Size Matters: Analysts argue for state income tax phaseout to trigger economic growth

A new analysis from the Oklahoma Council of Public Affairs (OCPA) and Arduin, Laffer & Moore Econometics (ALME) makes a bold case for state policymakers to move toward a decade-long reduction of state income taxes, reaching abolition of the unpopular levy by the year 2022.

The study asserts, “Oklahoma can significantly increase its economic competitiveness by phasing out its personal income tax.” The analysis is certain to provoke controversy and conversation “under the dome” at the state Capitol, and throughout the government of Oklahoma.

Arguments favoring the glide path to abolition are based in assumptions about the role of government, taxation and economic activity.

In an executive summary of the ALME analysis, the writers reflect, “It used to be the case that the sole purpose of the tax code was to raise the necessary funds to run government. But in today’s world taxes play many other roles, including redistributing income, rewarding favored industries, and punishing unfavorable behavior.

“Even with the greatly expanded tax mandate, finding an appropriate tax code would be relatively straightforward if only people would stop changing what they do when the tax code changes. The system is like dodgeball; if only the opponent would not duck when we threw the ball at him it would be easy to win. But the opponent does duck, and he almost always ducks just when we throw the ball at him.”

Continuing to present this case, the writers say, “Economics is all about incentives — ducking to avoid being hit by the dodgeball. When a state’s economic policies establish pro-growth economic incentives, strong economic growth follows. The reverse is true as well. Overall, Oklahoma’s economic policies are good.”

As CapitolBeatOK has reported, the Sooner State is doing well in certain analyses (including monthly unemployment rates and overall growth). A June 28 story on “The Eyes of the Beholders” detailed ways in which Oklahoma, traditionally one of the poorest states, is edging upward in varied measurements of economic dynamism. In sum, Oklahoma has a better outlook than most U.S. states because of its improved economic performance over recent years.

That story also distilled contrary arguments from the data, put forward by David Blatt of the Oklahoma Policy Institute.

In cooperation with economist Arthur Laffer, the American Legislative Exchange Council (ALEC) ranked Oklahoma seventh in economic performance and 14th in economic outlook, with first being the best and 50th being the worst. The rankings are detailed in “Rich States, Poor States: ALEC-Laffer State Economic Competitive Index” released last summer. However, that research was completed before the state income tax rate dropped to 5.25 percent.

In the new OCPA-ALME analysis, authors contend “Oklahoma’s Achilles’ heel remains the state’s progressive personal income tax. Progressive income taxes filled with special interest loopholes and exemptions are especially bad. Progressive income taxes produce disproportionately large distortions and revenue volatility, and thereby seriously damage the

economy. The damage they cause to the economy always reduces other tax revenues.”

In order to reach the top tier of states in terms of economic growth and prospects, the authors contend the state needs to take additional steps, including phaseout of the state income tax. Authors detail varied performance benchmarks to make the case that over time (and notably in recent years) states without an income tax, including Texas, perform better than states with that tax.

Arguing from available data, the OCPA-ALME analysis released this week postulates a simple yet provocative fundamental premise about government taxation, “It is not just the size of the tax burden that matters — although clearly size does matter.”

The authors assert, “on average, low-tax states significantly outperform the highest-taxed states whether one focuses on Gross State Product growth, employment growth, population growth, in-migration, and, yes, even tax revenue growth. These types of differences are not achieved by chance. Taxes matter and they matter a lot.”

“Data points” supporting the authors' contentions can be examined in several tables found within the study.

Their conclusion, succinctly stated, is “Economic growth is stronger in states with no personal income tax and weaker in states with the highest marginal personal income tax rates — in good times and bad. States without an income tax also exhibit less economic volatility. States without a personal income tax exhibit more tax revenue stability during bad economic times and stronger tax revenue growth during good economic times.”

The new analysis was crafted by the econometrics group in collaboration with OCPA, Oklahoma's leading free market/limited government “think tank.” A lead contributor to the study is Dr. Arthur Laffer, who spoke today (Tuesday, November 29) at the 55th annual joint meeting of the Downtown Oklahoma City Rotary, Lions and Kiwanis.

Professor Laffer's famous “curve” assumes income generators respond to tax rates – and that there are “arithmetic” and “economic” effects. Rates too high reduce government revenue, while lower rates provoke new productive activity, higher income and tax revenue that would otherwise never emerge. This is known as the “Laffer Curve.” (It is illustrated in a graphic found on page 9 of the new OCPA-ALME study.)

John Maynard Keynes, considered a “liberal” economist, had his own analysis that assumed taxpayers with resources respond rationally to incentives. In one sketch of economic motivation, featured in the new OCPA-ALME, Keynes reflected:

“When … I show … that to create wealth will increase the national income and that a large proportion of any increase in the national income will accrue to an Exchequer, amongst whose largest outgoings is the payment of incomes to those who are unemployed and whose receipts are a proportion of the income who are occupied, I hope the reader will feel, whether or not he thinks himself competent to criticize the argument in detail, that the answer is just what he would expect – that it agrees with the instinctive promptings of his common sense.

“Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to a resemble a manufacturer who, running at a loss, decides to raise his prices, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more – and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.”

President John F. Kennedy, who pressed for what was then the largest reduction of income tax rates in American history, distilled Keynes reflections, on this matter at least, in a January 17, 1963 budget message to Congress. Kennedy wrote, “Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased — not a reduced — flow of revenues to the federal government.”

Two decades later, Kennedy's tax rate cuts were exceeded by the reductions achieved early in the presidency of Ronald Reagan.

In the ALME-OCPA summary, “The basic idea behind the relationship between tax rates and tax revenues is that changes in tax rates have two effects on revenues: the arithmetic effect and the economic effect.”

In summary form, the arithmetic effect postulates that “if tax rates are lowered, tax revenues per dollar of tax base will be lowered by the amount of the decrease in the rate. And the reverse is true for an increase in tax rates.”

On the other hand, the economic effect “recognizes the positive impact that lower tax rates have on work, output, and employment and thereby the tax base by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities.”

In addition to his speech at the joint gathering of the city's largest civic organizations, Dr. Laffer was meeting this week with state officials and supporters of OCPA during his visit to Oklahoma City.

Laffer's partners in the ALME group are Wayne Winegarden and Donna Arduin. Winegarden is a well-known and respected economist. Arduin is former state budget director for California, Florida, New York and Michigan.