High Taxes, Low Growth: What Maryland Hasn\’t Learned from Others

Governor Glendening has reneged on his pledge to cut taxes. This is a political mistake as well as an economic one for the state. While he may pay the political price that befell George Bush in 1992 and the Democrats in 1994 after they broke their promises on taxes, it is Maryland residents who will pay the economic price.

Numerous studies of nations and states have shown a link between higher taxes and lower economic growth. All this research should be closely considered by Maryland policy makers. A RAND Corporation study found that for every 10 percent of a nation’s total annual income spent by government, the growth rate of that economy is reduced by one percent.1 What is true for countries is true for states. The Dallas-based National Center for Policy Analysis, in a study examining states’ economies from 1957 through 1987, found that higher taxes almost invariably led to slower economic growth.2 For example, Delaware, which had the lowest economic growth rate, at the same time experienced an increase from 5.2 percent to 11.3 percent in its overall proportional tax burden (here measured as state and local taxes expressed as a percentage of personal income). Wyoming, which had the second-lowest growth rate, had its total tax burden increase from 9.1 percent to 20.8 percent.3

Conversely, RAND found high economic growth to be linked to low taxes. Alabama, Tennessee and Arkansas experienced relatively strong economic growth. Their overall proportional tax burdens were well below the national average. The average tax burden each of these states was 8.47 percent in Alabama, 8.63 percent in Tennessee and 8.73 percent in Arkansas. These numbers compared favorably with the national average of 10.01 percent. The states’ economic growth rates from 1957-1987 were 2.47 percent in Alabama, 2.57 percent in Tennessee and 2.68 in Arkansas – all well above the U.S. mean of 2.03 percent.

More recent analysis indicates that the relationship between higher taxes and lower economic growth in the states remains strong. The impartial State Policy Research (SPR) organization has devised what it calls the “Index of State Economic Momentum” (ISEM). This is a composite figure derived from the states’ annual changes in income growth, employment and population growth, then measured relative to the national norm, expressed as 0.00. States with positive ISEM figures did better than the U.S. overall; states with negative figures did worse.

Comparing states’ 1991 ISEM scores with their tax-raising activity from 1989 through 1991 indicates that higher taxes led to economic slow-down.4 Of the seven states with the worst ISEM scores, five were among the ten states that increased taxes the most; and all seven were in the group of the 20 states that raised their taxes the most.

Table 1 further confirms the link between high taxes and slow growth. This chart portrays the relationship between states’ ISEM scores and their “tax efforts.” The “tax effort” statistic measures the degree to which a state burdens its residents more or less than other states, as explained within the text accompanying table 1. Maryland’s December 1991 ISEM score was -0.43, the tenth-worst figure of all 50 states.5 This should have surprised no one: The state’s tax-effort score of 103 meant that in 1991 the Free State taxed Marylanders three percent more than they would have been taxed if national average state and local taxation rates had been applied in Maryland. Table 1 shows a strong relationship between tax effort and ISEM score: Of the 10 states with the best ISEM figures, nine had below average tax-effort indices; of the ten worst ISEM-scoring states, seven had above average tax-effort indices.6

Economist Richard Vedder has also found a clear relationship between higher state taxes and lower economic growth. During the period of 1979 to 1989, the ten states that raised taxes the most in relation to personal income grew far less than half as rapidly as the ten states that lowered their tax burdens the most, 8.59 percent compared with 21.36 percent.7

Voting with Their Feet

Further, Vedder has found that higher taxes lead people to “vote with their feet.” High taxes repel people – and businesses – while low taxes attract them.8 High-technology firms, in particular, are found to be sensitive to taxation matters in making location decisions.9 In fact, a 1993 Fortune magazine survey of business executives found Baltimore City to be the tenth-worst place to do hi-tech business in America.10 High taxation acts as a serious impediment to start-up enterprises, and serves as a inducement for existing ones to leave.11 Vedder found that from 1980 to 1988, almost three million people migrated to the ten states with the lowest tax burdens, while 36,000 left the ten states with the greatest tax burdens.12

In another study, Money magazine surveyed its readers and found that 28 percent had either moved or considered moving to another state because of higher taxes. And 23 percent moved or considered moving to another city because of taxes.13 A 1994 study of the beleaguered District of Columbia found similar results. Conducted by the George Washington University Center for the Advancement of Small Business, the survey found that the primary reason for businesses to leave Washington was taxes of all types controlled by the city.14

