Taxes

Laboratories for Prosperity

A comprehensive study confirms that free-market principles work outside Washington.

|

Over the past three decades, America's state and local governments have experienced a large and underappreciated divergence. Some places, usually but not always led by Republicans, have become friendlier to free enterprise. Other places, usually but not always led by Democrats, have become friendlier to big government. Some political scientists call it the Big Sort. You can see the self-selection manifest itself in polls, in voting behavior, in migration patterns, and in policy outcomes.

Think of it as a vast natural experiment in economic policy. Because states have a lot otherwise in common-cultural values, economic integration, the institutions and actions of the federal government-testing the effects of different economic policies within America can be easier than testing them across countries. Governors, state legislators, and other policy makers have dutifully supplied the experimental data. And scholars have been studying the results.

I head the John Locke Foundation, a state policy think tank in North Carolina. A recent change in our state's political leadership prompted us to assemble a summary of all that diverse academic research for legislative leaders and our new governor, Pat McCrory. Setting aside studies published by think tanks, we limited ourselves to scholarly articles about economic policy published in academic or professional journals. At present our database contains 528 articles published between 1992 and 2013. On balance, their findings offer strong empirical support for the idea that limited government is good for economic progress.

Taxes Matter

Of the 112 academic studies we found on overall state or local tax burdens, for example, 72 of them-64 percent-showed a negative association with economic performance. Only two studies linked higher overall tax burdens with stronger growth, while the rest yielded mixed or statistically insignificant findings.

On smaller categories of taxation, the trend was similar: There was a negative association between economic growth and higher personal income taxes in 67 percent of the studies. The proportion rose to 74 percent for higher marginal tax rates or tax code progressivity, and 69 percent for higher business or corporate taxes.

Some of the strongest negative results appeared when scholars were able to isolate policy variables from background effects. For example, a 1996 study in the American Economic Review exploited the fact that some foreign countries gave domestic tax credits to companies that pay taxes in the United States, so those companies would be expected not to care much about state tax rates. In other countries, companies didn't receive such credits and would thus be subject to greater variation in state tax burdens. By looking at the behavior of firms based on their home country, author James Hines of the University of Michigan found that "state taxes significantly influence the pattern of foreign direct investment in the U.S." A 1 percent change in the tax rate was associated with an 8 percent change in the share of manufacturing investment from taxed investors.

Another study, published in Public Finance Review in 2004, zeroed in on counties that lie along state borders. Because territories in such close proximity often share characteristics that might not be captured in other measurements, this is a promising approach for isolating the effects of state policy. Studying 30 years of data, the authors concluded that states that raised their income tax rates more than their neighbors had significantly slower growth rates in per-capita income.

Similarly, economists Brian Goff, Alex Lebedinsky, and Stephen Lile of Western Kentucky University grouped pairs of states together based on common characteristics of geography and culture. This is the economic equivalent of studying identical twins to probe the relative importance of genetics and environment. Writing in the April 2011 issue of Contemporary Economic Policy, the authors found "strong support for the idea that lower tax burdens tend to lead to higher levels of economic growth."

Liberal analysts often argue that isolating variables such as tax rates misses the point. States would be better served, they suggest, adopting a growth strategy that maintains or increases current tax burdens to fund education, infrastructure, or other government programs. Whatever economic cost may come with higher taxes, they say, is more than offset by the economic benefits of the amenities that government spending provides.

This argument may seem plausible in theory, but it lacks empirical support. Of the 43 studies testing the relationship between total state or local spending and economic growth, only five concluded that it was positive. Sixteen studies found that higher state spending was associated with weaker economic growth; the other 22 were inconclusive.

Admittedly, economic benefits may not be evident for total state budgets, which combine three different categories of spending: protective (law enforcement and the courts), productive (education and infrastructure), and redistributive (health, welfare, and other transfers). Although a few Keynesian bitter-enders insist that transfer programs such as Medicaid boost the economy via multiplier effects, most proponents of government spending as an economic development tool prefer to emphasize the potential benefits of schools, roads, and other infrastructure. That's wise: Nearly three-quarters of the relevant studies found that welfare, health care subsidies, and other transfer spending are bad for economic growth.

