CP generates sufficient revenue without hurting growth

Policymakers in several states are reviewing options to strengthen support for public investments crucial to state economies and residents’ well-being, such as quality early education, affordable college, and modern infrastructure. One way to raise the necessary funds is to raise personal income tax rates on the highest incomes, a policy choice sometimes referred to as a “millionaires’ tax.” This approach makes sense: evidence indicates it can generate substantial revenue for public investments that boost a state’s productivity in the long run, without harming economic growth in the short term.

High-income tax increases can generate substantial revenues for investments in people and communities that provide economic and social benefits over the long term. Raising personal income tax rates has allowed states to prevent or minimize harmful budget cuts or invest in ambitious new initiatives such as expanding early education, boosting access to college, improving infrastructure, and strengthening “rainy day” funds to prepare for the next recession. Evidence indicates that sustained support for public building blocks of growth can help states improve their residents’ well-being, expand opportunity and racial equity, and build more prosperous economies over time.

Real-world experience suggests that raising top income tax rates is unlikely to harm state economies in the short run, contrary to some claims. In six of eight states (including the District of Columbia) that enacted millionaires’ taxes since 2000, private-sector economic growth met or exceeded that of neighboring states since enacting the tax increases.[1] Seven of the eight states had per capita growth in personal incomes at least as strong as nearby states, and five of the eight added jobs at least as quickly as their neighbors. Only one state that raised its state income tax rates, Connecticut, has seen markedly weaker growth than its neighbors, likely for reasons other than state tax levels.

The bulk of mainstream academic research finds that interstate differences in taxes, including differences in top personal income tax rates, have minimal effects on state economic growth. Fifteen of the 20 major studies published in academic journals since 2000 that examined the broad economic effect of state personal income tax levels found no significant effects and one of the others produced internally inconsistent results.[2] As a pair of university researchers described in a comprehensive literature review in 2018, “The vast majority of the academic studies that examined the relationship between state and local taxes and economic growth found little or no effect.”[3]

Millionaires’ Taxes Increasingly Common

The personal income tax is a major source of revenue for 41 states. Although some states apply a flat rate to all taxable income, most states with a personal income tax maintain a graduated structure that applies increasing rates to increasing levels of income. Prior to the 2000s, however, special brackets or rates targeted specifically to the highest incomes were relatively uncommon. California levied a temporary 11 percent rate on incomes above about $200,000 from 1991 to 1996,[4] and in 1992 Ohio created a new bracket on incomes above that same level.[5] But as of 2000, only five states had top rates kicking in above $100,000.[6]

In the early 2000s, policymakers began looking at targeted rate increases for affluent households to help close stubborn budget shortfalls stemming from the 2001 recession, as well as to respond to the increasingly skewed concentration of wealth and income at the top. The top 1 percent of households accounted for 21.5 percent of income in 2017, compared to only 9 percent in 1970.[7] (See Figure 1.)

In 2003, New York launched the trend by enacting a three-year surcharge on incomes above $500,000; California and New Jersey followed suit with millionaires’ taxes in 2004.[8] Overall, 12 states (including the District of Columbia) have enacted rate increases targeted to affluent taxpayers since 2000. Nine of them — California, Connecticut, District of Columbia, Hawaii, Maryland, Minnesota, New Jersey, New York, and Oregon — either still have some form of the policy today or maintained it over a span of several years. The other three (Maine, North Carolina, and Wisconsin) either repealed the policy before implementing it, kept the higher rates for only a short span, or undermined them through later income tax cuts. [9]

In some cases, a so-called “millionaire’s tax” only applies to people with annual incomes of at least $1 million. But the term can also refer to a range of personal income tax increases on the highest incomes, generally starting at about $100,000 or more. For example, California levies top personal income tax rates of 10.3, 11.3, and 12.3 percent on annual individual incomes over $250,000, $300,000, and $500,000, respectively, as well as an additional 1 percent surtax on incomes over $1 million, for a top rate of 13.3 percent on the state’s wealthiest residents. People subject to these top rates still pay the same rates as other state residents on their income below these thresholds, since graduated income tax systems apply different marginal rates to different increments of income, rather than taxing all income at the same rate.[10]

