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Lower State Income Tax Does Not Spur Economic Development

Lower State Income Tax Does Not Spur Economic Development
Cris Kelly/Shutterstock.com

The idea that lower income taxes spur economic development is a mantra for many Republicans and fiscal conservatives. Their argument is that lower tax rates provide the needed financial incentives that attract capital, entrepreneurs, businesses, and talented people.

But is this actually true?

There is considerable variation in income tax rates across states. The first map below charts the maximum income tax rate for a single person at the state level for 2013, relying on data from the Tax Foundation. The darkest blue represents the states with the highest income tax rates. (Most, although not all, states have progressive income tax rates, which means the rates increase as income increases. The rates in this map are the maximum percentages, but keep in mind that the amount of taxed income varies.) The gray states have no state income tax.

Map created in Google Drive   

California (13.3 percent) and Hawaii (11 percent) have the two highest tax rates, followed by Oregon (9.9), Iowa (8.98), and New Jersey (8.97). Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming all have no state income tax.

The second map charts the amount of state income tax collected per capita in 2011. States with the most collected are in shades of red (the darker the shade the more collected) while lower-taxed states are in white. States with high collections per capita are concentrated in the Northeast (New York, Massachusetts, Connecticut, New Jersey), West Coast (Oregon and California), and Upper Midwest (Wisconsin and Minnesota). States where less taxes are collected per person are mainly in the Sun Belt — Florida, Texas, and Nevada are all zero tax states — as well as the Plains (Wyoming and South Dakota), and surprisingly Washington state.

Two things stand out. One, states with higher tax burdens are also more affluent. States with tax burdens that range from $1,205 to $1,864 per person average $10,000 more in income than states with zero state income taxes — $81,594 versus $69,612. The same pattern is true of wages — states with high collections average $50,610 in wages versus $43,638 for states with low collections.

States with high tax collections also have higher concentrations of talent and highly educated people. A third of the adults in high-collection states hold college degrees compared to a quarter in the states with low collections. Similarly, a third of the workforce in the high-collection states are knowledge, professional, and creative workers compared to 28 percent in low-collection states.

Of course, the reason for this may stem from factors beyond state tax rates. High-tax states, for example, may have more robust economic structures, higher levels of technology and economic clustering, or higher levels of amenities that may be independently attractive to more highly-skilled people, as David Schleicher of George Mason University School of Law has pointed out to me in online conversations.

Still, the lack of a connection between state tax rates and economic development is backed up by a substantial numbers of studies. A detailed study of state fiscal policies and economic performance (which I wrote about previously in The Atlantic) found little evidence of any effect from lower taxes, concluding that the evidence appears "to support the spending orientation favored by liberals and pose a rather stark challenge to Republican governors who are embracing austerity."

A recent study contends that various rankings of state tax rates and "business climates" are sometimes designed with political ends in mind. As political scientist Kenneth Thomas put it:

These indexes are designed to pressure state governments into lowering taxes, even if that requires cutting spending that benefits business throughout the state (such as a university system); and putting downward pressure on wages, even though it is hard to see how you create a prosperous state based on low-wage jobs.

Top image: Cris Kelly/Shutterstock

Keywords: Taxes, Income Tax, States

Richard Florida is Co-Founder and Editor at Large at The Atlantic Cities. He's also a Senior Editor at The Atlantic, Director of the Martin Prosperity Institute at the University of Toronto's Rotman School of Management, and Global Research Professor at New York University. He is a frequent speaker to communities, business and professional organizations, and founder of the Creative Class Group, whose current client list can be found here. All posts »

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