States Don't Invest Effectively

That said, the empirical evidence isn't overwhelmingly friendly toward "investments" in education and infrastructure either. While most relevant studies found that measures of education outcomes, such as test scores or college attainment, are correlated with economic growth, the same can't be said for expenditures. Of 79 research findings on the relationship between education spending and economic growth, only 30 were positive, with 34 findings of mixed or insignificant results and 15 negative. (In the latter cases, any economic gains from additional education spending are more than offset by the economic losses from the taxes required.) Of the 84 studies examining infrastructure spending, 44 percent found positive results, but most studies still found either inconclusive or negative relationships.

One recent paper deserves special attention. In the Winter 2013 issue of the Journal of Education Finance, two political scientists, Norman Baldwin of the University of Alabama and William McCracken of the Ohio State University, published one of the most carefully designed studies of education spending I've seen. For example, they built in time lags to account for the fact that education spending is cumulative-its net effects show up years later, when pupils become workers or entrepreneurs, not in real time. So in evaluating overall higher-education spending, Baldwin and McCracken used a seven-year lag to allow for university students to obtain degrees, find employment, and adjust to their new jobs. They used a 13-year lag for K-12 spending. Neither variable demonstrated a consistent relationship with state economic growth. A separate measure of state spending on academic research did show a positive effect from 1988 to 1996, but the effect turned negative for the 1997-2008 period.

One common fallacy is to assume a close correlation between public spending and the quality of the programs or assets it funds. Some states with generously funded public schools, for example, have relatively high levels of educational achievement. But other high-spending states produce miserable results. Both national and international research suggests that other factors explain differences in school achievement or completion.

Some of those factors, such as family background, lay largely outside the scope of government action. To the extent that public policy makes a difference, a 2007 paper in the Peabody Journal of Education found that countries with high-performing students don't necessarily rank high in spending; instead, they tend to devolve personnel and instructional decisions to localities and to encourage competition among public and private schools. Similarly, a 2012 study in the Southern Economic Journal found that countries with greater central-government involvement in schooling experience both lower student performance and lower economic growth.

Another fallacy is to mix up average and marginal effects. There is strong support for the proposition that some government spending does foster economic growth. The strongest case for net economic benefits from state action involve public safety and a legal system for protecting property rights and adjudicating disputes, though the number of studies testing that relationship isn't large. But there is a point of diminishing returns.

In a 2006 paper in Contemporary Economic Policy, economists Lori Taylor of Texas A&M University and Stephen Brown of the University of Nevada-Las Vegas discussed the evolution of the scholarly literature on the subject. While "early research suggests some increases in state and local government spending more than offset the negative effects of the tax increases needed to fund them," Taylor and Brown wrote, "more recent research finds the growth of state and local government generally discourages private-sector growth."

The Taylor/Brown study suggested that the trend was explained partly by the starting point of governments' size. As state governments have grown over time, adding new programs and services, the economic value of additional tax dollars spent has diminished, then turned negative.

The same authors, along with the Southern Methodist University economist Kathy Hayes, had published an earlier study probing the growth effects of every major program of state government: public safety, education, transportation, housing subsidies, health care, and public assistance. According to their findings, published in 2003 in the Review of Regional Studies, raising state taxes from modern levels to fund additional spending almost always harms economic growth. Indeed, the study suggested that if states slowed their spending growth, even on education, and used the savings to reduce tax rates, the net result would be higher levels of private investment and employment.

Regulation is at least as important as taxes and spending. There are 123 scholarly articles in our database that looked at state or local regulatory policy in some form; 31 articles studied broad indexes of state economic freedom that mix both fiscal and regulatory variables. Scholars found a positive economic effect for less regulation 67 percent of the time and for economic freedom 77 percent of the time.

In the most recent example, economists Lauren Heller and Frank Stephenson of Berry College used the Fraser Institute's Economic Freedom of North America index to explore state economic growth from 1981 to 2009. They found that if a state adopted fiscal and regulatory policies sufficient to improve its economic freedom score by one point, it could expect unemployment to drop by 1.3 percentage points and labor-force participation to rise by 1.9 percentage points by the end of the period studied.

