The Difference Between A Low Tax And A Harmful Tax
In September, the Missouri General Assembly attempted to override Missouri Gov. Jay Nixon’s veto of House Bill 253. Discussion was robust as sides were formed. On one side, groups argued that Missouri is not a high-tax state; indeed, quite the opposite is true. The other side argued that Missouri’s 6 percent maximum individual income tax rate (7 percent if you include the earnings taxes that apply in Saint Louis and Kansas City) is at least partly responsible for slow growth in the state’s economy. Winston Churchill famously wrote, “Statistics are like a drunk with a lamppost: used more for support than illumination.” So, let us plow through the results. Ultimately, my goal is to turn to economics as the way to illuminate all the facts.
First, what is the case for Missouri being a low-tax state? Most often, people cite the Tax Foundation’s calculations based on Census Bureau data. For example, in 2011, Missouri ranked 46th lowest in terms of per capita state tax collections. No one would disagree with that stat, per capita state tax collections is measuring the amount of taxes paid to state government divided by the population of the state. In other words, it is a measure of the average state tax burden for people living in Missouri. It follows that Missouri government does not collect much from its citizens compared to other states.
Most often, economists focus on the marginal income tax rate. The marginal rate is the policy variable while the actual payment is the product of the income tax rate, which is the state government controls, and the base, which reflects the decisions people make. In terms of 2011 corporate income tax rates, Missouri had the 33rd-highest tax rate of the 50 states. Missouri’s individual income tax rate of 6 percent is the 21st-highest rate among the 50 states. Some would argue that we want to include Saint Louis and Kansas City earnings taxes. It is true that both rates apply, but only to those living or working in the two cities (probably about a million people). If we include the earnings tax rate, then the marginal rate for people living or working in those two cities is 7 percent. Accordingly, people living or working in those two cities face the 14th-highest individual income tax rate. (Similarly, the corporate tax rate would rank higher if you included earnings taxes.) These are the facts.
Do the facts imply that Missouri is a low-tax state? To help illuminate how people change their behavior and how these responses affect some of the alleged “low-tax” measures, consider, for illustrative purposes, that there is a state consisting of two houses, labeled House A and House B. Suppose that House A and House B each produce goods and services that are sold to the rest of the world. The value of each house’s production is $100,000 so that total production is equal to $200,000. Now consider that the state government implements a tax rate of 2 percent on House A’s production. For simplicity, assume that the people in House A can walk to House B and produce there, thus avoiding the new state tax. Because there is no production in House A, 0.02 times zero equals zero. By the state tax burden measure, the state would not impose any burden on its citizens. The marginal income tax rate is 2 percent.
Now, suppose every other state consists of two houses just like our home state. Total production is $200,000 in every other state. We consider a case in which every other state imposes a 1 percent income tax rate on all houses. In addition, it is costly to move from state to state so everyone stays in his or her own state. The total tax revenues in every other state would be $2,000, or the per capita state revenue burden would be $1,000.
Based on this hypothetical snapshot world, if we call the first illustrative state “Missouri,” then it would be the 50th-lowest tax state because its per capita state tax burden is zero while all other states’ per capita state tax burden is $1,000. In contrast, Missouri would have the highest marginal income tax rate because 2 percent is greater than 1 percent. Missouri would simultaneously be ranked the lowest- and highest-taxed state.
There is one last fact that needs to be raised. What is the state economy’s performance? Between 1997 and 2012, Missouri’s economy increased at a 0.9 percent annual rate. This is the 47th-slowest growth rate among the 50 states. And the corporate and individual income tax rates are the two rates that are most associated with economic growth; in other words, these are the tax rates that are most harmful to economic growth.
Missouri’s slow economic growth is not solely the result of its tax structure. The tax structure, however, does not help. The key facts are that Missouri is growing slowly and there are tax reform measures that can improve economic growth without shrinking state government. Let’s talk about those.