Tag Archives: Maryland

The battle of the taxes

In my last post, I discussed several exciting tax reforms that are gaining support in a handful of states. In an effort to improve the competitiveness and economic growth of these states, the plans would lower or eliminate individual and corporate income taxes and replace these revenues with funds raised by streamlined sales taxes. Since I covered this topic, legislators in two more states, Missouri and New Mexico, have demonstrated interest in adopting this type of overhaul of their state tax systems.

At the same time, policymakers in other states across the country are likewise taking advantage of their majority status by pushing their preferred tax plans through state legislatures and state referendums. These plans provide a sharp contrast with those proposed by those states that I discussed in my last post; rather than prioritizing lowering income tax burdens, leaders in these states hope to improve their fiscal outlooks by increasing income taxes.

Here’s what some of these states have in the works:

  • Massachusetts: Gov. Deval L. Patrick surprised his constituents last month during his State of the State address by calling for a 1 percentage point increase in state income tax rates while simultaneously slashing state sales taxes from 6.25% to 4.5%. Patrick defended these tax changes on the grounds of increasing investments in transportation, infrastructure, and education while improving state competitiveness. Additionally, the governor called for a doubling of personal exemptions to soften the blow of the income tax increases on low-income residents.
  • Minnesota: Gov. Mark Dayton presented a grab bag of tax reform proposals when he revealed his two-year budget plan for the state of Minnesota two weeks ago. In an effort to move his state away from a reliance on property taxes to generate revenue, Dayton has proposed to raise income taxes on the top 2% of earners within the state. At the same time, he hopes to reduce property tax burdens, lower the state sales tax from 6.875% to 5.5%, and cut the corporate tax rate by 14%.
  • Maryland: Last May, Maryland Gov. Martin O’Malley called a special legislative session to balance their state budget to avoid scheduled cuts of $500 million in state spending on education and state personnel. Rather than accepting a “cuts-only” approach to balancing state finances, O’Malley strongly pushed for income tax hikes on Marylanders that earned more than $100,000 a year and created a new top rate of 5.75% on income over $250,000 a year. These tax hikes were signed into law after the session convened last year and took effect that June.
  • California: At the urging of Gov. Jerry Brown, California voters decided to raise income taxes on their wealthiest residents and increase their state sales tax from 7.25% to 7.5% by voting in favor of Proposition 30 last November. In a bid to put an end to years of deficit spending and finally balance the state budget, Brown went to bat for the creation of four new income tax brackets for high-income earners in California. There is some doubt that these measures will actually generate the revenues that the governor is anticipating due to an exodus of taxpayers fleeing the new 13.3% income tax and uncertain prospects for economic growth within the state. 

It is interesting that these governors have defended their proposals using some of the same rhetoric that governors and legislators in other states used to defend their plans to lower income tax rates. All of these policymakers believe that their proposals will increase competitiveness, improve economic growth, and create jobs for their states. Can both sides be right at the same time?

Economic intuition suggests that policymakers should create a tax system that imposes the lowest burdens on the engines of economic growth. It makes sense, then, for states to avoid taxing individual and corporate income so that these groups have more money to save and invest. Additionally  increasing marginal tax rates on income and investments limits the returns to these activities and causes people to work and invest less. Saving and investment, not consumption, are the drivers of economic growth. Empirical studies have demonstrated that raising marginal income tax rates have damaging effects on economic growth. Policymakers in Massachusetts, Minnesota, Maryland, and California may have erred in their decisions to shift taxation towards income and away from consumption. The economies of these states may see lower rates of growth as a result.

In my last post, I mused that the successes of states that have lowered or eliminated their state income taxes may prompt other states to adopt similar reforms. If the states that have taken the opposite approach by raising income taxes see slowed economic growth as a result, they will hopefully serve as a cautionary tale to other states that might be considering these proposals.

