How Changes in State & Local Tax Burdens Affect Growth in Per Capita Income
by Mike Kimel
How Changes in State & Local Tax Burdens Affect Growth in Per Capita Income
Cross posted at the Presimetrics Blog.
I’ve had a number of posts recently looking at the effect of reductions in the tax burden during Presidential administrations or during (or just following) recessions and how those affected subsequent growth. In each case, cutting the tax burden did not lead to faster growth. In fact, the data shows that, contrary to theory, real economic growth tends to be slower following cuts in the tax burden than following hikes in the tax burden.
As noted in my last post , one common criticism, that there aren’t enough observations, is mooted by the fact that state and local level data seems to show the same thing. But it occurs to me that I haven’t done this sort of an analysis at the state and local data in a while, so that’s what I’m going to do in this post.
The data I’m going to use in this post comes from the Tax Foundation. Here’s how the Tax Foundation describes itself:
The mission of the Tax Foundation is to educate taxpayers about sound tax policy and the size of the tax burden borne by Americans at all levels of government. From its founding in 1937, the Tax Foundation has been grounded in the belief that the dissemination of basic information about government finance is the foundation of sound policy in a free society.
I would add to that – from what I can tell, their primary goal seems to be to convince people that lower taxes produce faster economic growth, which is something that contradicts all the data I’ve looked at so far. Thus, though I don’t normally use data from advocacy groups, I figure it adds an interesting dimension to the analysis in this case.
Anyway, the data I will use comes from this file , and it shows the state & local tax burdens and the per capita income for every state plus the District of Columbia for every year from 1977 to 2008. Despite my trepidation, I’m going to trust the data.
Now, showing results that involve three decades of data for all 50 states and the D of C (henceforth “the states”) graphically – which is what Michael Kanell and I tried to do in Presimetrics – isn’t easy. Here is what I did in this case. For every year for every state, I computed the change in the state & local burden for the two subsequent years, and the growth rate in per capita income for the six years after that. (Per capita income is not adjusted for inflation, but for the purposes I’m using it, that doesn’t matter.) Thus, in 1977, I computed the change in the state & tax burden for Alabama between 1977 and 1979, and the annualized change in per capita income from 1979 to 1985. The same thing was done for every state, and for each state, it was performed for every year for which data was available. Regular readers will recognize that I’ve used the 2 years of tax changes followed by 6 years of growth in the past when looking at data at the Presidential level.
Now, in some years, tax cutting was the norm. In other years, most states hiked taxes. So the trick is to compare relative performances. If the tax cutting proponents are right, in general, the states that reduced tax burdens the most (or increased them by the least) in any given two year period should have the fastest growth in per capita income in the next six year period. To check that, in each year, I divided states into three buckets with 17 states each. The 17 biggest tax cutters over the next two years are placed in one bucket, the next 17 appear in the next bucket, and the last 17 are placed in the next bucket. Obviously, a state won’t be in the same bucket every year. The median growth rate in per capita income in the subsequent six years is computed for each bucket, and buckets are ranked according to whether they produced the fastest, second fastest, or third fastest growth rates in per capita income.
For example… from 1977 to 1979, most states were in tax cutting mode. The 17 states that cut taxes the most are placed in the “biggest tax cutters” group, the next 17 states are placed in the “medium tax cutters” group, and the 17 remaining states (including the D of C) are placed in the “smallest tax cutting” group. Now, the biggest tax cutters produced a median annualized growth rate in per capita income from 1979 to 1985 of 7.8%. By contrast, the median tax cutters from 1977 to 1979 enjoyed a median annualized growth of per capita income from 1979 to 1985 of 7.9%. On the other hand, the smallest tax cutters produced a median growth in per capita income of 8.3% from 1979 to 1985. Thus, for the 1977 year, we rank the smallest tax cutters as first, the median tax cutters as second, and the biggest tax cutters as third.
The following graph summarizes our results for all the years available:
Figure 1
The table is interpreted as follows: the smallest tax cutters (i.e., those who cut taxes the least or raised them the most in any given year) produced the fastest economic growth about 42% of the time, second about 29% of the time, and third 29% of the time. By contrast, the middle group came in first in one third of all occasions. The ”tax cuttingest” group came in first place a mere quarter of the time; in half of all years, it came in last place.
