Tax Cuts:  No Panacea

The idea that cutting personal income taxes might boost the economy is not new.  Over the last three decades, a significant number of states have tried this approach.  The results make clear that deep personal income tax cuts are no panacea for state economies.  States that followed this prescription for growth did not do particularly well in later years. 

Biggest Tax-Cutting States Since 2010

More than a dozen states have cut personal income tax rates in recent years in hopes of spurring their economies in the aftermath of the Great Recession.  Five states ― Kansas, Maine, North Carolina, Ohio, and Wisconsin ― enacted especially large cuts in the last five years.^[1]  In all five states, leading policymakers claimed that the tax cuts would produce stronger economic growth.  For example, after signing the cuts in his state, Kansas Governor Sam Brownback claimed, “Our new pro-growth tax policy will be like a shot of adrenaline into the heart of the Kansas economy.”^[2]

None of these big tax-cutting states have seen their economies surge since enacting the tax cuts.  For instance:

• Job growth in four of the five states has lagged the nation’s since the tax cuts were enacted. (See Figure 1.)  This is true whether one looks at total nonfarm employment or specifically at private-sector job growth.
  
   

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• The biggest tax-cutting states have not seen particularly strong personal income growth, either.  Annual growth in personal income in four of the five states lagged the nation’s between the year before each state’s tax cuts took effect and 2014.^[3] 
• Kansas, which enacted the most aggressive personal income tax cuts of recent years, has nearly drained its operating reserves to pay for the tax cuts.  It now faces hundreds of millions of dollars in cuts to funding for schools and other priorities already damaged by the recession.^[4] 

Biggest Tax-Cutting States in the Early 2000s

In the 2000s, before the onset of the Great Recession in late 2007, six states — Arizona, Louisiana, New Mexico, Ohio, Oklahoma, and Rhode Island — enacted significant personal income tax cuts.  In every case, proponents claimed the tax cuts would improve the state’s economic standing, just as proponents of similar cuts today claim.  For example, the House Majority Leader in Rhode Island said, “This new tax rate . . . is certain to create new jobs, spur economic development, put money back in taxpayers’ pockets, and otherwise bring Rhode Island to a position of twenty-first century economic leadership in the region and, indeed, in the country.”^[5]

Since enacting the tax cuts, four of the six states ― Arizona, Louisiana, Ohio, and Rhode Island ― have seen their share of national employment decline, and New Mexico’s share of national employment has risen only slightly.  (See Figure 2.)  Only Oklahoma has seen its share of national employment rise markedly. 

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Further, the jobs performance of New Mexico and Oklahoma likely has little to do with the tax cuts.  Both states are major oil and natural gas producers whose economies benefited from the tripling of oil prices in the mid-2000s and the rapidly growing use of a new technique for extracting oil and gas that combines horizontal drilling with hydraulic fracturing, or “fracking.”  Indeed, these two states have seen their share of national employment drop in the last couple of years as oil prices stagnated and then declined sharply, reversing some ― but not all ― of the price growth from earlier years.  More specifically, both New Mexico and Oklahoma have seen their share of national employment fall by 3 percent since October 2012.^[6]

Biggest Tax-Cutting States in the 1990s

States that experimented with large cuts in personal income taxes in the 1990s also did not perform particularly well in later years.

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As the economy emerged from the recession of the early 1990s and entered the remarkable boom period of the middle and late 1990s, many states enacted tax cuts.  In six states — Colorado, Connecticut, Delaware, Massachusetts, New Jersey, and New York — the cuts exceeded 10 percent of state revenue.^[7]  Each of these states enacted major personal income tax cuts.

