What’s wrong with Louisiana?
Tyler Cowen has a post on the problems encountered by Republican tax cutters at the state level. The post focused on Kansas and Louisiana, which were both recently forced to raise “revenues” to cover budget shortfalls. I decided to take a broader look at the states, and to focus on the sine qua non of supply-side economics, reducing the top income tax rate.
I found that between 2010 and 2015, 19 states changed their top income tax rate, with 5 increases and 14 reductions. So it’s not just Kansas and Louisiana. Even more surprising, Louisiana was not one of the 14, its top rate remains at 6%, a bit above average for states:
So what happened in Louisiana, I thought Bobby Jindal was a supply-sider? Inertia happened. Here’s Bruce Bartlett:
In January, Gov. Jindal proposed a tax reform that conformed to the Republican ideal, which he hoped would make him a contender for the 2016 Republican presidential nomination. It would have completely eliminated the state’s corporate and individual incomes taxes, replacing the revenue with an increase in the state sales tax to 7 percent from 4 percent.
The Institute on Taxation and Economic Policy, a liberal think tank, charged that the Jindal plan would raise taxes on the bottom 80 percent of Louisiana citizens. Conservative tax guru Grover Norquist of Americans for Tax Reform cheered the Jindal plan, calling it “the gold standard for pro-growth reform.”
But the Jindal plan was not received well, even in conservative Louisiana. An April 2 poll from Southern Media & Opinion Research found a sharp drop in Jindal’s popularity to 38 percent from 51 percent in October. His tax reform was opposed by 63 percent of Louisianans and supported by just 27 percent. Even among Republicans, fewer than half supported the Jindal tax plan.
On April 8, Jindal admitted defeat and withdrew his tax reform. Bloomberg’s Josh Barro said that Jindal had overreached, noting that over the last 50 years only one state, Alaska, had abolished a major state tax, which oil revenue allowed it to do.
It’s not that a tax regime with no income tax is politically infeasible; you see that in a number of other states. The problem is getting from here to there. Potential losers will squawk more loudly than gainers.
So in one of the 14 states that cut the top rate (Kansas) the policy failed, while the other 13 are . . . not discussed by the New York Times. Some of the tax cuts were small, with the largest being:
Rhode Island, down from 9.9% to 5.99% (why not 5.999%?)
North Carolina, down from 7.75% to 5.75%
Kansas, down from 6.45% to 4.6%
North Dakota, down from 4.86% to 3.22%
Oregon, down from 11.0% to 9.9%
Ohio, down from 5.925% to 5.33%
It’s worth noting that top rates were cut in some very liberal states like New York and Massachusetts, but only by small amounts. Among the 5 increases, the two notable cases were California and Minnesota, both of which were enacted for “progressive” reasons, and both of which seem (so far) to be fairly successful.
Let’s return to the “inertia” problem, and try to figure out the strange map above. It makes sense that liberal states would have high taxes, but why some more than others? Why no income tax in Washington State, and a top rate in Massachusetts that is lower than in many southern states? And why the 14 states seeing recent cuts in top rates? I think there are clear answers to these questions, but we need to consider several factors:
1. Voters don’t like high income tax rates. In both Washington (state) and Massachusetts, voters rejected referenda proposals calling for progressive income taxes, by wide margins. Even more shocking, in 2002 about 45% of Massachusetts voters voted to entirely eliminate the state income tax. Even the Republicans opposed that initiative. I recall a colleague told me about a taxi ride where the driver said; “like, I don’t get it. Why would anyone not vote to eliminate the income tax.” If the driver came from somewhere like Somalia, then it’s not hard to understand why there might be a disconnect between taxes paid and perceived benefits received. I was born here and even I don’t see much connection. My town spent $200 million replacing a perfectly good high school built in the 1970s. Why?
2. High income tax rates are more feasible where you have a captive audience. I hope I don’t need to explain California. (I plan to retire there rather than (low tax) Austin or Miami.) And the New York area has cultural amenities. But what about frigid Minnesota? Here’s what non-Midwesterners may not know. If you are a highly educated “Millennial,” and like cities like Seattle, Portland, Austin, Boston or Raleigh, there’s really only one place in the Midwest that would work for you—Minneapolis/St. Paul. Governor Walker keeps getting hammered because Wisconsin is not doing as well as Minnesota, but there’s not much he can do to keep well-educated UW grads (who want to stay in the Midwest) from moving to the Twin Cities. I’m not saying their tax increase will work in the long run, but it will work in Minnesota better than in any other Midwestern state.