Maryland’s budget troubles continue into the New Year

Each year a committee made up of Maryland state legislators gets together to set a spending growth limit for Maryland’s general fund budget. The Spending Affordability Committee (SAC) has been in place for 30 years. Originally created to avoid instituting a Tax and Expenditure Limit (TEL), the SAC has proven unable to stop the persistent structural deficit which emerged in 2007. This year the SAC recommends a budget of $37 billion, one billion more than last year. That’s an increase in spending of 4 percent

In a paper for the Maryland Journal entitled, “The Appearance of Fiscal Prudence” Benjamin Van Metre and I detail the flaws of the SAC process based on our read of the official reports. The main problem with the process is that lawmakers have convinced themselves that the SAC imposes fiscal prudence on the legislature. We find while there is some formulaic guidance in the form of a limit based on the growth in personal income, it only applies to part of  the budget. The SAC also involves policymakers deliberating over spending “needs” while referring to revenue estimates. The result is not a hard limit on spending but a recipe for a budget soufflé. To be fair, the SAC wasn’t designed to be a hard limit. It was built to be flexible.That’s fine if the SAC is clear about its own limitations in setting a spending limit.

What’s interesting is that over the years there’s been a bit of hand-wringing in the SAC reports about fast-growing areas of the budget – the Transportation Trust Fund, Medicaid, and a growing reliance on debt finance. Debt limits are covered by a separate legislative committee, the Capital Debt Affordability Committee (CDAC). But, the SAC’s warnings about debt tiered up with the CDAC’s increase in the debt cap. It leads one to conclude that these two committees are, at best, talking past one another.

Given the recent history of Maryland it’s more likely legislators will continue finding ways to fund “increased needs.” And they will do so by seeking more revenues in the form of new taxes, tax rate increases, and debt.  As one legislator put it with this year’s SAC recommendation, “we’re setting our citizens up for massive tax increases.”

 

 

This Week in Economic Freedom

It’s been a promising week for supporters of freer markets as several states and municipalities have taken steps toward deregulation and consumer choice. Here’s a roundup of some new developments:

1. Washington state is making headlines by being the first state (and first place globally) to legalize recreational marijuana. This policy change comes after recent polls indicate that most Americans favor legalizing marijuana. Of course what remains to be seen  is how the federal government will respond to this change in state law. The U.S. Attorney General’s office has issued a letter stating that marijuana remains illegal under federal law in these states and under the Obama administration the office has aggressively prosecuted medical marijuana dispensaries that are legal under states’ laws.

2. In Michigan right to work legislation looks poised to pass. The change would make it legal for employers to pay workers who choose not to be union members. James Sherck explains the political calculus behind this potential policy change:

Republicans have large majorities in both houses of the state legislature. Until now, however, Governor Rick Snyder has insisted right to work was not on his agenda. But today he changed his tune and called for the legislature to pass the bill — Snyder’s support removes the last obstacle to right to work passing in Michigan.

How did this happen? For one, unions badly miscalculated. They tried to amend the state constitution to preemptively ban right to work and attempted to elevate union contracts above state law. Michigan voters roundly rejected the proposal, but the debate put the issue on the public’s agenda.

Unsurprisingly, Michigan unions strongly oppose this change and are currently rallying against this potential change.

3. In Washington, DC City Council took two steps toward greater economic freedom. On Tuesday, the DC Council passed legislation allowing Uber, a popular sedan service which customers use their cell phones to book, to continue operating in the city. The new legislation legalizes “digital dispatch” and permits this new type of service that fits between taxis and traditional car services. Uber still faces legal challenges in San Francisco, Boston, Toronto, New York, and Chicago. Also on Tuesday, DC joined its neighbors Maryland and Virginia with legal Sunday liquor sales. As is so often the case with regulation,  many liquor store owners supported the status quo of mandatory Sunday closings. Store owners testified that they appreciated the mandatory day off and worried that the policy change would allow competitors to cut into the profits of stores that choose to close on Sunday.

