Lower Taxes = Higher Economic Growth

Commentary, Taxation, Richard Vedder

One of the very best places to examine the impact of taxation on economic growth is to look at the United States. It is a nation with 50 states, each of which has its own tax system in addition to that of the federal government. There are many examples that demonstrate the basic point: high taxes mean low growth.

Two small states in the northeastern part of the country are New Hampshire and Vermont. They are very similar to each other in terms of geographic features and climate, and are adjacent to each other. I am speaking in each of those states next week. In 1929, the total income of citizens of New Hampshire, the larger state, was 43 percent above that in Vermont. By 2000, it was 149 percent larger. Part of that growing difference is explained by the fact that population grew more in New Hampshire, but the income per person, which was 9 percent lower in Vermont than New Hampshire in 1929, was more than 18 percent lower in Vermont in 2000. Why? New Hampshire is one of America’s lowest tax states, the only state without levies on income or general sales. Vermont, by contrast, has high taxes, particularly on income. Economic theory says that where there are no barriers to migration, income differentials should narrow over time – but in this case, they widened. Why? In Vermont, taxes lowered the return on productive economic activity – saving, investing, working – far more than in New Hampshire, so it grew slower.

Another two states that are neighbors are Kentucky and Tennessee. Both are hilly states, both make whiskey and many other similar things. In 1929, both total income and income per person were lower in Tennessee than in Kentucky. Today, Tennessee has 51 percent higher total income, and eight percent higher per capita income compared with its neighbor to the North. Why? Tennessee has no tax on income, while Kentucky has a fairly high tax. Moreover, Tennessee’s tax burden has actually fallen in the last two decades, while Kentucky’s has risen rapidly.

My last example uses two of America’s largest states, California and Florida. Both are in the Sun Belt, areas popular with older Americans after retirement. Both attract immigrants from nations to the South, such as Mexico and Cuba. Both have famous tourist attractions, including Disney resorts. Yet Florida has gained consistently on California economically. In 1929, total income in Florida was only 14 percent as large as in California; today, it is nearly 41 percent as large. In 1929, the average resident of Florida had less than 53 percent as much income as the citizen of California. Now that average resident has more than 86 percent as much income. Florida has grown faster economically, because it does not tax income, and it does not tax people when they die, while California does both.

In all of these examples, high taxes mean lower growth. People literally flee high taxes and oppressive government. The Berlin Wall was a pathetic attempt by the Communist regime in East Germany to prevent people from moving to West Germany, where the burden of government was less and where people could engage in private activity. Where walls do not exist, people move. From 1990 to 1999, for example, more than 2,800,000 Americans moved from the 41 U.S. states that had income taxes to the nine states without state income taxes. People voted with their feet for smaller government and a lower tax burden. This movement says that people believe that the overall quality of life is higher in the states that did not tax their income. This migration says that people prefer to spend the money themselves than letting government doing it. People were fleeing Welfare State policies in order to pursue individual freedom without as much governmental interference.

The experience in the United States has been duplicated throughout the world. In Western Europe, Ireland has the lowest overall tax burden of any major country, and the highest rate of economic growth over the past decade. Great Britain had the lowest growth rate of major European countries in the 1950s and 1960s, yet by the 1980s and 1990s it was growing faster than most of the major continental nations. Why? After 1970, the tax burden rose sharply in Western Europe, but much less so in Great Britain. By 1990, taxes on average were significantly lower in England than in such major continental nations as France, Germany or Italy. Lower taxes meant more capital formation, more entrepreneurship, more output. London has again become clearly the leading commercial city of Europe.

Sweden, by contrast, has declined in a relative economic sense. By virtually every indicator, Sweden was one of the world’s three or four richest countries in 1970. Today, it is not in the top 15 countries by any measure, and per capita income is actually falling below the average of the European OECD countries. A crushing tax burden has led to a reduction in capital formation, a decline in hours worked, and general stagnation.

High taxes, low growth.