Policy Documents

Taxes and Economic Growth: A Strategy for State Officials

Teresa Bauman –
May 1, 2002

In September 2001, Taxpayers Network, Incorporated released Taxes and Economic Growth, a 28-page report by Professor Richard Vedder of Ohio University. The report asks, and answers, the question, “Should states adopt a safe haven strategy of low tax burdens to foster economic growth, capital formation, and innovation?” The report is summarized in the article below, written by Teresa Bauman, a freelance writer.

A free copy of the complete report may be obtained by e-mailing your name and mailing address to mriley@taxpayersnetwork.org. Or use the Web-based order form at http://www.taxpayersnetwork.org/taxeseconomicgro.html.

As state legislatures grapple over how to balance their budgets, a new report suggests spending cuts be generous and income taxes—for decades a bottomless source of revenue for the perpetual expansion of state government—be thrown out and replaced with the sales tax.

The report, authored by Ohio University economist Richard Vedder, offers more resounding evidence that the income tax, more than any other form of taxation, has a detrimental effect on economic growth and Americans' overall financial well-being.

"The income tax is the champion of bad taxes, in terms of its destructive effect on people, prosperity, and their economic well-being," according to Vedder.

To demonstrate the negative effect of income taxes on economic opportunity, the study takes a 40-year look at the personal incomes of citizens living in high- and low-tax states. The results show that the lower a state's tax burden, the higher the rate of personal income growth for its citizens. Between 1957 and 1997, real personal income growth was more than twice as high in the states that did not raise their income taxes (or increased them only minimally), compared to states with the biggest increases in income taxes.

The report also uses state comparisons to illustrate the impact of taxes on economic growth. For example, while Kentucky and Tennessee are alike in many respects, these neighboring states have contrasting economies because they have taken different fiscal paths over the past 40 years. While Kentucky implemented massive hikes in its income tax between 1957 and 1999, Tennessee never even adopted an income tax. As a result, by 1997, Kentucky's overall tax burden was 25 percent higher than Tennessee's. On average, a family of four in Tennessee earned $703 more per month than its counterpart in Kentucky.

Sales Tax vs. Income Tax

As most states in the nation struggle to dig their way out of large budget deficits, Vedder encourages policy makers to "avoid the enormous temptation to raise taxes." Instead, he suggests they cut spending and then reverse their dependence on the income tax by turning to a sales tax approach for funding essential services.

Vedder criticizes the income tax as a punitive levy on people's positive and productive activities. "The income tax is the worst of taxes. It's a tax on labor, on production, on what people contribute to society," he said.

Property taxes also have an adverse effect on economic growth, Vedder concludes. Just as in the case of income taxes, states with high property taxes experienced less personal income growth when compared to states with low property taxes.

So when it comes to taxes, Vedder believes his research clearly shows the sales tax is the tax of choice. It is a less harmful approach for raising revenue, he said, because "it does not tax production, but rather what people consume, what they take away from society."

Voting with Your Feet

"Let's pack up and move!" Taxpayers aren't just saying it—they're doing it. Rather than paying income taxes, people are moving to destinations that allow them to keep more of their hard-earned money.

"It's no secret why Bill Gates, the richest man in the world, lives in the state of Washington," said Vedder, noting Washington does not have an income tax.

Vedder's report, which tracks the movement between 1990 and 1999 of native-born Americans within the United States, showed that nearly 3 million people moved out of states that impose an income tax and into states without an income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

"With the exception of Sundays, some one thousand persons moved every day for nine years to the no-income-tax states," Vedder reported.

How Do the States Stack Up?

According to the report, income taxes are such potent revenue sources—with revenues typically rising faster than personal income—that they provide governments with great revenue growth.

However, because politicians tend to spend and not save added revenue, income tax states are generally big-government states, as Connecticut, Delaware, Maine, Minnesota, and Wisconsin show. States likes Florida, New Hampshire, and Texas, which do not have an income tax, also tend to have more moderate levels of government spending and taxation relative to income levels, the report indicates.

Between 1957 and 1997, the average overall tax burden rose by 37.2 percent in the income tax states, compared with a more moderate 10.5 percent increase in the no income tax states.

According to Vedder, states wishing to increase economic opportunity for their citizens must have a low overall tax burden. Also, they must rely mainly on consumption or sales tax-based taxes more than those that impact production, such as income and property taxes.

Grading the States:

Do tax policies promote
economic prosperity for their citizens?
Grade A Grade F
South Dakota Connecticut
Tennessee Delaware
Texas Maine

The report uses these criteria to rank and grade states according to their overall tax burden. South Dakota, Tennessee, and Texas ranked highest and were awarded A’s for having the lowest overall tax burden. None of the three has an income tax. Florida and Nevada, which do not have an income tax, received an A-.

On the flip-side, Connecticut, Delaware, Maine, Minnesota, and Wisconsin all received an F for having overall high tax burdens.

Oklahoma May Give it a Try

While some policy makers may think abolishing their state income tax is too radical, at least one state is considering it.

Oklahoma Governor Frank Keating is attracting national attention for his proposal to eliminate the state's individual income tax and raise the state sales tax from 4.5 to 5.9 percent. The Governor's office estimates middle-income families would save $100 to $150 each month under the tax plan.

"Governor Keating is showing the nation that even though ending the income tax is a huge undertaking, it is possible," Vedder said.

It remains to be seen if other states will follow Oklahoma's lead. Regardless of how states address their budget woes, Vedder has three words for those that are thinking about raising taxes: Don't do it.

"They should cut government spending. They should also let private industry compete for operating state-run programs, such as university dormitories, prisons, public school transportation and cafeteria services, and highway maintenance," Vedder concluded. "What they should not do, however, is raise taxes."