Missouri lawmakers, haggling over tax cuts in a special session this month, know they can buy popularity with some timely election-year largesse.
They need to be reminded, however, that the way they structure the cuts can help or hinder the state’s economy.
A growing body of research shows that changes in a state’s income tax rate matter a great deal to the entrepreneurs who start businesses, create jobs and create wealth.
Economists Enrico Moretti, of the University of California, and Daniel Wilson, of the San Francisco Federal Reserve Bank, found that star scientists are especially mobile — and especially sensitive to changes in the top tax rate. Joshua Rauh, of Stanford University, found that a 2012 California tax increase accelerated the out-migration of high earners from the state.
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Missouri’s top rate of 5.3% isn’t particularly high. California charges high earners 12.3%, New York 10.9% and Minnesota 9.85%. Gov. Mike Parson’s proposed cut to 4.8%, though, should help attract and retain the innovators who are creating jobs in fields like agricultural science, health care and geospatial technology.
“You have St. Louis building up a better ecosystem for innovation and entrepreneurship,” said Aaron Hedlund, an associate professor at Purdue University and chief economist at the Show Me Institute. “This would be like jet fuel added to that.”
By contrast, a competing proposal to send Missourians $325 rebate checks would do nothing to change future entrepreneurs’ incentive to invest, build or hire in the state. Parson vetoed a rebate plan this spring, but some legislators are trying to revive it in the special session.
Anything that puts money in taxpayers’ pockets is valuable, Hedlund said, “but if we’re talking about what we really need to do, which is to increase growth in the state, the more you can reduce marginal rates the better.”
The Show-Me Institute, whose billionaire founder Rex Sinquefield has been a longtime advocate for eliminating Missouri’s income tax, isn’t the only think tank that thinks a lower marginal rate is feasible.
The Missouri Budget Project, a non-partisan organization that tracks state spending, crafted a tax-cut plan with the same 4.8% top rate as Parson’s, but with a lower overall cost, $586 million instead of $700 million. Its proposal also beefs up some credits for low-income people who wouldn’t benefit from Parson’s plan.
The savings would come from eliminating a loophole that allows certain taxpayers, who organize their businesses as partnerships or limited liability companies, to avoid taxes on 20% of so-called pass-through income.
Traci Gleason, the Missouri Budget Project’s vice president for external affairs, said the loophole “encourages companies to game the system, and there’s not a good rationale for it.” Missouri passed the tax break in 2014, copying an even more generous Kansas law that later caused severe budget problems in that state.
The ideal tax system is one that funds public services with the broadest possible base and the lowest possible rate. Down the road, Missouri should look for other ways to trim its thicket of special-interest deductions and credits, perhaps with an eye toward trimming the tax rate even further.
For now, a cut to 4.8% would be a good start. Politicians may like the message that rebate checks deliver to constituents’ mailboxes, but economists prefer the message that a lower tax rate sends to innovators deciding where they want to live, work and invest.
In today’s work-from-anywhere world, the competition to attract entrepreneurs and knowledge workers will only intensify. Missouri shouldn’t miss this chance to send a positive message.