Taxes and Economic Outcomes: Indiana and Wyoming Edition

October 11, 2013

With the 2014 State Business Tax Climate Index released this week, it may be worthwhile to look more closely at the real-world consequences of tax policy in a few states in particular. Economists call this a “natural experiment,” a case where, due to some outside reason, two similar samples (in this case, two similar states) adopt different “experimental treatments,” allowing us to have a relatively controlled set of data. Comparing Nevada (ranked 3rd) to California (ranked 48th) isn’t very useful, for example, because Nevada and California have notable differences other than taxes. But comparing, Indiana with Ohio and Wyoming with Colorado may be more fruitful because they have similar demographic and regional characteristics, and similar industrial makeup. There are still non-tax differences between these states (such as Indiana and Wyoming both being right-to-work states, while Colorado and Ohio are not), but it’s closer to a fair, apples-to-apples comparison than pundits who suggest that, because there are still businesses in California, taxes don’t matter.

These sorts of comparisons strongly suggest that taxes are very relevant. They aren’t always world-shakers given the relatively small differences in rates observed between states, but they do matter. According to Bureau of Labor Statistics (BLS) data on private sector job gains and losses, in the period 2002-2012 (the most recent 10 years), Wyoming’s private sector job growth has averaged 0.9 percentage points more than Colorado’s, while Indiana’s has been 0.5 percentage points more than Ohio’s. Put another way, private sector employment grew three times as fast in Wyoming (1.4 percent average vs. 0.5 percent). Meanwhile, Ohio’s private sector employment shrunk despite access to the Marcellus shale natural gas field, while Indiana’s expanded.

Critics may suggest that because Indiana and Wyoming are right-to-work states, new jobs may be low-wage jobs and the employment effect is an illusion. However, that’s not the case. Since 2002, the BLS reports that nominal annual pay for Wyoming workers rose 57 percent, as compared to 34 percent for Coloradans, while Ohio and Indiana were essentially tied at 29 percent and 27 percent, respectively.

At least for this sample, when we look at apples-to-apples comparisons of similar states, taxes matter. They aren’t the only variable, something we make clear in the Index report, but they are a significant variable that legislators can control directly. Politicians can’t choose whether or not oil will be found on their land, or whether they have good deep-water harbors and internationally-connected ports, or whether they will be recipients of huge capital investments by previous generations. As far as legislators are concerned, those factors are fixed. But if policymakers want to improve employment opportunities in the 50 states and encourage growth, they might do well to learn the lesson shown in the above comparison: taxes matter, and high, unprincipled taxes hurt.

Bonus: check out the academic literature on taxes and growth.

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