It is true that, from 1980 through 1992, Maryland’s population grew by 16.6 percent, notably higher than the national increase of 12.6 percent. However, much of this is attributable to the extraordinary growth in the size of the federal government and its accompanying distribution of taxpayer-financed bounty. During the same period that Maryland grew by 16.6 percent, the bedroom-community counties of Montgomery and Frederick grew by, respectively, 34.9 percent and 39.2 percent in population. It now seems unlikely that this federally underwritten boon to Maryland will continue. In which case, consider the example of Baltimore City: The high-tax old port town lost 7.7 percent of its population from 1980 through 1992, a higher percentage than any other local jurisdiction in the state.15

Damaged Economy

Vedder has also performed regression analyses to determine the exact relationship that taxes, as opposed to other causal variables, have on state economic growth. There is a strong statistical relationship, he finds: The drag put on the American economy by state spending growing faster than the overall economy during the 1980s cost taxpayers $292 billion in personal income by 1990. Additionally, taxpayers had to pay $61 billion more in taxes in 1990, making a combined cost of $353 billion. This meant $1,415 per person.16

But there is a qualitative dimension to taxation as well. Taxes on productive activity – work and investment – are more damaging to economies than taxes on consumption. The current drive to change the federal tax system is based on this premise. Maryland fares particularly poorly in this respect. For fiscal 1992, Maryland was No. 1 among the 50 states in the percentage of state and local taxes raised from individual income taxes (37.4 percent versus the national average of 20.7 percent), as opposed to other forms of taxation.17 Maryland was the third-highest state in terms of individual income taxes, $874 per resident (the U.S. average was $452).18

States are similar to countries inasmuch as both experience negative economic consequences from higher taxes. But states face an additional challenge because their economies are much more open than any national economy. Individuals and businesses can migrate much more easily between states than between nations, after all. Price Waterhouse concludes, “As state legislators seek to raise revenue, they are frequently turning to higher taxes. Although this policy is an obvious tactic to combat revenue shortfalls, it may ironically lead to the opposite effect. For example, high taxes hinder economic growth by deterring businesses from moving into a state. Similarly, residents in a higher-tax state have an incentive to cross the border into a lower-tax state to purchase certain goods.”19

This provides a clear and vital lesson for Maryland policy makers: Lower taxes mean greater prosperity.20 Businesses will have more money to reinvest; individuals will keep more of what they earn.

Maryland’s Budget

Governor Glendening claims that for fiscal 1997 he has cut spending to the bone and therefore that the state cannot afford a tax cut. Yet, from either a “macro” historical perspective or a “micro” budgetary, line-item perspective, this is plainly not the case.

Looking at spending trends, it is apparent that the state budget and the bureaucracy’s rewards have ballooned in recent years. They are ripe for cutting back. Adjusting for inflation and changes in population, Maryland state per-capita spending grew 27.8 percent from 1980-1990.21 And no wonder: Over the same period, 1980-1990, once again adjusting for inflation, state-government average wages grew by 25.2 percent; local-government wages, by 22.1 percent. Private-sector real wages increased by just 9.3 percent.22 While the planned increase in the budget of one tenth of one percent is the smallest since 1945, given the recent largess in state spending, budgets should be heading downward.

Meanwhile, an examination of the details of Glendening’s $14.7 billion budget shows a number of expenditures that will do taxpayers no good. One prime example is the $249 million dollars of various bond, tax and lottery monies to be allocated for the development of football stadiums and related infrastructure in Baltimore and the Washington suburbs. While economists have conducted many studies on this issue, none has ever found a positive link between subsidies for sports and economic growth, as Professor Michael Krauss describes elsewhere in this journal.23 The Glendening administration also proposes to spend another $30 million on “economic development.” Rather than hiring an army of economic-development bureaucrats to manage the state’s economy,24 Maryland would be much better off simply lowering taxes and letting businesses and individuals allocate resources in the most efficient manner.

In his “state of the state” address, Glendening said, “The days of large corporate and government spending are gone. It is no longer size, but agility and boldness that determine success in business and government.”25 The words are right but, with the size of government not decreasing, the reality does not match the rhetoric. Maryland must really start to cut the size of government and provide tax relief for businesses and residents.

Dr. Berthoud is the vice president of the Alexis de Tocqueville Institution and a member of the Calvert Institute’s board of advisors.


End Notes

[Top] 1. Cited in Charles Wolf, Jr., Markets or Government: Choosing Between Imperfect Alternatives (Cambridge, Mass.: Massachusetts Institute for Technology Press, 1988), p. 146.

[Top] 2. Gerald W. Scully, How State and Local Taxes Affect Economic Growth (Dallas, Tex.: National Center for Policy Analysis, 1991).

[Top] 3. See Alan Reynolds, “New Jersey’s Suicidal Tax Policies,” briefing paper prepared for New Jersey Citizens for a Sound Economy Foundation, January 22, 1993.

