Higher tax rates do not bring more revenue
Among all too many today, it is an article of faith that if you raise tax rates you also raise tax revenues. But what does the evidence show?
Figure 1 shows the top rate of Minnesota’s state income tax going back to 1974 and the total state income tax collections as a share of GDP.
Figure 1 – Top rate of state income tax % (LHS) and Total state income tax collections % of state GDP (RHS)
What is striking is the stability of the revenue line. The mean average is 2.8% of state GDP, the median is 2.7% of state GDP. The same is true of revenue more broadly, both the mean average and the median of state tax revenues as a share of GDP come in at 6.6%. In other words, there is very little variation in these numbers.
This is in spite of state tax policy. In the 1970s and into the 1980s, Minnesota’s politicians tried to claim a large share of their citizen’s income with top rates of tax of up to 17%. But Minnesotans did not respond to these rates by handing over a greater share of their money, as shown by the stability of the revenue line. Indeed, they handed over a larger share of their incomes to the government in the 1990s with tax rates of 9% than they did in the 1970s with rates of 17%.
There is an important policy lesson here. The dollar amount of tax revenue seems far more likely to be a function of the size of the state’s economy than of its tax rates. This means that if you want more money to fund government services, you are better off looking to increase the state’s GDP than its tax rates.
John Phelan is an economist at the Center of the American Experiment.