Laffer Debunked: States without an income tax do not enjoy stronger economic growth

Update: We have put out a fact sheet summarizing major flaws in the Laffer report.

Do states without an income tax enjoy stronger economic growth? This is one of the central claims made by economist Arthur Laffer in a recent report published by the Oklahoma Council of Public Affairs and echoed repeatedly by proponents of eliminating Oklahoma’s income tax, including by Governor Mary Fallin in her 2012 State of the State address (1). However, a new report from the Institute for Taxation and Economic Policy (ITEP) shows that Laffer’s claim is based on a highly misleading analysis.

The ITEP report, titled “Don’t Be Fooled By Junk Economics”,  shows that: 1) Laffer cherry-picked metrics that are all tied to population growth; 2) population is growing in the South and West, where most of the no-income tax states happen to be, for reasons of climate, demographics, and the housing market, not state tax rates; 3) when more accurate indicators of economic growth are used, states without an income tax are doing no better than other states, including Oklahoma.

Laffer’s study compares the nine states without an income tax to the nine states with the highest personal income tax rate. He concludes:

Economic growth is stronger in states with no personal income growth and weaker in the states with the highest income tax rates – in good times and bad… To single out just one metric over the past decade, employment growth in the zero-tax states was 5.38 percent versus 0.51 percent for the nation and -1.68 percent for the highest tax-rate states.

The key problem with his analysis is that his various metrics of economic growth are really just measures of a single variable –  population growth. As ITEP explains:

The Laffer analysis distorts reality by focusing on a number of variables that are very closely related, including population growth, total employment growth, and total growth in economic output (GSP).  Since a larger population brings with it more demand, it’s only natural that states experiencing the fastest population growth would also experience more growth in the total number of jobs and total amount of economic output.  Simply put, the Laffer analysis is hugely distorted by its failure to acknowledge the importance of population changes to the variables it presents.

When state economic performance is measured by variables that control for population growth, the results are very different. ITEP compares economic performance in non-income tax states and high rate income tax states along three measures: growth in per capita real gross state product, change in real median household income, and average annual unemployment rate. On all three measures, most non-income tax states are faring worse than the average state. And on all three measures, Oklahoma is doing better than six of the nine non-income tax states. The table below compares growth in real per capita GSP (Gross State Product) from 2001-2010 in the nine non-income tax states, the nine highest tax states, the average of all 50 states, and Oklahoma:

It becomes clear that Laffer has Gerry-rigged his results by selecting variables that reflect strong population growth in the states without an income tax.  But could one say that it is the absence of an income tax that led to strong population growth in these states? ITEP convincingly makes the case that this is a coincidental correlation related to geography, not tax policy:

According to the U.S. Census, eighteen of the top twenty states in terms of population growth between 2001 and 2010 are located in the south or western part of the country, and seven of these states are located in the so-called Sunbelt. Demographers have identified a large number of reasons for the population growth occurring in the south and west that are completely unrelated to these states’ tax structures. Lower population density and more accessible suburbs are important factors, as are higher birth rates, Hispanic immigration, and even warmer weather. With this in mind, the growth of states lacking an income tax is no more than coincidental [emphasis added]. Six of the nine states not levying a personal income tax are located in the south or western parts of the country (eight of nine if you count Alaska and South Dakota), and are therefore benefiting from the same regional trends also bolstering growth in states with higher income taxes like Oregon, Hawaii, Idaho, and North Carolina. In this light, it should come as little surprise that the state without an income tax that experienced the lowest rate of population growth was New Hampshire – the only non-income tax state located in the northeastern part of the country.

If Oklahoma is going to decide to do away with the state’s largest revenue source that provides one out of every three dollars funding education, health care, roads and bridges, and the other core public services in the state, that decision needs to be grounded in far more convincing research than that offered by Arthur Laffer.

(1): Governor Fallin attributes the claim to Americans for Prosperity but the data she cites comes directly from the OCPA/Laffer study: “According to Americans for Prosperity, non-income tax states have seen 59% economic growth over the past decade, versus just 38% for high income tax states. Additionally, job growth has increased significantly in non-income tax states, while high tax states have actually lost jobs.”