New Op-Ed: Do States with Good Tax Systems Grow Faster?

October 11, 2006

This morning we released one of our most anticipated studies of the year, the 2007 State Business Tax Climate Index. The goal of the Index is to evaluate the quality of state tax systems—what economists call the “economic neutrality” of state tax codes—regardless of whether the state has high or low overall tax burdens.

This year marks our fourth edition of the Index, which incorporates several methodological improvements we’ve made since the first edition in 2003. Read the full 64-page study for yourself here.

We’ve also published an op-ed summarizing the results of the 2007 State Business Tax Climate Index. Here’s a clip from the piece:

Attracting Business With Honey: Business-Friendly States See Rapid GrowthHere’s a piece of free advice for every candidate running for state office this year: Make your state’s business tax climate more competitive and economic growth will follow.

A new report by The Tax Foundation, which ranks the business tax climate of all 50 states, known as the 2007 State Business Tax Climate Index, reveals that states with the most competitive business climates consistently have faster growth rates in population, employment, output and personal income than states ranking poorly.

In fact, between 2000 and 2005, income in the top 10 states in the 2007 Index grew 44 percent faster than in the bottom 10 states. Employment in the top 10 states grew 115 percent faster, output 52 percent faster and population 164 percent faster.

It is commonly argued that more economically developed states like New Jersey and New York have slower growth rates because their economic indicators, such as population and median income, are so much higher than those of developing states. Texas, however, debunks the myth that economically developed states do not have room to grow.

One of the largest states in the union in both population and output, Texas comes in seventh in population growth, 11th in output growth, and 17th in increasing personal income. While its big-state brethren lag far behind, Texas remains near the top by embracing favorable conditions for businesses such as the absence of a state income tax.

Size is no excuse. State tax systems that are simple, fair, broad-based and low-rate can experience significant growth regardless of size or level of economic development.

The speed at which labor and capital can relocate increases exponentially every day. A T-shirt shop or bookstore no longer needs to be located near a large market in order to do business there. If economically developed states like Rhode Island, New Jersey, Ohio, New York and California are unable to make their tax systems more competitive and business-friendly in the modern market, the states that score well on the Index will rapidly close the gap.

We can see this trend clearly by looking at the labor force growth rates of highly competitive states that neighbor those with poor business tax climates. Since the beginning of 2004, the average labor force in each state has grown by about 3 percent nationwide.

However, California, with its punitive business tax climate, saw only a 2 percent growth in labor, while its more business-friendly neighbors, Nevada and Arizona, doubled and tripled the national average, respectively.

While taxes are among the many considerations in business location decisions, an attractive tax climate is a relatively simple way for a state to set itself apart from the pack. Promises of increased funding for education, infrastructure improvements and tougher crime laws — even if realized — can take years, if not decades, to have any effect. But making a state’s business tax climate more competitive will have an immediate impact. The research shows modest improvements in a state’s business tax climate can produce rapid growth in income, output, employment and population.

Taxes are by no means the only factor that contributes to economic growth, but the data are hard to ignore. With state coffers filled to the brims, state officials have the opportunity right now to mitigate the transition pains of changing their tax systems, and thereby improve their state’s business tax climate for years to come. (Full piece here.)

Read more about the new State Business Tax Climate Index here.

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