In most cases, states created a new bracket or set of brackets above a higher threshold of income, rather than raise existing tax rates. Minnesota, for example, created a new 9.85 percent bracket for top earners, 2 percentage points above its prior top rate, which applied to incomes over about $250,000 for married couples and $150,000 for single filers (adjusted annually for inflation). Hawaii created three new brackets with rates of 9, 10, and 11 percent — a policy that expired in 2015 but was reauthorized in 2018.[11]

Even modest rate increases on high incomes can generate significant revenue from a relatively small number of taxpayers — namely, the narrow sliver of households at the top of the income distribution, who are most able to afford the cost. In California, just 0.3 percent of taxpayers reported more than $1 million in income when the state’s 2005 millionaires’ tax took effect, yet they accounted for more than 21 percent of all income in the state.[12] When Oregon approved an increase on high-income earners in 2009, the state’s legislative office projected that it would raise nearly $472 million over two years from 2.5 percent of tax filers.[13] And in Maine, a 3 percent surcharge on household incomes above $200,000 that voters approved in 2016 but the legislature repealed and was never implemented would have raised over $320 million a year from fewer than 1 in 40 state taxpayers, according to one estimate.[14]

This report focuses on the eight states that substantially raised top income tax rates since 2000 and have characteristics allowing for reasonable comparisons to other states: California, Connecticut, the District of Columbia, Maryland, Minnesota, New Jersey, New York, and Oregon. It excludes Hawaii, as is done in some academic studies, since its unique geography complicates comparisons to other states.[15]

Track Record of Tax-Raising States Rebuts Dire Predictions

Proposals to raise state income tax rates often spark contentious debate, with anti-tax activists and commentators predicting widespread economic harm. Yet the actual experience of the eight states that have adopted this approach over the past decade belies such claims.

Available data on common measures of economic health, like job creation and per-person income growth, reveal that these tax-raising states have performed comparably to other states in their region after raising taxes. Some states have exceeded their peers across multiple measures, while others have done so only on some measures. Only Connecticut has consistently underperformed relative to its neighbors, likely for reasons unrelated to the state’s income tax levels (see box, “Connecticut’s Economic Struggles Likely Reflect Non-Tax Factors”).

Six of the eight states enacting millionaires’ taxes since 2000 had economic growth about as good or better than neighboring states while the tax cuts were in effect. (See Figure 2.) In four of the eight states (California, the District of Columbia, Maryland, and New York), growth in private-sector gross domestic product (GDP) exceeded other states in the region. Two other states (Minnesota and Oregon) had about the same growth as their neighbors, while in Connecticut and New Jersey, economic growth fell below that of nearby states.

Seven of the eight states had per capita income growth as least as good as their neighbors after enacting a millionaires’ tax. California, Minnesota, and New York exceeded their neighbors’ average by at least 5 percentage points, while the District of Columbia, Maryland, New Jersey, and Oregon met or slightly surpassed it. Connecticut fell behind on this measure, as it did on private-sector GDP growth. (See Figure 3.)

Five of the eight states added jobs at least as quickly as their neighbors. New York added jobs at a significantly higher rate than its neighbors; Minnesota slightly exceeded its neighbors; and the District of Columbia, Maryland, and Oregon kept pace with their neighbors. California, despite strong growth in its overall economy, fell slightly below the regional average on jobs due to above-average employment growth in neighboring states such as Arizona and Nevada, though it exceeded the U.S. average.[16] Connecticut and New Jersey trailed behind on job creation after raising tax rates. (See Figure 4.)

