Laffer & Drinkwater: The false promise of state income taxes


President John Kennedy, so the legend goes, held a meeting of the Western Hemisphere’s Nobel laureates in the White House and opened his remarks by saying, “I think this is the most extraordinary collection of talent, of human knowledge, that has ever been gathered together at the White House, with the possible exception of when Thomas Jefferson dined alone.” And indeed, Kennedy’s remarks may not have been an exaggeration.

Our founders deliberately created a nation of separate autonomous states, to allow political and economic competition among those states. The logic was that political experimentation, combined with economic competition, would allow good policies to proliferate and bad policies to wither and die. And, by and large, the model held true to its design. In the new book, “An Inquiry into the Nature and Causes of the Wealth of States” (Wiley 2014), we closely examine which policies have created prosperity, and which have been spectacular failures.

In 2014, we have 50 states with long and detailed records of successes and failures; none more important than the relationship between a state’s tax policies and its provision of public services. While there is a lot more to state tax policies than simply the existence or absence of a state income tax, that’s certainly a good place to start.

In 1961, West Virginia adopted its state income tax, and, since then, 10 additional states have initiated a state income tax. The modern era of creating a state income tax culminated in 1991 with Connecticut, under Republican Gov. Lowell P. Weicker. In addition to West Virginia and Connecticut, we have Maine, Rhode Island, New Jersey, Pennsylvania, Ohio, Illinois, Michigan, Indiana and Nebraska as modern-day adopters of a state income tax.

Let’s take a quick look at just how the state income tax worked out for these 11 states.

In terms of economic performance, you probably won’t be all that surprised to find that every one of the new members of the state income-tax club declined vis-vis the rest of the nation in terms of population, state output and even in terms of state and local tax revenue. Comparing the 11 states that introduced an income tax since 1960 with the remaining 39 states, not only did all 11 underperform the rest of the nation as a whole, some – Michigan, Ohio, Pennsylvania and New Jersey – saw their fortunes really plunge.

Going back to the debates held in these 11 state capitols just prior to adoption of a state income tax, you have to assume that the politicians were aware that higher taxes wouldn’t lead to more growth. So, just what did they think would be the benefits of higher taxes? The obvious answer is that well-meaning politicians had to believe the state would get more tax revenue, which, in turn, would translate into improved public services, such as schools, police, highways, etc.

But, as we said above, when compared with the total of all other states’ state and local tax revenue, state and local tax revenues for each of the 11 states also declined. Whoops!

Fortunately, we also have great data on each state’s provision of public services. We have annual data on the number of full-time-equivalent employees per 10,000 population for each state. We also have some external measures of the quality of public services, such as the Department of Education’s National Assessment of Educational Progress scores for each state.

Suffice it to say, the 11 states that adopted the state income tax over the past 54 years did not show any overall improvement in the provision of public services for their declining populations. In fact, most of the tax-adopting states deteriorated in both the quantity and the quality of their public services.

Take education, for example. More than half of all state and local full-time-equivalent employees are involved in education. And, education is the one category of public services that those who want to raise income taxes mention most.

Relying on the Department of Education’s testing of students in all 50 states (NAEP scores), over the past 20-plus years, only three of the 11 states showed minor improvement in fourth-grade reading scores, while eight states’ rankings worsened, four of which worsened by a lot. The same is true for fourth-grade math scores, except the three states that improved didn’t improve by much, and the eight states that worsened did so by a large amount.

In eighth-grade math test scores, six of the 11 states worsened, and five improved relative to the nation. Those that showed worse results declined by larger amounts than the five that improved.

It seems clear to us that the assumed relationship between adopting income taxes and providing better educational outcomes for students is nonexistent at best.

We also have official FBI data for each state’s violent-crime rate relative to all states for the year the state introduced its income tax and for 2012. Only three of the 11 states showed an improvement in their relative violent crime rates; eight had increased violent crime rates.

You have to ask yourself: If a state income tax doesn’t increase economic prosperity or provide enhanced public services, just what is the argument for the state income tax? Let our founders’ wishes prevail.

Arthur B. Laffer is founder and chairman of Laffer Associates, was an adviser to President Reagan and is a co-author of “An Inquiry into the Nature and Causes of the Wealth of States” (Wiley, 2014). Nicholas C. Drinkwater is a research analyst at Laffer Associates.