3. Tax rates have lagged far behind political change. During my lifetime, many red states have gone blue, and vice versa. California’s recent tax increases reflect this fact, as do the many tax cuts in states that have become more red. I predict that South Carolina will have to cut its top rate at some point, now that it has the highest taxes in the South. It’s odd that many (blue) rust belt states have (for historical reasons) lower top rates than many conservative southern and western states. That will gradually change.
4. Don’t let the NYT tell you what is “popular.” I’ve already mentioned the opposition of liberal Washington and Massachusetts voters to a progressive income tax. I might add that although Governor Brownback is extremely unpopular among Republican legislators, it’s not clear that this applies to voters. Before the election last fall there was a flurry of articles telling us about how unpopular Brownback was with the voters. I expected a whole slew of follow up articles after he lost the election. But something kind of strange happened, he won. And those follow-up articles? I didn’t see them. Maybe Kansas voters liked the tax cuts.
5. On the other hand there’s no way to hide the fact that Brownback did screw up—his policies performed poorly. He cut the top rate, eliminated taxes on small business, and did little to cut spending. The result was predictable—suddenly everyone and his brother declared “I’m a small business.” and revenues plummeted. A deficit opened up, leading to the recent (regressive) tax increases. But even today Kansas has a tax regime that is more progressive than the regime in Massachusetts. And spending in Kansas is higher than in the other Great Plains states. A much better example is North Carolina, which slashed its top rate, and also cut other programs such as unemployment insurance, to avoid running deficits. Unlike Kansas, North Carolina is doing well, although in fairness it’s been doing well for decades. It’s hard to draw conclusions because most state level changes are small, and the effects show up very gradually. That’s why I prefer a cross sectional approach, and on balance that approach does suggest that people prefer states with no income tax. On average they vote that way with their feet, and in the case of Washington State, also at the ballot box.
Progressives can take heart from the fact that (in my view) the supply-side argument for lower top rates will gradually weaken over time. In the new economy firms have tremendous pricing power, and states have more taxing power than in the old commodity-driven economy. In the old days high taxes would make people and companies move to other states. Commodity industries are highly competitive on price. That’s Kansas and Louisiana. But the new economy in places like Manhattan and Boston and DC and Silicon Valley has companies with lots of market power, and people so rich they care more about amenities than a few extra bucks. So that works in favor of the progressives, but not yet in all 50 states.
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14. June 2015 at 07:03
I see no obvious flaws in Sumner’s op-ed (which is much ado about nothing, as property taxes are usually a bigger bite than state taxes for most rich). When Sumner sticks to microeconomics he’s quite competent. My only two cents: I was a legal resident of California but, as an overseas expat, who does not get taxed on the first 90+k of my income, I switched to a no-tax state so I don’t have to pay any tax. It only cost me a mail drop at that state and a one day mandatory visit to the state to establish domicile.
14. June 2015 at 07:30
Prices are not sticky. They are what they should be when individual private property is respected and enforced.
Rather, fiat money has a lagged effect on prices.
To call prices sticky suggests that everyone is failing to do something, failing to change prices in accordance with an anti-market ideal. It condemns the human race. Every socialist theory is based on a condemnation of everyone, except of course an escape hatch for the socialist ideal.
The more rigid the money, the smaller the probability of any sudden, widespread rise in money holding, ceteris paribus.
14. June 2015 at 07:35
Out here in Seattle they prefer to tax the poor with such devices as a $15/hr minimum wage.
14. June 2015 at 09:18
Highly educated midwestern millenials can only live in mpls? What about chicago?
14. June 2015 at 09:25
Here is my point:
1) Governor tax policies have little effect on state economics. Sam did his Kansas tax cuts right when the commodities started hitting so the fall of corn (or commodities etc.) offset any benefit.
2) Texas…Other states don’t have the ability to reach that level and they do not have the labor supply to attract businesses against Texas.
3) Most red states are lousy for younger middle class people and there is growing shortage of skilled labor. (For most people and I did live in Minnesota for 7 years) Where would you rather live Minnesota or Wisconsin? I bet most 30 – 40 year old who say Minnesota and you bet one main reason is the “School quality.”