These trends closely resemble these states’ relative economic performance before they raised income tax rates at the top. Six of the eight states had job growth about as good or better than their neighbors in the three years preceding their income tax hike, for example. In the three years before raising taxes in May 2013, for example, Minnesota added jobs at a rate of 4.9 percent, compared to a 5.1 percent average in neighboring states. Since that time, its rate of job growth equals 8.1 percent, versus 6.9 percent in adjacent states. Similar trends play out across the other states and on other economic measures as well.

Research Confirms State Personal Income Taxes Don’t Harm Growth

Examining how a state’s tax policies affect its relative economic performance can be difficult, since large-scale trends like job creation and personal income growth depend on many interrelated factors, ranging from local workforce and economic development policies to global forces like trade. Most mainstream academic experts have found that state tax rates may play some role at the margins but likely have little to no impact on states’ overall economic performance. Thus, modest changes to personal income tax rates would be highly unlikely to alter core economic trends.

Empirical studies conducted by economists over the last 40 years find no consensus that lowering state taxes is a good strategy to boost state economic growth and create jobs, or, conversely, that raising taxes dampens economic growth.[17] Studies focusing on narrower issues, such as the impact of state tax levels on entrepreneurship, also find little to no impact. For instance, a rigorous 2012 study commissioned by the U.S. Small Business Administration found “no evidence of an economically significant effect of state tax portfolios on entrepreneurial activity.”[18]

The same is true of research on personal income taxes. Of the 20 major studies published in academic journals since 2000 that examined the effect of state personal income tax levels on broad measures of state economic growth, 15 found little to no significant effect, and one of the others produced internally inconsistent results.[19] (See Appendix II.)

Another recent analysis comes to similar conclusions. A comprehensive literature review by two Oklahoma State University tax experts in 2018 looked at 36 studies, including ten published since 2014. [20] Regarding state tax policies overall, they concluded:

The overall state and local tax burden is not a major driver of economic growth differences across states. The vast majority of the academic studies that examined the relationship between state and local taxes and economic growth found little or no effect. Where [statistically] significant effects were found, they generally were modest at most.

As for state personal income tax taxes in particular, the researchers found evidence suggesting that “states recently reducing their personal income taxes more likely harmed economic growth and states increasing their personal income taxes more likely spurred their economic growth.”

Millionaires’ Taxes Enabling States to Make Crucial Investments

Targeted income tax increases on high-income households can generate substantial revenues, allowing lawmakers to minimize harmful cuts when budgets are tight as well as to undertake ambitious initiatives such as expanding early education, boosting college access, improving infrastructure, and strengthening “rainy day” funds to prepare for the next recession. For example:

Minnesota created a new income tax bracket in 2013 for the state’s richest households, along with other changes such as revisions to the state’s tobacco and corporate taxes. The new revenue-raisers prevented more than $600 million in cuts over two years to services such as schools, natural resource protection, and assistance programs for children and seniors,[21] and allowed lawmakers to invest more in residents and communities.[22] In the years following, revenues from the higher taxes and a rising economy enabled the state to make a number of promising investments in education in particular, including making free full-day kindergarten possible in all public school districts,[23] helping more low-income children afford preschool,[24] bolstering financial aid for low- and middle-income college students, and helping stabilize tuition after years of higher education cuts.[25] The state also boosted spending for economic development, affordable housing, and support for local communities.

California lawmakers have enacted two millionaires’ taxes since 2000. The first, passed in 2004 and still in effect, levies an additional 1 percent on incomes above $1 million to help local communities fund mental health services such as prevention and early treatment. A rigorous study found that the tax, which raises about $2 billion a year, has helped local governments improve mental health outcomes, minimize unnecessary hospitalizations, and reduce homelessness and incarceration.[26]

In 2012, California voters approved Proposition 30, which added new rates of 10.3, 11.3, and 12.3 percent on varying levels of income starting at $250,000, bringing the state’s top rate to 13.3 percent on incomes above $1 million. The state used the resulting revenues to increase investments in K-12 and college access and to rebuild the state’s “rainy day” fund (see box).

