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High taxes sap Minnesota’s productivity, economic growth

This op ed appeared December 22nd, 2018 in the Duluth News Tribune

The economist Paul Krugman once wrote that, “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

He was right. The ability to turn a given amount of inputs into a larger amount of outputs — productivity growth — is the essence of economic growth. Sadly, as we with the Center of the American Experiment illustrate in our new report, “The State of Minnesota’s Economy: 2018,” our state does worse than the national average on this score.

There are different ways to measure labor productivity. One is GDP per worker, which is GDP divided by the number of workers in a state. On this measure, Minnesota lags the national average. In the private sector, our GDP per worker was 7.8 percent below the national average in 2017.

Another measure is to look at GDP per hour worked. This can help to account for a relatively greater share of part-time workers in our state’s economy. But, again, on this measure we lag the national average. In the goods-producing sector, Minnesota’s GDP per hour worked was 7.3 percent below the national average in 2017 and 6.9 percent below it in the services sector.

Why is this? Labor productivity depends on three things.

The first is the skill of the labor force. Here, Minnesota’s education system stands it in good stead, our scores comparing favorably with those of other states. But we have a problem holding onto workers. Data show that, between 2011 and 2016, Minnesota lost residents in every income category above a modest $25,000 annually. It gained residents in the categories below that. Using income as a proxy for productivity, this means Minnesota’s labor force was deskilling in those years.

The second is the amount of capital a worker has to utilize. For example, a farmer planting seeds will do much better using a plough (a capital input) to dig a furrow than using his hands. But here again, Minnesota lags the national average. In 2015, each Minnesota worker had 3.9 percent less capital behind them than the average American worker.

The third is a slightly trickier concept called “Total Factor Productivity,” to use the jargon. This is a measure of the quality of the capital a worker has at his or her disposal (as opposed to the quantity) and the skill with which these are used. Simply put, we can think of this as innovation and entrepreneurship.

But, once again, Minnesota fares badly on these measures. We once led the national average in research and development spending as share of GDP but have lagged in every year since 2012. Each of Minnesota’s workers has an average of 63.5 percent less venture capital behind him or her than the national average. Between 2002 and 2017, the national stock of venture capital increased by 249 percent, but in Minnesota it increased by just 39 percent. And, in 2014, new and young businesses made up 30 percent of all businesses in Minnesota compared to 34 percent nationally.

Why does Minnesota do so poorly, relatively speaking, on these key drivers of productivity and economic growth? Evidence suggests our state’s high taxes play a role. There is a body of empirical evidence suggesting that people move from high-tax to low-tax states, and Minnesota is a high-tax state. We have the third-highest top rate of income tax in the U.S., and our lowest marginal rate is higher than the top rate in 23 states.

There is also empirical evidence that investment and innovation is deterred by high taxes. High state corporate taxes, for example, are found to decrease capital investment, and Minnesota has the third-highest business tax rate in America.

At present, Minnesota’s economic strength is its hard-working population. In 2017, our labor force participation rate was the second highest in the country. This meant elevated levels of GDP to divide among the population, leading to above-national-average per-capita GDP and personal income while the per-worker numbers were below this average, reflecting low productivity.

But this advantage will erode. As baby boomers retire, Minnesota’s labor force participation rate is forecast to fall to 64.4 percent in 2035. The only way to maintain rising per-capita incomes in the face of this will be for the Minnesotans left in the labor force to become more productive. For this to happen, we need to adopt lower tax policies, which will encourage skilled workers to make their homes here and facilitate investment and entrepreneurialism in the state.

John Phelan is an economist for the Center of the American Experiment (AmericanExperiment.org), which is based in Golden Valley, Minn.

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