4) Supply side is hitting diminishing returns in red states…It would work wonders in California but in Louisana
14. June 2015 at 09:56
Chalk up another small improvement in Europe for Jean Tirole (and others);
http://www.voxeu.org/article/graded-security-theory-practice
———quote———
The Italian Graded Security Contract (‘Contratto a Tutele Crescenti’) has been effective since 7 March this year. The previous open-ended contract for firms with more than 15 employees involved the compulsory reinstatement of workers in the case of unfair dismissals. This reinstatement, although rarely enacted (about 3,000 cases in a typical year), was a strong deterrent to hiring in open-ended contracts as it made the costs of dismissals very high (up to 36 months of pay) even for very short tenures. The reinstatement is a major deterrent also because there is a risk of a long trial and eventually a reinstatement, with the employer having also to pay back the worker during the trial period.
The new contract has been introduced on a flow basis (limited to new hires), but will be the only type of open-ended contract allowed in Italy henceforth. It will also involve all workers of firms growing above the 15 employees threshold.
The new contract phases out the possibility of reinstatement for economic dismissals, and almost entirely also for disciplinary reasons. Basically, the protection is offered only in terms of a mandatory severance pay in case of unfair dismissal increasing steadily (by two months per year with a low threshold of four months and a maximum of 24 months) with tenure, as depicted in Figure 3. Fair economic dismissals (as well as fair disciplinary dismissals) continue to involve no transfer to the worker at all tenures, while an option has been introduced that allows the employer to offer an intermediate level of severance (one month per year of tenure, starting from a threshold of two months and a maximum of 18 months) together with the notification of the dismissal. If the worker accepts the payment, then there is no possibility for the worker to sue the employer. This compensation is called ‘rupture conventionelle’ in Figure 2, as it mimics the French legislation in this respect.
———-endquote———
Sad, but this is an improvement in Italian labor law.
14. June 2015 at 10:10
Michael, Sure, but it’s not the sort of mid-sized city on my list. Chicago is nothing like Portland or Austin or Raleigh. Minneapolis is more similar. Chicago had much worse crime, traffic congestion, schools, etc.
Patrick, Well at least any change in Italy is likely to be a small step in the right direction.
14. June 2015 at 10:48
– Jindal’s plan simply would tax those who earn more EVEN more !!!!
The people who earn the most also have the best tax lawyers that are able to reduce taxable income to a (very) low level. But instead those people would see the amount of (SALES !!!) taxes go up substancially. And that’s why a sales tax is one of the best taxes around. Then the amount of taxes paid will go up when one has the ability to spend more.
No more income tax also means that tax deductables would go up in smoke as well. No more tax deductions for federal taxes. (Think AMT).
No more tax deductions for interest received from municipal bonds.
No more tax deductions for Obamacare.
Why is this so hard to see that this plan was booted out ?
14. June 2015 at 14:08
Scott, you say that new-economy “firms have tremendous pricing power.” How do we know this?
I can see that Apple charges a premium for its products, but Apple is just one company, however famous. What should make us suspect a broader rise in pricing power?
14. June 2015 at 14:59
Daniel, that’s an interesting point. So many internet firms and software firms look like they would have pricing power in some sense, because they have a lot of intangible value and monopoly power from network effects. But, in a way, the outsized level of intangibles is more a result of the decrease in capital. So, the irony is that many of these firms don’t have prices at all. What does pricing power mean, when the price is zero?
That is, I suppose, Apple’s innovation. After all was said and done, their strategy of keeping hardware and software tightly bundled allowed them to use their hardware to capture more of the consumer surplus that really comes from their software.
14. June 2015 at 15:18
Scott, re your rebuilt local high school: I felt when I lived in California I actually saw a result from my local taxes, even if I suspected it was 50 cents of results for a dollar of taxes. Streetlights, roads, public transit, parks, schools, fire and police etc. State and local taxes were also a much smaller amount than my federal taxes.
I never saw a return on my federal taxes.
14. June 2015 at 17:35
Daniel, It seems to me that lots of these companies are based on products protected by patent and copyrights. Biotech is one obvious case. But software seems like another. If Exxon or US Steel or GM raise their product’s prices by even 10%, they lose a huge amount of business to competitors. If Microsoft raises the price of Windows by 10%, they lose some business, but not as much.
