Taxation and Growth: A North American Cross-Border Comparison

My last comparison of U.S. states and Canadian provinces with respect to their federal transfer revenue shares got me thinking about the other revenue sources and whether any relationship could be found between economic growth and revenue composition.  Income taxation is supposed to have incentive and distortion effects on saving, risk taking and labor supply and therefore one might expect to see a relationship between reliance on income taxation and economic growth rates. 

So I went ahead and obtained real GDP growth data for 2012 for U.S. states and provinces from Statistics Canada and the U.S. Bureau of Economic Analysis.  In addition, I got revenue data on personal income tax revenues for Canadian provinces from their respective public accounts and similar data for U.S. states from the U.S. Census Bureau’s State Government Finances. 

Figure 1 ranks and plots real GDP growth rates in 2012 for these 60 jurisdictions.  Average real GDP growth across these 50 U.S. states in 2012 was 2.1 percent whereas it averaged only 0.8 percent across the ten Canadian provinces mainly because of Newfoundland. Removing Newfoundland would raise average real GDP growth to 1.4 percent.  Either way, average growth was higher across U.S. states than it was across Canadian provinces in 2012.  When ranked together, the top three jurisdictions were all American – North Dakota, Texas and Oregon (with Alberta a close fourth) and the bottom three were all Canadian – Nova Scotia, New Brunswick and Newfoundland.

Figure 2 ranks and plots personal income tax revenues as a share of total government revenues for provincial and state governments in 2012.  They range from a high of 28.5 percent for Quebec to a low of zero for seven U.S. states – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.  Unlike the real GDP growth ranking, which saw Canadian provinces spread out from the highs to the lows, when it comes to reliance on personal income taxation, Canadian provinces are pretty much clustered in the top half.  Some American states also have high revenue shares from PIT such as Connecticut and Massachusetts.

So, bringing the two variables together in Figure 3 shows a negative linear relationship between the two variables.  A greater reliance on personal income taxation as a revenue source does seem to be weakly correlated with lower real GDP growth.  However, this is not too definitive a result for several reasons. After all, it is only one year of observations and there are some definite outliers in the data.  If you get rid of the two biggest outliers – North Dakota and Newfoundland – you get Figure 4.  There is a negative relationship still but not much.  Getting some more solid results definitely requires more years of data as well as data on other tax revenue shares (corporate income tax, general sales taxes) and other variables that are determinants of growth.  Seems like a good project for a graduate student thesis.

 

Comments

[jl]

Has anyone here commented on this repport?
http://www.cbc.ca/news/business/taxing-the-rich-is-good-for-the-economy-imf-says-1.2552141

[Livio Di Matteo]

Jl
Thanks for the link. Will take a look. Do you know offhand if the definition of rich the study uses is "Top 1%" or something broader?

[Livio Di Matteo]

Jl:
Found the paper and read the executive summary - the media take that taxing the rich is good for the economy seems to be based on the paper's conclusion that one should not assume a big trade off between redistribution and growth based on the results in the paper. The paper is a bit more complex than that. Will try and take a detailed look- seems interesting.

[Bob Smith]

I think the spin put on the IMF study by the media is a testament to the general policy illiteracy of journalists and the sad state of policy development in North America by proponents of increased redistribution. The paper says precisely nothing about the merits of "taxing the rich", or tax policy generally, its focus is limited to effects of redistribution on economic efficiency.

Now, "taxing the rich" may be one policy to redistribute income, but it isn't the only one, or necessarily the one used by many countries to achieve greater income equality. One might raise revenue with broad-based and relatively non-redistributive, but efficient, taxes (such as payroll taxes or VAT) and use those proceeds to fund heavily redistributive spending policies. In fact, I think that's probably a fair high-level description of the redistributive fiscal policies one sees in a lot of European countries (which rely to much higher degree on payroll taxes and VAT than do North American jurisdictions to fund their social spending). In contrast, it is the non-redistributive North Americans who largely use heavily progressive (but inefficient) income taxes to fund far more limited redistribution schemes. I don't think many economists would have difficulty with the proposition that redistribution funded with a hefty VAT (but, perhaps low levels of taxation on investment income or corporations - a la Sweden) would not have significant adverse efficiency implications (indeed, a high level of redistribution funded with an efficient tax, such as a VAT, may be more efficient than a low level of redistribution funded with inefficient taxes, such a corporate income tax or tax on investment income, a la US). Indeed, I wouldn't be at all surprised if further research showed a correlation between inefficient tax policy and low redistribution, since one strategy adopted to keep government (and therefore redistribution) small, is to adopt inefficient tax policies which impose natural limits on how much revenue governments can raise without wrecking your economy - not for nothing did the Canadian Conservatives cut the GST, or do US conservatives heartily oppose VAT proposals.