Many conclusions are reasonable from this. However, concluding that states that cut taxes have produced the fastest growth rate in per capita income is not one of them. After all, in general, the states that cut tax burdens in a two year period have, as often as not, turned in the worst performance when it comes to growth in per capita income in the following six years.
Tying everything back to the work I’ve been showing in recent months (and which supports our findings in Presimetrics) – looking at data over the length of Presidential administrations since 1929 (when national accounts data became available), those Presidents that cut tax burdens in the early years tended to have worse real economic performance in later years than those that raised tax burdens. Similarly cutting tax burdens during or just following a recession produces slower, shorter recoveries. Now we find that cutting tax burdens isn’t the prescription at the state level either.
I’ll repeat something I’ve noted before – any economic theory for which just about every observation is a special case is wrong.
I can see both promis and a problem with this. I think it would tell us more if tax rates for the fed and states were combined. If the state taxes went up and fed taxes went down more that could skew results.
Mike
I just have to stop here to comment on “not enough observations”
You observed every president over a period of 80 years. In order to get “enough” observations you would have to observe every president over what? a thousand years? please tell those people to get real.
They are bitching about “enough observations” because they read something in a freshman statistics book that they didn’t understand, but they can repeat because it helps them feel better.
They are like the guy who comes home unexpectedly and finds his wife in bed with another man. Just as he starts to yell, she jumps up and says “now, you really don’t have enough observations to draw a conclusion.” And they, being good statisticians, are forced to agree with her.
Brueswitz
i don’t think so. mike is comparing states to states. no doubt the fed tax level affects the results overall, but should not affect the state to state comparisons… unless the feds put their taxes into some states more than others… which they do… but that is a different question.
Mike,
We will get a test case of the theory very soon. The Bush tax cuts will end (effectively making a tax increase from current base line) and thus we will see if the economy rebounds with a tax increase per your theory.
Anyone making any bets?
Islam will change
buffpilot,
That’s assuming that indeed the Bush tax cut are allowed to expire. Let us see if they really are allowed to do so.
ah buff
it does, sadly, depend on what’s done with the tax increase. i have no faith that obama will do anything intelligent with it.
he could pour it all into a hole in afghanistan.
“In each case, cutting the tax burden did not lead to faster growth.”
Please correct me if I have misunderstood, but by tax burden you mean taxes/GDP, right?
If so, “cutting the tax burden” sounds funny, to say the least. The gov’t can cut tax rates, OC, but the size of the tax burden depends upon a number of factors. It could go down simply by the GDP going up, if taxes remain the same, without anything being **cut**.
yes, but
if taxes are assessed as a percent of income, they would go up along with GDP, leaving “tax burden” the same.
in fact, to the extent taxes are “progressive” you would expect tax burden to go up with increase in GDP.
i think what Mike is trying to get at here is the loud braying we get every year and all year that “taxes” kill jobs. taxes cut growth. so tax cuts for the rich are good for us. and we already knew that tax cuts for us is good for us.
what Mike has shown is that tax cuts in years one and two do not lead to more growth in years 3 through 6 than tax raises did. in fact, quite the opposite, as one might expect if his head hasn’t been shrunk by voodoo doodoo.
Bruesewitz,
I agree with Coberly. Think of two kids standing at the back of a plane and throwing a ball down the aisle. Sure, from the perspective of someone on the ground, the plane itself is the biggest contributor to the speed of the balls, but the stronger kid’s ball will still move faster.
coberly,
True. But I still like to look at things with different data to see if the same relationships show up.
buff,
Everything is always a test. But I think you continue to misunderstand – I am not talking about marginal rates. Big changes to marginal rates might have a one or two year effect on tax burdens, but I believe the bigger effect, in the long haul, is what I have been calling enforcement.
Also… bear in mind… the strongest relationship I have found so far is the first two years to the last six years. The first two years are enough to get an idea of what the President’s attitude is. In Obama’s year 1 we’re working with one heck of a cut in the tax burden.
Min,
As noted upthread, I like to use different data sets to see if the same results continue to hold. That also applies to the definition of the tax burden – over the past four years, I’ve tried a number of different definitions but results don’t change all that much.
That said… yes, every version of tax burden I have used is some variation of gov’t revenue (or taxes paid) as a share of GDP or income.
The point is that you can see big changes in this variable even when marginal rates don’t change and GDP doesn’t change much. And you can see instances where a President cut marginal rates a lot and raised the tax burden (e.g., LBJ), or where a President raised marginal rates and yet the tax burden fell (e.g., Bush the Elder).
coberly,
Yes. (note – that’s 3 – 8, not 3 – 6).
