Rik W. Hafer

The city of Kansas City grew in population by 4 percent between 2000 and 2010, but the population of its surrounding metropolitan area grew at a much faster 13 percent rate during the same period. Meanwhile, the city of Saint Louis saw its population shrink by 8 percent during the first decade of the century while the population in its metro area expanded by 6 percent.

Why the marked differences in population growth between Missouri’s two major cities and their surrounding areas? Undoubtedly, there are a number of factors involved, like housing prices, amenities, and school quality. But what about taxes? Specifically, what about the 1 percent earnings tax that both cities impose on everyone who works there and on everyone who lives there even if they work someplace else? A new study by Howard Wall, commissioned by the Show-Me Institute, suggests that the earnings tax could be impeding the population growth of both cities.

In 1947 the Missouri Legislature authorized cities with populations of 70,000 or more to levy an earnings tax, capped at 1 percent. Only Saint Louis and Kansas City chose to impose this tax. But earnings taxes are known to have bad economic side effects. A study by Dr. Joseph Haslag of the University of Missouri–Columbia found that Saint Louis and Kansas City’s earnings taxes help explain the decline in personal income in those cities relative to the surrounding non-taxed metro areas during the first part of the 2000s. Wall, the director of the Hammond Institute for Free Enterprise and the Center for Economics and the Environment at Lindenwood University, tackles a different question: Does the imposition of earnings taxes help explain differences in population growth across cities?

Wall conducted his investigation using population growth rates for 185 cities (population 25,000 or more) over the period 2000 through 2010. Seventy-nine of the cities included in his study levy an earnings tax. Nineteen Missouri cities are included, of which only Saint Louis and Kansas City have an earnings tax.

After controlling for other factors that might explain differences in population growth, Wall finds that having an earnings tax has a statistically significant, negative effect on population growth. And the impact is not small: A 1 percentage-point increase in the earnings tax is associated with about a 4 percentage-point reduction in population growth over a decade.

What does that mean for Saint Louis and Kansas City? Based on his results, Wall suggests that the earnings tax in Saint Louis accounts for about half of the population decline experienced over the decade. For Kansas City, the earnings tax may have cut its population growth in half.

The effects of the earnings tax apparently do not stop at city borders. Wall finds that there are negative metro-wide effects emanating from the central city’s earnings tax. The population loss of Saint Louis City dwarfs the population increase in its ring cities, yielding a net reduction in the metropolitan population. The effect is similar for Kansas City. There are substantially fewer residents living in the metro area than there would have been were it not for Kansas City’s earnings tax. Employing an earnings tax has adverse effects on population growth for the taxing city that spill over into surrounding communities.

Even though the earnings tax produces such negative effects, how would cities replace the lost revenue if they were removed? One option is to reorder tax priorities. Wall notes that, on average, property taxes account for about 17 times as much in revenue as income taxes in cities across the country. In sharp contrast, Saint Louis and Kansas City rely more heavily on taxing income. In Saint Louis, the earnings tax revenue is more than twice that from property taxes; in Kansas City it is a little over 1.5 times as big.

The evidence in Wall’s study and in previous research lends credence to the view that shifting priorities from taxing income to taxing property may be the answer to reversing the negative economic effects of the earnings tax on Missouri’s major cities.

R. W. Hafer is the distinguished research professor of economics and finance at Southern Illinois University Edwardsville and a research fellow at the Show-Me Institute.

 

About the Author

Rik Hafer
Research Fellow

Rik Hafer is a Show-Me Institute research fellow and a professor of economics and the Director of the Center for Economics and the Environment at Lindenwood University in Saint Charles, Missouri.