Maryland Study Finds States Spend Too Much on Wall Street

A report from the Maryland Tax Education Foundation and the Maryland Public Policy Institute finds that state pension funds spend a significant amount of money paying investors to manage their funds. States spent $7.8 billion on Wall Street in 2011. Funds’ recent poor performance casts these expenditures in a particularly bad light for taxpayers, and the Maryland researchers Jeff Hooke and Michael Tasselmyer suggest these funds are not well-spent.

Much less expensive investment strategies are available to investment funds, however, these investment strategies rely on index funds that typically seek to match the market’s performance rather than outpace it. However, as Governing the States and Localities explains:

Pension experts interviewed for this story, though, question the validity of the report, which compares investment firm fees with each plan’s net assets. Even with the higher fees, they say additional returns from investment managers outweigh the added cost in the long run, and tossing more money into equity index funds wouldn’t diversify portfolios.

“The suggestion that all public pensions should be shifted into index accounts is just not well informed,” said Keith Brainard, research director for the National Association of State Retirement Administrators.

The need to outperform the market comes from the way that states value their liabilities. Rather than valuing defined benefit pensions at the appropriate risk-free discount rate, states choose to assume higher rates of return, commonly 5 percent above the risk-free rate. When a low-risk investment strategy fails to meet these returns, state fund managers are incentivized to pursue riskier strategies with the hope of making the return needed to make the defined benefit obligations. This is demonstrated in state funds’ participation in recent IPOs.

The Maryland report states:

For many state pension funds, investment results over the last 10 years have failed to hit target returns of 7 to 8 percent annually. This has prompted Maryland’s System and other state systems to make large commitments to “alternative investments,” like leveraged buyout funds and hedge funds, with the hope of obtaining higher returns than conventional public stocks and bonds. In fiscal 2011, 25 percent of the Maryland System’s investment portfolio was in alternative investments, including private equity and real estate.

alternative investments are less liquid, less transparent, and more volatile than conventional public stocks and bonds. It is also questionable whether these investments provide higher returns than a similar risk-adjusted portfolio of public equities. Buyout fund promoters claim higher returns, for example, but many of their leveraged buyouts from the pre-crash period have yet to sell, and the state pension systems rely on the buyout funds’ in-house valuation of such investments to determine pension investment returns. The states exercise limited supervision over the buyout funds, and the examination of buyout fund portfo- lio values by fund auditors is typically inadequate.

With a risk-free discount rate for valuing guaranteed defined benefits, state fund managers would not be faced with the choice of either accepting higher risks or facing a reality of falling short on obligations. In determining what discount rate to choose, state policymakers should remember that the benefit level determines the cost of pension plans. Lowering the assumed rate of return does not change the cost of pensions, but merely means taxpayers will be paying for benefits as they are accrued, whereas a higher discount rate pushes these payments into the future.

 

The Appearance of Fiscal Prudence in Maryland discussed on WBAL-TV

Yesterday I did an interview with David Collins of  WBAL-Baltimore on my recently published paper co-authored with Benjamin VanMetre in Maryland Journal on Maryland’s Spending and Affordability Committee (SAC). Set up in 1983, the SAC was put in place to help legislators control the growth of spending. Over the interim, spending has grown beyond the capacity of annual revenues to keep pace. Thus, the SAC, created to ensure spending discipline, has presided over the creation and continuation of a structural deficit in Maryland. In 2010, the effectiveness of the SAC was called into question by the SAC itself. In this TV report the reasons for the SAC’s poor performance are discussed as well as what a rule to control spending might look like.

You can check out the video here.

 

 

 

Red ink flows in state-run prepaid tuition programs

In three years the Prepaid Alabama College Tuition Program (PACT) will run dry. The State Treasurer reports PACT which pays $100 million in tuition a year, has $347 million in investments remaining. To fulfill its obligations to all 40,000 participants over the next 20 years, PACT needs an additional $843.9 million. The state Supreme Court recently struck down a potential solution put forth by the legislature: cap payouts to 2010 tuition levels and have beneficiaries make up the difference. The remedy didn’t pass scrutiny due to a 2010 law that promises PACT be 100 percent funded.

