Planning Decisions, Inc.

THE BOTTOM LINE FROM CHUCK LAWTON

The Tax Burden-Income Growth Puzzle

Published Sunday February 24, 2008

I cannot forecast to you the action of Russia.
It is a riddle, wrapped in a mystery, inside an enigma.
~ Winston Churchill

Churchill’s famous observation about his struggle to understand Britain’s wartime ally, might equally well apply to the effort to understand the relationship between tax burden, or, more precisely, the burden of public expenditure, and economic growth. A reader recently asked, “Why in the hoopla that always accompanies announcements of Maine’s high tax burden does no one comment that the states with the highest income growth also seem to be the states with the highest tax burden?”

To explore that question, I looked at the growth patterns of income and state and local government revenue over the period 1993 to 2006. What I found was nothing if not puzzling. For the nation as a whole, per capita income over this period jumped from about $21,300 to about $36,600, an increase of 71.6 percent. This ranged from a high of 103 percent—Wyoming—to a low of 50 percent—Hawaii. Maine ranked 31st with a growth of 71.3 percent, barely half a percentage point below the national average.

Yet considering state and local public expenditure burden—meaning taxes plus all governmental fees and charges—Maine ranked 4th in the nation in 2006 at 17.1 percent of personal income, well above the national average of 14.4 percent and behind only Alaska, Wyoming and West Virginia. In addition, Maine’s public expenditure burden increased nearly 7 percent over the period, ranking us 13th among the states in terms of growth in public expenditure burden, well above the national average of less than 1 percent.

In short, Maine’s relatively “middle of the pack” rating in per capita income growth seems somewhat out of step with the relatively high rate of growth of its public expenditure burden.

Comparing the top five states by per capita income growth (Wyoming, the District of Colombia, North Dakota, Massachusetts and Oklahoma) with the bottom five (Hawaii, Alaska, Michigan, Ohio and Georgia), this apparently paradoxical conclusion is further reinforced. The average growth in per capita income for the top five states was 89 percent. Their average growth in per capita public expenditure was 86 percent, and their average public expenditure burden in 2006 was 16 percent. All three values were far above the comparable national averages.

In contrast, the average for the five states with the lowest per capita income growth was 58 percent. Their average growth in per capita public expenditure was 56 percent, and their average public expenditure burden in 2006 was 18 percent. The first two values were far below the comparable national averages, and the third far above the national average.

So is initial public expenditure burden the key to growth?

Apparently not. The five states with the highest public expenditure burden in 1993 had an average growth of per capita personal income over the 1993 to 2006 period of 78 percent. The five with the lowest burden averaged 71 percent per capita income growth.

How about current public expenditure burden?

No explanation here either. In 2006, the five states with the highest public expenditure burden—their average was 20 percent of personal income—had an average increase in per capita personal income of over 75.3 percent, nearly 4 percentage points above the national average. The five states with the lowest public expenditure burden—their average was 12 percent of personal income—had an average increase in per capita personal income of 75.8 percent, almost identical to the increase of the top 5 states.

How about population growth alone? Or income growth alone? Again, no clear relationship. The simple fact seems to be that above average growth in per capita income comes in many forms and occurs for many reasons. For some states—Wyoming and Oklahoma—doubling income with only modest population growth was the key. For others—North Dakota and Washington, D.C.—more modest income growth coupled with population declines explained the high rate of per capita income. Conversely, in Georgia, income increased by nearly 120 percent, but population increased by 34 percent, pushing the per capita increase to the 47th position.

So if there is any solution to the puzzle here it is that tax (or public expenditure) burden alone is not the explanation for economic prosperity. A high public expenditure burden does not preclude high per capita income growth. Nor does a low public expenditure burden ensure a high per capita income growth. Like Tolstoy’s unhappy families, high growth states are all different. So the good (or bad) news seems to be that we have to find our own way.

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