What Does the Earnings Tax Cost Saint Louis and Kansas City?

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.