The myth about taxes and economic growth | Arkansas Blog

Wednesday, March 20, 2013

The myth about taxes and economic growth

Posted By on Wed, Mar 20, 2013 at 11:44 AM

As soon as the Republican legislature gets through with its gun/fetuses orgy (though still more gun and fetus legislation remains in the pipeline), it will get to the business of making Arkansas a jobs magnet by slashing taxes on rich people. As yet, no legislator has gone so far as some other Republican states have in ending income taxes altogether. But just wait.

Blind faith tends to drive the tax cutting mania. But, just for the record, Ezra Klein offers some facts about the topic today:

So it’s pretty clear that getting rid of income taxes makes state tax codes more regressive [disproportionately burdens the poor, in other words]. Does it help growth, at least? The evidence here is murky at best. Economists generally prefer consumption taxes to income taxes, which would seem to argue for a shift from taxing income to taxing sales. But as Nicholas Johnson, director of state policy at the Center for Budget and Policy Priorities, explained the first time [La. Gov. Bobby] Jindal floated this idea, state sales taxes aren’t particularly good consumption taxes. Typically, many services are exempt, and business-to-business transactions are taxed more than optimal consumption taxes would have it. Jindal’s specific plan focuses on limiting exemptions to the sales tax, which could blunt some of these concerns.

ITEP, understandably, is skeptical of claims that state tax changes make a meaningful change to growth. Comparing states on economic metrics is maddeningly difficult, as the number of potential factors influencing performance, from weather to migration patterns to federal subsidy levels, are so numerous. But on the most immediately evident metrics, there doesn’t appear to be much if any difference between states without income taxes and states with them [see link for graphic]:

The academic literature is divided on the question. Economists James Alms and Janet Rogers found the effects of individual income tax levels to be quite variable between states, and never significantly negative (that is, high rates never led to a significant decline in growth rates). The University of Oklahoma’s Robert Reed and Cynthia Rogers found no evidence that income tax cuts in New Jersey in the 1990s improved economic conditions, while Hunter College’s Howard Chernick and Paul Sturm found no evidence that rates on wealthy individuals affected growth, and some evidence that taxing the poor heavily through income taxes hurt growth. Drew University’s Marc Tomljanovich found some effects of tax rates on state growth in the short-run, but none in the long-run.

But plenty of studies have found the opposite. Barry W. Poulson and Jules Gordon Kaplan, in a study published by the Cato Institute, found a significantly negative effect of state taxes on economic growth, including income taxes. Thomas Dye and Richard Feiock found that state income taxes reduce (pretax) state personal income, as do Randall Holcombe and Donald Lacombe.

Even those studies concede that there are many more important factors in determining state economic growth than are state tax levels. And most of them don’t differentiate strongly between types of taxes, or find strong differences in the effects (if they exist or not) between types of tax. So the evidence that scrapping income taxes and replacing them dollar-for-dollar with sales or property taxes would help growth is thin at best. And the evidence that that change would increase taxes on poor people and decrease them on the rich are considerable. Depending on your political preferences, that could be a poor bet.

Again: As Ernie Dumas noted this week, Arkansas has always ranked near the bottom of the states in per capita tax burden. It hasn't been a ticket to overall prosperity yet. Cutting taxes just for the sake of putting more money in a rich person's pocket is, of course, its own reward.

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