Voters in St. Louis and Kansas City Keep the Earnings Tax

April 7, 2016

On April 5, voters in St. Louis and Kansas City supported identical proposals for extending the cities’ 1 percent earnings tax at least another five years. In Kansas City, unofficial returns have 77 percent of city voters supporting extension; it passed with 72 percent support in St. Louis.

If the proposals had failed, the taxes would have decreased incrementally by 0.1 percent each year until the statutory rates reached zero, and the taxes could not have been reinstated.

Some state lawmakers still contend the taxes are a matter of statewide concern; they point to the fact that more than half of the approximately $160 million in city revenue generated by the tax in St. Louis is paid by non-resident commuters who did not vote on April 5 and to whom city officials are not held accountable.

Sound tax policy is an important matter, but ensuing earnings tax debates should also be informed with facts about the tax’s effect on business investment in local economies.

What is the earnings tax?

The earnings tax is levied against the income of those who live or work in the city, meaning non-resident commuters are also required to pay. In some states, this is called a “wage tax” or, more descriptively, a “non-resident income tax.” In St. Louis and Kanas City, businesses are also required to remit 1 percent of net profits to the city. Historically, the tax is most common in so-called “Rust Belt” states, but it is not imposed in most states.

St. Louis and Kansas City are of particular interest, though, because they are the only tax authorities in Missouri allowed to impose an earnings tax. In 2011, even though the tax only existed in the two cities, voters supported a statewide ballot proposal barring local tax authorities from imposing new earnings taxes; conditional upon retaining the tax in St. Louis and Kansas City is city voters must renew it every five years.

Some supporters of the tax, including politicians and newspaper editorial boards, justify it as an indispensable revenue stream. In St. Louis, for example, the tax raises a third of the city’s projected $492.6 million in general revenue; in Kansas City, receipts exceed 40 percent of the city’s $538.7 million in general revenue.

But critics contend the economic costs of the tax, as well as the problematic tax base, do not justify the revenue.

The Earnings Tax is an Investment Disincentive

From 2000 to 2010, Kansas City netted 18,242 new residents, a 4.1 percent increase in population growth. But a 2014 study by Lindenwood University economist Howard Wall, commissioned by the Missouri based Show-Me Institute, estimates the population increase was only about half of what it would have been in the absence of the earnings tax.

A simple story might explain Wall’s finding: the statutory tax rate on labor is effectively shared, in some proportion, between workers and employers. This means the earnings tax increases the price of labor in the cities relative to the metro areas, thus incentivizing businesses to locate outside the cities. If this has held true, then it is reasonable to suspect some workers have been drawn to these businesses and, in turn, chosen to live closer to work instead of commuting from the cities.

The investment disincentive is especially concerning in St. Louis, where population has declined by more than 60 percent since 1950. Wall’s study estimates the earnings tax caused about half the decline between 2000 and 2010.

To be sure, taxes are but one of many factors considered by families and individuals when they choose living and working arrangements, but even city officials supportive of the tax recognize, at least to some extent, the tax’s distortionary impact.

“I agree with the conclusion that the City’s earnings tax … is a disincentive to some residents and business,” conceded St. Louis Mayor Francis G. Slay to the Missouri General Assembly in March, although he argues the tax is an appropriate price for non-resident commuters to pay in return for city services they consume.

Recognition of the investment disincentive the tax creates is also revealed, if inadvertently, by the cities’ willingness to exempt large firms from remitting it. The St. Louis Post-Dispatch (which supported extension of the tax) highlights several high-profile exclusions in a February story:

In 2008, the Board of Aldermen approved a $1.75 million deal to divert earnings and payroll taxes for the development of downtown’s Culinaria grocery, operated by Schnucks. In 2009, Anthem, then known as Wellpoint, moved 300 jobs into the city in exchange for diversion of up to $4.5 million of earnings and payroll taxes. The city then struck a $1.67 million earnings tax diversion deal in 2012 with Wells Fargo Advisors. All of the deals have expiration dates.

The tax is hailed as a 1 percent flat tax on all earnings, but some critics point to these exemptions and assail it as regressive in practice, because it is not uniformly imposed. They argue large firms can promise new jobs as leverage for negotiating exclusion, but there is little possibility of exemption for ordinary individuals and small businesses.

The Future of the Earnings Tax

Some state lawmakers appear ready to push for legislative repeal of the cities’ earnings taxes, if not press the issue of constitutionality. In either case, continued existence of the tax should at least be justified on the basis that it is the least economically distortive policy for raising desired revenue, and it ought to be proven to provide a net benefit to the people of St. Louis and Kansas City.

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