A State Income Tax Would Increase Government Spending and Reduce Personal Income Growth
2002-08
The Tax Structure Study Committee, created by Washington's legislature last year, is reviewing state taxes and will release its report in late November. One proposal that could be part of the Committee's recommendations is a state income tax.
Before adopting such a radical change, however, one should look at the experiences of other states to see if an income tax makes sense for Washington. Economic and personal income data from other states shows clearly that an income tax would have a deep and lasting effect on our state's economy.
Washington is one of only seven states that do not tax citizens' incomes. In most of the nine states that have recently adopted income taxes the rate of government spending increased significantly in the years following the transition. Six of these states also experienced a marked reduction in the rate of personal income growth.
Current research illustrates the strong tendency of an income tax to spur higher government spending. A comparison among states shows that those without income taxes consume a much smaller portion of their citizens' earnings. In states that do not have an income tax, taxes account for an average of $89 per $1,000 of household income. In contrast, the eight states with the highest income tax rates collected an average of $131 per $1,000 for government coffers.
Increasing the tax burden on the citizens and businesses of a state has a profoundly harmful impact on economic vitality. As the chart below shows, the ten states with the lowest total state and local taxes enjoy stronger economic growth, a faster rise in household incomes and greater growth in gross state product than the ten states with the highest tax burden.
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High-tax states have lower economic growth and less household income growth than low-tax states.
During the 1990s people living in states without an income tax enjoyed greater personal income growth than their neighbors living in higher tax states. Personal income in Texas, for example, grew at a rate more than one third faster than in neighboring states. Personal income growth in New Hampshire outpaced that of all other New England states. Personal income in Washington state grew more than 9 percent faster than in adjacent Oregon. Nevada's rate of personal income growth was almost double that of the nation as a whole. With the lone exception of Georgia, not one state that taxes income was able to exceed, or even match, the rate of economic growth in states with no income taxes.
Econometric modeling shows that in Washington a state income tax would increase government spending by an inflation-adjusted $48 billion in the first ten years. Over the same period growth in personal income would be reduced by about $210 billion. The reduction in personal income growth would mean the loss of an average of $5,740 in personal income for state residents, compared to the existing tax system.
Government spending tends to increase faster in states with an income tax for two primary reasons. First, the addition of an income tax simply adds one more way policymakers can gradually increase tax revenues to fuel a faster rate of government growth. With more ways to tax, citizens notice less of the impact of each incremental increase in tax rates. Over time, the accumulation of small increases combines to stifle economic growth, transferring more money out of the productive economy and into the hands of government.
Second, an income tax would have wide-ranging effects on how people live their lives and run their businesses by reducing the overall competitiveness of Washington state. The state's regulatory burden already takes a heavy toll on the business climate, but lack of an income tax helps give Washington at least one competitive edge over most other states. Throughout the country, states without an income tax use that fact to attract new businesses and spur job growth.
For example, Micro-Radian Instruments Inc., a maker of laser measuring instruments, is moving from San Marcos, California to Bellingham, where it will build a 7,000-square-foot manufacturing plant. Company managers say one of the main reasons for the move is, "Washington has no personal income tax and no corporate income tax."
Other examples include South Dakota, where economic growth consistently outperforms that of neighboring North Dakota, which has a stifling income tax. Farther south, both Oklahoma and New Mexico are considering repealing their income taxes to compete better for businesses and jobs with their more prosperous neighbor, Texas. In South Carolina gubernatorial candidate Mark Sanford is proposing to eliminate that state's income tax.
Maintaining Washington state's competitive advantage is important. Many business owners say that not having an income tax is one of the few clear advantages they find to doing business in Washington. Recent studies show that complex regulations, a high business tax burden and a prevailing anti-business attitude among state regulators place the state in a decidedly unfavorable position when competing with other states in attracting new jobs and businesses.
If the Tax Study Committee includes an income tax among its recommendations, Washington citizens will have to consider all the facts before taking such a drastic step.