Politics & Policy

A Texarkana Tax Tale

Talent and capital always will flow toward higher returns.

State Line Road is the boundary that separates the Arkansas and Texas sides of Texarkana, a border town that is sometimes described as “the Gateway to the American Southwest.” State Line, to the casual observer, is merely another road separating two states. But for those in the neighborhood, the road represents something of a great divide.

#ad#Of course, on the cultural side of the ledger, we have the date that will live forever: December 6, 1969. That’s when the top-ranked Texas Longhorns edged the second-ranked Arkansas Razorbacks, 15-14, in a dramatic college football game witnessed by President Richard M. Nixon and George H.W. Bush, a congressman at the time. “The Game,” as it is known locally, is still talked about on both sides of State Line Road.

But in terms of economic growth, the divide is much more lopsided: Employment growth in Texas has been significantly higher than in Arkansas during periods of economic expansion. The population in Dallas has nearly tripled in the post-WWII period, while the population in Little Rock has barely doubled in size. Per capita personal income in Texas is 94 percent of the U.S total. In Arkansas it’s 77 percent of the nation’s total, a level that has hardly budged since the 1970s.

The list of statistical disparities is long, and there’s a good reason why: While Arkansas and Texas share a common border, each taxes income and capital in radically different ways.

Arkansas has a top income-tax rate of 7 percent, the highest among the bordering states. Texas, however, does not impose an income tax. The imbalance is the same for capital gains: Arkansas taxes them. Texas does not.

As a result, we can see a very basic economic principle at work: Talent and capital always will flow toward higher returns.

Just look at Texarkana: The state income tax in Arkansas was last increased in 1971 under the tutelage of Democratic Gov. Dale Bumpers, who sought to raise the top rate from 5 to 9 percent in order to “broaden the tax base.” The proposal fell short in the state legislature, forcing a compromise that left Arkansas with the highest top rate (7 percent) among its six bordering states.

Over by State Line Road, the result was a brain and capital drain from the Arkansas side to the Texas side. By 1977, the situation in Texarkana had turned so bad that Bumpers’ successor, Democratic Gov. David Pryor, signed a bill that created an income-tax exemption for the border town. (In exchange, the state legislature allowed Texarkana citizens to raise their sales tax 1 cent.) That made Texarkana the sole low-tax bastion in high-tax Arkansas. Not coincidentally, capital and talent returned to the Arkansas side of State Line Road.

Texarkana’s labor market is now the fourth-largest in the state of Arkansas, ahead of well-known cities like Hot Springs, Jonesboro, and Pine Bluff.  And here’s a remarkable economic statistic: While national employment contracts in periods of recession, employment in Texarkana continued to expand during three of the last four recessions (1980, 1981-82, and 2001).

Gov. Pryor, who deserves much of the credit for Texarkana’s resurgence, also proposed lowering the entire state’s income-tax rate, although the proposal was rejected by legislators. Two succeeding Arkansas governors — William Jefferson Clinton and Mike Huckabee, both of whom hailed from Hope, a close neighbor of Texarcana — turned in fiscal performances closer to that of Dale Bumpers. Instead of addressing the state’s high tax rates, they focused on ways to increase state-government revenues, such as the sales tax levied on groceries. They didn’t think on the margin the way Gov. Pryor did, and Arkansas, on the whole, has suffered.

Variants of “marginalism” form the foundation of microeconomics, the branch of economics that examines individual, and entrepreneurial, behavior. Marginalism, as the name suggests, focuses on margins — which is to say those very points where economic decisions are made. Marginal behavior, for instance, can be studied in border towns along high- and low-tax states. To wit, after the Bumpers’ tax hike, physicians in Texarkana led the exodus to the Texas side.

Today, along the borders of Nevada and California, and Washington and Oregon, we can witness similar marginal economic behavior. The former states levy no state income taxes, while the latter impose significantly high tax rates. And which direction is the talent and capital flowing in each instance? Toward the higher returns, and away from the higher taxes.

Envy is the common, and failed, policy response of the high-tax states toward the states with lower or non-existent tax rates on income and investment. And envy only ignores the obvious solution: If high-tax states are to best compete with their low-tax neighbors, they need to lower the tax rates they impose on their inhabitants.

It’s in this way that the high-tax states can get back in “the game” and even the score.

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