From the “Macroeconomic Effects of Progressive Taxation” by Tae-hwan Rhee of the Samsung Economic Institute (via the American Economic Association annual meeting):
In this paper, I analyze the progressivity of state income tax in the United States. Using the IRS public use file data and NBER TaxSim, two types of indices – the Suits index and effective progression – are constructed for each of 50 U.S. states and for each year from 1979 to 2004. While federal income tax makes up the bulk of the combined federal plus state tax and drives most of the combined fluctuation over time, the state income tax still has significant variation from year to year and from state to state. Using these indices of progressivity, the relation between macroeconomic growth and income tax progressivity is investigated. Contemporaneous regressions do not show any significant effect in either direction. However, with three years of lag, income tax progressivity has a significant negative effect on the current year’s growth rate, after controlling for the average tax rate and state/year fixed effects. Although these regressions do not prove causality, these findings do support the idea that there is a tradeoff between economic growth and egalitarian redistribution.
Three possible reasons are offered to explain the apparent growth-equality tradeoff:
1. Migration. High income, high productivity people leave a state when the tax code grows more progressive — that is, raises taxes on them.
2. Work incentives. A progressive income tax effectively lowers the wage of higher-income groups, who then substitute leisure for labor.
3. Weaker entrepreneurship. Rhee:
Entrepreneurship can play a role here, too. Starting a new business is risky. The biggest motivation to take this risk is the higher expected income from the start-up than from the current job. A more progressive income tax makes this expected gain smaller after tax, which leads to less risk-taking behavior. This means that a highly progressive tax system might discourage small-scale innovations, leading to lower gross product
Are you paying attention, Illinois and California?