Economic Freedom Works

To the extent that the national media notice this natural experiment, they tend to oversimplify it as a contest between Texas and California. To be sure, it's easier to find a job in Texas (it had an 6.1 percent unemployment rate in November 2013) than in California (with an 8.5 percent rate the same month). And yes, the Lone Star State has a much freer economy than the Golden State. But the Big Sort is going on across the country, not just across the Grand Canyon.

In the past year alone, Indiana has abolished its estate tax and cut its marginal tax rates on personal and corporate income. Wisconsin collapsed tax brackets and sunset its death tax. Kansas trimmed its top income tax rate by a quarter, while New Mexico cut its corporate tax rate by a fifth. On the other hand, Minnesota just jacked up its top income-tax rate, and a number of "blue" states are adopting new regulations aimed at combating climate change, low-density development, and obesity.

Here in North Carolina, the new McCrory administration and its legislative allies replaced the state's graduated income tax, which had topped out at 7.75 percent, with a flat tax of 5.75 percent; they also slashed the state's corporate tax from 6.9 percent down to as low as 3 percent (if future revenue targets are met). They required all state regulations to undergo regular reviews every 10 years. Rules that no longer comply with state law, or produce more benefits than costs, will automatically expire.

In education, the new administration re­placed teacher tenure with multi-year contracts, introduced merit pay, expanded charter schools, and created two choice plans that will provide private-school scholarships to as many as 13,000 students within three years. And on transportation, they followed the Reason Foundation's recommendations by rewriting the state's funding formula and using tollways to add new highway capacity.

In other words, in the great debate about how best to promote economic growth, North Carolina has come down clearly on the side of fiscal conservatism, competition in public services, and a more limited government. It was a bold choice based on the best available research about what makes economies prosper. The nation's capital should follow suit.

NEXT: Rand Paul: "Republicans Will Not Win Again" Without Total "Transformation"

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. And evident in the bitterness of libertarians trapped by family and work in Blue hellholes like Illinois…

    1. Or trapped by houses that you can’t sell.

      /grumble

      1. You live in Rockford?!

        *walks around craters formed from falling home values*

        1. Elgin

          Not that much different really.

          1. I live on the far west side of Elgin – it is no Rockford, but the home value plunge may be similar…

            1. I’m up near Round Lake- sales there seem to be relatively brisk. We’ve been pretty much priced out.

              The move here from Texas was… jarring.

              1. Oooh – that was a step backward on the ol’ freedom and taxation scale.

              2. Omwc what made you move ?

                Business ?

            2. Motorola and RIM tanking didn’t help a lot either.

    2. And evident in the bitterness of libertarians trapped by family and work in Blue hellholes like Illinois…

      I hear you, bruvuh. My wife understands the logic of moving to Florida, Texas, Washington, etc. where there is no state sales tax. We could keep 10% more of our salaries. That’s a nice bit of money. Hell, I’ve recently proposed we move to Vancouver, WA. No state income tax, and across the Willamette (Portland, OR), no state sales tax. Moving from Cali, would give us almost 15% savings in taxes. We could get a great house on a big plot. Set up a distillery. All for way more cheaper than here in California.

      We don’t have children. We’re both easily employable. I moved around a lot as a kid, and as a young adult. So, to me it’s not a big deal to up and move. My wife grew up by the beach. Moving more than 40 miles from her parents is a no go. I should put together a PowerPoint outlining my argument?

      1. My wife grew up by the beach. Moving more than 40 miles from her parents is a no go.

        I just keep pushing it, and one day my wife is going to cave like that chick who claimed she was raped because her bf kept asking for sex and it was easier to just say yes. So right now we’re at the “just the tip” stage. (“Hey look at this awesome house in Texas that we could totally afford if we saved your salary for 18 months.”)

      2. My wife and I both agreed that we would have been significantly better off moving from NJ to PA. Houses are cheaper, taxes are way lower, most laws are more sane, an hour or less from both our families, and we would be within commuting distance of our current jobs. Unfortunately, my wife is barred by statute from living anywhere but NJ should she wish to continue teaching here, so in NJ I must stay.

      3. I have one friend that escaped to Texas – he smiles alot these days. The rest of us are still here – and I will be as long as my parents are alive, the kids are still in school, etc.

        I just cannot escape duty… gah!

      4. Just an FYI – there are state sales taxes in Texas, Florida and Washington. There are no state income taxes – at least in Texas. I’ve never lived in Washington or Florida, so I couldn’t say.

