Missouri Would Be Better Off Without an Income Tax

This article first appeared in the St. Louis Beacon.

The Missouri House recently took an ambitious step toward improving the state’s economic competitiveness. House Joint Resolution 36 calls for a popular vote in 2010 to repeal the state’s income, corporate, and estate taxes. This amendment of the state constitution would, as a number of studies show, improve Missourians’ economic well-being.

H.J.R. 36 would replace the revenue lost from eliminating these taxes primarily through raising existing sales taxes. The resolution would ask voters to raise the state’s sales tax to 5.11 percent from its current rate of 4.225 percent. The new sales tax would cover more services and goods than the existing sales tax.

Vocal opponents of the resolution are quick to point out that sales taxes are more regressive than income taxes. That is true.

But this undesirable outcome can be circumvented as the tax plans are developed in switching from income tax to sales tax revenue. One method is to means-test the sales tax. Individuals below a certain income level would pay no sales taxes on purchases up to some established amount. Of course, means testing is straightforward for someone filing an income tax form. For those who do not, it is more difficult, but not insurmountable.

Another approach is to exclude certain items or services — such as food, medicine, or medical services — from the sales tax.

Arguing that repealing the income tax would put the tax burden on the backs of the poor is simply a scare tactic that diverts reasoned debate.

Opponents also argue that if the proposed change is revenue neutral — meaning the state would receive the same amount of tax revenues after the switch as it does before — why bother?

Isn’t a dollar in taxes the same regardless of its origin? The answer is no.

According to standard economics, imposing a tax on income, whether a tax on individuals’ labor or on corporations’ earnings, diminishes those activities generating taxable income.

Think of it this way: In a world with no taxation, employers and workers settle on some market clearing wage that is beneficial to each. With an income tax, a worker’s take-home income must go down for the same hours worked. Unless firms raise wages to make up the difference, rational workers supply less after the tax is imposed. The tax reduces the amount of work, which reduces the goods and services available to consume.

Proponents argue that eliminating the existing income tax will be economically beneficial. Economic theory says the change should lead to more work, more goods and services being produced. And that equals an overall increase in economic well-being. Is there hard evidence to support this notion?

An oft-cited study conducted by the Federal Reserve Bank of Atlanta found that — after holding constant the effects of many different factors explaining state economic growth — a state’s marginal tax rate has a significant and negative affect on its relative growth rate. The higher a state’s marginal income tax rate, the lower is its rate of economic growth compared with low marginal income tax states.

This important finding has been replicated many times across states (and countries). The weight of the evidence is that low-tax states economically outperform high-tax states. On average, low-tax states have higher comparative growth rates in personal income and in employment.

Why should voters in Missouri seriously consider this proposed change?

Missouri ranks in the lower third of states when it comes to economic improvement. Using data from 2006, on a per-capita basis, Missouri ranked 37th in real output growth, 31st in personal income growth, and 36th in the growth of wage and salary income.

Missouri did rank high in one category: It was 6th in firm termination. Not an enviable economic track record.

I am not Pollyannaish enough to think that eliminating the state’s individual and corporate income tax would vault Missouri to the upper echelon of high-growth states. But doesn’t that possibility beg for open and informative dialogue on the issue?

Rik Hafer is distinguished research professor and chair of the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.