PACT worked for about 20 years until hit with the combination of unrelenting tuition inflation and a bear market which halved the plan’s investments.

Unfortunately, Alabama isn’t the only state with a prepaid program in the red. The Wall Street Journal reports South Carolina’s plan expects to run out of funds in 2017. Tennessee’s budget seeks an infusion of $15 million into its program. And West Virginia recently transferred funds from an unclaimed-property program to shore up its struggling prepaid plan.

In remarkably bad shape is IllinoisCrain’s Chicago Business finds that Illinois’ 12-year old $1.1 billion prepaid plan has the largest shortfall in the entire nation. Worse still, plan managers are making up for losses by embracing a huge amount of risk. In 2011, 47 percent of Illinois’ prepaid tuition plan was shifted into alternatives and investment expectations set at 8.75 percent. An expectation that far outstrips any other prepaid plan by a long-shot. (Florida has the country’s largest prepaid tuition plan and operates with an expected return of 4.3 percent on plan investments).

This year the agency that runs the prepaid program, the Illinois Student Assistance Commission ,has dropped that return assumption to 7.5 percent.  According to its actuarial report College Illinois! has enough money to pay out tuition for a few more years.

Prepaid plans are a type of 529 plan (the other is the college savings program) that allow parents to purchase contracts (or credits) for their children’s education.  The prepaid tuition plan locks-in tuition for the current year for eligible in-state colleges. Contributions are invested and benefits paid from those funds. To remain well-funded asset performance must track or exceed tuition increases. Given the rapid increase in college tuition which on average has increased 5.6 percent per year over the rate of inflation in just the past decade, it’s easy to see why so many plans have gone bust.

PACT participants who may not recoup their initial investments are understandably upset, “everything about the way the plan was promoted implied it was backed by the state.”

But, just how good is the state’s guarantee?

That is often in the fine-print. The WSJ finds three levels of guarantee in operation. 1) Full Faith and Credit – the state promises to pay for shortfalls if the fund goes dry. (Washington, Texas, Ohio, Mississippi and Florida)  2) Legislative appropriation – the legislature must consider an appropriation to cover shortfalls. (Illinois, Maryland, Virginia, South Carolina and West Virginia)  and 3) Fund Assets – the plan is solely backed by the assets in the plan. (Alabama, Michigan, Nevada, Pennsylvania, and Tennessee.)

Alabama’s PACT participants found they had little recourse in 2009.  Since the state doesn’t guarantee payment of tuition,they were technically out of luck. However, after a series of demonstrations and hearings in 2010 the Alabama legislature granted a $548 million bailout, tiding the plan over for the next three years. And then what? The state legislature filed a bill last week to tweak the previous solution to the court’s liking. It is again proposing to cap tuition payouts at 2010 levels.

Strangely, in spite of the risk present in pre-paid tuition plans they continue to provide a “flight to safety” for some investors. Last year growth in pre-paid plans outstripped growth in 529 college savings plans. The lure of higher returns attracts some who are banking on the ability of governments to keep their promise to pay it out regardless of market performance or the fine-print.

Maryland realtors fight to protect their subsidy

Image via Flickr user Images_of_Money

We’ve already explored Governor O’Malley’s proposal for the Maryland budget here and here, but recently, a perhaps unintended consequence of the budget came to light. By limiting the deduction that residents earning over $100,000 can make on their state income taxes, the proposed budget would limit the size of the mortgage interest tax deduction for many taxpayers.

