Laffer curve phenomenon visible in American states

Faced with revenue shortfalls, many of the American state governors are turning to tax increases. But when they tried this during the economic downturn of the early 1990s, the states that raised taxes to balance their budgets dug deeper financial holes.

Tax hiking states lost businesses and taxpayers, prolonging the recession in those states.

In 1991 and 1992, California, Connecticut and New Jersey raised income taxes only to see tax revenues decline still further.

Revenues fell because upper-income homeowners and businesses fled to more tax-friendly climates like the Carolinas, Florida, Nevada and Texas.

In fact, after California raised its incomes taxes on the rich to nearly 10 percent in 1992, the state actually lost domestic population and revenues for the first time in history.

The states that took the opposite course – cutting taxes and state spending – saw both revenues and personal income grow.

New Jersey's tax receipts grew twice as fast in the two years after Governor Christie Whitman cut the income tax as they had in the two years after her Predecessor, Governor Jim Florio, raised it.

In Michigan, Governor John Engler cut income taxes, froze state agency spending and eliminated low priority programmes – over the next five years, Michigan led the nation in job creation and income growth.

Furthermore, over the last 10 years the states that lessened their tax burdens the most have created almost twice as many jobs as the states that increased their tax burden.

Source: Stephen Moore (Club for Growth), Governors and Drunken Sailors, National Review, June 3, 2002.

For more on State & Local Taxes http://www.ncpa.org/iss/tax

RSA Comment:
The experience of the US states provides a pointer to countries that wish to attract investment. Low taxes attract investment, but the overall package offered to investors needs to be more attractive than whatever is available in other countries. Subsidies are not the answer, as they merely disadvantage local investors and are impermanent. Overall conditions should be attractive to both local and foreign investors to be credible. And if there are detrimental factors, such as South Africa’s high crime rate, there will have to be compensating factors such as even lower tax rates and very friendly immigration laws. Unfriendly legislation, such as the recently adopted quotas for foreign workers, the onerous labour laws, and the empowerment requirements that foreign companies are expected to meet even though they had nothing to do with South Africa’s past, are detrimental factors that will deter investment.
Eustace Davie, Director, FMF.

FMF Policy Bulletin\11 June 2002