SLU Economics Professors Misstate Findings of Earnings Tax Paper Print E-mail
By Joseph Haslag   
Friday, June 11, 2010

In a recent St. Louis Post-Dispatch commentary (“Don't blame the earnings tax,” May 6), Drs. Lisa Gladson and Jack Strauss cited a paper that I wrote about the earnings tax, which was published by the Show-Me Institute. Unfortunately, Gladson and Strauss made at least three incorrect statements in their article.

First, they state that my paper’s main contribution was to report a simple negative correlation between cities with earnings taxes and real per-capita income growth. That is incorrect. The paper’s main finding was a negative correlation, between a measure of the city economy relative to the whole metro area economy and the earnings tax rate for more than 100 cities across the United States.

In other words, I presented evidence that cities with higher earnings tax rates are, on average, smaller relative to their suburbs than cities with lower earnings tax rates, suggesting that businesses relocate from cities to the suburbs in response to the earnings tax.

Second, a correlation is not causation. Economists do not have controlled experiments for aggregate economies. Consequently, they take observations, like my correlation statistic, and develop economic theories to account for that observation. Think about a physicist who observes the heat generated by the sun. The physicist cannot “recreate” the sun, but can develop a theory that accounts for the sun. The theory I applied is standard, off-the-shelf stuff; higher taxes raise prices, and people adjust their behavior to higher prices. In this case, a higher earnings tax rate can be explained by people avoiding the tax. In a metro area, tax avoidance can be accomplished by conducting business activity and generating income in a location outside the city boundaries.

Third, different statistics answer different questions. Gladson and Strauss use convergence regressions to see whether the earnings tax rate matters. When they find no significant correlation, they conclude that there is no relationship between the earnings tax rate and a city’s economic growth. They base their analysis on the result that there is no significant correlation between the earnings tax and the growth rate of income in the metropolitan area.

This result suggests that per-capita income growth in metropolitan areas across the country tend to converge. So, the earnings tax in Philadelphia, for example, has not harmed the growth rate of Philadelphia and all its suburban areas. Metropolitan areas are not harmed by a city earnings tax rate, but any careful person would recognize that this is a different question than the one asked in my paper. It is not terribly surprising to me that the St. Louis earnings tax has not harmed the growth rate of Chesterfield or Saint Charles.

To reiterate, my evidence suggests that people respond to higher earnings tax rates, avoiding the earnings tax by shifting from the city to the suburb. Their result does not contradict mine; rather, it answers a different question. The undisputed evidence is that a city economy is systematically weaker relative to its suburbs when that city’s earnings tax rate increases.

Based on this evidence, and on economic theory, my hypothesis is that Saint Louis city’s policy mix has resulted in a stronger economy in Saint Louis County. If that is the objective for St. Louis city government, then well done. Otherwise, the open question is: Are there other tax structures that will raise the same revenue and have smaller deleterious effects on the city economy?

Joseph Haslag is executive vice president of the Show-Me Institute, a Missouri-based think tank, and a professor in economics at the University of Missouri–Columbia.

 

 
 

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