I stand by my earlier argument that reducing deductions for only one group of people is not a step in the direction of fairness, but a reduction in the mortgage interest tax deduction may be a positive side effect of an otherwise bad policy. From a limited-government perspective, the obvious downside of a reduction in the mortgage-interest tax deduction is that this represents a revenue-positive change in Maryland’s tax code in a state that already has one of the highest tax burdens in the country. Overall though, I think reducing this tax expenditure is a positive change because the policy has many negative consequences.

While the causes of the financial crisis were many, by subsidizing investment in homes, the mortgage interest tax deduction played some part in the overvaluation of housing stock. Aside from the poor incentives that this tax expenditure creates in financial markets, it amounts to favoritism of suburbs over cities. In Triumph of the City, Ed Glaeser argues that the deduction leads many people to abandon renting in a city center for homeownership in the suburbs. However the Federal Reserve Bank of Boston provides evidence that the policy is more likely to lead people to buy larger homes than they otherwise would rather than trading renting for buying a home. Richard K. Green and Andrew Reschovsky write:

If one set out to design a policy to encourage homeownership, it would make sense to target the
largest subsidies to the households least likely to be homeowners, while providing little or no subsidy to
households likely to become homeowners even without a subsidy. Data from countries that do not
subsidize homeownership (such as Canada, Australia, and Japan) indicate, not surprisingly, that
homeownership rates rise with household income. This suggests that a policy to encourage
homeownership should give the largest incentives to households with modest incomes and no subsidies
to high-income households.

The MID, however, does exactly the opposite. For low- to middle-income taxpayers, the mortgage
deduction provides little financial incentive to abandon renting for homeownership. For those
purchasing modestly priced houses and facing the lowest marginal tax rate (currently 10 percent) the
benefits of the mortgage deduction are small. In fact, for households with low state income taxes, the
mortgage deduction may be of no value at all, because the mortgage deduction, even when combined
with other itemized deductions, may be smaller than the standard deduction.

For most high-income taxpayers, the tax savings resulting from the MID are a minor influence on
their decision to become homeowners; these households are likely to own a home regardless of the tax
treatment of housing. Rather than encouraging homeownership among high-income households, the
MID provides an incentive to buy a larger house and to take out a bigger mortgage. Economists have
long argued that the result is an inefficient pattern of investment, with too many resources invested in
housing and too few resources placed in more productive investments in factories and machinery (Mills,
1989; Poterba, 1992).

This analysis ignores that those at the margin of being least likely to be homeowners are likely the riskiest loan candidates and those most likely to foreclose, but they do make a strong case for why the MID leads to larger homes. Regardless of whether the deduction primarily increases homeownership or leads to larger houses, it results in a subsidy for suburban sprawl and its negative side effects of traffic congestion and demand for public services across a wider geographic area.

Unsurprisingly, the Maryland Association of Realtors is strongly opposed to a budget that would lead to lower tax expenditures on housing. The current policy directly subsidizes their industry. The Washington Post reports:

The Greater Capital Area Association of Realtors says that mortgage interest and property taxes account for almost 70 percent of total itemized deductions in Maryland, and they argue that the proposal, if passed, would further harm the area’s housing market, which has struggled to recover.

WAMU interviewed a leader among MD realtors on the issue:

Jim Scurvin, past president of the Howard County Realtors Association says it’s just wrong to jeopardize an industry responsible for 49 percent of revenue that goes to state and local government

“When someone buys a house, on the average you employ two people, and you put $60,000 into the economy right then and there,” he says. “Real estate is the lead when it comes to getting the economy moving again. We have the wind in our sails, the last thing we need is someone to knock the wind out.”

Scurvin, however, is acknowledging only the visible impact of the tax expenditure. As Frederic Bastiat artfully explained, all policies have unseen consequences. In this case, the unseen impact is that the mortgage interest tax deduction fuels malinvestment in housing at the expense of other, more productive sectors of the economy. While Governor O’Malley’s budget proposal has many negative features, the potential for reducing the state subsidy to housing could be its silver lining. Unfortunately as Maryland realtors demonstrate, eliminating tax expenditures is a painful and politically difficult process.

