Economy & Jobs

Why Low-Tax States Are Driving the American Economy

By  | 

Every state government has control over its economic policies, including tax rates. This creates a great opportunity to look at what works and what doesn’t. If you examine the data, a clear pattern arises: Low-tax states are driving the American economy, while high-tax states are falling behind.

Here are three reasons such states are faring much better than their neighbors:

1. Low Tax Rates Bring in Jobs

Companies and business owners have a choice over where they’ll locate, and tax rates play a big part in their decision. With lower rates, business owners can keep more of their hard-earned profits and use that money to expand their companies. High tax rates, on the other hand, are one more burden that can prevent companies from growing and hiring more employees.

It’s no wonder large companies are packing up and moving to low-tax states. After spending more than 50 years in California, Toyota, for example, decided in 2014 to move its headquarters and thousands of jobs to Texas, a state with no income tax.

Overall, low-tax states tend to create more jobs than high-tax ones do. From 2003 to 2013, the nine states with no income tax grew their total employment by 9.9 percent on average, according to the Heritage Foundation. The nine states with the highest tax rates only grew their total employment by 4.3 percent, less than half of that experienced by the no-income-tax states.

2. Low Tax Rates Attract Talent

Americans have a choice over where they can live, and they tend to vote with their feet when it comes to tax policy. States with lower income taxes are seeing huge population growth, while high-tax states are barely growing. A few are even shrinking.

Data from “Wealth of States” demonstrates that, from 2002 to 2012, most low-income-tax states saw double-digit population expansion. Nevada, which does not charge income tax, ranked number one during the decade with nearly 27 percent growth, while Texas saw its population increase by more than 20 percent (p. 6). States with high income taxes didn’t see that kind of growth. New York, New Jersey, and Connecticut, for example, all grew by less than 4 percent, and Rhode Island lost 1.47 percent of its population.

What makes this situation worse for high-tax states is that the people who leave tend to be the most driven, talented, and wealthy members of society. These people are hurt most by high tax rates because they earn more. When they leave, a state’s economy suffers. It’s no coincidence that California, with the highest income tax rates in the country, has one of the highest poverty rates as well (p. 227).

3. Low Tax Rates Bring in More Tax Revenue

Low-tax states not only have stronger economies than high-tax states do, but they tend to raise more tax revenue, too.

High tax rates discourage people from working hard, and they create an incentive to hide income in an effort to avoid taxes. Conversely, states with low taxes attract high-income earners. Residents are also less willing to cheat, because their tax savings aren’t worth the risk.

This is why states such as Texas are growing their tax revenues more quickly than states such as California (p. 218). As a result of its favorable tax policies, rather than in spite of them, Texas is able to hire more teachers and police officers, build more roads, and fund more public services.

When it comes to economic performance, low-tax states are the clear winners. High-tax states should consider adjusting their tax policies so they can share in the same prosperity.