Eliminating Income Tax Would Lead to Faster Growth, Despite Opponents’ Scare Tactics
The scare is on. Some wild economic predictions have been put forward by Amy Blouin, director of the Missouri Budget Project, and James Moody, former state budget director, regarding the legislative proposal to eliminate Missouri’s income tax and replace it with a higher sales tax rate.
One egregious mistake they both make is the failure to understand economic growth. Since the work of Nobel laureate economist Robert Solow in the 1950s, and more recent research advances from Washington University economist Rodolfo Manuelli and Larry Jones in the 1990s, economists have understood the impact that income taxes have on the payments made to workers, business owners, shareholders, and lenders. This work presents a consistent and compelling result: People will realize higher after-tax returns when income tax rates are lowered. As after-tax returns increase, they will be employed more intensively as factors of production, and economic growth rates will rise.
Blouin and Moody repeatedly downplay this, but based on what? They demonstrate no economics expertise. Neither of them cite even one vetted economic article to support their claims. The reason: They cannot find such an article in the economics literature. Their rhetoric is akin to claiming that the sun will rise in the west. Anybody can claim it, but science stands firmly against that claim. Blouin and Moody go further, predicting that implementing a revenue structure based on sales taxes will cripple the Missouri economy, but by what economic expertise? Such claims are made to scare people who are not experts.
To further illustrate their economic mistakes and half-baked analysis, note that they ignore the benefit to Missourians that comes with expanding after-tax income. Missourians will see their take-home pay rise. Blouin and Moody got half of their analysis right, noting that an increase in the sales tax rate and a broadened sales tax base will affect consumer spending. This effect on consumer spending is the cost of faster economic growth. These two points must be considered jointly. If we focus only on the near-term costs, we miss the gains of faster growth unleashed by the change in the tax structure.
Like any project, the costs are borne up front and the rewards are realized later. This analogy holds for any number of investments — things like plant expansion, education, and kitchen remodels. In each case, there is an initial sunk cost, and rational people can decide whether the rewards are worth that cost. In Missouri’s case, faster growth means that the economic pie gets bigger, growing in size. These are the kind of attractive qualities that make a state’s economy the envy of other states.
Moody predicts that retailers would cross the border if Missouri’s higher sales tax rate were implemented. He is half right (note that 50 percent is a failing grade). It is true that a few retailers might make the decision that it is in their best interest to locate differently based on a regime that taxes purchases at a higher rate. The other half of the story is also important. Because income taxes would be simultaneously eliminated, there would be an incentive for many other out-of-state businesses to relocate here. Missouri’s economy would likely experience a change in its industry composition if the income tax were replaced with a higher sales tax. It is wrong, however, to ignore the growth benefits that go with eliminating the income tax. Some stores may cross the state line, but Missouri shoppers will be richer.
Do not be afraid. See through these wild claims and make up your mind based on the evidence. Tennessee is not crippled by relying on sales taxes and eschewing the state income tax. You may not want to bear the costs associated with the proposed switch. I can understand that. In my view, it is worth it because it will result in faster economic growth — more specifically, faster income growth for Missouri’s citizens and faster growth in state revenues. Weigh the costs against the benefits and decide, but do not let the fear mongers scare you.
Joseph Haslag is an economics professor at the University of Missouri–Columbia and chief economist for the Show-Me Institute, an independent think tank promoting free-market solutions for Missouri public policy.