        1. Washington and Florida have no income tax.

          On the state income tax note, NH actually has an income tax. It’s called the “Interest and Dividends Tax”.

        2. Jan S: Thanks for the correction. I meant no income tax in WA, TX, and FL. An instant 10% savings over CA. WA is unique in that you could live in Vancouver and do your shopping in Portland, OR and save an extra 10% on purchases (about 5% of income per year).

          Which is an interesting situation for any Californians who want a “living wage”. Wake up dipshits, the CA government is taking 20% of your pay between income and sales taxes. Add to that gasoline taxes, license fees, and other fees, and almost 25-30% of your wages goes to the State. It’s not your employers’ fault that your government steals a third of your salary. Just sayin’.

          1. I meant no income tax in WA, TX, and FL.

            AK, NV, WY, and SD also have no income tax, and TN and NH have no state income tax other than a tax on interest and dividend income over a certain threshold.

          2. I have this discussion with friends and my wife all the time but in my case about leaving Quebec. It’s a shit hole in terms of taxes, corruption and the political climate.

            I’ve been working on my wife to leave. I’ve taken it from ‘never’ to ‘ok, I’ll consider it.’ Next, is to pick a place.

            For me it’s simple, the bottom line in Quebec is they ‘tolerate’ others but don’t accept them and the prove of this fact is in their laws. Above all, economically I don’t get bang for my buck.

            My wife will work summer school and gross $5000. The government takes $2800 of it. Only a complete moronic idiot won’t look at that and conclude ‘not only do they hate my language they take my money.’

            Yet, I have friends who shrug their shoulders to this irrational situation.

            Anyway. Alberta, Ontario, Vermont are on our list. Not necessarily greener but we figure better. Peace of mind politically is worth a lot to us.

            And fuck the xenophobic assholes in the PQ.

      5. Texas has lots of beaches, and you’re allowed to have fun on them.

        Go to work on the parents. Retirees can often benefit more than workers.

      6. Vancouver sounds good for you.

        Florida, and especially Texas….not so much.

      7. Join the Free State Project and move to New Hampshire then. They’re up to 15,358, on the way to 20,000 to trigger the move.

  2. This is clearly wacko-bird research, probably funded by teh Koch Brothers?.

    Have fun turning America in to Somalia, libertardians.

    1. MUH ROADZZZ! WHAT HAVE YOU DONE WITH MUH ROADZ???

      1. Here’s what kills me about the argument from roads.* Progressives talk about the need for high taxes to pay for road construction but are the first to oppose road construction. It’s almost as though they regarded taxation as its own reward.

        *Is that an acknowledged fallacy? It is now, chillens.

        1. Also, roads aren’t very expensive, and the quality of road maintenance has no apparent relationship to how bloated the government is somewhere.

          1. To a great extent road maintenance is dependent on living somewhere the winter doesn’t tear them up, and you can repair them year-round.

            1. Try driving in California sometime. Winters are awesome, and the roads are hell. Someone is on the take.

    2. Businesses move to high-tax localities because of the better public services. Yes, someone did tell me that once. I am careful not to attack straw men, but real-world dumbassery is often so extreme that people think I do.

      1. I know this is true for my business, and why we’re ONLY putting work into Cali and New Nawk.

        Oh, wait…

      2. The only reason to start a business in Silicon Valley is the available talent, which is also moving increasingly to Washington, Oregon, Texas and North Carolina.

        1. Recent college grad overheard: “Moving to California for a job is like booking a cruise on Carnival.”

      3. “Because your business won’t have a chance if your city doesn’t have opera, symphony, and a football team.”

        1. Ft. Worth, Texas sounds like a great place then. If the Cowboys ever put it all together again.

  3. I head the John Locke Foundation

    Dude, “LOST” ended, like, 50 years ago.

    You head up the “John Locke Foundation”? Yeah – and I’m the head of the Dharma Initiative.

    Pssshhh…right.

    1. You work for Darma? When is my replacement ever going to arrive? I’ve been entering these numbers for the past 3 years!

  4. One common fallacy is to assume a close positive correlation between public spending and the quality of the programs or assets it funds.

