New Evidence Demonstrates How Earnings Taxes Harm City Growth

Voters in Saint Louis and Kansas City will soon vote on whether to retain their respective city earnings taxes. What’s at stake? In those two cities, the earnings tax brings in significantly more than $100 million each year, but a new Show-Me Institute essay suggests that the cost could be found in the decreased growth of both population and employment within the cities. Written by economist Howard J. Wall, the essay takes a new approach and contains new findings that will prove important for those concerned with the future of Missouri’s two largest cities.

The impact of earnings taxes has been studied before, in multiple ways. In 2006, University of Missouri–Columbia economist Joseph Haslag compared 101 cities, 24 of which had an earnings tax. In his analysis, Haslag found support for the idea that a city earnings tax encourages businesses and people to locate outside the city, in the suburbs or the county. In 2010, two Saint Louis University economics professors, Lisa Gladson and Jack Strauss, studied 179 metro areas and examined the effect of an earnings tax on growth between 1969 and 2007. They determined that an earnings tax did not affect overall metro area growth, although it should be noted that this result is not contrary to Haslag’s study, which looked at the distribution of income within a metro area rather than at overall regional growth.

Wall’s essay, “New Evidence on the Effects of City Earnings Taxes on Growth,” builds on these two prior studies. He focuses, however, on population and payroll employment rather than on income — a novel approach that can shed light on another important question about the impact of earnings taxes. Wall wants to know whether an earnings tax affects how many people move in or out of a city, and whether that tax affects employment.

Wall compared more than 1,000 cities with populations higher than 25,000, controlling for a number of important factors. He found that an earnings tax does indeed have a significant negative impact on population growth, as well as on employment growth. For every percentage-point increase in an earnings tax, the population growth rate is reduced by an average 3.04 percentage points, and the employment growth rate drops by 2.32 percentage points. As Wall points out, this means that, in the absence of an earnings tax, the population in Saint Louis city could have contracted by only 10 percent between 1990 and 2000, instead of by 13 percent — retaining almost 14,000 additional residents. Given the recent bad news about the continuing population contraction in Saint Louis city during the last 10 years, this is a great time for residents and lawmakers to sit up and take notice at what may be a significant contributing factor to the decline.

The essay also shows that the 1-percent earnings tax in Saint Louis and Kansas City is associated with 1.65 additional percentage points of population growth — not for the cities themselves, but for their surrounding suburbs. This bolsters Haslag’s 2006 finding, and further demonstrates an important point: The unintended consequences of an earnings tax tend to be felt in the long term. Businesses and individuals won’t necessarily haul up and move right when a 1-percent earnings tax is first implemented. Over time, however, the influence of such a tax makes new businesses marginally more likely to locate outside the city, and has a subtle influence on where people choose to live when they find themselves making such a choice.

Wall’s findings contain important insights that should be heeded by earnings tax supporters. As he points out in his conclusion, many cities successfully make do without an earnings tax. The long-term picture is brighter for such cities, given that they face fewer negative effects of diminished population and employment growth. It is time for public officials in Saint Louis and Kansas City to explore ways of replacing the earnings tax, if they wish to enjoy the associated benefits of increased growth rates in population and employment.

Josh Smith is a research assistant at the Show-Me Institute, an independent think tank promoting free-market solutions for Missouri public policy.