Mike
by all means. i’m on your side. i just have a soft spot for statisticians.
thanks mike
us non statisticians have trouble counting on the fingers of more than one hand.
Of course, if low taxes were what created economic growth, we would have an immigration problem with Mexico — the other way, since Mexico’s taxes historically have been only half those of the United States. Which of course makes Mexico paradise on Earth, and our punditry pushing for low taxes is doing so only because they don’t qualify for emigration to Mexico, right? Right?!
– Badtux the Snarky Penguin
Mike,
To be honest I think the enforcement idea may be the winner. Not necessarily in a bigger IRS enforcement division budget (smile!), but in how the government levels the playing field between big and small businesses. Small business/start-ups can easily get killed by regulation changes but the big ones (especially the too big to fail types) have an inherent power both in buying politicians and in the ability to price small locals off the playing field. BY trying to keep the field level Government gives the little guys some room to breath and become big guys. Microsoft was once a few guys in a garage. Same with Apple and Dell. Was the anti-trust actions against Microsoft part of the tech boom by helping keep MS off the litlle guy (and scaring the other big guys who didn’t want the MS treatment??).
I’m not sure enforcement is the right word, but its good enough for now. And the best part is to find a policy that either party could implement and get good results from. (see Cold War – Containment, author H. Truman-D).
Though right now I think the biggest impediment to any growth is business uncertainty. To many questions out there to make any moves. (At least that’s what I get from reading around the net). Also jives with what I’m getting around my business buddies. To much uncertainty to figure a ROI….but hopefully after Nov we will get a divided Gov and put some breaks on all the changes.
And, of course, double the budget for the IRS enforcement Division 🙂
Islam will change
Norman,
After all the demogoggery from the Dems on the Bush tax cuts to you really think there is a chance in he!! of then NOT being alowed to expire???
That would require the Dem Congress to pass and Obama to sign a bill which would basically validate the cuts in the first place. Sort of like Biden’s comments about Iraq being one of this administrations successes.
I just don’t see it.
Islam will change
Bad Tux,
Mexico has a few other problems that way overcome any tax advantages it may posses. The corruption is epidemic, education standards low (in general), and non-citizens cannot own property.
Even given that, many companies already move manufacturing there to take advantage of low wages and low taxes.
And there is a significant retired ex-pat contingent there – taking advantage of what you pointed out.
Islam will change
And you get corruption because low taxes mean public servants don’t get paid a living wage. Education standards are low because low taxes mean schools cannot have adequate facilities or pay teachers a living wage. And non-citizens *can* own property in Mexico, just not in the coastal zones — yes, I know someone who is a U.S. citizen who retired to Mexico and owns property there, inland.
In other words, bing bing bing! You are the winner of the contest, “Why don’t low taxes make Mexico into a paradise?” Please report to your nearest Home Depot for your prize — your very own wetback to cut your lawn!
— Badtux the Snarky Penguin
buff,
Business uncertainty is trumped by the certainty that demand is currently slack.
My bet is that uncertainty about gov’t behavior is probably no more now than it was 1.5 years into the FDR or JFK administrations, and both produced monster growth rates.
Ok so if state a cut taxes in 89 and state b cut taxes in 92 there is no relativity possible. If you want to do that you have to compare states over time not just time after cutting or raising taxes. This is why I think fed taxes should also be accounted for so we have overall tax burden.
Mike,
But you still cling to the fantasy that the Presidents cause GDP growth. And that nothing else does.
And of course that all economic conditions are the same. Another fantasy.
Explain why Clinton who had the best economic situation ever didn’t even get to LBJ style growth – even with the bubble? BTW what would the GDP growth had been if Bush Sr had been elected? Would Bush have stopped the information age from even starting?
Do you really beleive Obama is going to give us FDR rates? From everything I read on lefty economic sites it looks like 10% unemployment will become the new steady state. Like Europe. That’s the ticket…
Islam will change
You mean like Germany’s *current* 7.5% unemployment rate is a 10% unemployment steady state? Have you been tippling the herring sauce again?
Of course, Germany began massive and immediate quantitative easing as soon as unemployment started rising, except they called it “social insurance benefits”, of which Germany’s are amongst the more robust in Europe. Which, according to loony Republican Sharron Angle who is running for Senate in Nevada, means nobody in Germany should be working because of their generous unemployment benefits. Wow, who could have known that reality would contradict right-wing propaganda so readily?!
