White House looks at eliminating state income taxes

The White House Council of Economic Advisers released a research study analyzing the economic impact of state income tax elimination.

The study, released Wednesday, compares states without income taxes, such as Florida, Tennessee and Texas against high-tax states such as California, New Jersey and New York. It noted that five of the nine states that currently have no personal income tax rank among the top 10 states in terms of GDP growth over the past decade and four rank among the top 10 states in terms of net migration rates from other states, according to U.S. News & World Report. On the other hand, some of the high-tax states appear to be suffering from a population exodus to the low-tax or no-tax states.

The study posits two different scenarios for state tax reform, one in which the state pursues full revenue replacement by broadening the sales tax, while leaving the baseline forecasted growth of total tax revenue unchanged. In the second scenario, the tax reform combines a broader sales tax base with a limit on spending growth that maintains government services at the current levels instead of allowing their continued expansion.

The study finds state income taxes to be more economically damaging than sales or property taxes. The harmful economic effects include outmigration, "brain drain," stifled innovation and entrepreneurship, and reduced GDP. The harmful fiscal effects include revenue volatility with "feast and famine" cycles, with "states often gaining little or no new tax revenue from income tax hikes because of the negative economic effects they unleash."

On the other hand, the study sees several benefits in state income tax phase-outs, including:

• A 1% to 1.6% increase in the level of GDP for the average state;
• A 16% to 19% increase in new startups for the average state;
• A $4,000 increase in the average wage;
• A significant influx of new high-income taxpayers;
• An average state sales tax rate of under 8% under full revenue replacement with no limits on spending growth; and
• An average state sales tax rate of 6.2% under a scenario with spending growth limits.

The study does not seem to examine the regressive impact of sales taxes versus income taxes on the poor, nor is there any mention of tariffs, which are a kind of national sales tax and have been a policy priority of President Trump's administration.

Tax research groups disputed the Council of Economic Advisers report. "The right-leaning Tax Foundation, which is cited repeatedly in the report, was quick to issue a rebuttal pointing out that the math underpinning these estimated tax rates is deeply flawed," wrote Carl Davis, research director at the Institute on Taxation and Economic Policy, in a blog post. "Of particular note, the CEA assumes that states would begin illegally taxing a wide range of purchases they are prohibited from taxing under federal law, such as airfare and internet access, as well as transactions that are not feasibly taxable such as free services provided by nonprofits. If the CEA had accounted for the fact that states cannot tax these purchases, then it would have realized that a far higher sales tax rate would be needed to replace state income tax collections."