[Top] 4. State Policy Research, Inc. (SPR), “Economic, Fiscal Outlooks Poor,” State Budget & Tax News, Vol. 10, No. 24, December, 23, 1991, pp. 1-4, table at 3.

[Top] 5. SPR, “Economic, Fiscal Outlooks Poor,” table at 3.

[Top] 6. SPR, “Economic Fiscal Outlooks Poor,” p. 3; David Baer and Lee Cohen, The State Economic, Demographic & Fiscal Handbook, 1993 (Washington, D.C.: American Association of Retired Persons, 1993), p. 240, table 17.

[Top] 7. Richard K. Vedder, “The Impact of State and Local Taxes on Economic Growth,” in John E. Berthoud and Samuel A. Brunelli (eds.), The Crisis in America’s States Budgets (Washington, D.C.: American Legislative Exchange Council [ALEC], July 1993), pp. 17-30, at 27, figure 4.

[Top] 8. See also Berthoud, “Weld vs. Weicker: The Tax Cutter Wins,” Hartford Courant, November 21, 1993, p. C1.

[Top] 9. Robert Premus, “Location of High Technology Firms and Regional Economic Development,” Staff Study, Joint Economic Committee of Congress, Washington, D.C., 1983.

[Top] 10. Kenneth Labich, “The Best Cities for Knowledge Workers,” Fortune, November 15, 1993, pp. 50-78, at 64.

[Top] 11. Timothy Bartik, “Small Business Start-Ups in the United States: Estimates of the Effects of Characteristics of States,” Southern Economic Journal, April 1989, passim; Dennis Carlton, “The Location and Employment Choices of New Firms,” Review of Economics and Statistics, August 1983, passim.

[Top] 12. Vedder, “The Impact of State and Local Taxes on Economic Growth,” p. 28, figure 5.

[Top] 13. Editorial, “Taxpayers Vote with Their Feet,” Washington Times, January 2, 1992, p. D2.

[Top] 14. Charles Toftoy, “Why Businesses Leave Washington, D.C. and the Economic Impact of Corporate Migration,” presentation to the National Economists Club, Feb. 7, 1995, p. 1.

[Top] 15. Overall, Baltimore City is not the most highly taxed jurisdiction in Maryland. Over 1986-1987, its per-capita local taxation was $703, well below that of such counties as Montgomery ($1,152) or Howard ($904). But in Baltimore this $703 average is very misleading. In Montgomery and Howard, the burden is spread fairly evenly. But because of Baltimore City’s poverty rate, many are exempt from local taxation, so the latter is very concentrated. The city’s poverty rate in 1989 was 21.9 percent. Montgomery County’s was 4.2 percent and Howard County’s was 3.1 percent. The state total figure was 8.3 percent. All figures from U.S. Bureau of the Census, County and City Data Book, 1994, 12th ed. (Washington, D.C.: Government Printing Office, 1994), table B, pp. 18-647, at 18, 256, 269.

[Top] 16. Vedder, Economic Impact of Government Spending: A 50-State Analysis (Dallas, Tex.: National Center for Policy Analysis, May 1993).

[Top] 17. U.S. Data on Demand, Inc. and SPR (USDD/SPR), States in Profile: The State Policy Reference Book, 1995 (McConnellsburg, Pa.: USDD/SPR, 1995), table D-2.

[Top] 18. USDD/SPR, States in Profile, 1995, table D-2.

[Top] 19. Price Waterhouse, Inc., Voting with Their Feet: A Study of Tax Incentives and Economic Consequences of Cross-border Activity in New England, Vol. 18, No. 11 of ALEC’s State Factor series (Washington, D.C.: ALEC, 1992), p. 6.

[Top] 20. Berthoud, “A Clash of Economic Visions in Maryland’s Gubernatorial Race,” Washington Times, October 13, 1994, p. A21.

[Top] 21. Berthoud and Brunelli, “The Budget Crisis in the States and the Challenge of Crafting Solutions,” in Berthoud and Brunelli (eds.), The Crisis in America’s State Budgets, pp. 3-6, at 4, table 1.

[Top] 22. Wendell Cox and Brunelli, “America’s Protected Class II,” in Berthoud and Brunelli (eds.), The Crisis in America’s State Budgets, pp. 73-109, at 97, table 8.

[Top] 23. Also, see Berthoud, “Why Subsidize Sports?” Investor’s Business Daily, November 29, 1995, p. A2.

[Top] 24. For an excellent discussion, see William Styring III, “The ‘EcoDevo’ Gang Doesn’t Shoot Straight,” Indiana Policy Review, April/May, 1994, passim.

[Top] 25. Charles Babington and Michael Abramowitz, “Cautious Glendening Proposes a Bare-Bones Budget,” Washington Post, January 18, 1996, p. B1.

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