There are numerous explanations for the large cross-city differences in economic growth, many of which have little to do with the policy decisions of city governments. Most notably, cities in the Northeast and Great Lakes areas have declined relative to cities in the South and West in the wake of longterm trends away from manufacturing toward services, and from cold climes to warmer ones. In the face of these broad region-level trends, however, some cities have performed better than others in the same region, suggesting that cityand state-level policies play some role in determining economic outcomes.
The 1-percent earnings taxes levied in Saint Louis and Kansas City are city-level policies that have received a great deal of recent attention. On Nov. 2, Missouri voters passed Proposition A, which prohibits cities in Missouri from enacting new earnings taxes and requires voters in Saint Louis and Kansas City to approve by referendum a continuation of their existing earnings taxes. Given that earnings taxes are responsible for substantial portions of total revenues in Saint Louis and Kansas City (31 percent and 36 percent, respectively), it’s not surprising that there is a great deal of interest in the implications of the proposition. If the earnings taxes in these two cities are overturned, their political leaders would face difficult decisions, although they would have 10 years to phase out the taxes.
The economic theory argument against earnings taxes is that they place a city at a relative disadvantage when people decide where to work and/or live. In particular, when earnings taxes are imposed by cities such as Saint Louis and Kansas City, a person can avoid the tax relatively easily by working and living outside the city limits while still remaining within the metropolitan area. If city governments instead were to raise the same level of revenue from taxes on other, less-mobile, factors, that should lead to a smaller tax-avoidance response and a smaller distortion within the metropolitan area.
Although the theory behind replacing earnings taxes with other revenue sources is fairly straightforward, its empirical importance has not been settled. Two empirical studies have addressed the issue and have arrived at opposing policy prescriptions. The purpose of the present essay is to offer a new perspective on the possible empirical implications of city earnings taxes in Saint Louis and Kansas City.