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The States Move to the Supply Side

by Stephen Moore

This article appeared on cato.org on November 5, 1996.

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Can the government really cut taxes and balance the budget all at the same time? For Washington, it's clearly a Herculean task given the meteoric rise in the budget over the past 20 years. But ask Gov. Christine Todd Whitman of New Jersey how tough it is to cut tax rates and balance expenditures and receipts at the end of the year. Or ask Fife Symington of Arizona. Or John Engler of Michigan. Or even ask a Democratic governor like Zel Miller of Georgia.

These and 20 other governors have cut state taxes in recent years while not only managing to keep the budget in the black but jump-start their state economies. The dirty little secret about Bob Dole's tax cut proposal is that while supply side tax policies seem to be in great disrepute in Washington -- in the rest of America they've become standard operating procedure. Even many Democratic governors, such as Evan Bayh of Indiana, acknowledge that states have to "cut taxes or fall further behind economically."

The facts support that proposition. For example, in recent years tax-cutting states have substantially outperformed tax raisers. At Cato, we compared the economic and fiscal results in the 1990s in the 10 states that increased taxes the most with the results in the 10 states that cut taxes the most (see Table).

• The tax-cutting states have not only balanced their budgets; they also have much larger budget reserves (7.1 percent of state expenditures) than the 10 tax-increasing states (1.7 percent). Moody's bond ratings are higher for the states that cut taxes than for the states that raised them. Cutting taxes at the state level improves the fiscal condition of the state, contrary to predictions of higher deficits.
  
• The tax-cutting states have economically outperformed the tax-raising states in the 1990s. The economies of the tax-raising states grew by 27 percent (in current dollars) from 1990 to 1995. The economies of the tax-cutting states grew by 33 percent over that period. Even on a per capita basis, the tax-cutting states saw a faster rise in income than the tax raisers.
  
• Income for a family of four grew by $1,600 more in the tax-cutting states than in the tax-raising states.
  
• Americans continue to vote with their feet against tax hikes. In the 1980s roughly 1,000 people every day left the highest tax states for the lowest tax states. In the 1990s the population has grown by 4.2 percent on average in the 10 tax-raising states. But population has grown by 7.4 percent in the tax-cutting states -- two percentage points above the national average.
  
• Jobs are much more prevalent in the 1990s in the tax-cutting states. The 10 tax-raising states created zero net new jobs from 1990 to 1995. The tax-cutting states gained 1.84 million jobs, an increase of 10.8 percent.

The states' experience with reducing taxes is of special relevance to the current debate in Washington, because many states have reduced income tax rates across the board -- as Bob Dole proposes. The top 10 tax-cutting states reduced taxes as a share of total state tax collections by about 6 percent to 7 percent. Michigan cut tax revenues by more than 10 percent. The Dole plan would reduce total federal revenues by 5.2 percent on a static basis and by 4.1 percent on a dynamic basis (adjusting for higher economic growth from the tax cut).

Arizona is perhaps the most compelling case study in the dynamic effects of tax cuts. Under Fife Symington, taxes have been cut by $1.5 billion since 1992. The top income tax rate has fallen from 8.7 percent to 5.6 percent. Over that period job creation, population and new business creation have grown at three times the national average. Employment had actually fallen in Arizona in the two years before Symington's tax cuts. "In Arizona, tax cutting "is an economic issue -- and a freedom issue," declares Symington.

In New Jersey two-thirds of the 150,000 jobs lost under Gov. Jim Florio's soak-the-rich policies have been recovered under Gov. Whitman. "Income tax cuts were the spark plug for the economic revival in New Jersey," boasts Whitman.

Not surprisingly, those kinds of supply-side success stories are rarely, if ever, reported by Dan Rather or Peter Jennings on the nightly news. But the lessons to be learned from tax cutting governors is quite unmistakable: on pro-growth tax policy, the states have demonstrated they will lead. Why does Washington lack the good sense to follow?