The Data Shows that State "Beggar Thy Neighbor" Policies Don’t Work.

by Mike Kimel

The Data Shows that State “Beggar Thy Neighbor” Policies Don’t Work.
Cross posted at the Presimetrics blog.

Many states seem to believe a “beggar thy neighbor” approach to taxes works best. That is, the state with the lowest taxes will “steal” business from other states and produce the fastest economic growth. A lot of people seem to believe it works. The data stands in opposition to them.

States raise revenues through a variety of means – state income taxes, property taxes, fines on overdue books, etc. The Tax Foundation , which bills itself as “a nonpartisan tax research group based in Washington, D.C” and which I believe can be fairly described as generally advocating lower taxes in general, provides a file showing the the overall state tax burden and per capita income for every state for each year from 1977 to 2008.

So here’s what I did after the fold.

I took the per capita income, adjusted by the CPI-U, and got the real per capita income, which I then used to compute the percentage growth (or shrinkage) in real per capita from one year to the next for every state and every year from 1977 to 2007. I did the same thing for the US, getting the US average growth in real per capita income from t to t+1 for every year from 1977 to 2007, and subtracted that amount from the state growth rates. This provided the amount by which each state grew (or shrunk) faster (or not) than average, each and every year from 1977 to 2007.

The next step was to take the state tax burden for each state for each year, and subtract from that the average state tax burden for that year. Result: 1,550 combinations of (tax burden for a state in a year less average tax burden for all states for the same year) on one hand, and (growth in real per capita income from one year to the next for a state in a year less the average growth in real per capita income over the same period). In other words, a comparison between being above or below average on tax burdens and being above or below average on real per capita income growth.

Here’s a histogram:

Figure 1

The graph is a bit busy, but let me interpret it. The first bar is for observations for which the tax burden was between 4.25% and 3.75% below (i.e., more 4.25% below, or less than or equal to 3.75% below) the average state tax burden for that year.(sentence updated….dan)
There are 7 observations (figure in purple at the bottom), and the median growth rate for those 7observations was 1.65% slower than the average for that year.

What the graph tells us is that there seem to be two maxima; going the beggar thy neighbor route can lead to faster than average growth, and there is a sweet spot: keeping tax burdens at about 2.5% below average has, historically tended to be associated with growth rates in real per capita income 0.47% above average. However, get too far away from that sweet spot and the doo-doo really hits the fan. The states that keep the tax burdens the lowest also produce the slowest growth, on average.

For states that don’t take the beggar thy neighbor route (i.e., they take a tax and spend approach), things generally go a little better. The sweet spot there – keeping tax burdens about 2% above average – produces growth rates about 0.67% above average. And getting too far away from that sweet spot doesn’t seem to lead to catastrophic outcomes either.

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This post continues the “Kimel curve” theme I’ve been following for the past few weeks, namely that there is a top that maximizes the growth of real GDP. This post has an analogous histogram showing the relationship between top marginal tax rates and growth in real GDP for the US from 1929 to the present. This one – the first of several to do so – computes the growth maximizing tax rate for the US economy. I plan to go back to work on the national data analysis in the coming posts, but everyone needs a break now and then.

As always, my spreadsheets are available to anyone who wants them. Drop me a line at my first name, period my last name, at gmail period com. And note my first name in the e-mail address is mike. An “m” gets you someone else whose patience is starting wear thin. Also, on the subject of “m”s – my last name has only one. Because a lot of people have been asking for my spreadsheets as of late, to make things easier please tell me the the name of this post, the date it appeared, and where it appeared.

Thanks.