The Saint Louis and Kansas City earnings taxes, 1-percent income taxes imposed on those living or working within city limits, have consequences. People have ways of avoiding these taxes, and the single easiest way is through their mobility. Put another way, people choose where to work and what businesses to operate based on a variety of factors, including the taxes in competing political subdivisions. This location decision is particularly pertinent to both Kansas City and Saint Louis, because each one’s metropolitan area straddles a state line. In contrast to metro areas that lie in the center of the state, any tax avoidance in Missouri’s largest cities will have repercussions for the state coffers as well for Kansas’ and Illinois’ benefit. Thus, in addition to the losses in economic efficiency and total productivity that it brings, earnings taxes leave the state and municipal governments with a shrinking tax base and a commensurate decrease in tax revenue, affecting all Missourians.

It is undeniable that the Kansas side of the Kansas City metropolitan statistical area (MSA) and the Illinois side of the Saint Louis MSA are gaining on their Missouri counterparts. The former has made such substantial gains in the last several decades that Kansas City is approaching an even split between the two states in terms of population, retail sales, and total employment. During the last decade, Missouri’s share of total employment within the Kansas City MSA slipped down to 0.57 in 2006, from 0.59 in 1998. Put another way, Missouri would have had another 19,000 people working in our state if the employment ratio had stayed the same. While Missouri is still by far the dominant state in the Saint Louis MSA, Illinois also has gained relative to the Missouri side. The ratio of Missouri employment to total employment in the Saint Louis MSA has fallen during the last decade from 0.85 in 1998 to 0.84 in 2006, reducing Missouri’s employment by 9,500 workers. In both cities, evidence indicates that employment is seeping across state lines, taking with it opportunities for tax collection and revenue accumulation for the state of Missouri.

How much of this phenomenon can actually be attributed to the city earnings tax? Saint Louis and Kansas City are hardly the only earnings-tax-enforcing cities that are losing economic power from their base state. Cities such as Philadelphia, Pennsylvania, and Cincinnati have also seen losses in employment to neighboring states. In fact, from 1998 to 2006, every MSA that includes counties from two or more states, in which one enforces a city income tax, has seen a decline in the ratio of employment within the area subject to an earnings tax relative to total MSA employment, even while similar multistate MSAs without earning taxes have experienced, on average, a modest increase in that ratio during the same period.

An elimination of the earnings tax could have a real, quantifiable impact on the level of total employment retained by Missouri in its two largest metropolitan areas. According to our calculations, eliminating the earnings tax in Kansas City would increase the ratio of Missouri employment to total employment in that metropolitan area by over one-half of a percent, an increase of approximately 4,700 Missouri jobs. Such an injection of employment into the state of Missouri would represent an annual gain of nearly $134.5 million in total state earnings. This increase in earnings would impact the municipal and state tax coffers as well, infusing over $4 million in additional tax revenue into Missouri state and municipal governments.

Missouri would stand to gain even more from elimination of the Saint Louis earnings tax. Our calculations indicate such a change in tax policy would precipitate an increase of more than 6,500 Missouri jobs in the short run, along with nearly $157 million in additional earnings within the state of Missouri. Local governments within the Missouri side of the Saint Louis MSA stand to gain nearly $5 million dollars in supplemental tax revenue from these additional Missouri jobs alone.

Perhaps an even more salient point is that all of these figures forecast benefits for the state of Missouri and its citizens in the immediate future. If the long-term gains are nearly as substantial as the immediate gains appear to be, eliminating the earnings tax could be a paradigm-shifting change for the Kansas City and Saint Louis MSAs, and for Missouri in general. It could help stem the trend of economic activity shifting outside city limits, fleeing toward suburban and out-of-state destinations, and help preserve Missouri’s fading dominance in those areas.

The earnings tax is, even without the concerns raised here, an economic force that adversely affects the cities that levy it, their metropolitan areas, and the state. It discourages investment and cultivation in the urban core, often the part of a city with the most infrastructure and economic potential, thereby weakening the entire economic structure of a metropolitan area and a state as a whole. When these potential pitfalls are combined with increasingly appealing out-of-state commercial options, the earnings tax becomes a formidable enemy to the economic stability of a state like Missouri. It is time to consider whether the costs of the earnings tax are worthwhile. Would the citizens of Missouri be better served by a balanced playing field that allows Saint Louis and Kansas City to compete with surrounding suburban and out-of-state areas unencumbered by the economic distortions produced by the earnings tax? The economic vitality and fiscal solvency of their state may depend on it.

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. Alex Schulte is an intern at the Show-Me Institute.

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Missouri’s two largest cities are shrinking relative to the rest of the United States. The city of Saint Louis is shrinking, period.  From 2000 to 2007, total personal income in Saint Louis averaged a whopping 2.1-percent annual decline when adjusted for inflation.  Taking a longer view, from 1990 to 2007, the U.S. Census Bureau reported that Saint Louis experienced a drop in total personal income — despite the fact that the 1990s were one of the most prosperous economic eras in American history. Even during normal or positive economic climates, Saint Louis seems to have some defect inhibiting its growth.

A similar, though slightly less dire, tale could be told of Missouri’s other economic giant, Kansas City. Since 2000, Kansas City has also recorded declines in personal income. The first eight years of this decade there have been just as bad as the situation in Saint Louis, with Kansas City having suffered a 2.3-percent average yearly drop in real personal income. However, the city capitalized on the prosperity of the 1990s slightly more than did its cross-state rival. Going back to 1990, Kansas City has treaded water, experiencing anemic income growth during America’s so-called “Great Moderation.” For comparison purposes, personal income increased nationwide at an average rate of 2.3 percent per year between 1990 and 2007.

Though neither city can completely attribute its woes to one bad policy, they share a common element: Both cities have implemented a 1-percent earnings tax. Under the prevailing school of thought, an additional 1-percent tax assessed on those working or living within city limits is insignificant. Indeed, proponents rationalize, the rate is low enough that it could not possibly harm a city economy. Both Saint Louis and Kansas City also have infrastructure advantage over the suburbs; all roads lead to the central business district. But technological gains are rendering infrastructure advantages obsolete. As technology and transit become cheaper, the earnings tax may actually be shifting the advantage toward suburban or even out-of-state areas. Springfield, the state’s third-largest city and one that does not employ an earnings tax, has seen much lower rates of economic suburban migration and substantially higher rates of personal income growth than either Kansas City or Saint Louis.

What would a future without the earnings tax look like for Kansas City and Saint Louis? We tried to answer this question by estimating the growth rate for each city if the tax were eliminated. According to our calculations, ending the tax would reverse Saint Louis’ current negative growth rate. If Saint Louis were to eliminate its earnings tax, our projections indicate that during the next 25 years, the cumulative discounted income gains would be $1.5 billion. If Kansas City were to do the same, its cumulative discounted income increase would be even more substantial, totaling $3.2 billion additional dollars in additional personal income for the next generation.

Missouri’s two largest urban areas are in danger of ceding their economic tax base to other parts of the state, and to Illinois and Kansas. If current trends continue, development and entrepreneurial activity will increasingly eschew locations within the city limits of both Saint Louis and Kansas City. Instead, they will opt for sites farther from the urban core, but that offer tax advantages to workers and entrepreneurs.

Armed with measures of the lost potential in each city, it is time to implement tax policies that will raise the living standards in Missouri’s urban core. Important questions remain: Most importantly, how does one replace the revenues from the earnings tax? Future studies will explore solutions. Let us begin, however, with a simple agreement: Ending distortionary policies like the earnings tax is certainly a step in the right direction.

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. Alex Schulte is an intern at the Show-Me Institute.

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