Lest We Think 1 Percent Is Small

Everyone knows that April’s showers bring May’s flowers. Unfortunately, it also brings Missourians’ tax bills. This year, individuals, businesses, and nonprofits will spend an estimated six billion hours complying with state and federal income taxes, according to research by The Tax Foundation. On April 15, Missourians will cough up more than $6 billion in state income taxes alone. If you happen to live in one of the thousands of households subject to the earnings tax this year, though, your bill will be even higher.

The earnings tax is a 1-percent tax levied on wages, salaries, and other earnings from all work performed in Saint Louis or Kansas City. Businesses and self-employed individuals pay an equivalent tax on net profits that averages near $1,500 per year. And in Kansas City, employers contribute an additional 0.5-percent match on their employees’ earnings. Missouri’s statutes authorize any city with more than 70,000 inhabitants to impose such a tax, yet to date only Saint Louis and Kansas City have actually elected to do so. In both cities, the individual earnings tax accounts for approximately 30 percent of general revenues.

Earnings taxes are not unique — about 25 percent of the nation’s largest cities collect them — but they have become increasingly rare in recent decades. One reason for their decline is that earnings taxes are particularly damaging to cities with significant suburban populations and small urban cores, such as Saint Louis and Kansas City, because they encourage businesses and residents to relocate out of town. Because suburban districts offer a similar range of cultural and employment opportunities as the city itself, households and businesses have little incentive to pay higher taxes solely for the benefit of a city street address.

This is true even in Missouri, where the earnings tax is relatively low in comparison to cities in other states. For example, defenders of the earnings tax often point to the fact that the 1-percent tax is lower than the 2-percent national average. In fact, among cities that levy earnings taxes, only Indianapolis has a lower rate, at 0.7 percent. And both Saint Louis and Kansas City have much lower rates than Philadelphia, which imposes a whopping 4.54-percent tax on city earnings. While these figures are comparatively promising, they mask the impact that earnings taxes have on total household wealth.

For example, consider a Missouri household with an adjusted gross income of $35,000, which is near the 2007 state median. The members of such a household would pay an additional $350 in income taxes each year simply by living or working in Saint Louis or Kansas City. While $350 may not seem like much at first glance, it has a dramatic impact when aggregated over 30 to 40 years of earnings.

Imagine that those in the above household chose to live and work in a suburb, rather than directly in Saint Louis or Kansas City. Presumably, the cost of living and employment opportunities would be similar to those that exist within the city itself. Sales and property tax rates in Missouri’s suburban districts are also similar to those that are levied in Kansas City and Saint Louis, on average. But by living in the suburbs, members of the household would no longer be subject to an annual earnings tax.

If members of this household chose to save the extra $350 they would keep each year in lower taxes, rather than spending it on increased annual consumption, their total household wealth during the following 40 years would be more than $80,000 higher than if they had paid the earnings tax each year. In other words, simply by choosing to live and work a couple miles down the road, the household’s earners would garner more than an additional $80,000 during the course of their careers.

If $80,000 still doesn’t seem like a big enough number to deter urban growth, consider a few facts. If 80,000 $1 bills were lined up end to end, they would cover the entire length of downtown Saint Louis and Kansas City, combined. That same number of $1 bills could cover the perimeter of Forest Park — nearly six miles — one and a half times. It would take most joggers nearly an hour and a half to run the length of their foregone earnings tax wealth. So much for the insignificance of one percent!

Taxes are a necessary part of urban living, but it’s important that cities adopt tax policies that encourage growth rather than driving it out of town. Earnings taxes can significantly impact a household’s lifetime earnings. In many cases, residents have chosen to “vote with their feet,” relocating to suburbs and lower tax rates. In fact, to help illustrate the incentives that varying tax rates provide, the Show-Me Institute recently released an estimator that helps Missourians compare their relative tax burdens across the state.

While Saint Louis’ and Kansas City’s metropolitan areas have continued to grow over the years, their urban cores have stagnated. Is the earnings tax really so insignificant?

Justin P. Hauke is a policy analyst at the Show-Me Institute and a graduate student at Washington University’s Olin Business School.