The Surplus: High tax rates restrain economic growth

On Dec. 7, Minnesota Management and Budget (MMB) released its budget forecast for Fiscal Year 2022-23 which foresaw a $7.746 billion projected surplus. This immediately sparked a debate about what should be done with that money.

For a number of reasons, it should be given back to the people who earned it — ordinary, hard working Minnesotans — via tax cuts.

High taxes restrain economic growth

One reason is that the balance of empirical research on the effects of state tax rates on economic growth is clear: high tax rates and tax hikes slow economic growth.  

Empirical research has found that taxes reduce economic growth generally, but more specific impacts have been found within that. High taxes have been found to have a negative impact on business location, business formation, the location of foreign direct investment, and job growth. Corporate taxes have been found to be particularly harmful economically, with a large negative effect on employment, aggregate investment and entrepreneurial activity, a major influence on foreign investment decisions, negative impacts on entrepreneurship, significant influence on firm and household location, and potentially unique harms for entrants over incumbent firms.

In a review of the literature measuring the impact of taxes on economic growth, economist William McBride concluded:

“…that there are not a lot of dissenting opinions coming from peer-reviewed academic journals. More and more, the consensus among experts is that taxes on corporate and personal income are particularly harmful to economic growth, with consumption and property taxes less so. This is because economic growth ultimately comes from production, innovation, and risk-taking.”

Of the 26 papers reviewed by McBride, 23 — 88 percent — find a negative impact of higher tax rates on economic growth. The other three papers find no impact. Not one paper finds a positive impact. Of the six studies looking at state tax rates specifically, every one found a negative impact of high taxes on economic growth. 

More recent research corroborates this conclusion. Of 12 papers looking at the impact of taxes on economic growth published since 2012, seven find negative effects, the other five find “mixed” or “unclear” effects, and none finds a positive effect. Furthermore, research suggests that the negative effects on economic growth from increased taxes are more pronounced when, as in Minnesota’s case, taxes are already high.

All of these make Minnesota’s high tax burden a problem and suggest an explanation for a number of Minnesota’s recent economic ills. Among these are below average growth of per capita Gross Domestic Product (GDP), especially since 2014, GDP per worker and per hour, business formation, and job growth.

Cut Minnesota’s taxes

Minnesota’s taxes are high and empirical research tells us that we should expect this to slow economic growth. Actual data suggests that this is happening. Legislators should take the historic opportunity presented by this surplus and cut Minnesota’s taxes.