State Taxes and Regulations Matter

by John Hood, Carolina Journal, September 18, 2013.

As the 2013 legislative session drew to a close, Gov. Pat McCrory and other Republican leaders said their main policy focus had been to improve North Carolina’s lackluster economy. They pointed to several enacted bills, including tax cuts and regulatory reform, to show that they hadn’t lost this focus during the sometimes-boisterous session.

In response, Democratic politicians, left-wing editorialists, and other critics of the GOP’s handiwork let out a collective snort. There is no empirical basis, they insisted, for believing that cutting state taxes or regulations will boost investment, growth, and job creation in the state.

Liberals are certainly free to make whatever theoretical arguments they wish. But they are not free to make factual claims about matters with which they are clearly unfamiliar. If you have read the relevant empirical research at all, you can’t possibly allege that there is no relationship between state tax or regulatory policy and state economic growth. The relationship is well documented.

Let’s start with tax policy. By my count, there have been more than 200 peer-reviewed studies published in academic or professional journals just since 1992 that explore the potential economic effects of state and local taxes. Some of these studies examine tax burdens as a whole, or a single policy such as income taxes. Other studies examine several tax policies at once. In some cases, the potential economic effects of state and local taxes are the primary focus of the research. In other cases, taxes are control variables in an equation aimed at answering a different question, such as the economic effects of highway spending or educational attainment.

In a clear majority of the studies, state and local taxes are negatively associated with economic metrics such as GDP growth, income growth, job creation, or investment flows after adjusting for other factors (ceteris paribus). While simple correlations do not prove causality — perhaps states with healthier economies tend to use some of the resulting revenue to cut taxes — it is plainly false to suggest that state tax rates and state economic growth are unrelated. Moreover, in cases where researchers used lagged variables and other techniques to explore the question of causality, most of them concluded that tax policy was likely to be the cause rather than the effect.

The results were even clearer for specific tax policies. More than two-thirds of the relevant studies found that lower personal income tax rates and lower business tax burdens were linked to stronger economic performance. On the other hand, three-quarters of the relevant studies found that targeted tax incentives such as per-job credits did not have a statistically significant link to stronger economic performance. It’s the structure of the state tax code, not just its revenue take, that matters most. States tend to experience faster economic growth to the extent they have broad tax bases and lower marginal rates — the very policies North Carolina put into place in 2013.

On regulation, the empirical data point to a similar conclusion. By my count, there are some 122 scholarly studies that examine either state regulatory climates in general or particular policies such as environmental rules, state minimum wages, or state financial-services regulation. In 68 percent of the studies, higher levels of regulatory stringency, activity, or cost were associated with lower levels of state economic growth. That doesn’t necessarily mean that the regulations in question were unwarranted. The health, safety, or other benefits of a rule might well be worth its cost in lower incomes or fewer jobs. But state and local policymakers who blithely assume regulation has no economic costs are in denial.

I don’t mean to assert that the debate about economic growth in North Carolina is settled. It isn’t. For example, some of these academic studies are better designed than others. And many that show negative economic effects from high state taxes still conclude that other factors — such as market conditions and federal policies — matter much more.

But to assert that there is no empirical basis for what McCrory and the legislature did this year is only to prove that, quite literally, you don’t know what you’re talking about.