As they do today, proponents of tax cuts in the 1990s often asserted that tax cuts necessarily strengthen state economies.  For example, Connecticut Governor John Rowland claimed that the “key to economic growth is cutting taxes and cutting spending to create jobs. . . .  By returning more money back to people’s purses and pockets, we will stimulate the economy, create jobs, and expand our tax base.”^[8]

But after enacting the cuts, Connecticut and the other biggest tax-cutting states saw their economies grow more slowly than the economies of more cautious states.  Between 2000 and 2007 — the first full economic cycle following implementation of the tax cuts^[9] — the states that had cut taxes most:

• Created fewer jobs.  The top five tax-cutting states saw job growth of less than 0.3 percent per year, on average, compared with 1.0 percent for the other 44 states.  (We exclude New Jersey because it, alone among the biggest tax-cutting states, raised taxes by enough in the 2000s to offset fully the 1990s tax cuts.)
• Had slower income growth.  In four of the five biggest tax-cutting states ¾ all but Delaware ¾ personal income grew more slowly than it did on average in the other 44 states.  In none of the biggest tax-cutting states did personal income growth exceed inflation.

Experiences of Tax-Cutting States Consistent With Academic Literature

The lackluster results from states that cut personal income taxes over the last two decades are consistent with the strong consensus from a large number of empirical studies conducted by economists over the last 40 years.  The large majority of these studies find that interstate differences in tax levels have little if any effect on relative rates of state economic growth.

This is particularly true of studies of the impact of state personal income tax levels on economic growth.  Of the 15 major studies published in academic journals since 2000 that examined the effect of state personal income tax levels on broad measures of state economic growth, 11 found no significant effects and one of the others produced internally inconsistent results (see Table 1).

Studies focusing on narrower issues, such as the impact of personal income tax levels on interstate migration and entrepreneurship, also have found little or no impact.  For instance, a carefully designed study by two Princeton University researchers on the impact of personal income tax increases on interstate migration concluded that a tax increase on high-income earners in New Jersey “raises nearly $1 billion per year, and tangibly reduces income inequality, with little cost in terms of tax flight.”^[10]  And a rigorous 2012 study commissioned by the U.S. Small Business Administration found “no evidence of an economically significant effect of state tax portfolios on entrepreneurial activity.”^[11] 

The Dangers of Experimenting With an Income Tax Cut

Despite the lack of academic evidence supporting income tax cuts as an economic growth strategy, policymakers may be tempted to take the risk.  This would be a mistake.  The potential downsides of an ill-advised income tax cut for families, communities, and the state outweigh the advantages for a number of reasons, including:

• States have little margin for error.  States have yet to fully recover from the severe 2007-09 recession, which caused budget shortfalls totaling well over half a trillion dollars.^[12]  Revenues have only barely returned to where they were seven years ago — far below what is required, since the number of people needing state services has grown.  There are, for example, about 485,000 more students enrolled in preK-12 schools than before the recession, but about 289,000 fewer teachers and other school employees.^[13]  Further, states largely drained their “rainy day funds” and budget reserves during the recession and have yet to fully replenish them in many cases.  Enacting tax cuts now, when state finances remain fragile, would make it even harder for states to recover fully from the recession and prepare for the next one.  
• Fundamental state services depend on income tax revenue.  In most states, schools, universities, health care services, public safety, and other public services rely heavily on funding from the personal income tax.  Because states must balance their budgets, personal income tax cuts that fail to produce the promised economic gains almost certainly will lead to deep funding cuts for schools and other public services.  
• The federal government is on track to cut funding for states.  The 2011 Budget Control Act already has caused cuts in grant programs to states and will push federal funding for a wide range of state and local services — schools, water treatment, law enforcement, and other areas — to its lowest level in four decades as a share of the economy.^[14]  Additional cuts known as “sequestration” will further reduce funding for states over the next several years, unless policymakers agree on a plan to avoid them.  States need to prepare to limit the damage from these federal funding cuts, not exacerbate the problem by cutting their own revenue.

Conclusion

States considering personal income tax cuts this legislative session should be skeptical of claims that these tax cuts will improve the state’s economic performance.  In the last two decades, a number of states have cut taxes deeply in hopes of spurring economic gains, with unimpressive results. That’s not surprising given that the preponderance of the peer-reviewed academic studies indicate that state and local personal income tax levels do not affect economic performance.

Rather than bet their futures on a tax-cutting approach that has not worked well in the past, states would do better to concern themselves with improving their schools, transportation networks, and other public services that act as building blocks of economic growth.