Blog Posts > States without Personal Income Taxes are Not Seeing Greater Economic Growth than States with Highest Income Tax Rates
January 12, 2021

States without Personal Income Taxes are Not Seeing Greater Economic Growth than States with Highest Income Tax Rates

Last week’s blog post explored how eliminating the income tax in West Virginia would overwhelmingly benefit the wealthy, and that replacing just half the revenue lost with an increased sales tax would result in a substantial tax shift, with low- and middle-income West Virginians seeing a tax increase in order to pay for a tax cut for the wealthy.

Lawmakers and advocates who support reducing or eliminating state personal income taxes often claim that a tax system where the rich pay less and the poor pay more will spur economic growth. This is usually accompanied with an assertion that a state without an income tax is booming economically, and West Virginia is just one tax cut away from robust economic growth.

However, similar to claims about business tax cuts leading to economic growth, claims that income tax cuts lead to economic growth do not hold water. One simple way to demonstrate this is to compare economic performances of the nine states without a broad-based income tax with the nine states with the highest income tax rates. And we find that, despite the wide difference in tax structures, where differences in economic performances should be most pronounced, there is little difference in economic performance between states with no income taxes and states with high income taxes across a broad array of economic indicators.

The past 10 years represent the longest economic expansion on record, with the country growing slowly but steadily from the end of the Great Recession in 2009 all the way up until the pandemic in 2020. And during that expansion, the nine states with the highest top income tax rates have seen virtually identical — and in some measures — greater economic growth than the nine states without income taxes.

alt= Bar chart comparing average per capita GDP, personal income, disposable personal income, and personal consumption growth between the 9 states with no broad based income tax and the 9 states with the highest income tax rates over the past decade, with high tax states averaging higher growth

On a per capita basis, the nine states with the highest income taxes have averaged higher gross domestic product (GDP) growth, higher personal income growth, and higher consumption over the past decade than the states with no income taxes, and disposable personal income is virtually identical between the two groups.

In addition to greater GDP and income growth, residents of the states with the highest top tax rates are also more likely to find employment than the residents of states without income taxes.

One simple but illustrative measure of the health of a state’s job market is the prime-age employment rate, which is the share of each state’s population in its prime working years (ages 25 to 54) that is currently employed. As the chart below shows, states with the highest income tax rates have a higher prime-age employment rate (81.7 percent) than states without income taxes (81.1 percent). While this has not always been the case, the recent trend is stronger in the states with the highest tax rates.

alt= Line chart comparing average prime-age employment rates between the 9 states with no broad based income tax and the 9 states with the highest income tax rates over the past decade, with high tax states averaging higher employment rates

The stronger labor market performance of the states with the highest income tax rates can also be seen by comparing unemployment rates across states. As the chart below shows, a range of measures of unemployment — including the U-3 rate (the official unemployment rate, or workers who are unemployed and who have looked for work in the past four weeks), the U-5 rate (the U-3 rate, but also including people that have searched for work at any point within the past year, as opposed to just the last four weeks), and the U-6 rate (the U-5 rate, but also including workers that have part-time jobs — less than 35 hours per week — but want full-time work) — show that the states with the highest top income tax rates are currently outperforming the states without such taxes.

alt= Bar chart comparing average U-3, U-5, and U-6 unemployment rates between the 9 states with no broad based income tax and the 9 states with the highest income tax rates over the past decade, with high tax states averaging lower unemployment rates

Comparing states in this way does not control for differences across states unrelated to taxes such as industry mixes, natural resource endowments, tourism advantages, federal spending patterns, geography, and climate, but it is still useful for evaluating claims that the states without income taxes are booming, and that changes in income tax policy can result in significant changes in a state’s economic trajectory. If dramatic differences in state income tax rates cannot provide a clear economic advantage to the states without income taxes, then it becomes hard to justify even modest changes.

One area where states with no income taxes are experiencing above average growth is in population growth. However, there is little evidence that population growth is driven by tax policy. Even for millionaires, the group with the most to gain by not having to pay income taxes on their sizeable incomes, differences in taxes have little to no effect on migration. Instead, housing prices, warm weather, and birth rates are all stronger explanations for population trends than tax policy.

For a state like West Virginia that is losing population, cutting the income taxes with the expectation that it will slow or reverse our population loss may even backfire. When tax cuts inevitably lead to budget cuts and the deterioration of public services, it is more likely to make the state a less attractive place to live.

There is little compelling evidence to support claims that cutting or eliminating West Virginia’s income tax will boost the economy. Despite large differences in tax rates and structures, states with no income taxes have slightly underperformed states with the highest income taxes over the past decade.

And notably, eliminating the income tax typically requires higher sales and excise taxes to fund public services, meaning low-income families often face a higher overall state and local tax rate in the states without income taxes.

The available data show that eagerness to cut taxes is misguided. Further, it dismisses the importance of the economy-sustaining investments in education, infrastructure, and other public services that are funded with income taxes.

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