Rich States, Poor States: How Much Difference Do Income Tax Rates Make?

By  | 

Wonder what determines the overall economic health of a state? It turns out that income tax rates may play a key role.

To measure the annual economic changes a state goes through, the American Legislative Exchange Council (ALEC), the nation’s largest nonpartisan voluntary association of state legislators, puts together “Rich States, Poor States.” This study is produced by three accomplished practitioners of the economic arts: Dr. Arthur Laffer, who popularized the Laffer curve representation of taxation rates’ effect on revenue; Stephen Moore, chief economist at the Heritage Foundation; and Jonathan Williams, director of the Tax and Fiscal Policy Task Force for ALEC.

Looking Back to Predict Forward

The report looks both back in time to evaluate the economic performance of the 50 states over the past 10 years, and forward to predict their varied economic outlook for the coming year. Cross-referencing performance and outlook with income tax rates shows how these rates can impact a state’s current and future economic status.

Of course, states vary in the amounts of sales and excise taxes they levy on residents, and their underlying economic strengths and weaknesses differ widely, so the economic status of each state does not solely depend on income tax. However, isolating the income tax when examining state economics does reveal fascinating trends.

The Economic Top 5: Performers and Outlook

The five states with the best economic outlook, according to the 2015 report, include:

  1. Utah (3rd in performance)
  2. North Dakota (2nd in performance)
  3. Indiana (40th in performance)
  4. North Carolina (10th in performance)
  5. Arizona (12th in performance)

The top five economic performers include:

  1. Texas (11th in outlook)
  2. North Dakota (2nd in outlook)
  3. Utah (1st in outlook)
  4. Oklahoma (16th in outlook)
  5. Wyoming (8th in outlook)

Zero Income Tax vs. High Income Tax

Top performers Texas and Wyoming are two of seven states that don’t tax personal income. But what about the other states with no income taxes—Alaska, Florida, Nevada, South Dakota, and Washington? “Rich States, Poor States” rates them as the following:

  • Alaska (14th for outlook, 11th for performance)
  • Florida (15th for outlook, 23rd for performance)
  • Nevada (10th for outlook, 15th for performance)
  • South Dakota (9th for outlook, 14th for performance)
  • Washington (35th for outlook, 6th for performance).

Two additional states, New Hampshire and Tennessee, tax dividends and interest only. The report ranks New Hampshire at 29th place for outlook and 36th place for performance, and Tennessee at 17th and 24th, respectively.

According to the Tax Foundation, the five states with the highest marginal income tax rates in 2014 were California (13.3 percent), Hawaii (11 percent), Oregon (9.9 percent), Minnesota (9.85 percent), and Iowa (8.98 percent). These states are ranked generally low by the ALEC report. California has an outlook of 44th place and a performance ranking of 37th place; Hawaii is ranked at 37th and 18th place; Oregon at 45th and 7th; Minnesota at 48th and 30th; and Iowa at 25th and 21st.

While the differences aren’t stark, it’s clear that states with low or no personal income tax rates have a discernible advantage. And we are seeing this in the news: Income tax cuts in Kansas, once described as ineffective, are now showing real results. And with more legislators pondering income tax cuts this year, it appears that a lesson on the impact of taxation is being learned and evidenced in research like “Rich States, Poor States.”