Western Europe’s average unemployment rate hasn’t been near 10% since the 1990’s, over a decade ago, though it approached 10% in 2009. It’s the 21st Century, dude. Clinton is no longer President, that dark-skinned feller is, and Spain won the World Cup. Come join the rest of us in the 21st century, it’s a cool place to live, despite the fact it’s getting a bit warm for penguins and other furry / feathered things (eep!).
— Badtux the Snarky Penguin
Considering how bad
things are in Germany with their high taxes and their high unemployment compensation
i’m surprised we don’t see more illegal Germans offering to cut our lawns.
Bruesewitz,
The three groups are compared each year. The table summarizes yearly performance. What it shows, among other things, is that in any given year, the fastest median growth rate in years 3 – 8 was more likely to be turned in by the group that did the least tax cutting or the most tax hiking.
buff,
You are clearly misunderstanding the last few years worth of posts. I’ve shown multiple times that tax policy correlates with growth. I’ve shown multiple times that Obama’s tax policy resembles GW’s more than it does FDR’s. So why would I expect that Obama will turn in FDR style growth?
As to Clinton/LBJ – that’s in the book. Hint – that’s the Fed. We show that clearly. And we also show that if you strip out the effect of outside influences, Clinton does the best job of all admins from 1952 to 2008. JFK/LBJ come in third.
coberly,
I understand that not long ago German companies could even write off the expense of foreign bribes on their taxes.
If I wasn’t clear… each year, every state is placed into one of three groups depending on what its tax policy turned out to be over the next two years. The three groups are then ranked according to their growth rate in per capita income over the subsequent 6 years.
E.g., for 1977 I put states into buckets by their ranking on cutting the tax burden from 1977 to 1979. Each of the buckets is then ranked by how its states did at producing growth from 1979 to 1985. It is a year by year comparison.
Mike,
If you can truely show the GDP growth attributed to Clinton’s actions and growth attributed to everyone else’s then I will stand back and applaud. I’ll even send you a congrats letter after you accept the Nobel.
In all the posts you have never once shown that to my knowledge. But since you have can you just cut and paste a part from the book and fill in the table below for 1992-2000?
GDP Growth due to Clinton =
GDP growth due to the information age =
GDP growth due to Fed actions =
GDP growth due to tax increases =
GDP growth due to everything else =
According to your premise the last 4 should be close to or zero, but I’ll wait for you answer.
As for why you should expect FDR/LBJ style growth from Obama? Becuase he’s a Dem and that’s why we should vote for him. The basic premise of your book. (BTW I still think you made a mistake not going whole-hog partisan, but that choice is behind you)
I still say your two going in assumptions are unsupportable
1) The President has dominant effect on the economy
2) All domestic/international economies faced by each President are the same
YMMV (obviously)
Islam will change
Buff
i usually end up voting for the dem these days because the repub is a mad dog slavering liar.
now you don’t sound like a mad dog slavering liar to me, except when you talk about dems vs repubs. then you remind me of when i was a kid in chicago and we had real fights over whether the white sox were better than the cubs… not did they have a better record, but were they better in some “moral” sense. and we had fights over whether chevys were morally better than fords. and of course, republicans and democrats got in the mix, though most folks there were democrats (my family was republican. we thought we were better than they were). and you don’t want to know about the public schools vs parochial schools. and all that was in the days before red jackets vs blue jackets.
and that was of course before i moved to the South and learned a whole new set of people to hate. we did remain republican because back in those days republicans were the sane people in the south. that all changed of course. right about the time David Walker became bi partisan. that was when the republics realized they could win votes by being the party against civil rights. ‘cept, just like the democrats a hundred years earlier, they called it being for states rights against the evil big gummint in washington and them pointy head liberals from up north coming down and making trouble with… well, you know, those people.
now during all this time i didn’t see a dimes worth of difference between the parties (george wallace said that, but i had something else in mind), and it took Anne Gorsuch and James Watt to tip me over the edge. There still are some Republics for Environmental Policy in Chigago, but my guess is they are still Republicans only because the Democrats are still the party in Power in Chicago.
What’s the point of all this… Buff you are intelligent enough to get over this Dems bad Reps good stuff. Unless of course your mother was scared by a democrat before you were born.