Nine states survive perfectly well with no state income tax at all. These include large states such as Texas and Florida, medium size states such as Tennessee and Washington, and smaller states, in terms of population, such as New Hampshire, Nevada, South Dakota, Wyoming, and Alaska. Louisiana Governor Bobby Jindal is now proposing to make his state the 10th in America with no state income tax, phasing out both personal and corporate state income taxes.
Experience proves the wisdom of that idea. Art Laffer, Steve Moore, and Jonathon Williams summarize the data in the 2010 volume of Rich States, Poor States, published annually by the American Legislative Exchange Council (ALEC). Economic growth in the 9 states without income taxes skyrocketed from 1998 to 2008 almost 50% faster than in the 9 states with the highest top personal income tax rates. Job growth rocketed ahead more than twice as fast in the 9 no income tax states as compared to the 9 top income tax rate states.
Yet, because of this more rapid economic growth, total state tax receipts in the 9 no income tax states still grew 30% faster than in the top tax rate states.
Laffer et al. also report on the change in the economic performance of the 11 states that adopted a state income tax in the last 50 years. All 11 states grew more slowly than the rest of the country after adoption of the income tax.
Moreover, per capita income relative to the U.S. average declined substantially after adoption of state income taxes in all 11 states. After Michigan adopted its income tax, it personal income per capita fell from 129.97% of the U.S. average to 88.8% by 2009, a decline of 41 percentage points. Indiana personal income per capita declined from 113.84% of the U.S. average to 85.79% by 2008, a decline of 28 percentage points. Ohio declined from I14.57% of the national average to 89.33% by 2008, a decline of 25 percentage points.
Yet, in 9 of the 11 states, after adoption of the state income tax, total state and local tax revenues in the state as a percent of total state and local revenues in the U.S. declined as well, in some cases sharply. Michigan’s share of state and local taxes nationally declined by 34%. In West Virginia, the decline was 33%, in Indiana, 28%, in Pennsylvania, 23%, in Illinois, 21 %. What this means is that in these states all they got for paying state income taxes was a lower standard of living.
Income taxes are so economically destructive because they tax directly the reward for work, savings, investment, and entrepreneurship. With the reward reduced, the incentive for pursuing these economically productive activities is reduced. The result is less work, less saving, less investment, fewer new businesses, less business growth, less job creation, lower wages and income, and lower overall economic growth. Higher marginal tax rates reduce these incentives more. Lower marginal tax rates reduce these incentives less. A marginal tax rate of zero, as with no income tax, maximizes these incentives. This explains the results presented above.
Jindal proposes a revenue neutral tax reform, with increased state sales taxes replacing the state income taxes. While sales taxes are less economically destructive than income taxes, because they tax consumption rather than production, people produce to consume, so those sales taxes still reduce the reward for production, and hence the incentive.
A better way was explained in my 2011 book, America’s Ticking Bankruptcy Bomb. Adopt a reasonable limit on state spending growth, like the Taxpayer Bill of Rights adopted by Colorado in 1992 through a statewide vote ofthe people. TABOR limits the state’s spending growth to the rate of population growth plus inflation in the state.
That spending limitation would still maintain the same amount of spending per person in real terms over time. But spending would grow more slowly than the state’s economy, which grows at the rate of state economic growth, not just the rate of population growth plus inflation. Spending would consequently grow more slowly than total state taxes, which also tend to grow at the rate of state economic growth.
The difference, or the excess of taxes over spending each year, should then be used to reduce state income tax rates each year, until the state’s income taxes are reduced to zero. I calculate in the book that this would phase out state income taxes in any state completely in less than 10 years. That would apply to the state individual income tax, the state’s corporate income tax, and the state’s capital gains tax, the latter two usually not raising a lot of money comparatively.
With the burden of state income taxes lifted, economic growth in the state would soar, new jobs would be created, and wages and incomes would rise, as the discussion above demonstrates. Revenues from the remaining taxes would rise more rapidly as well, along with the booming economy, as the results discussed above also showed. After state income taxes are phased out, the TABOR spending limit should remain to ensure that state spending doesn’t get out of hand in the future.
Jindal’s proposal is still not in final form, and should be modified to follow this model instead. That model should then be adopted across the entire south, filling in between Texas, Florida, and Tennessee. North Dakota, with booming revenues from the state’s oil and gas fracking revolution, would be another prime candidate for a state income tax phaseout.
Indeed, this model plan for phasing out state income taxes should be adopted across all the 25 states now governed by Republican governors and Republican controlled state legislatures: Virginia, North Carolina, South Carolina, Georgia, Florida, Alabama, Mississippi, Louisiana, Tennessee, Texas, Oklahoma, Kansas, Nebraska, South Dakota, North Dakota, Wyoming, Idaho, Utah, Arizona, Alaska, Pennsylvania, Ohio, Indiana, Michigan, and Wisconsin.
Indeed, America is conducting a national experiment regarding capitalism versus socialism between these 25 Republican controlled states, and the 15 states with Democrat Governors and Democrat controlled state legislatures: California, Oregon, Washington, Hawaii, Colorado, Minnesota, Illinois, West Virginia, Maryland, Delaware, New York, Connecticut, Rhode Island, Massachusetts, and Vermont.
Soon we will be able to compare the fiscal and economic performance of California, Illinois, and New York, with Texas, Florida, and Virginia, not to mention Indiana and Wisconsin. The very mention of California, Illinois, and New York in the context of fiscal and economic performance makes you wince, while mention of the states of Texas, Florida and Virginia makes you proud to be an American again.
This competition between the states holds out the prospect of remaking the economic and political map of America, as new economic state powers pursuing pro-growth policies arise, replacing the over-the-hill, declining, economic state powers pursuing the blind alleys of sterile, defunct, redistribution policies of the past. Moreover, people and the resulting political power follow economic growth and the rising economic powers among the states.
[First posted at Forbes.]
Peter Ferrara, J.D., is a senior fellow at The Heartland Institute and an advisor for entitlement reform and budget policy at the National Tax Limitation Foundation.
