The American Legislative Exchange Council (ALEC) released the fifth edition of its “Rich States, Poor States” report yesterday. For fiscal wonks the report is a fun read, as it is chock full of tax and economic comparisons between the 50 states.
The first part of the report is a “Supply Side 101” lesson on the advantages of low marginal tax rates and the mobility of labor and capital. One point that policymakers often overlook is that a high tax rate on one tax base tends to shrink not just that tax base, but other tax bases as well. Thus, high income tax rates shrink reported incomes, and in turn that shrinks both income and payroll tax bases. Similarly, high corporate income tax rates shrink the corporate tax base and the individual and payroll tax bases as corporate investment, hiring, and wage growth are reduced.
The ALEC report explores these sorts of effects in detail for death taxes, which are taxes on estates and inheritances. States that impose death taxes induce people with substantial assets to relocate to states without those burdens. When people move, the death-tax states lose not just death-tax revenues, but also revenues from income taxes and other taxes. They also lose the productive contributions that high-earners often make in their communities, such as their aid to start-up businesses and charities.
I agree with the ALEC report’s authors—Art Laffer, Steve Moore, and Jon Williams—that taxpayers can be very responsive to marginal tax rates, especially over the longer term. I might quibble with them, however, with the overwhelming importance they seem to assign to the effect of state tax rates on economic growth as compared to other state policy factors such as regulatory burdens. The authors present statistical tables showing that high-tax states tend to grow more slowly than low-tax states. But in those correlations, I wonder whether tax rates are serving as proxies for broader state policy environments? In other words, states with high taxes often tend to be the states that impose an array of anti-market policies. Low-tax states often tend to be more broadly growth-friendly.
The second part of the ALEC report presents state-by-state policy and economic data. Here, the authors do examine numerous non-tax factors. State right-to-work laws, for example, affect business location decisions in labor-intensive industries that are prone to unionization. With policy levers such as right-to-work laws, worker compensation costs, and the quality of state legal systems, state policymakers have the power to attract or repel business investment and thus spur or hinder economic growth.
Chris Edwards is the director of tax policy studies at the Cato Institute, and editor of www.DownsizingGovernment.org. Before joining Cato, Edwards was a senior economist on the congressional Joint Economic Committee, a manager with PricewaterhouseCoopers, and an economist with the Tax Foundation.
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