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Look to the States for Tax Policy That Boosts Growth

April 9, 2012 7 minute Read by James K. Glassman

This article originally posted on Forbes.com. Economics is called the “dismal science,” but it’s not. It’s really the study of how people make choices, and choices aren’t dismal. They are at the root of what it is to be human. Governments have the power to shape our choices by the policy incentives they provide, and the most powerful incentives that government can wield in the economic sphere are tax laws. Edward Prescott, the Nobel economist, for instance, has shown that higher marginal tax rates are the predominant reason that Europeans work one-third fewer hours than Americans. For the remainder of this year and probably into the next, Americans will be engaged in one of the most important debates about taxes in our history. The tax reductions on personal and investment income, proposed by President George W. Bush and passed by Congress in 2001 and 2003, are about to expire. Democrats are pushing for much higher rates on top earners while the House of Representatives has passed a budget devised by Republican Budget Chairman Paul Ryan that reduces the top personal rate from 35 percent to 25 percent and broadens the tax base by eliminating loopholes and preferences. Meanwhile, it is becoming clear that something must be done about corporate tax rates. As of this month, the U.S. has the highest corporate rates among developed nations.  Even Treasury Secretary Tim Geithner has said that the U.S. needs to reduce rates to “a level that’s closer to the average of that of our major competitors.” Choices are going to be made by policy makers that will deeply affect the choices that Americans make as individuals, and those individual choices, in turn, will determine whether America as a whole grows or stagnates. The right tax policy means people will work more, investors will deploy more capital, and more businesses will be launched or expanded. Taxes count. What may be surprising is that critical tax policy choices are already being made around the country in the states. A few states have boosted rates. In Illinois, the top income tax rates have been hiked from 3 percent to 5 percent and the corporate rate from 4.8% to 7%. A California ballot initiative, backed by Gov. Jerry Brown, calls for an increase for high earners from 10.3% to 13.3%. But the bigger story in a time of budget shortfalls is that many states are moving to reduce tax rates. In Maine, a state with a poor economy and among the highest taxes in the country, the new governor, Paul LePage has already cut the lofty personal income tax rates with the aim of eliminating the tax entirely. In Oklahoma, Gov. Mary Fallin also wants to end income taxes; her latest proposal reduces the rate from 5.25% to 3.5%. In Kansas, Gov. Sam Brownback seeks to end the corporate tax for 200,000 businesses and chop the top personal rate from 6.45% to 4.9%.  In New Jersey, Gov. Chris Christie vetoed a bill that would have raised the top rate to 10.75% and now is advocating a major cut. Other governors are also pushing to cut rates. The reason is simple. Lower tax rates appear to lead to higher growth rates. We already have a good laboratory to test the proposition. Compare the nine states that have no personal income tax (PIT) with the nine states with the highest personal income tax. Between 1999 and 2009, the no-PIT states increased their gross state product (output of goods and services) by 61% and their populations by 14%; the states with the highest PIT rates increased their gross state product by just 45% and populations by 6%. Jobs increased 8% for the no-PIT states, 1% for the average state, and 0.5% for the highest-PIT states. As for revenues, the no-PIT states increased total tax receipts over the period by 123% while the average state raised 70% more in taxes and the highest-PIT states just 62% more. Low tax rates don’t necessarily mean inadequate revenues to provide for schools and other state services. The extra growth leads to extra tax dollars from other sources, such as sales taxes. Certainly, there may be reasons other than tax policy for the success of the nine no-PIT states, but look at their diversity: Texas, Florida, South Dakota, Washington state, Nevada, New Hampshire, Tennessee, Wyoming, and Alaska. Govs. Christie, LePage, Fallin, and Brownback – along with Gov. Bill Haslam, whose state already has no income tax (Haslam wants to cut the sales tax on groceries) – will be speaking at a conference of the George W. Bush Institute, with Forbes as a co-sponsor, in New York on Tuesday. The conference will look at what works – which states and nations are growing and which periods of U.S. history saw the strongest growth – and then will examine the role that tax policy played in that growth. In the end, growth is the goal – specifically the sustainable 4% real GDP growth rate of which this country is capable. We’ve achieved it in 23 of the past 60 years, but most economists are now projecting long-term rates of just 2% to 2.5%. That’s not good enough to provide the opportunity and prosperity Americans want and deserve. States are performing experiments that can help policy makers at the federal level come to the right conclusions. And the evidence points to low rates, a broad base (that is, few loopholes and preferences), and taxes on consumption rather than income as the route to strong growth. But states are important for another reason, too. The average no-PIT state grew 30% faster than the average state. The implication is that, by merely eliminating the PIT (and favoring consumption taxes), every state could boost its output 30%. And, since the nation is composed of states, the nation too would increase GDP by 30%. Look to the states. The ones that are faltering have high personal income and corporate taxes. The ones that are gaining have low taxes. There’s a lesson here. This post written by James K. Glassman, the founding executive director of the George W. Bush Institute.


Author

James K. Glassman
James K. Glassman

James K. Glassman is the Founding Executive Director of the George W. Bush Institute and the interim Director of the Military Service Initiative.

He served as undersecretary of state for public diplomacy and public affairs from June 2008 to January 2009, leading the government-wide international strategic communications effort. Among his accomplishments at the State Department was bringing new Internet technology to bear on outreach efforts, an approach he christened “Public Diplomacy 2.0.”

From June 2007 to June 2008, Glassman was chairman of the Broadcasting Board of Governors (BBG). He directed all non-military, taxpayer-funded U.S. international broadcasting, including Voice of America, Radio Free Europe, and Alhurra TV.  Glassman was a senior fellow at the American Enterprise Institute in Washington, D.C., from 1996 to 2008, specializing in economics and technology.

He has been moderator of three weekly television programs: Ideas in Action and TechnoPolitics on PBS and Capital Gang Sunday on CNN.

Glassman has had a long career as a journalist and publisher. He served as president of Atlantic Monthly, publisher of the New Republic, executive vice president of U.S. News & World Report, and editor and co-owner of Roll Call, the Congressional newspaper. Between 1993 and 2004, he was a columnist for the Washington Post and the International Herald Tribune and continues to write regularly for Kiplinger’s Personal Finance and Forbes. Shortly after graduating from college, he started Figaro, a weekly newspaper in New Orleans. His articles on finance, economics, and foreign policy have appeared in The New York Times, The Wall Street Journal, the Los Angeles Times, and various other publications.

Glassman has written three books on investing, and in April 2012 was appointed to the Investor Advisory Committee of the U.S. Securities and Exchange Commission. He was formerly a member of the Policy Advisory Board of Intel Corporation and a senior advisor to AT&T Corporation and SAP America, Inc.

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