The problem with this debate in North America, which is reflected in the coverage of this report in the media, is that the only tools for redistribution discussed by proponents of redistribution is "taxing the rich" or "taxing corporations" (which, in their mind amounts to the same thing, even if the incidence of corporate tax is actually borne by Joe Schmoe). If those are the only tools for redistribution, then a report that implies that redistribution might not be harmful necessarily implies the same thing about taxing the rich. That's an erroneous reading of the report, but you can see where it comes from.

The sad thing about the provincial outlook of North American proponents of increased distribution (who seemingly don't know or care about how other countries actually raise revenue) is that they have bought into the message advanced by proponents of small government, namely that taxes are bad, so are unwilling and unable to try to persuade voters that their proposed spending plans are actually worth being funded with broad-based taxes. One need only look at NDP opposition to the HST in BC to marvel at the ridiculousness of a purportedly social-democratic political party (and its public sector union allies) opposing the single most effective revenue tool for fund its social policies (and public sector wages). Instead, the only policy tool that North American proponents of redistribution are willing to advance are taxes paid by "someone else" (the rich, corporations), which implicitly adopts the conservative message that "taxes are bad", subject to the caveat "but not if paid for by someone else". That those taxes are likely to be both economically inefficient and ineffective at raising significant revenue is apparently neither here nor there.

Not only is this lousy fiscal policy, but I also think it raises questions about democracy. If you can't persuade all citizens to contribute to the funding of new social programs with broad-based taxes (even broad-based taxes like a VAT that are still mildly progressive), then I question the merit of those social programs. If those programs are truly desirable, voters should be willing to pay for them. Just once, I'd like to see a political party that believes in higher social spending (presumably on the basis that such spending is socially beneficial) also advance the argument that such spending is actually worth paying for.

[Livio Di Matteo]

Thanks Bob. That was a nice and insightful contribution. It was a pretty disappointing media headline on a rather interesting study.

[Bob Smith]

It was also a remarkable consistent media headline, across media platforms with a different ideological perspectives, suggesting that within the media policy illiteracy is non-partisan. The consistency suggests that this study was just brought to the attention of the various media outlets by someone else with an axe to grind, and those outlets just published that person's press release or summary (or excerpts from it)verbatim (rather than reading or digesting the underlying report). Wouldn't be the first time I've seen an activist group's press release republished as a news story without attribution and that sounds more plausible than the prospect of a bunch reporters reading IMF research papers and coming to the conclusion that was reported.

Agree that the study was interesting, and does suggest all sorts of future areas of study on the link between redistribution and efficiency.

[jl]

I suspected this coverage was off, thanks for the clarifications. I think the reason why VAT is so unpopular is that everyone sees it as a burden. People perceive it as directly affecting their purchasing power or the purchasing power of those in need. When stuff is more expensive people feel it.

I don’t think political parties will gain from a vat increase unless they explicitly accompany it with redistribution programs with a net benefit to middle class and lower income citizens (at least lower income). That may work, but one problem I see is that a lot of people may miss out by not filling out their tax returns or not doing it properly. Incompetence it may be, but incompetence is a severe disadvantage which can put people in very vulnerable situations. The other problem is that HST returns is money latter, not money now. The timing of cash flow is important for people with lower income. Again it’s the most vulnerable who are disadvantaged. But I may be wrong, I am not an economist.

[Bob Smith]

JL: "That may work, but one problem I see is that a lot of people may miss out by not filling out their tax returns or not doing it properly."

Sure, there can be those sorts of problems (and you see that with OAS or GIS in Canada and GST rebates). That being said, those strike me as problems that are solvable if there's a will to do so (i.e., hire people to go out to disadvantaged neighbourhoods and groups and fill out forms). Ditto for the timing issues.

I think you're right that the political problem with using efficient taxes like VAT to fund redistribution is that the burden is visible (compared to others like corporate income tax or on investment income, where the tax is often borne indirectly through wages). But left-of-center parties (and activists) don't help themselves when they demonize such taxes (as the NDP has done in Canada since the GST was enacted - though interestingly, not in provinces, like Nova Scotia, where they actually govern). The flip side is that a VAT will actually generate sufficient revenue to fund their proposed spending policies, without embracing increased vat taxes (or payroll taxes), their spending commitments are just pie-in-the-sky.

Sure, that's the flip side of the reason why small-government political parties have to advocate across-the-board tax cuts (think Mike Harris' income tax cuts or the Harper government's GST cut), which are expensive and not particularly efficient

[genauer]

thanks a lot to Bob Smith for the interesting comments AND judgements.
Makes it worth to come here.

Needless to say, that I have the same impression with many media statements in my Germany as well.

Somehow it feels good, that there are some sane people in other places as well.