Do State Marginal Tax Rates Lower State Labor Productivity?

Joseph E. McPhail, Peter Orazem, Rajesh Singh and Rick Stammer

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: There are substantial differences in output per job across states that have persisted over time. This study demonstrates that in the context of a neoclassical growth model, differences in marginal tax rates on income from capital investment, capital ownership, and consumption will lead to persistent differences in labor productivity across states. Conversely, taxes on wages will not alter labor productivity. These theoretical predictions are supported by data on state marginal tax rates and output per job over the 1981- 2015 sample period. Over that period, the mix of state marginal tax rates lower labor productivity by an average of 15% per year and lower per capita income and wages per job by just under 10% per year. The implied loss of labor productivity differs substantially between states from -3% in Wyoming to -22% in California. Because states infrequently change their tax structures, the productivity differences across states associated with distortionary tax policies persist over time.

Date: 2018-04-12
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