Do Higher State Taxes Hurt the Economy?

July 15, 2014

Economist Pavel Yakovlev has authored a new study for the Mercatus Center that analyzes the impact of state taxation on economic performance, business growth and migration rates. Yakovlev determined that higher state taxes do lead to lower economic performance, with the size of that effect depending upon the particular tax and economic activity being analyzed.

According to the study:

  • A 1 percent increase in the state's average tax rate creates a 1.9 percent decrease in the growth rate of the state's Gross State Product.
  • The notion that high state taxes hurt the economy and employment is confirmed by migration data. A higher personal income tax rate is associated with a greater likelihood that a state's residents will move to another, lower-tax state.
  • Florida, Nevada, Washington and Tennessee (four of the nine states without a personal income tax) are among the top 10 states that have gained population from 1989 to 2005.
  • The progressivity of an income tax directly impacts business creation, finding that a 1 percent increase in personal income tax progressivity is associated with a reduction in the growth rate of new firms of 1.2 percent. This is important, because new firms are responsible for 20 percent to 50 percent of state productivity growth.

When state residents are faced with higher taxes, Yakovlev concludes, they consume less, produce less or move to another state entirely.

Source: Pavel A. Yakovlev, "State Economic Prosperity and Taxation," Mercatus Center, July 10, 2014. 

 

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