Graduated Income Taxes Hurt State Growth

(Editor's note: This blog entry was originally posted Oct. 28, 2009. It is being reposted after Sen. Alma Wheeler Smith, D-Salem Township, a 2010 gubernatorial candidate, announced her plan to restructure Michigan's taxes, including a graduated income tax topping out at 9.35 percent.)

During a series of public policy presentations before the state Board of Education on Monday, one speaker made a pitch for a graduated state income tax, where tax rates increase as one's income rises. He even argued that, "A graduated income tax doesn't matter that much on the economy." 

Not so fast! Tax structure matters a great deal — in some cases perhaps as much as the total amount that state and local governments extract from families, entrepreneurs and investors. The most persuasive scholarly literature on the subject concludes that badly structured taxes hurt economic growth and drive away people and businesses.

In 2000, the Federal Reserve Bank of Indianapolis published a study titled, "Does the Progressivity of Taxes Matter for Economic Growth?" The authors concluded, in short, Yes:  Tax progressivity inhibits growth, and the "structure of taxes has more of an effect than reform in the level of taxes alone." Also, contrary to what levelers might think, they also found that less progressive systems are more "egalitarian" or equitable and more helpful to the poor than progressive ones.

But wait, there's more! In a 2006 paper called "The Robust Relationship Between Taxes and State Economic Growth," economist W. Robert Reed examined the relationship between tax burdens in the 48 contiguous states and economic growth from 1970 through 1999. He found that higher taxes to fund general expenditures have "significant, negative effects on economic growth." Specifically, raising taxes by just one percentage point led to a 1.37 percent decline in per-capita personal income growth.

In 2008, Barry W. Poulson and Jules Gordon Kaplan published "State Income Taxes and Economic Growth," estimating the impact of marginal tax rates on state economic growth from 1964 to 2004. They found that in states that do have graduated income taxes, ones with relatively higher rates do worse economically than those with lower rates. States with no income tax do better than either, even if their alternative taxes extract the same amount of revenue.

By that standard, Michigan's flat income tax may not be as economically helpful as the zero rates in other states, but it's a lot better than Minnesota's three rates — all higher than ours — or Wisconsin's five rates, or Ohio's absurd nine-rate system. Indeed, a flat income tax system is probably the only tax advantage Michigan has over these bordering states — which of course makes throwing away that advantage a perennial hot topic in Lansing.

Creating a graduated income tax system would harm Michigan at a time when this state has already been suffering the nation's highest unemployment and slowest economic growth in the nation (our state Gross Domestic Product has actually shrunk 3 percent since 2000). This might be called Forrest Gump economics: "Stupid is as stupid does."

Permission to reprint this blog post in whole or in part is hereby granted, provided that the author (or authors) and the Mackinac Center for Public Policy are properly cited.