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 Taxpayers thought they were getting a town hall meeting to tell
state Rep. Terra Costa Howard, D-Glen Ellyn, what they thought about a
progressive income tax hike. Instead they got a 30-minute speech from one of the
governor’s backers that was more fiction than fact.
Howard held the event April 23 while the Illinois General Assembly was on a
two-week spring break and allowed Ralph Martire to deliver a “fair tax” sales
pitch riddled with inaccuracies and misleading information. Martire is the
director of the Center for Tax and Budget Accountability, or CTBA, and was also
a member of Gov. J.B. Pritzker’s transition team.
Among the most blatant falsehoods touted during the presentation was that state
income taxes have no effect on state economies. Martire has made this claim in
interviews and opinion columns for years.
It flies in the face of the vast body of the empirical academic literature,
which comes to the consensus that tax hikes hurt economies.
Experts ranging from Nobel Prize winners such as Edward Prescott, to former
Obama Administration chair of the Council of Economic Advisors Christina Romer,
to Congressional Budget Office Director Douglas Holtz-Eakin, to George W. Bush
economic advisors Harvey Rosen and Greg Mankiw – whose textbooks are the most
widely used in college macroeconomics classes – agree on the following: higher
taxes hurt economic growth; and higher marginal tax rates reduce small business
employment, employee wages and firm growth.
New studies consistently confirm these results.
So how does Martire ignore overwhelming evidence debunking his claim? He cites a
white paper written by the Institute for Taxation and Economic Policy, or ITEP,
and the alleged findings of three studies.
ITEP report
The ITEP report is a direct rebuttal to the annual “Rich States Poor States”
publication by the American Legislative Exchange Council, or ALEC. The ITEP
report suggests the performance of state economies from 2006-2016 shows
arguments claiming that cutting or raising taxes affects state economies are
overblown.
But both the methods of ITEP and ALEC are descriptive, making no attempt to
investigate the impact of tax policy on economic performance. In addition, the
studies only pay attention to the nine states with the highest marginal income
tax rates and the nine states without broad-based income taxes.
The main disagreement between the two reports is how to handle population
growth. The states without income taxes have seen far faster population growth
than those with the top income tax rates. ITEP attributes superior growth in
nearly all measured variables to faster population growth, and insists on
looking at per capita growth, which benefits states where population grows
slower.
The only measure that was worse among no-income-tax states during that 10-year
period was GDP. ALEC attributes this mainly to the decline of energy prices,
which are vital to the economies of Texas and Wyoming.
ALEC claims dismissing population growth is irresponsible, as a quickly rising
population shows low-tax environments are more attractive for families and
businesses. For example, Illinois has been losing population from outmigration
for five consecutive years. Looking only at per capita GDP growth, Illinois’
economic performance would appear healthier than it actually is despite hundreds
of thousands of people fleeing the state.
Both of the studies focus on a problematic time period because they include data
from the Great Recession, which affected states in vastly different ways. The
Illinois Policy Institute has also performed a similar exercise focusing on
different outcomes in progressive and non-progressive income tax states in the
post-recession period, finding support for ALEC’s theory that high progressive
income tax states have underperformed.
ALEC’s analysis also examines the long-run growth of personal income across
states, finding that since the 1960s, states without income taxes have
consistently had faster-growing economies than the states with the highest top
marginal income tax rates. Not only does simply looking at the data reveal the
significant underperformance of high-tax states, the vast body of peer-reviewed
empirical literature agrees that higher taxes harm economic growth.
Other studies
Beyond the ITEP paper, Martire points to three studies for his claim that tax
hikes don’t harm state economies. And in all three cases, Martire horribly
misrepresents these studies’ findings.
The first comes from the Small Business Administration. Martire implies the
study confirms his pro-progressive income tax position. He often takes this
quote from the study out of context: “We find no evidence of an economically
significant effect of state tax portfolios on entrepreneurial activity.” This
quote is particularly misleading because “state tax portfolios” refer to the
share of revenue generated by certain taxes in a given state – not the level of
taxation.
Martire leaves out this key detail. Income tax differences across states matter
for where researchers found the most entrepreneurs. The study reveals states
with lower top marginal tax rates have a larger share of entrepreneurs.
Additionally, “progressive” income taxes – meaning effective rates increase with
income levels, just like Illinois’ flat tax – also encourage greater
entrepreneurship rates. Taking both of these conclusions together, one would
think Illinois could foster the friendliest entrepreneurial environment by
levying a low, flat income tax with large exemptions and deductions for those
below the median income level.
The paper concludes that “Rather than attempt to target tax breaks to small
businesses, then, states should focus on traditional tax reforms involving lower
tax rates, broader tax bases, and simpler tax systems that will create a more
neutral and productive tax environment for small businesses, large businesses,
and individuals alike.”
