You’re Better Off in a State With a Higher Income Tax
Many lawmakers in Congress and in statehouses around the country peddle the same supply-side theory about income taxes: the lower the tax, the more the economy will grow. But new research from the Institute on Taxation and Economic Policy reveals this economic approach is failing to deliver in the states. In fact, states with higher income taxes outperformed states with no income tax.
My colleagues and I compared the economic track record of the states that have charted the most radically different courses with their income tax policies, or lack thereof. Specifically, we examined economic growth in the nine states with the highest top income tax rates (averaging 10%), and the nine states with no broad-based personal income tax. What we found undermines claims that income taxes are a drag on growth that must be reduced or eliminated.
Over the last decade, states with the highest top tax rates saw their economies grow by 25.8% on a per-person basis, while those states without income taxes saw growth of just 17.4%. This growth isn’t just about numbers in a spreadsheet or bragging rights. It has translated into an improved quality of life for the residents of states with higher income tax rates. Over this same period, residents of those states saw more rapid growth in take-home pay (disposable personal income per person) and their job prospects, as measured by the official unemployment rate and the ratio of people in their prime working years who have managed to land a job.
To be clear, these types of cross-state comparisons don’t prove that higher income taxes are causing faster growth in the states that have embraced them. But they do cast serious doubt on claims that lowering income taxes is a surefire way to grow the economy.
To hear many lawmakers tell it, nothing is more important than lowering taxes on our nation’s wealthiest “job creators.” But the nine states without income taxes, despite having lower overall tax rates on the wealthy than any of the nation’s other 41 states, are not the shining example of economic success that this line of argument suggests.
Lowering personal income taxes or forgoing such taxes entirely requires difficult tradeoffs that can come at a high cost to the economy. The states without income taxes, for instance, tend to invest less in education—a direct consequence of the low-tax approach that threatens the long-run quality of these states’ workforces.
States without income taxes also tend to rely more heavily on sales and excise taxes, which fall disproportionately on moderate-income families. Balancing the budget on the backs of families who lack a stable financial footing is unsustainable in the long run, and it runs the risk of dampening consumer spending that fuels so much of our nation’s economy.
While some lawmakers are concerned about how their highest-income residents might respond to having to pay a higher tax on their incomes, the reality is that this group isn’t nearly as sensitive to tax policy changes as is often claimed. Wealthy individuals don’t stop working or investing simply because they are required to pay an income tax.
If lightening the tax load for those at the top were key to economic success, then states without income taxes would be trouncing the rest of the country—most of all those states with the highest top tax rates. Instead, these states’ economies are underperforming.
Federal lawmakers are now considering a fundamental overhaul of our nation’s tax code. The proposals and frameworks released thus far adhere to the principle that lower taxes on individuals, especially the richest, are the key to economic growth. Lessons from the states reveal this is not so. We should all be deeply skeptical of any lawmaker’s claim that lowering income taxes is a guaranteed strategy for boosting economic growth.
Carl Davis is the research director at the Institute on Taxation and Economic Policy.