The push to eliminate Oklahoma’s personal income tax relies heavily for intellectual support on a study done for the Oklahoma Council of Public Affairs by economist Arthur Laffer and his colleagues. The Laffer report makes two claims: (1) that states without an income tax enjoy stronger economic growth, and (2) that abolishing the income tax would boost Oklahoma’s economy to such a great extent that the state would recapture a major share of lost revenue and not have to slash core services. Last week, we reported on a study from the Institute on Taxation and Economic Policy (ITEP) showing that when more accurate indicators of economic growth are used, states without an income tax are doing no better than other states, including Oklahoma. A follow-up ITEP study now reveals that Laffer’s second claim regarding the economic growth that will result from eliminating the income tax is equally dubious. Together, the debunking of its two main economic arguments leaves the OCPA proposal tottering.
Laffer claims that by phasing out the income tax, which takes less than 4 percent of most Oklahomans’ income, Oklahoma’s annual personal income growth rate would more than double, while 312,000 more jobs would be created than if tax rates remain unchanged. Although intuitively dubious, Laffer’s calculations are derived from a regression analysis that is based on tax rates and personal income for all 50 states from the years 2001 to 2008. However, when ITEP went in to duplicate the analysis, they discovered that Laffer chose to measure each state’s tax rate by combining the top marginal state and federal tax rate in each state. This decision to include federal tax rates in a study of state tax policy had a decisive impact on the findings. ITEP writes:
Since the goal of the regression is to show how state tax rates affect economic growth, it’s hard to see why Laffer et al. would muddy the waters by measuring the combined federal and state tax rate—that is, until you see how that choice affects their results. As noted, the Laffer regression finds a “negative and highly significant” relationship between the combined federal/state tax rate in a given state and economic growth over the 2001-2008 period—but that relationship actually becomes positive and insignificant when the model is corrected to include only variation in state tax rates [emphasis added]. Put another way, when the noise created by changes in federal tax rates is removed, it becomes obvious that differences in state tax rates are not driving the economic predictions made by Laffer.
Laffer’s regression is also fundamentally flawed in failing to make any effort to measure the impact of other factors that might affect economic growth, from coastlines and climate to natural resources. They point out that a 2011 study by James Alm and Janet Rogers that tests the impact of more than 130 variables explaining state economic growth and finds” no significant impact of state income taxes.”
Without this flawed regression analysis, there is not even the semblance of an argument left to support the idea that eliminating the income tax will spark the miraculous economic benefits that Laffer claims, or that growth will generate sufficient revenues from other state taxes to provide for a basic level of funding for schools, roads and bridges, public safety and retirement benefits. The flimsy intellectual edifice on which this proposal to abolish the income tax has been constructed has been left without a leg to stand on. Over the coming months, it remains to be seen whether the scheme comes crashing down or can manage to stay afloat based on pure political calculations.
For a one-page fact sheet summarizing major flaws in the Laffer report, click here.