Other states have used targeted personal income tax increases to close stubborn budget shortfalls and stave off harmful budget cuts, especially in the wake of falling state revenues after the Great Recession.

In Oregon, lawmakers in 2009 approved two new top rates of 10.8 percent and 11 percent on households above $250,000 and $500,000 in income, respectively; the new rates were merged into a single 9.9 percent top bracket in 2012.[27] The policy responded to a pending $4 billion shortfall caused by prior state tax policy choices and declining revenues. The tax increase, which raised an estimated $349 million over the first two years,[28] was part of a balanced approach to the state’s budget that combined new revenues with federal stimulus funds to reduce the harm to core state services.[29]

Several other states raised personal income tax rates on high earners in the wake of the Great Recession to minimize harmful budget cuts caused by falling revenues.[30] The District of Columbia, for instance, added a top rate of 8.95 percent on income over $350,000 in 2011, after personal income tax revenues had fallen by nearly 20 percent over the prior two years.[31]New York in 2009 enacted a millionaires’ tax estimated at the time to raise $4 billion a year, after projected revenues for the coming fiscal year came in $3.2 billion below original expectations.[32] And in 2012, Maryland approved a package of rate increases on six-figure earners designed to prevent more than $400 million in cuts to schools, police, and other services.[33]

New Revenues for Public Investments Can Help State Economies Long-Term

Expert research and evidence from other states indicate that sustained support for the kinds of public investments made possible by personal income tax increases can help states improve their residents’ well-being and expand opportunity, especially for people of color and other marginalized communities. That, in turn, can help bolster states’ overall economies over time.[34]

FIGURE 6

School Funding Increased Lead to Big Gains for Poor Kids

High-quality education. Well-funded public schools help children get a good start in life, especially when funding targets investments shown to produce better outcomes, such as early learning programs, smaller classes, and higher teacher quality.[35] One extensive nationwide study examined the relationship between school funding and student outcomes from the early 1970’s to 2011. It found that low-income children whose school districts received a 10 percent increase in per-pupil spending before they began their 12 years of public school had 10 percent higher earnings — and 17 percent higher family income — in adulthood, were likelier to complete high school, and were less likely as adults to be poor.[36] (See Figure 6.)

Long-term economic benefits also flow from investments beyond the K-12 system, especially early education and affordable access to college. High-quality preschool improves not only children’s academic performance but also recipients’ earnings in adulthood, one landmark study found. The analysis estimated that workers’ increased earnings alone outweigh the cost of preschool by more than five times.[37]

FIGURE 7

Higher Earned Income Tax Credit or Other Income for Poor Children Expected to Boost Work and Earnings Later in Life

Affordable access to higher education is important as well, but many states have underfunded their public colleges, universities, and financial aid in recent years.[38] When students from low- and high-income families attend the same college, they earn similar salaries post-college; this helps level the playing field for students of different backgrounds, providing an added economic boost down the road.[39] These are among the many reasons why states with a better-educated workforce tend to have higher wages and better productivity in the long run, as one study demonstrated.[40]

Stronger family finances. State economies also thrive when families have enough income to afford the basics, invest in their own well-being, and have enough left over to support local shops, restaurants, and financial institutions. For example, a growing body of research finds that young children in low-income families that get an income boost from policies such as the Earned Income Tax Credit (EITC) tend to do better and go further in school because the additional resources help parents better meet their needs.

And because children in low-income families that receive income boosts attain more skills and education, they tend to work more and earn more as adults. Each $3,000 a year in added income that children in a poor family receive before age 6 leads to an estimated 135 more working hours a year between ages 25 and 37, plus a 17 percent increase in annual earnings, research has found.[41] (See Figure 7.) This helps communities and the economy because it means more people and families are on solid ground and fewer need help over the long haul.

