How Does the Introduction of Income Tax Affect State Fiscal Growth?

Family houses with dollar bills and central goverment tax over a US map.USA finance and economy concept related to the Tax Cuts and Jobs Act. approved by the Senate in December

In the United States, state individual income tax programs were introduced at different times. Wisconsin’s was first in 1911, while the Oregon legislature fought through the 1920s to successfully implement income tax in 1930. Ohio, Pennsylvania, Rhode Island, and New Jersey did not introduce individual income tax until the 1970s, and some states, including Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, levy no individual income tax on their citizens to this day.

Individual income tax is an important way for states to generate revenue and encourage a thriving market economy, but little research has been done on how the introduction of the tax affects a state’s bottom line. Culverhouse’s Dr. Traviss Cassidy, with collaborators Mark Dincecco (University of Michigan) and Ugo Antonio Troiano (UC Riverside), tackles these issues in “The Introduction of the Income Tax, Fiscal Capacity, and Migration: Evidence from U.S. States,” which was published this month in American Economic Journal: Economic Policy. The authors study how the introduction of the individual income tax impacted fiscal policy and migration in U.S. states between 1900 and 2010.

They found that though total per capita revenue gradually increased in states that introduced the tax, important differences existed between states that introduced the tax before World War II and states that introduced it afterwards. For instance, unlike the states that introduced it before WWII, the states that introduced the tax after WWII lost significant numbers of middle to high-earning households because they migrated out. That means that when income taxes are introduced, fiscal growth within the state can be slowed when taxpayers migrate to states with no or lower income taxes.

“An interesting implication of our results is that population mobility imposes a check on the growth of government, at least at the subnational level,” Cassidy said. “Even though the income tax allowed states to extract more revenue per resident, in the long run their total budgets did not increase relative to states that did not adopt the income tax.”

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