Tax Competition Pushes States to Improve Tax Policy

Thanks to the mobility of labor and capital, state politicians face pressure to lower tax rates and reform tax systems. Indeed, the Wall Street Journal explains that the nine states without income taxes soon may have company, especially since it is increasingly apparent that no-tax states are growing much faster than states that have adopted the punitive levy:

In Georgia, Missouri, and South Carolina, governors and state legislatures are drafting serious proposals to repeal their income taxes to promote economic development. St. Louis, one of America's most distressed cities, may overturn its wage/income tax as a way to spur urban revival. And in Michigan, the legislature is in the last stages of phasing out its hated business income tax — the most onerous in the land.

"States are now in a ferocious competition to attract jobs and businesses," says economist Arthur Laffer, who is advising several governors and legislators on the issue, "and one of the best ways to win this race is to abolish the state income tax."

…The idea of financing state services without an income tax is hardly radical. Nine states today — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming — manage well without one. With a few exceptions, the non-income tax states are America's most prosperous. Meanwhile, the high income tax states, which tend to be congregated in the Northeast, keep surrendering jobs, people, and voters to the South and West.

State lawmakers also seem to have learned from two of the most recent states to adopt an income tax: New Jersey and Connecticut. As recently as 1965 New Jersey had neither an income nor sales tax, but managed to balance its budget every year. Now it has both taxes — its income tax is the 5th highest in the nation — but the state is facing what Stateline.org calls a "staggering budget deficit." Allied Van Lines reports that the Garden State is now one of the leading places for people to flee.

The latest state to adopt an income tax was Connecticut in 1991, but a new report by the Yankee Institute reveals that the tax has been a calamity. The state has ranked last in employment growth since 1991, losing 240,000 of its native born citizens between 1991–2002. No other state has since enacted an income tax, and lawmakers in Georgia, Missouri, and South Carolina say Connecticut is now the model for how not to run a state economy.