The recession has dominated economic news of late. As with any downturn, there is an opportunity now to reevaluate the structure of the economy and try to create a situation that will produce the most future growth. More specifically, what is the best tax structure for the Missouri economy? In this article, we quantify the impact that the Missouri individual income tax will have in terms of foregone economic growth.
Even before the recession, Missouri’s economy had suffered relative to the rest of the country. For the last 20 years, the standard of living for the typical Missourian has not kept pace with the national average. The real GDP of the United States increased 34.3 percent between 1995 and 2005, but during the same 10-year period, Missouri reported a more modest 23.8-percent increase. That difference means that Missourians realized a lower standard of living.
Seven states do not have a personal income tax, and two others that levy an income tax only on interest and dividend income. These states have seen their economies grow at a much higher rate than those with an income tax. For example, between 1995 and 2005, Texas saw 53.2-percent GDP growth — a rate that is more than double the rate of increase reported by Missouri.
Without the current 6-percent income tax, the take-home pay for Missourians would increase, leading also to an increase in consumption. This would generally improve standards of living, and attract new businesses to Missouri that want to cash in on the benefits that the lack of an income tax brings. If Missouri were to become the only Midwestern state without a personal income tax, the state would gain a regional advantage.
To quantify the gains Missouri would see without an income tax, we projected the growth rate in Missouri’s real GDP for the next 25 years. In one projection, we assumed that Missouri would continue to grow at the same rate that it has in the recent past. In the second projection, we used an economic model to compute what Missouri’s growth rate would be without a state income tax. Our calculations indicate that Missouri’s real GDP would increase at a 2-percent annual rate if the state income tax were eliminated, as opposed to Missouri’s historic 1.3-percent growth. While a 0.7-percent increase in the growth rate may not sound like much, its impact would be significant for the next generation of Missourians. Indeed, Missouri’s real GDP gains would total $438.6 billion over this 25-year period, a substantial amount that would translate into more jobs and a higher standard of living. This would be a substantial windfall that Missouri cannot afford to forego.
The income tax adversely affects the state’s economic growth. Missouri could go a long way toward catching up by eliminating its state income tax. Although there are significant challenges associated with such a policy, such as the need to replace state revenues in a way that will not impinge upon economic growth the way that taxing income does, Missouri has a relatively small state government, at least in terms of government spending relative to state GDP. Replacing the revenue would be a challenge, but one that could be well worth it. The current recession would be a great time to implement state policies that eliminate the negative effects of an income tax on growth, and instead set up Missouri’s economy to thrive.
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. Michael Owens and Caitlin Hartsell are interns at the Show-Me Institute.