Tag Archives: evidence-based policy

Taxes And Growth

One of the most reliable laments I post to this blog is the absolute refusal of many policymakers  to base their decisions on evidence. We live in a time when experience and reality are no match for the preferred ideologies of our lawmakers. (In all fairness, that phenomenon is probably not new, but it has certainly become more obvious.)

Marketwatch is a business publication that focused upon that disconnect in an article from early May. The title was”Texas, California and Indiana offer surprising lessons about low taxes and economic growth” and the subtitle–which trumpeted the basic conclusion–was “Indiana slashed taxes. Yet wages have fallen even further behind the national average.”

If the subtitle was insufficiently clear, the introductory paragraphs left no doubt:

Among the most common claims of state economic development officials is that higher taxes drive down growth and cause businesses and people to relocate to low-tax states. If you listen to cable news, you are likely to hear dire stories of people fleeing high-tax states in droves.

Yet the high-tax parts of both California and Texas are growing faster than the low-tax parts of both states. And growth in Indiana, which has cut corporate and personal income taxes in the past decade as well as put a cap on property taxes, is dismal.

I tend to foam at the mouth whenever I encounter a reference to Indiana’s property tax cap–not only is the cap bad policy, not only does it disproportionately strangle urban areas in our rural-privileged state, but in an unconscionable move to elevate political game playing over responsible governance, former Governor Daniels constitutionalized the cap–ensuring that, even if subsequent evidence of its counter-productivity emerged, the measure would be virtually impossible to reverse.

The article wasn’t aimed at the multiple flaws of the tax cap, however, so I will leave my extended diatribe for another day.

Why is it that prescriptions for lower taxes, like other seemingly obvious economic “cause and effect” formulations, turns out to be contradicted by real-world evidence?

Modern economic research consistently reports that lower taxes tend to promote growth and migration, but only when all other factors are held constant.

Here’s the rub: It is straightforward to create a model holding all these other factors constant, but in the real world, they never are constant. So the role of taxes has to be weighed against the value of what tax dollars provide.

It took me a long time to recognize the importance of that insight. I used to think it was obvious that a higher minimum wage would depress job creation–until I realized that such a result required all things being equal–and all things are rarely, if ever, equal. The “obvious” result ignored–among other things–the effects of low-wage workers’ increased buying power. We now have real-world evidence from jurisdictions that raised the minimum wage that the “obvious” result isn’t necessarily the actual result.

In the case of economic growth, the article looks at the rivalry between Texas and California, and finds (surprise!) that the popular rhetoric doesn’t reflect reality.

Stories about people “fleeing” California for Texas are common, and Elon Musk’s high-profile announcement that he was moving to Texas fuels the anecdote-driven news cycle. Taxes per capita are higher in California than in Texas, giving weight to the story that low taxes are driving this migration.

In fact, in the last year for which we have data, two out of every 1,000 Californians departed for Texas, while 1.2 of every 1,000 Texans moved to California. This is hardly a notable exodus, and it hardly explains why a rational Texan would head to California. Something else has to be going on.

Furthermore, as the article notes, people are more likely to move from city to city within a state than they are to move out of state, and tax rates vary far more between local governments than between states.

In California, the total state and local taxes in the highest-taxed place were more than three times that of the low-tax county. In Texas, the difference is three times as large as in California.

Further contradicting the preferred story, it turns out that population growth in both California and in Texas is concentrated in the higher-tax places. That’s because–as city planners have long insisted–what matters most isn’t the tax rate (although it certainly factors in) but the quality of life. It’s value for the dollar.

 Taxes represent one price for living in a particular city or town, but value — not price — is the key decision variable.

For the average family, value comes from tangible amenities like safe, livable neighborhoods, high-quality schools and great parks and trails. They go far beyond natural amenities such as beaches and mountains.

That’s a lesson I doubt Indiana’s gerrymandered legislators will ever learn.