Better infrastructure and amenities. States that generate new revenues for targeted investments in key infrastructure systems can create jobs now and improve economic growth and job quality in the long run.[42] Businesses need well-maintained roads, rails, and ports to get products to market, and local communities need well-functioning water, sewer, and traffic systems to maintain health and preserve a high quality of life. Expanding and improving a state’s broadband internet infrastructure can especially help smaller towns and rural areas, where unreliable access to high-speed internet poses a steep obstacle to residents looking to start a business or obtain an online credential. [43]

State investment in other public amenities such as greenspace, libraries, and cultural institutions can give communities a competitive edge, too. Both entrepreneurs[44] and well-educated professionals[45] are often drawn to communities with attractive amenities and pleasant neighborhoods, according to research. And larger companies looking to relocate or expand increasingly take the quality and attractiveness of local services and amenities into account. As Amazon noted in its 2017 search for a second headquarters, “We want to invest in a community where our employees will enjoy living, recreational opportunities, educational opportunities, and an overall high quality of life.”[46]

Improved planning and review. States can maximize the value of new tax revenues by making sure they’re spending existing dollars efficiently. For example, a growing number of states are saving money and improving residents’ well-being by reforming outdated criminal justice systems and dramatically reducing overincarceration. High rates of adult incarceration are costly to families, communities, and state budgets, particularly communities of color overly targeted by harsh incarceration policies.[47]

States also can improve their planning practices, such as by strengthening state “rainy day” funds. In hard times, these funds help protect state investments that promote economic growth and provide taxpayers with vital services.

Millionaires’ Taxes Can Help States Advance Racial Equity

Targeted income tax hikes for high-income residents can allow state lawmakers to pursue another crucial goal beyond raising revenue and curbing runaway economic inequality: redressing historic and current racial inequities and building a more inclusive economy.

Although policymakers typically think of tax policy as neutral with respect to race, most state tax structures worsen racial and ethnic inequities because they fall harder on lower-income households, which are disproportionately households of color.[48] Black and Latinx households comprise 22 percent of total U.S. population, for example, yet account for nearly 30 percent of the nation’s poorest households.[49] And in 45 of 50 states, lower-income households pay a larger share of their income in state and local taxes than high-income households.[50] The poorest fifth of U.S. households pay an estimated 11.4 percent of their income in state and local taxes, on average, whereas the top 1 percent of households pay just 7.4 percent.[51]

Millionaires’ taxes can be a sound strategy for making state tax systems more equitable, for two reasons. First, they fall exclusively on taxpayers at the very top, who are disproportionately white. White families are about three times more likely than Black and Latinx families to be among the nation’s top 1 percent of earners, according to one estimate.[52] Racial gaps in wealth are also stark: white families comprise 65 percent of U.S. households but own an estimated 87 percent of the nation’s wealth, whereas people of color make up 35 percent of all households but own just 13 percent of the wealth.[53] (See Figure 8.)

FIGURE 8

Wealthiest 10 Percent of White Households Own Two-Thirds of U.S. Wealth

Second, targeted income tax increases provide resources that lawmakers can use to improve schools in low-income communities of color, invest in safer water systems and other public infrastructure that supports these communities, expand access to affordable health care, and make other crucial investments that reduce racial and ethnic inequities and help build an economy whose benefits are more widely shared. One example is Minnesota, which in 2013 adopted a new income tax rate on very high incomes and used the revenue in part to help more low-income children attend high-quality preschool programs, providing an outsized benefit to young people of color.[54]

Conclusion

Raising income tax rates on high-income residents can enable states to boost investment in education, infrastructure, and other vital services that strengthen local communities and aid long-term economic growth. Similar policies enacted in the past decade haven’t harmed states’ ability to add jobs or compete with neighboring states, evidence shows. Mainstream experts largely agree: modest shifts in state income tax rates, including rate hikes on high-income residents, are unlikely to affect short-term growth. And the additional revenues may provide economic benefits down the road if they go toward proven, targeted investments like high-quality education and tax credits for working families, which bolster opportunity and help people maximize their economic contributions over time.