Tennessee vs. Missouri: Taxes May Tip the Odds

Missouri nestles against eight states, so border wars of all sorts are common. Some are fun, such as this week’s Missouri-Illinois football game. But others we can’t afford to lose. That includes economic competition between Missouri, which has an income tax, and Tennessee, which does not.

By any economic measure, Missouri dominated Tennessee at the end of World War II. Since then, Tennessee has reported faster economic growth and now has higher per-capita income than Missouri. With continued strong growth, the gap will just keep widening.

It is easy to see the switch by looking at the past decade’s worth of data. In 1997, Missouri led Tennessee: The market value of goods and services produced within its borders, divided by the state population, was $30,688. That measure is called per-capita gross state product. Tennessee’s per-capita gross state product was $29,647. Ten years later, Tennessee’s annual per-capita gross state product, after adjusting for inflation, was $34,117 while Missouri’s per-capita value was $33,326.

Tennessee’s growth rate during that period was 0.6 percentage points higher than Missouri’s growth rate. This may not seem like much, but note the effect that compounding has. Over a generation, if the growth-rate gap were to continue, the average Tennessean would realize income equal to $48,416 while the average Missourian’s income would be $40,975. In other words, the gap would expand from $791 to $7,441 in 25 years.

Productivity, employment, and population all show the same leapfrog by Tennessee when compared to Missouri. Economic growth depends on lots of different factors. Research shows that the rule of law, especially property rights enforcement, is related to growth rates across countries. Tennessee and Missouri share the same basic contract law.

Moreover, they share regional similarities that cannot account for the growth-rate discrepancy. By taxing income, the state government is collecting revenues on something that you own — your labor. Economic theory indicates that the difference in income tax rates — that is, the property rights enforced on people’s labor, and the payment for that factor of production — can help to account for the differences in growth rates.

The basic idea is elementary economics. Consider two people with identical characteristics, one in Missouri, the other in Tennessee. Suppose those two people were given identical work opportunities, so that they had access to the same machines and plant surroundings. For one hour of work, each produced the same amount, and was paid $20. Excluding federal taxes, the person in Missouri would take home $18.80 while the person in Tennessee would take home $20. (If the person worked in Saint Louis or Kansas City, take-home pay would only be $18.60. We will save that discussion for another time.) The person in Tennessee will supply more labor because he realizes a higher return for his effort.

The difference in returns applies also to those owning machines, plants, and other equipment. Other things being equal, the after-tax return to capital in Tennessee is higher than in Missouri. Consequently, when deciding where to locate plants and equipment, Tennessee has an advantage.

Together, the incentives to locate machines and people in Tennessee can account for why the Tennessee economy is performing better than the Missouri. This is not to ignore other factors that affect the two states’ economic performance. But the comparison does suggest that tax structure does matters. Perhaps it is time to ask: What tax structure is in Missouri’s best interest?

Joseph Haslag is executive vice president of the Show-Me Institute and a professor in economics at the University of Missouri-Columbia. This piece originally appeared in the St. Louis Beacon .