The Economic Impact of Income Taxes

by Michael on Mar 1, 2013 · 3 comments

Graph of Growth on Chalkboard

In honor of Sequestration Day I thought I’d highlight the results of a recent study from the Institute of Taxation and Economic Policy.

As I’m sure you’re aware, there’s pressure in a number of states to reduce or abolish personal income taxes.

In general, the argument in favor of doing this has been that states without such taxes outperform the rest of the country, and that this outperformance is due to the lack of income taxes.

But is that actually true? Well… A careful look at the data suggests otherwise.

As it turns out, states with the highest income taxes have seen more per capita economic growth and less decline in (real) median income levels over the past ten years than states that lack an income tax.

As for the job market, unemployment rates don’t appear to vary across states as a function of their income tax status.

Graph of Economic Performance as a Function of State Income Taxes

The study concludes that:

“Residents of the states that levy income taxes – including residents of those states with the highest top tax rates – are experiencing economic conditions at least as good, if not better, than those living in [other] states.”

They further state that earlier arguments to the contrary are fundamentally flawed because they were based on cherry-picked, aggregate data.

So does this mean that state income taxes spur economic growth? Perhaps. An argument could certainly be made that by investing in public education and infrastructure, states are positioning themselves for success.

Then again, as we all know, correlation doesn’t necessarily imply causation.

In this light, one could argue that the observed patterns are indicative of something else entirely. For example, maybe those states that employ an income tax (or have higher rates) enjoy other advantages that allows them to succeed despite the added tax burden. Seems plausible, right?

Well, the opposite may be true. States without income taxes have often chosen that course because they possess unusual advantages – abundant natural resources, federal military spending, or even favorable climates that spur tourism – that allow them to raise revenue and grow their economies in ways that other states can’t.

Anyway, I thought this was an interesting bit of contrarian data given that so many people take it as gospel that tax cuts necessarily spur economic growth.

Source: ITEP.org


1 Kurt @ Money Counselor March 1, 2013 at 3:36 pm

I’ve noticed that states with the lowest taxes also are ranked similarly — near the bottom–with respect to “quality of life.” I suppose for those for whom high quality of life = low taxes — and this seems to be a rather large cohort in the US — the correlation wouldn’t apply.

2 Josh @ Live Well Simply March 11, 2013 at 9:39 am

I’ve lived on both sides of the state income tax fence (WA & PA) and to be honest, state income tax doesn’t impact you much. You just plan for it as you would any other expense. As long as my state income tax money goes to building better infrastructure and providing great services, I don’t mind paying it.

3 Steven J Fromm March 21, 2013 at 9:01 am

You make the fundamental argument as to why statistics need to be looked at carefully and that they can be deceiving if not outright wrong. I can see how Florida can get away with not having an income tax, but Pennsylvania, that will never happen. And what about Philadelphia, they would never be able to survive without an income tax. It just came out that they failed at the switch in collecting real estate taxes.

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