To grow Minnesota’s economy, we need tax cuts from state rather than federal government

Academic research finds large and significant expansionary effects of tax cuts in the aggregate (examples here, here, and here). But there is wide variation between the economies of American states. How are the aggregate effects of measures such as the Tax Cuts and Jobs Act felt regionally? In a new paper titled ‘State-level implications of federal tax policies‘, economists Chang Liu and Noah Williams investigate that question. 

Using more than 50 years worth of state level data, Liu and Williams find that

given a unanticipated negative federal personal or corporate income tax shock, the output or employment responses are significantly positive for less than half of the states, not significantly different from zero for over a half of the states, and that a few states respond to neither tax change significantly. There are more states showing significantly positive output or employment responses to a corporate than personal income tax cut, but the average responses to [personal income tax cuts] are higher. 

What might account for these different responses? Liu and Williams explore two possible explanations: differences between states in the state tax structure, measured by the average state personal income, corporate income and sales tax rates, and differences in the state economic structure, measured by the overall capital share of income.

They find little evidence that different tax structures account for these different responses, but do find “robust evidence that output responses to a 1 percentage point corporate tax cut are negatively correlated with the average state capital share of income”: in other words, less capital intensive states have larger responses to the tax cuts.

What does this mean for Minnesota? With a capital share of 0.35, we rank joint 20th out of the 50 states. This suggests that federal tax cuts will have less impact on our economy than those of, say, South Dakota, which ranks joint 2nd, and Iowa, and North Dakota, which rank joint 4th (our other neighbor, Wisconsin, ranks joint 32nd). If we are looking for tax policy which will give our economy a boost, we will need to look closer to home.

John Phelan is an economist at the Center of the American Experiment.