Missouri’s income tax rates are not the problem
Over the past two decades, the Missouri economy has performed abysmally relative to other states. Between 1997 and 2017, Missouri’s real gross domestic product increased at a 1 percent average annual rate, while the United States’ real GDP increased at a 2.39 percent average annual rate. In dollar terms, if Missouri’s economic growth rate had been equal to the national rate, then the additional income spread across 6 million Missourians would have resulted in their average 2017 incomes being $13,600 higher. That means per capita real GDP would be more than 30 percent higher if Missouri had just been average.
Why has the Missouri economy performed so poorly? One thing that we are learning is that the tax rate is probably not the problem. For years, the perception has been that the top marginal tax rate in Missouri is 6 percent, and many have argued that tax rates are too high. With better data, the picture is clearer. In a recently published paper, MU research analyst Dean Crader and I showed the average marginal tax rate — the change in total taxes collected divided by the change in total income — in 2017 was closer to 3.5 percent and has been edging down from a high of 3.66 percent since 2000. Thus, the actual average marginal income tax rate is much lower than the published rate in the income tax tables.
How can the rate be 3.5 percent instead of 6 percent? With deductions, exemptions and especially tax credits, each extra dollar of income paid to Missourians does not result in 6 cents of individual income tax. Indeed, economic development tax credits have been increasing over the past decade.
In addition, other forces are acting on the average marginal tax rate. Presently, the top published marginal tax rate is 5.4 percent, meaning that the estimated average marginal tax rate would fall to 3.04 percent under the current law.
With a one-half percentage point decline, the idea is that such change will foster faster economic growth. The economics are sound enough. However, the growth impact is quantitatively small. In other words, with only the tax rate cuts and everything else constant, Missouri’s real GDP growth would have risen from 1 percent to 1.15 percent.
There is a more important point: Specifically, lower marginal tax rates are not the key to faster economic growth in Missouri. Indeed, the evidence is that the actual marginal tax rate is already pretty low.
Rather, more effective tax reform would reduce the rate and eliminate tax credits. For example, Missouri could easily set the rate between 3.5 percent and 4 percent, even giving some tax relief to households with federal adjusted gross income below perhaps $40,000 through earned income tax credits, and get rid of any further exemptions, deductions — and especially so-called economic development tax credits. Complex subsidy schemes encoded in economic development tax credit programs, including tax-increment financing and others, are probably well-intentioned means of spurring economic growth. But at their heart, such subsidies are equivalent to the state investing money collected from taxpayers.
I tend not to take my investment advice from politicians. Instead, I would prefer to see how simpler tax rules could adequately fund the state government and unleash Missourians’ productivity.
The bottom line is that by simplifying the state income tax code and enacting a simplified sales tax structure would probably be more helpful means to raising the standards of living for Missourians than tinkering with an already-low income tax rate.
Joseph Haslag is a professor and Kenneth Lay Chair in economics at the University of Missouri-Columbia.