Hamilton’s Paradox

I recently finished reading Jonathan Rodden’s 2006 book Hamilton’s Paradox: The Promise and Peril of Fiscal Federalism. The book provides a fascinating analysis of fiscal federalism that combines theory, qualitative and quantitative analysis, and contemporary case studies.

Rodden begins by detailing the potential promises and perils of fiscal federalism. He states that the promise of federalism is straightforward: “decentralized, multitiered systems of government are likely to give citizens more of what they want from government at lower cost than more centralized alternatives.” The perils of federalism, although less examined in the literature, are rooted in the idea that “In decentralized federations, politically fragmented central governments may find it difficult to solve coordination problems and provide federation-wide collective goods. As in the private sector, public institutions only produce desirable outcomes when incentives are properly structured” (p. 5).

In Chapter 3 Rodden provides a very interesting history of federalism and federal bailouts in the U.S. Specifically, he discusses the federal assumption of state debt that took place in 1790, the rapid growth in state borrowing in the early 1800s, the nine states that defaulted in 1841 and 1842 (Maryland, Pennsylvania, Arkansas, Florida, Illinois, Indiana, Louisiana, Michigan, and Mississippi), and the constitutional debt limitations that many states adopted in the 1840s and 1850s.

Most interesting is the game theory model Rodden develops in the second half of Chapter 3. Specifically, it’s a dynamic game of incomplete information that takes place between the central government and a single subnational government. Information is incomplete because subnational governments don’t know exactly how the central government will behave in the event of fiscal crisis. That is, the central government will either allow the subnational government to default (resolute type) or will provide a bailout (irresolute type).

The fist move of the game occurs when a subnational government experiences a fiscal shock with lasting effects (i.e. recession). In response to the fiscal shock it can either adjust immediately or refuse to deal with the shock by borrowing, with the long term hope of receiving a bailout. The path that the subnational government takes is a function of, among other things, the expected probability of the central government being resolute or irresolute (the complete game is much more detailed than the brief description provided here).

Rodden utilizes this game as he develops each of the case studies provided later in the book. The case studies involve comparing and contrasting the events that have taken place in Germany and Brazil. In the 1990’s two states in Germany received formal bailouts by the federal government (the Bund). During the same time, however, bailouts were distributed to virtually every state in Brazil. In Chapters 7 and 8 Rodden carefully details the structures of government in these two countries and outlines the reasons their outcomes were so different.

Two of the many important conclusions that Rodden makes in this book are (1)

when free to borrow, growing transfer dependence is associated with increasing deficits, both among federated units and local governments (p. 116)

and (2)

The central government must not only allow subnational governments significant tax autonomy and disentangle its books from those of the subnational governments, but it must demonstrate through costly action that it will not assume subnational liabilities when times get tough (p. 267)

This brief review of Hamilton’s Paradox only covered a few of the many important topics that the Rodden details in the book. I strongly recommend this book for anyone interested in fiscal federalism.

Governor O’Malley Ties Taxes to Educational Achievement

Maryland Governor Martin O’Malley has proposed several new taxes that he says are necessary to close the state’s $1.1 billion budget gap.

Image from Flickr user loop-oh

He’s proposing eliminating income tax exemptions for those earning over $100,000 per year along with increased gas taxes, sewer taxes, and a new internet sales tax.

Ben VanMetre argues that these changes are positive reforms to the extent that they make the state’s tax code more neutral. This may be true if the higher gas tax eliminates road spending from the general fund. The income tax change seems more ambiguous though — I’m not sure that I agree that eliminating income tax exemptions for a select group of taxpayers is closing a loophole.

