by Fergus Hodgson
Director of Fiscal Policy Studies
The Laffer Curve lesson playing out across the states
The logic is surprisingly simple: A 100 percent tax on an activity will cause that activity to cease. The conclusion, however, that at some point higher taxes will cause revenues to decrease eludes many legislators.
This "Laffer Curve" relationship is perhaps best understood in graphical form. As one can see, there is a tax rate (t*) at which state officials maximize the revenue available. Beyond that point, disincentives become great enough that constituents exit the jurisdiction, cease or reduce taxable activity, or switch
into the grey market.
A new report from Art Laffer himself, along with a colleague from The Laffer Center for Supply-Side Economics, presents compelling evidence that many states have already gone beyond their maximum revenue point. In "Taxes Really Do Matter: Look At The States," they note that, "in any ten year period [dating back to 1960], the no-income tax states consistently outperform the equivalent number of highest income tax states." Further, "the no-income tax states even have higher [overall] tax revenue growth than the average of all states and the highest income tax states." (See the right hand column.)
Along with affirming the Laffer Curve relationship and the counterproductive consequences of income taxes, this finding underlines the importance of federalism and competition between the states. Legislators in those states with no income tax have reduced the overall rate of taxation to a level that has attracted immigration, at the expense of overtaxed states. (See the left hand column.) Their Gross State Product measures have also grown comfortably faster than those of states with income taxes.
While North Carolina’s income tax is slightly below the national average, with a top rate of 7.75 percent, it is higher than that of all neighboring states and its closest competitors. In fact, Tennessee does without an income tax on almost all personal income.
In the context of potential tax reform, this new research highlights how the Laffer Curve relationship and competitiveness with other states remain relevant. Combine that with North Carolina’s 44th placing in the 2013 State Business Tax Climate Index, which came out earlier this month, and a reduced tax burden in North Carolina is ever more necessary.
Warning from a Danish expatriate
Last week, the founder and CEO of Saxo Bank spoke at UNC-Chapel Hill on the dangers of European socialism, based on his experience with Denmark. He has now migrated to Switzerland, given fears that an exit would grow increasingly difficult as more productive individuals leave and exit taxes rise. The associated article, the basis for his presentation, is "Capitalism or Socialism," and I was there along with Carolina Liberty PAC, which covered the event.
As Lars Christensen spoke, the stories just kept on coming, from a 200 percent tax on automobiles — yes, you better believe it — to the world’s "leader" in wind energy getting just two percent of its energy needs from wind power. Christensen joked that the United States is now following suit and has become Denmark’s best customer when it comes to wind farms.
Perhaps the most fascinating insight, though, was regarding the immense generosity and redistributive power of the Danish welfare state. Two politicians engaged in a bet over whether there were poor people in in Denmark who needed more generous transfer payments. This "poverty" stunt backfired big-time, since the poorest person the one politician could find in the entire country was a woman who received the equivalent of between $2,600 and $2,700 per month as a government allowance. After all expenses, including cigarettes, television and internet subscriptions, veterinarian bills, and specialist soccer coaching for one of her sons, she still managed to save $900 each month! Naturally, this did not amuse working people who were struggling to make ends meet.
Christensen pleaded with Americans to preserve whatever respect for free enterprise remains here. Once it is lost and a majority of people are beneficiaries of government largesse, he said, reclaiming it is so difficult as to be perhaps impossible without systemic failure and default.
For further discussion of what happens after an extended period of welfare state policies, please see my article, "The Dark Side of the Welfare State," published with The Future of Freedom Foundation. This includes input from Sven Larson, a Swedish expatriate who now lives in Wyoming and who authored Remaking America: Welcome to the Dark Side of the Welfare State.
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Governor Bev Perdue(D) received a C grade, which placed her at 28th and equal with the Montana and Texas governors. The authors noted that she brought in substantial tax increases at the start of her term in 2009, just prior to the index period, and that more recently she proposed but failed to achieve an extension of an earlier sales tax increase. On a positive note, she has proposed cutting the corporate income tax rate from 6.9 to 4.9 percent, but that too has not occurred during her tenure.
Among some of the broader trends, the authors have identified a clearer distinction in policy priorities down party lines. In the latest release, the top five governors are all Republicans, and the bottom five are all Democrats. In the previous two reports, 2008 and 2010, a Democratic governor made the top five and a Republican governor made the bottom five. Further, in the 2010 report, on average, Democratic governors scored 47 out of the 100 and Republicans scored 55. In 2012, the gap has increased to 43 versus 57.
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