    FTFY

  5. It will be interesting to see how things turn out in NC. I can’t say I’m a fan of the McCrory administration in general, but I do think they got it right on the tax reform.

  6. I realize this study needed to be done to counter the profound ignorance of the Tonys of the world, but this is on the level of studies showing that water is wet or that women prefer bigger dicks. It is pathetic that this had to be done, or the Cathy Young article on the failings of communism. Just pathetic.

    Arent the trolls going to come here and stamp their feet, throw a shitfit and tell us how this is all bullshit?

    1. Presidents’ Day. Their all out at their Emperor Worship Parades.

      1. *They’re

        Apparently my grammar module is on vacation, too.

    2. Arent the trolls going to come here and stamp their feet, throw a shitfit and tell us how this is all bullshit?

      Are you kidding? They’re probably salivating over the idea of being able to concentrate all the kulaks and wreckers in “prosperity zones.”

  7. Washington

    No state income tax

    Gay marriage

    Legal pot

    Ports for oceanic trade

    All they need is right-to-work and Washington will become cosmotarian central.

    1. Washington:
      Statue of Lenin in Fremont.
      Socialists on the Seattle City Council
      Team Blue mysteriously winning gubernatorial races by “finding” extra boxes of ballots when things don’t go their way.
      Highest minimum wage in the country.
      SPD resistance to Justice Dept reforms after a series of cases involving excessive use of force.

      Not exactly Libertopia.

      1. SPD resistance shouldn’t surprise you. If you went to Libertopia and they had monopolized courts and law enforcement the libertarians cops in the ranks would resist diminishing their own power. Most people trust themselves with power, it’s their neighbors that they don’t. It’s human nature. Institutions of political power perverse incentives and provide incentives for sociopaths to do what they do.

      2. Statue of Lenin in fremont

        OH NO A STATUE! Seriously I find a statue of Lenin to be as offensive as that Jesus statue in Rio de Janeiro but that wouldn’t keep me from being a “sinner” (I don’t believe they exist for scientific reasons but you know what I mean) while visiting. I grew up in the Bible belt where there are crosses all over the place. It’s nothing I can’t handle.

        Socialists on the Seattle City Council

        I doubt there’s a city council anywhere in the US where there’s neither socialists or their conservative equivalents.

        Team Blue mysteriously winning

        Nothing mysterious about one of the two major parties winning. I’m a registered independent who was registered with the Libertarian Party when I was younger and adhered to the libertarian ideology. I’ve never had anything to do with either of the major parties. Never voted for their candidates or anything.

        Highest minimum wage in the country

        I said they needed right-to-work which is a similar issue. I don’t believe unions or the minimum wage law should exist as they do nothing but raise the prices of goods and services.

        There’s a reason my username is Centrist Classical Liberal and not something with libertarian in it. I like mandatory food labeling and I see nothing rational about doing away with worker’s comp (the Cato Institute has alot of great material on worker’s comp reform).

        1. The last paragraph was in response to you saying it’s not libertopia. I’m not a utopian.

          1. pray, why not? The utopian water is fine, jump right in. 🙂

  8. I moved from the Blue hellhole of Hawaii to Texas, and my rent dropped by half for a waay nicer place. Everything here is about half the price or less than I was paying, and went from double digit marginal state income tax rates to 0%.

    If we had 1,000 states to choose from instead of just 50, this effect would be greatly magnified.

    1. Six Californias to the rescue:

      http://techcrunch.com/2013/12/…..nitiative/

  9. I’d go here to help decide where to move:

    http://freedominthe50states.org/overall

    I wound up choosing Texas because it was the free-est state with a warm, temperate climate and a liveable big city (Austin, though other big cities were good here too). Florida, Tennessee, and Georgia were also places I think I would have been happy living, too.

  10. Moved here from New York, and started noticing a bumper stickers and t-shirts with: “I wasn’t born in Texas, but I got here as fast as I could.” I actually didn’t rush to get here, but I’ really glad I came. Meanwhile, back in NY, my old friends are all “What? Bubbaville? What are going to first, a revival meeting or cross-burning?”

    I just smile as I drive by 3500 square foot homes going up 40 acres at a time, and spanking new parks and malls, and people who don’t really give a shit about politics (except they HAAAATE unions here).