O’Malley is insisting that these taxes increases are necessary to protect Maryland’s quality school system. By some measures, Maryland does in fact have the best public schools in the country. However, a study from the American Legislative Exchange Council suggests that the likely reason for this is that Maryland has a high median income, not because of its high tax rates. Student success is influenced much more by parental income than school spending, the report finds. As a Baltimore Sun editorial explains:

According to an analysis of data from the Annual Survey of State Government Finances from the U.S. Census Bureau, all education spending accounted for 47 percent of Maryland’s total revenue in 2009, the most recent year available. Health spending, which is always cited as the monster in the state budget, ate 9 percent of total revenue in 2009. By comparison, public education represented 26 percent of total revenue in 2000.

The results are sparkly — on paper. Maryland earned the top spot for the third year in a row in Education Week’s survey of the nation’s K-12 public schools last week. But for the wealthiest state in the nation, home to some of the most highly educated parents, it would be surprising if it did not score high. And few know how much that ranking costs at a time when the state faces a $1.6 billion budget gap and legislators are debating whether to raise taxes yet again in a state with one of the largest tax burdens in the nation.

Only 8 percent of Marylanders guessed that the state spends more than $10,000 per pupil, according to a 2008 poll by the Foundation for Educational Choice. According to 2008 data from the National Center for Educational Statistics, the state spends about $15,100 per pupil each year, or about double the cost of tuition at most private and parochial schools.

These results are also consistent with what Eileen Norcross and Frederic Sautet found in their study of New Jersey budget drivers. In New Jersey, the poorest school districts are required to spend as much per-pupil as the state’s wealthiest districts. This sounds like a formula for providing a quality education for New Jersey’s disadvantaged students, but unfortunately throwing money at the problem of poor educational outcomes is not an effective way to improve results. Students in these Abbott districts are some of the most well-funded in the country, yet many of these schools continue to fail their students as they achieve below grade-level test scores and high dropout rates.

Education is not a simple equation in which adding money to school systems provides better results. O’Malley may be able to successfully pass higher taxes in the short term by convincing voters that it’s for the sake of Maryland children. But suggesting that Maryland’s schools perform relatively well because of high tax rates is a misleading statement, detrimental to making real improvements to Maryland schools for the benefit of children from all income backgrounds.

Tax Foundation Releases New State Business Tax Climate Index

On Wednesday the Tax Foundation released the updated State Business Tax Climate Index by Mark Robyn. Wyoming, South Dakota, and Nevada ranked highest on the index because they have low overall tax burdens and tax policies that introduce minimal distortions to business behavior.

The three states at the bottom of the ranking — New Jersey, New York, and California — were also the worst-ranked states last year. Unsurprisingly, these three states are also experiencing domestic outmigration as individuals and businesses leave for locations with lower tax burdens. A study by Jed Kolko, David Neumark, and Marisol Cuella Mejia demonstrates that the SBTCI is one of the most accurate indexes for predicting economic outcomes.

 

Illinois had the largest change in ranking over last year’s, dropping 12 spots. Robyn writes on the importance of tax policy in business decisions:

Anecdotes about the impact of state tax systems on business investment are plentiful. In Illinois early last decade, hundreds of millions of dollars of capital investments were delayed when then-Governor Blagojevich proposed a hefty gross receipts tax. Only when the legislature resoundingly defeated the bill did the investment resume. In 2005, California-based Intel decided to build a multi-billion dollar chip-making facility in Arizona due to its favorable corporate income tax system. In 2010 Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate. Anecdotes such as these reinforce what we know from economic theory: taxes matter to businesses, and those places with the most competitive tax systems will reap the benefits of business-friendly tax climates.

The Tax Foundation is not alone in finding these states relatively lacking in economic freedom. Indexes developed by the Mercatus Center and the American Legislative Exchange Council also ranked these states as among the least economically competitive in the country.

While lawmakers may be tempted to try to improve their states’ rankings in these types of indexes with special business tax breaks or increasing state spending, all three studies demonstrate that the best way to improve a state’s competitiveness ranking is to provide a climate of low, stable taxes that do not favor specific industries.