While Washington, D.C., debates the best tax policy, states tackled similar arguments this year. Some states passed tax reform, but others decided to continue failed tax-and-spend policies.
The battles for lower tax rates and broader tax bases will benefit taxpayers and businesses struggling in this weak economic recovery.
Kansas and Maryland illustrate these diametrically opposed approaches to tax policy. In Kansas, lawmakers fought to secure the largest tax cut in the state’s history. The state is consolidating three income tax brackets into two, lowering rates and cutting taxes for small businesses.
Maryland increased taxes on the so-called “rich.” Rates increased on those making more than $100,000 a year to an astounding 8.95 percent.
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Opponents in Kansas argued lower tax rates do not bring economic growth. The results do not show the benefits of lower tax rates, they argued, pointing to a study from the Institute on Taxation and Economic Policy that claims nine states with high income taxes grew faster than nine lowest. ITEP’s analysis relies on selective samples and counterintuitive methods.
The nine high-tax states’ real gross domestic product grew by 10.1 percent versus 8.7 percent for no-tax states over the past 10 years. While true, this analysis is misleading.
First, one of the high-tax states, Oregon, grew by more than 25 percent. Oregon’s growth is attributable to one company, Intel. Ironically, one of the reasons Intel is located in Oregon is the state’s massive tax subsidies sheltering it from high taxes. These subsidies are an explicit acknowledgment of Oregon’s uncompetitive tax climate.
Similar arguments can be made for other high-tax states like Maryland, whose economy has grown rapidly in recent years – not because of its private sector but because of its proximity to an unlimited pot of wasteful government spending in Washington, D.C.
Additionally, ITEP’s analysis relies on per capita growth rates. Generally, there is no problem with utilizing per capita growth rates, but the nine high-tax states are experiencing much slower population growth than the nine no-tax states – three times slower. As such, per capita growth will happen slower in any state gaining population that rapidly.
Recalculating the analysis using real GDP figures for the same groups of states illustrates the argument for low income taxes. During that time period, the no income tax states grew by 26 percent – well above the national average of 19 percent. The high-tax states grew by only 17.8 percent.
By reforming tax systems, individuals and businesses keep more of their hard-earned money, increasing their ability to spend and save and the incentive to earn more. While not all things are within the control of lawmakers, they can create a welcoming environment for economic growth. States should follow Kansas’ lead and reform tax codes for all their residents.