The second paper Martire references comes from the University of Missouri. It
mentions that tax cuts accompanied by a corresponding drop in public spending
result in a net economic loss. It is true that public spending can provide a
small initial boost to the economy. However, in the long-run, the depressing
effects of tax hikes outweigh the benefits of additional spending, resulting in
a smaller economy. This is because higher taxes and government spending have a
strong negative effect on investment spending.
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More importantly, the positive effects of
government spending are often attributed to meaningful investments
such as education. However, during the past 20 years in Illinois,
state education spending, adjusted for inflation, has increased by
$5.4 billion annually, but two-thirds of this increase has gone to
pensions instead of to classrooms.
Despite that syphoning of state education funds, Illinois still
spends more per pupil than every Midwestern state except for North
Dakota. Illinois’ spending yields below average educational
outcomes. Without structural reforms, a progressive income tax will
be a tax for pensions, not for school funding.
The third study Martire mentions is actually part of congressional
testimony given by the Congressional Budget Office, or CBO. The
testimony discusses how to best increase employment, and thereby
economic growth, after the recession. The testimony came during a
time when employment was still low compared to the pre-recession
peak. Martire suggests the CBO research finds no correlation between
tax policy and job creation, but this is simply not what the
testimony says.
While the testimony does say private sector demand is the most
important factor for job creation, it also states that “[i]f widely
anticipated changes to current law, such as an extension of tax cuts
that are scheduled to expire under current law, were enacted,
economic growth would be notably stronger in 2013, according to
CBO’s projections.” That’s because tax cuts provide both families
and businesses with more disposable income to consume or invest. The
testimony also adds that in order to prevent crowding out private
investment, the extension of tax cuts should not yield greater debt
burdens.
Once again, Martire’s conclusions are politically motivated and far
removed from what these studies actually found.
Income taxes matter for states’ economic growth
Despite Martire’s false claims, there are statistically significant
differences between states that collect income taxes and states that
don’t. States with no income taxes grow faster.
While the ITEP and ALEC exercises recorded the experience of states
in recent years, the Illinois Policy Institute examined a larger
sample and extended the analysis to the 1998-2016 period, in order
to include two recessions and two economic expansions. Due to the
well-established connection between taxes and economic growth, the
Institute includes all 50 states in this analysis to examine the
differences between states with income taxes and states with no
income taxes.
Here are the results, in contrast with myths claimed by Martire and
implied by the ITEP study.
Myth No. 1: States levying the highest top personal income tax rates
are experiencing faster economic growth.
Reality: From 1998 to 2016, per capita GDP growth was 6.3% higher in
states with no income tax, after adjusting for inflation. This
difference is not statistically significant (see appendix).
However, per worker GDP growth was 10.3% higher in states without an
income tax, after adjusting for inflation. This difference is
statistically significant (see appendix). Per worker GDP growth is a
better measure of states’ economic performance, because it better
accounts for age and other demographics across states.
While there are many factors that influence state
economic growth, descriptive statistics support the existing
economics literature, which suggests tax policy plays an important
role in explaining differences across states.
On one hand, there may be vast pre-existing differences that are
correlated with the tax regime across states that can explain why
some states grow faster than others. On the other hand, tax policy
could also by itself be the reason. Regardless, this exercise
reveals life is simply better for residents of states that do not
collect income taxes.
Myth No. 2: Average incomes are growing more quickly in the states
with the highest top tax rates. Per capita personal income and
disposable per capita personal income both grew more rapidly in
these states during the past decade. Per capita personal consumption
growth is also more robust in the states with the highest top tax
rates.
Reality: Wages and salaries grew 4.2% faster on average in states
with no income tax when compared with states that levy an income
tax. The difference is statistically significant (see appendix).
Myth No. 3: Residents of states with the highest top income tax
rates are more likely to have a job than people living in states
lacking income taxes. Compared with states that do not levy an
income tax, a larger share of people in their prime working years
(ages 25 to 54) have found work in the states levying the highest
top tax rates.
Reality: Job seekers find jobs faster in states with no income tax,
with a 6.9% lower unemployment duration on average.
When comparing states with an income tax with
states that don’t collect income taxes, job seekers in states with
an income tax are unemployed for 10 more days on average than job
seekers in states with no income tax. The difference in unemployment
duration across income tax regimes is statistically significant (see
appendix).
Conclusion
The broader analysis reveals the results from the ITEP study are
highly dependent on the sample size and cannot be generalized. When
looking at a larger sample over a greater number of years, residents
of states without an income tax see greater GDP growth (in all
measures), greater wage and salary growth per worker, and shorter
durations of unemployment.
Illinoisans should reject calls for the $3.4 billion graduated
income tax hike. Proponents of the governor’s tax plan rely on lies
and misinformation in the hopes of tricking Illinoisans into
accepting higher taxes.
Families and businesses in Illinois already suffer from a weak
economy. They cannot afford political efforts to worsen it.
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