The trend of international corporate inversions is the most recent high-profile indicator that taxes matter for economic development and job creation, but that signal is hardly the first to do so. While the overly complicated and burdensome federal Internal Revenue Code and its excessively high tax rates have been the driving forces behind firms’ desire to seek out more competitive tax codes, federal taxation is not the only yoke weighing down the American economy. State-imposed taxes affect state economies and business development across the country as well, as demonstrated by routine stories of corporations moving from high-tax states to economically freer ones, e.g., when California lost Carl’s Jr. to Tennessee. Another example: Decades after its more competitive tax system brought General Electric over from Manhattan, Connecticut recently passed a series of historic tax increases and — as a result — lost GE to Massachusetts.
These “domestic inversions” are evidence of a state’s commercial attractiveness and commitment to providing residents with jobs. Unlike their international counterpart, however, the fiscal policies impacting corporations’ moves between states are frequently reformed. The last time the federal government comprehensively re-worked the tax code was 1986. By contrast, more than a dozen states have significantly cut taxes each of the past three years.
The American Legislative Exchange Council (ALEC) Center for State Fiscal Reform recently released the state economic-outlook rankings for the ninth edition of the Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index. The economic-outlook rankings are drawn from 15 data points representing a state’s economic policies. The policies weighed include tax rates, labor issues, and the regulatory-policy climate. The 2016 edition of the report demonstrates two things: 1) the longstanding trend of businesses and individuals seeking out lower state taxes, and 2) the more recent revelation that if a state isn’t actively working to become more competitive, it can lose ground to neighboring states just by standing still.
It is an inherent strength of free markets that individual participants are afforded signals by which to navigate, otherwise known as profit and loss. An inherent limitation of government, on the other hand, is that it is too often insulated from market signals, making the success (or failure) of its decisions difficult to gauge. Paired with economic-policy trends, domestic-migration patterns can serve, at least partially, as a form of a policy “profit and loss” yardstick. After all, there is no greater signal sent to a state capitol than when a resident finds its policies too much to bear and decides to leave altogether.
As such, looking at migration trends, it becomes easy to see what governments are enacting “profitable” policies. The top ten states for economic outlook in 2016 have gained nearly 2.5 million individuals due to domestic in-migration over the past decade. The bottom ten states, on the other hand, have lost a combined total greater than 4.15 million people to other states. The top three population-gaining states were North Carolina, Texas, and Florida, while the most individuals fled from tax-and-spend states like New York, California, and Illinois. When state governments enact bad fiscal policy, on the margin, individuals react rationally and opt to move to a more business- and taxpayer-friendly state. Simply put, Americans can be trusted to consistently pursue enhanced economic opportunity.
Examining certain states’ recent shifts and historic trends in the economic-outlook rankings shows which ones are committed to pro-growth, pro-taxpayer reforms, and those that have either stagnated or made grave policy miscalculations. In the ninth edition of Rich States, Poor States, there emerge a few clear examples of states that chose to get government out of the way and let the private sector grow.
There is no greater signal sent to a state capitol than when a resident finds its policies too much to bear and decides to leave altogether.
Tennessee, which claims its first top-ten ranking since 2011, made few major changes to most of its policies, but shot up in the rankings (17th to seventh) thanks to completing the phase-out of its inheritance tax. Estate and inheritance taxes, otherwise known as “death taxes,” are economically damaging and encourage high-income or elderly individuals to move, making it difficult to pass on their small businesses or farms to relatives. Just before the end of this legislative session, the Tennessee General Assembly continued its commitment to economic growth by voting to repeal the investment-punishing Hall Income Tax. If signed into law, Tennessee would likely continue its rise up the competitiveness rankings.
By virtue of adopting right-to-work, Wisconsin enjoys its first top-ten ranking ever. Oklahoma, meanwhile, cracked the top ten for the first time, too, passing neighboring economic powerhouse Texas in the process. However, Oklahoma may drop back down sooner rather than later, given the state’s recent tax-hiking overtures. Likewise, a recent Colorado bill that allows the state to bypass spending and taxation limits imposed by the state’s Taxpayer’s Bill of Rights could curb one of Colorado’s greatest advantages in controlling the growth of its state government.
Unfortunately, our data show another ongoing trend: The Northeast continues to struggle. The average economic-outlook ranking for New England states is 36. This year, New Jersey fell two spots to 48. Given the fact that New Jersey is so dependent on high-income earners that the move of a single individual may seriously impact its balance sheet, its future prospects remain in doubt absent considerable reforms. Across the Hudson, New York also held onto its dubious title of worst-ranked. That said, despite a bleak overall outlook, there remains some hope in the Northeast. New Hampshire and Rhode Island rose to their highest all-time Rich States, Poor States rankings, and of the eight states that form the New England/Tri-State Area, only one, New Jersey, actually implemented policies harmful enough to lower their ninth edition ranking. Thanks to significant tax reforms, Maine found itself improving into the 30s for the first time in our index’s history.
People and businesses can be reliably trusted to react to a state’s fiscal climate.
One interesting pattern found in the historic rankings implies that states are reacting to the messages sent by individuals, both voting and migrating. Seventeen states significantly cut taxes on net in 2015, which is also part of an ongoing national trend. The largest shifts in the historic rankings are toward improvement: Seven states have moved up at least ten spots since the first edition, and five have moved at least a dozen. Only three states have made declines of ten spots or more. This, along with migration data, seems to imply that state legislatures are actively working toward improving their economies in light of the behavior and preferences of individuals and businesses. Further, that reductions in outlook are relatively smaller implies that states tend to lose competitiveness due to stagnation, rather than the implementation of new and harmful policies (although this does happen, on occasion).
Interestingly, one area of major growth is the region derisively dubbed the “Rust Belt.” Not only did Wisconsin join Indiana in the top ten, but Michigan and Pennsylvania also improved their policies enough to improve two spots each. The greatest success story in the history of Rich States, Poor States is the improvement of Ohio, largely under Governor John Kasich and a state legislature that has overseen major tax reform. In 2008, Ohio ranked a dismal 47 out of 50. Since then, Ohio has moved up 29 total spots, landing at 18 in our latest report, thanks to a considerably lighter tax burden on individuals and businesses alike. If these states continue to implement pro-growth reforms, there is a considerable chance that their collective outmigration trend could reverse.
With every passing year, the trends above only become clearer: People and businesses can be reliably trusted to react to a state’s fiscal climate. Whether that reaction is increased or reduced investment, or moving altogether, preferences will always be revealed. Rich States will control spending and reform taxes, and — by reducing the burden of government — will see healthy, diversified economies capable of providing enough revenue to fund core services. Poor States, in their constant efforts to chase revenue, will continue chasing revenue away.