Kevin, I’m outside my area of expertise, but I’d always assumed that companies like Google and Facebook made money selling ads, or in related ways. The price they charge for ads is the price that matters.
Ben, Yes, state and local government does provide some valued services, and you are right that the Federal government is far worse. I think 50 cents on the dollar is about right for state and local. A public education that costs $20,000 per student is probably worth about $10,000 per student.
14. June 2015 at 21:27
Off-topic.
Noah Smith wrote an unsatisfying review of Deirdre McCloskey on Piketty:
http://noahpinionblog.blogspot.com/2015/06/deirdre-mccloskey-says-things.html
14. June 2015 at 23:44
Scott, isn’t selling ads normally the last refuge of a firm with no pricing power? Like in radio stations, where ads are a sort of innovation to allow for the private ownership of a public good?
15. June 2015 at 02:17
[…] Scott Sumner has two excellent posts on state taxes, here and […]
15. June 2015 at 06:14
Isn’t Madison becoming something of a yuppie Mecca? Seems like more of my peers are talking of it as something beyond a college party town. UW-Mad is still a quality school and Wisconsin waives a lot of professional licensing requirements if you attend an in-state school (don’t need to take the bar to practice law, don’t need to take NAPLEX if you’re a pharmacist, etc.)
15. June 2015 at 07:56
Thanks Travis.
Kevin, Pricing power means something very different to economists as compared to business people. I was referring to elasticity of demand, not ability to charge a positive price.
Beta Guy, Yes, my hometown of Madison is a smaller version of Minneapolis. But it’s much smaller, say 500,000 as compared to 3 million in the metro area.
15. June 2015 at 08:11
“the new economy in places like Manhattan and Boston and DC and Silicon Valley has companies with lots of market power”
If this happens in red states, then even more people will start complaining about falling labor share of GDP.
Also, bubble-monger makes one good point, albeit not succinctly: States, especially rich ones, have a powerful incentive to keep high state income taxes in order to maximize the benefit of itemized deductions vis-a-vis state sales taxes or budget cuts.
15. June 2015 at 09:13
That seems to be an unnecessary distinction in this context. Facebook and radio stations face near infinite demand elasticity, so they end up with a Coasean bargain where they charge their customers tiny little micro charges through time and attention, which is only possible because the transaction costs are minimized by aggregating the charges for millions of customers through one advertiser.
If all your market power comes from network effects, you can’t price out any part of the pool of customers.
15. June 2015 at 09:27
Steve, I agree about the deductions.
Kevin, Time and attention are not a part of revenue to the firm. The prices that matter for firms are the prices that feed into revenue. And in those cases the demand is not even close to being infinitely elastic.
Revenue is P*Q. The issue for Facebook is how much does Q fall as P rises?
15. June 2015 at 10:08
In Louisiana, that 7% state sales tax proposal is a bit nuts when you consider that the parishes add their own sales tax on top of it. In Orleans parish, for example, the parish tax is 5%, making it 9% in total. So 7% would actually be around 12% in most of the state.
15. June 2015 at 10:32
You’re right. Seeing the advertisers as the customers is probably the more reasonable framing. But, even there, is pricing power what sets these firms apart? There may be factors that keep them in high tax areas, but these seem more related to geographic advantages. Which reminds me of a question. How much does California’s economy owe to being the location of Stanford University? The proportional benefit to California compared to the size of the institution seems mindboggling.
15. June 2015 at 13:03
Scott, why are you moving to California? Do the amenities really make up for the tax increase? Also, by ‘captive’, do you mean ideologically or by the luxuries we enjoy in this state (speaking from a native SoCal resident)?
15. June 2015 at 14:22
gregor. Louisiana should just adopt the Texas fiscal policy, lock stock and barrel. Texas has dramatically outperformed Louisiana in recent decades.
Kevin, I think it’s Stanford that owes its success to being in California. If it was in Mississippi, it would be relatively unknown. California has huge geographic advantages.
Pras, Yes, amenities easily cover the extra taxes. The only debatable point is whether they cover the far greater problem of higher real estate prices. And even there I’ve concluded they do (partly because I’m not all that materialistic.)
15. June 2015 at 14:35
Touche!
16. June 2015 at 23:01
[…] State tax rates discussed and explained by Scott Sumner, or “What’s wrong with Louisiana?” The post is fascinating, contrary to the […]