  11. Admittedly, economic benefits may not be evident for total state budgets, which combine three different categories of spending: protective (law enforcement and the courts),

    That protection monopoly is financed by coercion, it is also redistributive.

    productive (education and infrastructure),

    Also redistributive

    and redistributive (health, welfare, and other transfers).

    Health, welfare and other transfers are just as immoral and impractical as any other program financed by coercion.

    The only difference in these categories is that it’s easier to justify some of them to a broader audience.

  12. Yap, Yap, and Yap about less government and then create more government related think tanks (state and local) on how to do this. How about we just do away with the federal government in Washington, DC and then all of our 50 different little countries (ironically called states) can simply become sovereign little nations with their own armies and foreign policy.

    Of course they can print their own money and issue their own passports too. Just think, that States with a coast line like North Carolina will be able to have their own navies and sail around the world showing the flag to all those countries who will tremble at the very sight of it all. By all means, less government. Again Washington, DC has to go. No more federal government! It’s 50 little sovereign nations.

    1. That would be ridiculous. Why it would be like Europe, before the EU. Who could stand such a system? It would be absolute chaos. Probably unlivable. Which must be why they created the EU: to stop the chaos.

    2. Didn’t you comment on a New Year’s article where you claimed you were never visiting this site again? What kind of pathetic loser are you?

    3. I don’t have a problem with a united federal government which would have no power to do anything other than represent the 50 states in foreign affairs (ie. you fuck with one of us your fucking with all of us, and “no we will not sign away any of our rights to the United Abominations so take your treaty and shove it square up your prohibitionist assholes or we will rain down atomic fire upon any who attempt to restrict our freedoms”), if we are talking about “Libertopia” here we would have no real use for a massive Military as we would no longer have a government engaging in illegal wars of aggression breeding more people who hate Americans, so the idea of NC taxpayers funding a massive undertaking such as a warship for the sole purpose of flying the NC flag around the planet is ludicrous. Breaking up the monopoly on money would be brilliant, as long as it was backed with physical property not imagination and FEELZ it would go a long way to re-stabilizing our economy

    4. We tried this, it was called the Articles of Confederation. Turns out it was awkward for New York and New Jersey to go to war over trade and territory disputes. The Constitution was intended as a corrective action toward a Federal government, with lots and lots of safeguards to minimize central government power. It’s taken statists a bit more than 225 years to really strip away most of those safeguards.

  13. Hey, road guy! Did it take you all day to think up such ridiculous straw men? Will you really leave this time?
    How can we miss you when you won’t got away?

    1. Did anyone miss Stalin when he died?
      no one likes socialists, even other socialists

  14. Proglodytes call this the “race to the bottom”, with states abandoning social welfare programs and high dollar education in favor of low taxes to lure businesses. Even leftist states like New York are joining in, with tax free (for 10 years) zones for businesses that relocate there.

    Want Detroit to once again lead the world in manufacturing? Make it a state and federal tax free zone.

    1. Well with 2 school age kids trying to re-learn math thru the common crap program among other bullshit, they should have just renamed race to the top the same way at least it would be a true representation of the educational destruction race to the top is wreaking upon all of our kids

      1. OK, I’ll take a swipe at the straw man. No Child Left Behind, Common Core, and Race to the Top are separate and dramatically different programs. I give race to the Top decent odds at actually producing results, because it’s competitive, with renewal contingent on outcomes, and (relatively) little imposed bureaucratic overhead. NCLB and CC are total crap implementations of statist control freak policies.

        I have a background in education. I have 3 kids in the public schools. As far as I can tell, the single hugest problem in the schools – the ill that’s generating all these toxic therapies – is irresponsible, disinterested, non-engaged parenting.

  15. thanks for these info. visit our web on Outbound Training Semarang.
    please comment to improvement.

    success for you all.

    PUSAT PELATIHAN SEMARANG

  16. Texas has lots of beaches, and you’re allowed to have fun on them.

    Go to work on the parents. Retirees can often benefit more than workers.
    Great,I love Texas

  17. That said, the empirical evidence isn’t overwhelmingly friendly toward “investments” in education and infrastructure either. While most relevant studies found that measures of education outcomes,

  18. a state policy think tank in North Carolina. A recent change i

Please to post comments

Comments are closed.