Does Progressive Taxation Exacerbate State Budget Gaps?

June 1, 2011

Because high-income earners and corporate profits tend to be magnified by economic cycles (very very good in good times, very very bad in bad times), it’s well understood that states that rely disproportionately on those income sources tend to have more volatile tax revenue streams.

Using budget gap data from the left-of-center Center on Budget and Policy Priorities, Dr. Matt Mitchell of the Mercatus Center attempts to see if states that rely heavily on high-earners see larger budget gaps. They do, he finds:

Among the six varieties of taxes, the share of revenue coming from two of them was statistically significantly related to the size of states’ 2010 budget gaps: the personal income tax share (significant at the 1 percent level) and the corporate income tax share (significant at the 10 percent level). Other factors being equal, a ten percentage point increase in a state’s reliance on personal income taxation increased the state’s budget gap by 3.7 percentage points (or 2.85 standard deviations).[…]

Individual Income Tax Regression Analysis

Reliance on the corporate income tax seemed to have an even greater impact on the size of a state’s budget gap. Other factors being equal, a 10 percentage point increase in a state’s reliance on the corporate income tax tended to lead to an 8.7 percentage point increase in the size of a state’s budget gap (6.78 standard deviations).[…]

Corporate Income Tax Regression Analysis

In sum: it appears that progressive taxation seems to be a recipe for rapid revenue growth when the economy is expanding (even tepidly). But it also seems to lead to larger budget gaps during recessions.

More here.

Update: A reader writes that Mitchell’s proxy for progressive taxation—greater reliance on individual and corporate income taxes relative to other taxes—may not be the best way of identifying progressive taxation. While it’s true that those are two revenue sources that are big contributors to progressivity, the point is a fair one.

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