Hicks
Among the more influential economic narratives in recent decades has been a publication by the American Legislative Exchange Council (ALEC), “Rich States, Poor States.” That work, now in its 15th edition, is authored by Arthur Laffer, Stephen Moore and Jonathan Williams
This document is a ranking of states across 15 policy variables that includes the highest marginal tax rates on households and businesses, the progressivity of the income tax system, burden of all other taxes, the presence of an inherence tax, along with recent tax policy changes (efforts to reduce taxes), size of debt, number of government workers per 10,000 residents, tort environment, workers compensation rates and state minimum wage and a tax or expenditure limit.
The index is transparent in its method and data, and provides a great deal of narrative. It has been enormously influential in Indiana. The index is designed to generate policy change that leads to economic growth. The 15th (2022) edition makes clear what the purpose of the ranking is for:
“Each of these factors is influenced directly by state lawmakers through the legislative process. Generally speaking, states that spend less—especially on income transfer programs—and states that tax less—particularly on productive activities such as working or investing—experience higher growth rates than states that tax and spend more.”
Before I review these claims, I need to be transparent about the research I’ve done on these issues. I’ve authored studies on nearly every one of these policy variables, from taxes, Right-to-Work, tort reform and minimum wage. I’ve spoken about tax reform at a conference headlined by Art Laffer, and Stephen Moore has highlighted my tax incentive research in a Wall Street Journal opinion piece.
My research in these areas, broadly summarized, concludes states should be mindful of all these issues. I’m sympathetic to arguments about efficiency in government, and think some of the narratives in “Rich States, Poor States” appropriately resonate with elected leaders. In particular, I like chapter two in the eighth edition, which offers a clear critique of crony capitalism.
But, to put it bluntly, there’s just nothing in the extensive body of research on economic growth, migration, population dynamics or business location decisions that would suggest these primarily tax-related factors play a critical role in prosperity or growth, however it is measured.
The “Rich States, Poor States” authors cite some interesting work on the subject, year after year. Still, the peer-reviewed studies they cite don’t make anything like the claims of supply-side tax policy as a panacea growth.
In fact, about the only theory the authors propose is the Laffer Curve argument, which argues that tax rate reductions can increase revenue through higher economic growth. A fatal problem with this argument is that the Laffer Curve applies to very high marginal tax rates—in excess of 75%. That’s maybe six times the top marginal tax rate in California.
An even more damaging challenge to the Laffer Curve theory is that state and local taxes affect the provision of local public goods (e.g., schools, public safety, etc.). There’s an abundance of research suggesting the quality of local public goods is the major contributor to business and household location decisions, that outweighs tax rates.
Still, this discussion should best be based on empirical fact rather than theory. The best way to do this is simply to see how state rankings on the Rich States, Poor States Index compares to economic growth. I’ll compare Gross Domestic Product (GDP), personal income and net interstate migration.
First, the relationship between GDP and the Rich State, Poor State rankings is neither statistically nor economically significant. Net migration is higher in the worse-ranked states, but again, it isn’t statistically significant. The Rich States, Poor States rankings do explain about 2.4% of personal income growth over the past dozen years.
A state’s movement from last place to first would have resulted in higher income of about 2.5% over that time period. How does that compare to other variables that economists argue influence economic growth?
The change in the share of adults with a bachelor’s degree or higher accounts for 20% of changes to personal income growth, compared to 2.4% from the Rich States, Poor States rankings. More importantly, moving just 2% points in the bachelor’s degree share of adults leads to more income growth than moving from last to first place in the Rich States, Poor States ranking.
In terms of state differences in per capita income, the Rich States, Poor States rankings explain less than 1% of differences in per capita income between states. In other words, it doesn’t matter. However, the state’s share of adults with a college degree explains 68% of per capita income differences. Moving up just one place in state education rankings would boost per capita incomes more than moving from 50th to 1st place in the Rich States, Poor States rankings.
Another way to assess the rankings is to see how the historical experience of moving up or down the rankings affected economic performance. Here we have data from 2007 to 2021 to compare. The results were astonishing—across the board, the states that did worse in the Rich States, Poor States rankings did better on GDP growth, personal income growth or net migration.
It isn’t just that the Rich States, Poor States rankings don’t predict economic growth as claimed. Rather, doing better in these measures actively worsens state economic performance. I know of no influential policy prescription that has performed this badly in practice since at least the late 1920s, and that one plunged us into the Great Depression.
And, it’s not a matter of trading off short-term losses for long-term growth. The reduction in state taxes proposed by the Rich States, Poor States ranking actually reduce long-run economic prospects. The reason for this is that the better a state performs on the Rich States, Poor States measure, the slower its growth in educational attainment has been over the past decade.
This has, and will continue to prove economically damaging for states that have chosen lower taxes over better educational attainment. The argument behind ALEC’s Rich State, Poor State rankings has failed both in theory and practice. It is well past time to dump the rankings and focus on policies that actually improve economic growth in states.
Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball Distinguished Professor of Economics in the Miller College of Business at Ball State University. Send comments to [email protected].
