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Response to Politico: Taxes and the Texas Miracle

3 min readBy: Lyman Stone

Caleb Hannan at Politico has a story today on Governor Rick Perry’s (R) tour promoting Texas’ business climate in other states. We’ve written about Governor Perry’s campaign several times before, noting that while Texas’ business taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. climate is generally good, it does have some problems, such as its margin tax. Over the course of Governor Perry’s campaign, several firms have announced intentions to relocate into Texas, most prominently Raytheon and Toyota. Meanwhile, Texas’ economic performance during the recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. has remained robust, creating close to 2 million net new jobs. As Politico reports, this has led to some talk about a “Texas miracle.” Additionally, state tax competition often includes distortionary tax incentives that lead to lose-lose economic policies among the states.

Exactly what makes Texas’ economy so strong is a matter of much debate. Politico suggests that most of Texas’ job growth is due to oil and gas extraction, and says that “a century’s worth of data suggest” that Texas’ experience isn’t something that can be engineered by policy changes. The article also quotes a variety of sources suggesting that taxes don’t matter much for site selection, and state and local taxes are quite small. Overall, it gives the impression that states can’t effectively use policy (or at least tax policy) to shape their own economic fortunes.

However, attributing Texas’ whole experience to fossil fuel industries is inappropriate. According to the Bureau of Labor Statistics, since 2007, Texas has added about 82,000 mining and logging industry workers, which constitutes major job growth by any measure. But meanwhile, the Lone Star State also added 228,000 workers in education and health, 156,000 in professional services, 162,000 in hospitality services, 130,000 in trade and transportation, even 80,000 in government.

So while fossil fuel extraction certainly matters, it’s hard to say that’s the whole story. Government employment (not something Texas is known for) grew by almost the same amount, and many other sectors added even more employees. Have fossil fuels helped Texas’ economic growth? Absolutely. Can Texas’ success be written down entirely to natural resources? Absolutely not.

In fact, the academic evidence that taxes affect economic growth is strong. High, progressive taxes on mobile factors of production do harm economic growth. States lacking Texas’ natural resource bounty, such as Indiana, have also seen strong economic results from adopting sound tax and other economic policies. And, as I’ve written at some length in response to criticisms of our State Business Tax Climate Index, there is enormous evidence to support the idea that sound tax policies support economic growth, ranging from academic studies to surveys of businesses. Beyond that, there is strong recent evidence that international investment choices (such as those that Toyota faces) are indeed influenced by state policy choices like taxes (as well as education expenditure, labor policy, etc).

There’s a fair point to be made that, insofar as states compete by offering narrow tax incentives, their policies are counter-productive. Narrow tax incentives favor some businesses over others, leaving mature firms in a state to foot the full freight of the tax bill while incentivized firms benefit. Furthermore, time-limited incentive plans probably don’t have a large impact on long-term investment decisions.

But long-term tax policies do matter. Stable, neutral, non-distortionary tax policies, offering low tax rates on broad tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s, can support economic growth. Firm site selection is one channel, through which taxes affect economic decisions on the margin. There is robust evidence that taxes (while certainly not the only or even the largest factor) do matter for site selection. And, as one of the few site selection variables policymakers can directly control, it makes sense for them to be concerned about the role of taxes.

Read more on Texas here.

Read more on tax incentives and credits here.

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